Business Breakdowns
· Matt Reustle
[00:00:00] S0: It's a very helpful overview. And these are unique businesses. I would almost say they're a class of business—not quite an asset class, but they're a class of business. And I know you have history, Horizon Kinetics has history in this space. So can you talk a little bit about the history that would result in these coming onto your radar and a little bit about that background?
· James Davolos
[00:00:00] S1: Absolutely. And can't take any credit for it because you're going back to 1995 when the firm was founded and I was 11 or 12 years old, but Murray Stahl, our chairman, came across this funky liquidating land trust in Texas that was listed on the NYSE called Texas Pacific Land Corporation. And the original thesis was very simple. We actually have a research report that he issued publicly back then. And it was essentially this: company was created through the bankruptcy of the Texas and Pacific Railway in the late 1880s. The idea was to connect Texas to Southern California. People that remember history of that era and the robber barons and railroads and the leverage are pretty familiar. That didn't end well. They got land grants for every mile of railroad that was built in the state of Texas. Impossible to sell off a couple million acres, certainly in 1888, probably no less so today. And so they listed it on the NYSE and it was a liquidating trust. So basically they would take their proceeds, much of it was from grazing land, later some small oil and gas royalties, and then buy back stock or pay dividends. But if you bought back stock at a lower value, you're effectively buying back acreage at a lower implied price. So if you're buying back stock at an implied price of $10 an acre and acres on the fair market were 100, it was the most accretive compounding machine you've ever seen. So that was the thesis. And then obviously things have changed dramatically with fracking, the development of water, the development of the Permian Basin. But our history with that company, which is now a corporation, and Murray is on the board of directors, was one of the earlier windows that we had into this large, nascent water infrastructure industry within the larger U.S. energy complex.
· Matt Reustle
[00:00:00] S0: Yeah, it's the fascinating background and the railroad story and them getting those grants. It's something that came up on our Union Pacific Railroad episode where their assets, they eventually sold to Anadarko for 4 billion 25 years ago. So it's interesting to see how these assets, these grants, all preserve some interesting value over the years. So how would you define this group or this concept of investing, if you could, in a snapshot—how do you frame it or approach it? Just in general terms.
· James Davolos
[00:00:00] S1: You can look at the broader energy industry. And most people in energy look at three different business models and there's nuance to each. So you've got your companies that are primarily E&P, so exploration and production—they drill and they make their money basically drilling for hydrocarbons. Then some of those companies then can be integrated where they're fully upstream, which is drilling. The second set is midstream, which would be transporting those hydrocarbons. The third would be downstream, which would be your refining and then your retail petroleum station. So those are the three traditional verticals. You can add a slight adjacency being oil field services. So the companies that Schlumberger, Halliburton, maybe some of the offshore companies that do services that are ancillary but part of oil field energy extraction, those businesses tend to be very capital intensive and very cyclical. Some of them have more stable cash flows, but generally they're all somewhat cyclical relative to the volume and the pricing of oil and gas markets. We prefer to look at companies that have lower capital intensity and less cyclicality. Now, you can't remove all of that. But so our protracted history now investing in Texas Pacific and then other companies within the ecosystem is we came to the conclusion that land. And land in Texas, there's really two different types. There's surface acreage and then there's the mineral estate. In some cases they are one and the same. But land is the preeminent asset because it's essentially a pure margin business that's perpetual with optionality. So within land, there are minerals or royalties. There's a variety of royalty companies that are public now. But if you were to think, okay, Chevron, Exxon, ConocoPhillips, they're spending hundreds of millions, if not billions, developing their U.S. energy position. The royalty holder is literally earning a percentage of the oil and gas that they produce off the top. So you participate in no OPEX and no CAPEX. In Texas parlance, they call this mailbox money. Because if you're so lucky as to have a ranch and ConocoPhillips is operating that lease, you just go out to your mailbox and you pick up your check every month. It's a pretty good gig if you can get it.
· James Davolos, Matt Reustle
Beyond royalties within the surface acreage world, your surface acreage can be monetized in any number of ways, primarily easements: easements for pipelines, easements for power, easements for access roads, power lines, et cetera. But we've also honed in on the infrastructure side of it with water. And up until very recently, there was really only one pure-play water infrastructure company, which was Solaris, which was sold to Western Midstream, which coincidentally, going back to your comments about Union Pacific and Anadarko, Western was the midstream assets of Occidental, who acquired Anadarko, which was very contentious but supported by Berkshire Hathaway. A big part of those assets that was bought by Anadarko is actually something we might talk about later in the sour gas window as you get to the eastern edge of the Delaware Basin. Anyway, going back on topic. So again, we look at it really, okay, surface acreage, and then within that surface acreage, royalties, where we're very active in a variety of companies, and now also companies that can be very dynamic in monetizing that surface acreage, LandBridge, whether through water or other types of easements, and then the water infrastructure that's operated, which is the WaterBridge business model. [00:00:00] S0: Maybe we can get into a bit on what's happening with the production of those four barrels of water for every one barrel of oil in this region. Can you just talk about what that looks like in practice and what WaterBridge is actually doing as a service with that water?
· James Davolos
[00:00:00] S1: So maybe a little history, just to bring people up to speed on exactly how this works. So the Permian Basin is the largest oil and gas producing region in the U.S. around 11 to 12 million barrels of energy equivalent, which includes natural gas, natural gas liquids. I mean, relative to a little over 100 million barrels a day of global production, 10% of global volume is enormous. It's even higher when you look at just oil. So these are the oily wells in the U.S. and so the broader U.S. production is influenced by gas and these natural gas liquids. But so the reason the Permian Basin in West Texas has hydrocarbons is that it's an ancient seabed. Decomposing carbon is where you have hydrocarbons over hundreds of millions of years. So it shouldn't be surprising that when you break up this shale rock, where there's oil and gas molecules trapped in that, that there is water. What should also not be surprising given that it's an ancient seabed of decomposing carbon, is that it's very high in salinity or salt content, just like the ocean. So now that we've established that, so you're going down in some cases, 3,500 feet, other cases 10,000, 12,000 feet deep, you're breaking up one, two, three. Now you're getting beyond three-mile fracs of rock, you have all of this water that's going into the wellbore and coming out with the oil and gas. So first thing you need to do is you need to separate your oil and gas from this water. And as I mentioned earlier, in the Delaware Basin, you're getting about four barrels today, about 3.7 to be exact, based on the last data of this, what's called produced water with your oil and gas. So now this water is not water seawater. It's actually many magnitudes more saline than seawater. It also has a variety of corrosive compounds and then very high total dissolved solid content. So in every sense of the word it is a waste product and so it needs to be remediated. And in the days of vertical wells, so you just drill down vertically, it's a pressure system. There was nowhere near as much water because you're not breaking up rock. But also you could take this produced water and then re-inject it into the well to increase pressure called enhanced oil recovery. So it didn't exist. This industry was completely non-existent before the shale boom. Call it 2014. So to be generous it's about a decade.