Oil and Gas

Yesterday, I bought some more Canadian Income Funds, also called Royalty Trusts or Canroys. As I mentioned before, I recently refinanced a property and I managed to pull some money out (totally tax-free!).

Rather than spend the money on an SUV or a big-screen TV, I opted to divide the money into 3 parts. The first 1/3rd went towards replenishing my emergency fund which was drawn down by vacancies in my rental properties. The second 1/3rd went towards future investments in summer just in case there’s a pullback in the stock market and the last 1/3rd went to building up my passive cash-flow.


Long time readers will realize that I haven’t made any effort display my net worth or any goals of net worth.
That’s because I feel its a meaningless number. If I had a $1 million dollar net worth and it only generated $25,000 a year in income (like Cd’s did a few years ago) that’s pretty sad. On the other hand, if I owned a $1,000,000 car-wash that generated $125,000 that’s pretty significant.

My goal is to generate passive income. Its your passive income that provides financial independence, not your net worth. If you have $3,000/month through various passive income streams, you’ve got your basic food and shelter taken care of and you won’t starve if you lose your job. That is my short term goal. My longer term goal is generate $10,000/month in passive income so I can travel the world without worrying (or working).

I’m currently not even at 50% of my $3,000/month goal so at least 1/3rd of all future investments must take me towards that goal. That’s why I bought some Canroys yesterday. I bought Harvest Energy (HTE) and Canetic Resources(CNE). They generate revenue from oil and gas production and refining. The noteworthy part is that they payout around 12% dividend per year. Since the selling of oil and gas leads to a depletion of reserves, its important that they keep some of their revenue for future acquisition of new properties and for drilling new wells. Both of them have a payout ratio of under 80% which isn’t bad considering they have proven and probable reserve lifespans of 9.5 years.

There are Canroys with lifespans of 6-7 years and payout ratios of 95% that yield 15% but I’m suspicious of their longterm viability. These two seem like pretty safe bets. If oil prices rise there’s a chance of increased payout and also capital appreciation. If not, I’m still getting my 12% yield.

The only issue I have is that the Canadian Government takes its 15% tax straight out of my account. But even considering for that, my yield is still just over 10%. Besides, I get a US tax credit for that amount, so its not a total loss.

I also bought some units in Prism Income Fund(QSR.UN) which owns and operates nearly 500 fast-food franchises in Canada (Taco Bell, KFC, Long John Silver and Pizza Hut). Their stock has been pretty stable compared to other Canroys following the whole Taxation issue. Its also currently yielding 12% and while I don’t expect much capital appreciation, I don’t expect it to drop in value or its dividend to fluctuate with the price of oil and gas.

So now I’m one step closer to my goal of $3,000 in passive income. This brings my total passive income from Canroys to $300 per month. I’m also getting $300 from a loan to a developer at 2% per month. And I average around $300/month from my various online ventures. (Even though my online ventures aren’t passive, I enjoy pursuing them and I have geographic independence. Thats why I’m counting it).I’m also making around $150/month from my direct oil and gas drilling investments, so I’m almost 1/3rd of the way to my goal!

When I get the money back from the developer, it’ll be redeployed at a much lower rate. But I expect the cash flow from the direct oil drilling program to increase enough to cover this short-fall.

According to an article in the Wall Street Journal, the rush to produce ethanol has resulted in sharply higher prices for corn. Corn is used to feed cattle and pigs and as a result of the price increase, farmers are feeding their pigs trail mix, candy and Top Ramen noodles!

Besides trail mix, pigs and cattle are downing cookies, licorice, cheese curls, candy bars, french fries, frosted wheat cereal and peanut-butter cups. Some farmers mix chocolate powder with cereal and feed it to baby pigs. “It’s kind of like getting Cocoa Puffs,” says David Funderburke, a livestock nutritionist at Cape Fear Consulting in Warsaw, N.C., who helps Mr. Smith and other farmers formulate healthy diets for livestock.

California farmers are feeding farm animals grape-skins from vineyards and lemon-pulp from citrus groves. Cattle ranchers in spud-rich Idaho are buying truckloads of uncooked french fries, Tater Tots and hash browns.

In Pennsylvania, farmers are turning to candy bars and snack foods because of the many food manufacturers nearby. Hershey Co. sells farmers waste cocoa and the trimmings from wafers that go into its Kit Kat bars. At Nissin Foods, maker of Top Ramen and Cup Noodles, farmers drive to a Lancaster, Pa., factory and load up on scraps of the squiggly dried noodles, which pile up in bins beneath the assembly line. Hiroshi Kika, a senior manager at the company, says the farm business is “very minor” but helps the company’s effort to “do anything to recycle.”

Mr. Smith says he’s paying about $63 to feed a single pig for five or six months before it goes to market — up 13% from last year. His costs would be even higher if he didn’t augment his feed with trail mix, which he says helps him save on average about $8 a ton on feed. This year, Mr. Smith has bought enough trail mix to feed about 5,000 hogs, and that will save him about $40,000.

Its only a matter of time before corn prices become too expensive for human consumption in the US. Already its too expensive for people in Mexico and being a major ingredient in their diet, thats having an inflationary effect on their lifestyle.

Rather than using corn-based ethanol, I wish the government would look into using vegetable oil instead. There are several kits available for diesel cars that allow the owners to switch to “used” vegetable oil whenever its available. In Southern California, there are companies like Socal Greasers that will fit your diesel car with a converter kit for a reasonable price.

So next time you stop by a fast-food place for a meal you can ask the manager for some of their used cooking oil. They have to pay to dispose of it and are usually happy to give it to you for free. It burns much cleaner than gasoline and your exhaust has a nice french-fry smell too!

I read an email today that mentioned China (who is already the planet’s largest coal consumer) claims it will need an extra 80 million tons by next January. India is also estimated to need an extra 120 million tons, and most other Asian countries are expected to increase demand by 7%.

According to Kevin Kerr, “Coal prices are going much higher than I thought. Keep an eye on those diesel prices too, they are already creeping up. These two markets are going to surge this summer, absolutely.”

Since I like to take advantage of investment opportunities whenever I come across them, I placed an order to sell PUT option contracts on James River Coal Company (JRCC). Its essentially a long position on the companies stock, which has nicely trended up 50% in the past several months.

If the order is executed tomorrow (the order was placed after hours) I get a net credit of $195/contract. By september, if the stock trades above $8.05, I’ll have made a profit. My maximum profit is $195/contract and it occurs at stock prices over $10.00. If the stock drops below $8.05 I will either have to buy it or sell my option before expiration date at a loss. But I’m bullish on the stock so the loss would be smaller than actually buying the stock outright.

If the stock stays at the same $9.50 price, I’ll still make $145/contract at expiry. Both my upside and my downside are limited, but I think there’s a great chance I’ll make more money selling the puts with a lower risk than by buying the stock outright. Plus for each contract instead of putting up nearly $1000, I’m collecting $195 instead. It does use up my margin limits, but it does mean I don’t need to pay interest on the amount, since I’m not borrowing any money.

Of course you manage the risk here by not betting the farm. If the stock moves against me and my option moves against me 50% (ie, I’m down $100/contract) I’ll close out my position. Since this total draw-down is only 0.33% of my portforlio, it doesn’t give me ulcers. And while the total profit is only 0.66% of my total portfolio and isn’t exactly an earth-shattering return, its a 2-1 risk-reward scenario that I’m comfortable with.

If the stock goes BK overnight and I lose the max $805 per contract, it still only 2.66% of my portfolio, which is a bearable loss. Remember, risk management will determine whether you succeed or fail in the long term.

I came across this article last night, 32 Reasons Why The Stock Market Will Jump This Year.

While its written as a serious prediction, I personally feel its more like a christmas wish list or a list of finalist answers at the Miss World Beauty Pagent!. Here are some of the gems

#1. Housing and Auto-manufacturing weakness will subside
Based on what? Major layoffs in both industries?

#5. Unemployment with stay at record lows.
Hmm…with the massive layoffs in Housing and Auto-manufacturing, you really think so?

#7. Inflation will continue to decelerate, with CPI averaging around 2.0%.
Hmm…ever since the minimum wage was jacked up, small business around where I live jacked up the price of everything along with it. That doesn’t sound like low inflation to me. Anyone who thinks that CPI is an accurate measure of inflation makes way too much money to begin with. Once you take out all the factors that cause inflation, of course you’ll be left with 2%. What a doofus.

#11. The US Dollar will firmer up and even maybe become stronger
With almost all the worlds major currencies strengthening against the USD how is this going to happen? Oh yeah, Bank of Japan is enforcing a weak Yen policy. And of course the USD will strengthen against the Iraqi Dinar! And with China owning a Trillion USD do you think a strong Dollar is actually in our interest????

#12. The U.S. budget deficit, which is currently 1.5% of GDP, well below the 40-year average of 2.3% of GDP, will continue to trend lower as healthy economic activity continues to boost tax receipts substantially more than estimates.
Uh…isn’t the US GDP is currently mainly comprised of government spending? Thats not really a show of healthy economic activity. Although it is true that the tax receipts are up more than estimated.

#15. The mania for commodities will completely end.
Yeah Right!!! All those millions of people in India and China who can now afford to buy a car and a decent place to live will choose to buy plastic go-karts and tents instead of regular cars and houses that use steel & copper. Is he completely blind to the global industrialization thats taking place? Every year China adds to its electricity generating capacity by the same amount as the entire UK. This electricity comes from coal and is used to make more cars and power more houses. The dude’s smoking crack now.

#16. Oil falls to $35 to $40 per barrel and eventually $20-$25.
#19. Gas prices will drop below $4/mcf.
#20. Gold will drop below $550 per ounce
This was written on the 1st of Feb 2007 when Oil was around $50/barrel. Its since gone up to nearly $60 and is probably on its way up. Corn has quadrupled to over $4/bushel making ethanol almost as expensive as gasoline now. Similarly Gold is also up to $665. I actually bought some GLD (the gold ETF) 2 days ago and I’m already up 7%. I predict its going to $800 in 2 years.

#17. Peace in the Middle East.
HAHAHA.

Some of the points are actually valid, but the ones I’ve mentioned are pretty stupid. Like I’ve said before, I’ve taken exactly opposite bets in my stock investing, so of course my views are out of line with the authors.

What do you think?

A few weeks ago, I cursed the Canadian Finance Minister for causing my CanRoys to drop significantly overnight. I may have been premature in cursing him.

I originally bought them for the dividends that they were paying out, mostly in the 8-12% range, with the occasional one paying out 13-14%. However, the severe drop in prices caused their yields to jump proportionately to 12-17%. One of the companies I bought became a 19% yield! Even if Flaherty’s taxation of dividends became true, it would still be 4 years away and by then you would’ve gotten nearly 80% of your money back. Last week money started flowing back in Canroys. I picked up a little more on margin. The one I picked up, AAV currently gives a 17% yield. So even if I have to pay 9-10% margin interest I’m still ahead by 7%. Plus if Oil & Gas prices continue to rise which I think they will I’ll see some capital appreciation.

There are a few Master Lease Partnerships in the US that are like Mutual Funds of Energy Stocks. They only pay 6% dividends however the divis are considered return of principle and thus are not taxed!!! Pretty sweet deal if you ask me.

I got my first oil revenue check today! It was for a whopping $35.12!!!! At this rate it’ll take 30 years to get my money back! Its for a project where they’re drilling 10 wells in the Gulf of Mexico.

To be fair the operators had told me not to expect anything until December 2007, so atleast they’re doing something.

I also got an email from them saying that as a christmas present they’ll be sending me a copy of The Millionaire Maker. Its a good book but I don’t recommend the mentoring course.

We finally resolved the insurance issue on our Natural Gas pipeline deal in Texas. Now thats resolved we can finally turn it on and start making some money! Of course it’ll probably be about 4 months before we see any money, but the insurance issue cost us atleast 3 months worth of delays.

The Canadian Royalty Trusts [or Canroy’s for short] sold off big today.[For a great post on Canroys, check out this post on Wealth Building Lessons.] People just dumped them. I lightened my load a little bit too. I sold about 15% of my Canroys and bought gold stocks instead.

I think a lot of it is an over-reaction. Even if the government does raise the taxes 40% some of them are yielding over 15% at these low levels. In the energy sector, between 40-60% of the dividend is termed as return of capital so its tax exempt.

So a 15% yield now becomes a 12.4% yield. Thats not so bad is it? What do you guys think?

Besides, on existing canroys theres a 4 year grace period. Maybe the next Canuck Finance Minister might reverse the decision.

But even then, just to make sure I’m not mistaken for a socialist, The POX on you Mr Flaherty!!!

And just a reminder, the competition at The Weekend Investor ends soon. Register and post for a chance to win a $50 Amazon gift certificate.

I’d recently put a bit of money into Canadian Royalty Trusts – the Canadian equivalent of REITs here in the US. Now, thanks to the socialist Finance Minister I’m down 10% today!

Toronto stock market tumbles after Ottawa moves to tax income trusts
Wed Nov 1, 12:34 PM

TORONTO (CP) – Finance Minister Jim Flaherty created havoc Wednesday on Bay Street and Main Street as income trust investors suffered massive losses following his Halloween surprise announcement that trusts will be taxed.

The Toronto stock market’s main composite index tumbled more than 300 points in early trading, and late in the morning was off 223.23 at 12,123.36, a decline of 1.8 per cent.

The loss was much steeper for trusts, with the S&P/TSX income trust index down 10 1/2 per cent.

“I’m put out, not to put too fine a point on it,” declared Brendan Caldwell, president of brokerage firm Caldwell Securities Ltd.

“I tell you, I’ve got seniors that have income trusts that are down $25,000 or $30,000 today. . . . They’re getting hit in a big way.”

Among major names, the Yellow Pages trust (TSX:YLO) faded 17 per cent, the CI Financial fund (TSX:CIX.UN) plunged 16 per cent and the Aeroplan fund (TSX:AER.UN) descended 12 1/2 per cent.

There also were big losses for Telus (TSX:T) and BCE Inc. (TSX:BCE), whose plans to convert into trusts – and the prospect that other major corporations would do the same – provoked Flaherty’s move. Telus was down 14 per cent and BCE lost 12 per cent.

The proposed rules would tax the money distributed to unitholders by newly formed income trusts, while existing trusts get a four-year transition period.

Income trusts pay much less tax than corporations as they distribute most of their cash flow to investors to be taxed in their hands.

Flaherty says changes are needed to prevent a shift in billions of dollars of the tax burden onto individuals and away from companies.

The Pox on you, Mr Flaherty!!!!

I’m surprised they announced this after they threatened last year and then reversed tune when the stock market tanked. I wouldn’t be surprised if they reneged on this announcement too.

Christian at InvestorGeeks.com thinks that Oil will stay in the $50-$60 range for a while and that the Dollar won’t continue it slide.

Opec just reported that its cutting production by 1.2 million barrels a day. This will definitely push the price of oil upwards.

No one knows where the price of oil or gas will go, but global demand will eventually push it upwards. The Energy Department isn’t promoting any alternative energy research so I don’t know where he think the alternative energy to substitute oil will come from.

I’m betting on oil prices going up and I don’t think pushing the price to $75/bbl will push our economy into recession. They might blame the coming recession on oil, but I doubt thats the main reason.

Damn, I was supposed to buy some PTR but I don’t think I’ll be able to get in under $110 anymore! I also tried selling puts on a silver mine but I guess I was asking for too much premium [considering that silver crossed $12/oz today]

Woohoo!

I’m not actually jumping with joy, but I’m still quite pleased. Every dollar that oil goes up, my returns from the oil well I’ve invested in go up along with it.

My calculations on the returns was based on my crude oil selling $55 dollars per barrel. With oil trading at $78 I can expect to sell my lite sweet crude for roughly $68/barrel. Thats a 23% increase in profits with no change in expenses or production!

Sure my gas expenditure goes up, and eventually it will push up the price of almost everything else, but so long as I keep my profits higher than the amount of increase, I’m ahead.

Its always good to hedge one bets and diversify a little bit.