Let’s roll out some stats related to Coronavirus cases in Malaysia as of 30th May 2020.

• Total cases per 1M population: 240. In the US it is 5,400 and in the UK its 4,021.
• Total active cases: 1,317. In Germany, its 9,494.
• Total deaths:  115. In Italy its 33,340. In Switzerland its 1919.
• Total new infections in the last 24 hous: 30. In Singapore, its 506.

In terms of Coronavirus response, Malaysia is at least an A candidate, second only to perhaps Taiwan which is the only A+ country in the world.

Under the previous Pakatan Harapan Government, we could not even manage a temple dispute without it turning into almost an all out race war. Under the current Perikatan Nasional Government, Tan Sri Muhiyiddin’s Government worked like a well trained Formula 1 Pit crew and navigated the Coronavirus crisis efficiently and effectively.

Let everybody be clear about this: Langkah Sheraton saved Malaysia!

A few days ago, the National People’s Congress (NPC), which is equivalent to the Dewan Rakyat in Malaysia, moved to impose a security law that will allow for officers from China’s Ministry of State Security to operate in Hong Kong as well as meet out stiff sentences for those accused of protesting against China. In effect, in one fell swoop, the legal system in Hong Kong will be changed and Hong Kong will no longer operate under a One Country, Two Systems approach but under a One China model.

We have been trawling various YouTube channels discussing Occidental Petroleum and finally, (after cleaning our room and attending Sunday Service online), we got down to the gritty details of forming a financial projection on Occidental Petroleum. We just focused  on the US upstream portion of things in order to get a conservative estimate of the likelihood of Occidental filing for Chapter 11. All other segments of Oxy are expected to break even , but this is still a work in progress so we may update it after looking at the midstream segment and Oxy’s  Chemical Manufacturing business. But the conclusion of this analysis has already given some confidence that Oxy has a better than 50-50 shot of surviving , at the expense of their bankster friends. However, this does not mean that we expect the stock to appreciate. Instead we expect it to trade at the price of a 1 year out of the money call option on WTI at strike price of $40 aka at GE stock pricing.

The key to Oxy’s profitability is the cost of extracting 1 BOE, or Barrel of Oil Equivalent vs the price it receives for a BOE extracted. Currently at $17 WTI, its operating margin for this core activity is -200% or Oxy loses $21 per Barrel of Oil Equivalent produced. The cash component is somewhat lower , Oxy loses $5 per Barrel of Oil Equivalent produced. However , if WTI futures drop further to under $10, Oxy could lose on a cash basis, $15 per Barrel of oil Equivalent produced. Simply stopping production to 0 is not so simple. Each well needs to be capped and sealed, which could cost $1M to $2M per well. In some cases, the entire well asset is destroyed and it may cost up to $4 to $5M to reactivate the well in the future. There is a further complication on asset retirement obligations, the cost Oxy needs to incur to permanently deactivate a well in order to conform to Environmental legislation.

The US shale business is operating cash flow dead at WTI @ $20, if WTI @ less than $10, the business is a toxic asset.

Oxy’s 3 way collar hedges expire in 2020 and is considered as an equity infusion of $1.2B. At current pricing, this can tide over 50 days of cover, of which 10 days has been extinguished. Next year, it no longer has this protection.

The mark that distinguishes the Rembau Times is that we are fact based and not based on conjecture. We spend countless hours to build a simple, intuitive financial model which we do share our work with the outside world. The link is here.

Detailed Analysis

We will start with the good news first. Bottom line is that Occidental will most likely not go under because of the Revolving Credit Facility but management could be incentivised to do a voluntary Chapter 11 bankruptcy if oil prices remain where they are in 3 months time. The intrinsic value of Occidental is low to mid single digits , and that is purely due to the put option granted to equity holders by credit providers. (Equity holders can put the Company back to the debt holders if the intrinsic value falls below $0).

Profitability wise at $20 WTI, OXY assets are worth less than its liabilities as reflected in its debt pricing of 60 cents on the dollar. Near term we may see further pressure on WTI so I won’t be surprised to see Oxy trading at GE level prices for an extended period of time. WTI will need to move 250% before OXY can make an accounting profit on its US shale operations.

Good news for Oxy

1. Occidental entered into a 3 way cost less collar to hedge 128.1 million barrels of oil, bench-marked to Brent. To simplify this, so long as Brent is less than $45 a barrel, OXY will receive $10. Brent is currently $21 for June and the December 20 price is $31.54. Oxy will receive $10 per barrel, we consider this a capital infusion of $1.28 billion.

2. Occidental has a $5.0b Revolving Credit Facility with no Material Adverse Clause. With Occidental’s $3.0b of unrestricted cash, this means that Occidental has $8b in liquidity.

Bad news for Oxy

1. Current US Production cost is approximately $33 per Barrel of Oil equivalent, or BOE. This is not to be confused with a Barrel of Oil, because you have to weight the components that go into a single barrel, namely Crude Oil, Natural Gas Liquids and Natural Gas, with Oil being the most valuable and Natural Gas soon to be essentially worthless. All 3 components have a different price benchmark. Based on our calculations, Occidental’s current price received per BOE is approximately $11.26. So Occidental makes a loss of $22 per BOE. On its production of 1.2m BOE per day, Occidental makes an operating loss of about $25M per day. The entire capital infusion from the hedges will be wiped out in approximately 50 days at current pricing

2. Occidental has long term obligations of $68.5b, arising from its debt and purchase obligations. This figure is important because it will be a determinant in the future whether Occidental can remain a going concern when the auditors prepare their annual audit opinion. At current WTI prices, the Company auditors may need some convincing

3. Occidental’s debt is currently rated as junk, meaning Occidental cannot hope to tap the debt markets next year to refinance its debt. Occidental’s 3.400% maturing 2026 is currently trading at 58 cents on the dollar.  This means fixed income investors expect to lose 42 cents on the dollar. Remember, equity investors will lose everything before fixed income investors lose one penny.

3. Warren Buffet has a $10b Perpetual Cumulative Preferred Shares  yielding 8.00% cash or 8.80% if settled in shares. Assuming it’s cash settled, this will cost $800m per year, and taken together with the $1,500m Occidental pays in interest means that the cost of capital is $2,300m per year currently on a cash basis.

The future cost of capital is not worth calculating because Occidental’s debt implies an unrealistic cost of debt financing – it just states that the debt market is closed to Oxy and the only financing available to Oxy in the future will be equity financing, after it draws on its revolver.

Electing to pay Buffet in stock is not wise given the potential significant dilution it poses. Occidental’s management should just default on the preferred, stop paying Buffett and ask him to accrue the dividend on the preferred stock while doing a debt to equity deal with the bondholders . Let Buffet take the loss for doing a deal on a Sunday morning. Unfortunately, common equity goes to ZERO but the employees and the banksters get saved.

Conclusion

1. Occidental’s dividend cut to 0 is a foregone conclusion. Those looking at Oxy’s dividend yield of 23% on Google Finance should not rely on Google Finance in making financial decisions.

2. Occidental’s is quite dependent on whether they can complete the sale of their African assets in Ghana and Algeria. It is in Total’s best interest to delay this, given the collapse of the oil market. Ghana is claiming a $500M tax charge and Algeria’s  Sonatrach Group is opposing the sale of the Algerian assets. (Hint, hint: Malaysian should be able to add 2 + 2 on this one. The first 2 is that Total probably hates the price it agreed upon with Oxy. The second 2 is that Algeria is blocking the deal. Figure it out!)

3. Occidental’s cash balance as of 31 Dec 2019 was $3.5b, comprising of $3.0b in unrestricted cash and $0.5b in restricted cash.

4. Given Occidental’s short term liquidity of $8B, Occidental could ride out this oil crisis at the expense of the banks which gave them the financing offer of a life-time. Congratulations, Brian Moynihan of Bank of America.

The question is whether Occidental will want to take down the banks by fully drawing on its revolver?

Of course, doing so will mean that Occidental will get no mercy next year when it comes time to settle their debts.

Some wise investment banker may suggest that  Occidental do a pre-packaged bankruptcy somewhere in the 3rd quarter, if oil prices remain where they are. Bottom line, an investment in Occidental means assuming that Occidental fully draws on its revolver and burns all bridges with their Wall Street bankers.

It will perhaps come down to the Audit Opinion at the end of the year whether Occidental could remain as a going concern. So Occidental still has at least 9 months left to fight, unless some wise banker does the prepackaged bankruptcy route.

By the way, the management of Occidental deserve an F for destroying $44B of shareholder value . (One could argue that $20B was oil market and that $24B was their own making) 

Note: Bottom line, what we are really trying to communicate is that we prefer cheese 🧀 and ketchup to oil.

(Note to the VIP elderly readers: Revolver: Its like an overdraft facility for corporates. Banks offer companies revolving lines of credit in return for the fees they generate but never really expect that all the companies will draw on their revolver at the same time, like what is currently taking place. )

Over the weekend of April 19th, many Oil and Gas bankers  in Singapore must have had an upset stomach as they digested the shocking news that Hin Leong, one of the largest oil trading houses in the region, was effectively insolvent.  The owner, the ex-billionaire OK Lim, had admitted that he had cooked the books and that Hin Leong’s true liabilities of $4,000m against assets of approximately $750m. In Singlish, Hin Leong is effectively a “gone case”. The 3 main Singapore local banks are on the hit for a combined total of $600M and HSBC by itself is on the hit for $600M. To make it even more dramatic, this announcement was made by Mr. Lim while he was on a conference call with the company’s network of banks who were assembled to discuss whether to offer Hin Leong a debt moratorium, or in other words giving the company a lifeline . Most bankers who heard Mr Lim’s confession were left in a state of shock and awe.

The details of what happened are well covered by this article in Time and this one in Straits Times . This article seeks to explore other aspects not covered in the article.

First a quick summary of the facts:

• A) Hin Leong trades about S$20,000m worth of oil and oil products in one year
• B) Banks lent Hin Leong S$4,000m in the form of commodity financing loans or Letters of Credit for the purchase of oil and oil products.
• C) A Hin Leong affliate, Universal Terminals, has storage capacity of approximately 14m barrels of oil.
• D) Hin Leong owns a lot of VLCC Tankers
• E) OK Lim is a well known gambler
• F) This sector has witnessed some spectacular bankruptcies such as OW Bunker’s bankruptcy in 2014. Bunker trading has a reputation as a shady business with shady operators.

Together, A,  B,  C, D , E and F is a recipe for disaster.

First some background. Let’s say in January, when an oil trader buys a cargo of oil, its called a cargo of oil based on the standard VLCC cargo of 2 million barrels, the amount for the purchase is probably about USD$90M based on the price of oil at $45 per barrel in a world before Covid19 aka #CCPVirus.  If this VLCC was loaded in Houston, Texas, the 13,253 nautical mile trip to Singapore will take approximately 2 months. The seller, let’s say for argument sake is that firm headed by that female CEO, yes Occidental Petroleum, is not going offer any credit terms whatsoever to the buyer. The title to the oil changes from Occidental to the buyer as the oil passes through the main flange of the oil tanker. From the sellers  point of view, its a done deal and they want to be paid.

Here is where the oil bankers step in, and for argument sake, lets call it HSBC. They issue a document called a Letter of Credit or LC to the buyer’s bank, let’s call it JP Morgan, which constitutes an irrevocable undertaking by HSBC to remit to JP Morgan in favour of Occidental Petroleum $90M once they have received  the original documents detailing the transfer of oil from Occidental to the trader. This could take several days. So from Occidental’s point of view, their payment is guaranteed by HSBC and not by the trader, who could be some fly-by-night outfit. The risk of non-payment is borne by HSBC and not by Occidental. So far, so good, and the VLCC sets sail from Corpus Christi, destination Singapore.

Now, to recap, an Oil Trader buys a cargo of oil from a producer, the payment is $90M and the payment risk is borne by the oil trader’s bank, in our case HSBC. At the heart of the issue is what makes the bank so confident of this transaction is that so long the oil is in the VLCC, the title to the oil actually belongs to the bank and not to the trader. So from the bank’s point of view, they will usually demand some form of collateral from the trader, maybe a 10% deposit or about $9M and finance the 90%, by issuing a $90M LC. The oil then arrives in Singapore, where the trader gets the banks permission to store the oil in its oil storage facility. The bank agrees and the LC is now converted to a loan, maybe a 180 day loan, once again secured on the value of the oil.

Ok here is where things mess up.  What happens if the oil trader secretly decides to sell the oil stored in the oil storage terminal without telling the bank?

This form of financing, called Inventory or Stock Financing has this weakness. Usually in the case of financing of industrial metals, like Copper, the Warehouse party is an independent party to the buyer and will only allow stocks to be taken out upon the explicit instruction of the bank.

It is a basic error in risk judgement for any banker to allow an oil trader, or any commodity trader, to store inventory FINANCED BY THE BANK in the warehouse of an affiliated party.

And that is most likely what happened in the case of Hin Leong. The oil which was bought was most likely stored in Universal Terminals, an entity linked to Hin Leong. The oil actually belonged to the banks, who financed the purchase transaction. But Hin Leong’s owner, would have on-sold the oil to get much needed cash to cover other bad debts and ordered the tank operator in Universal Terminals to pump the oil to a ship.

The financing bank is left issuing a loan against NOTHING.

So at heart, bank’s suffer when they do not hire experienced risk professionals to vet through transaction deals and protect the bank’s interest.  Either the risk officers are happy for the 9 to 5 paycheck without raising a fuss or they have had the experience of being shouted down by the powerful commercial folk in the bank. In the latter case, the bank usually defer to the Oil and Gas banker, who is in for the short haul, gets the commission on the financing transaction and jets off when things go bad. The job of risk management in a bank is to cost a bank $1 a year so that they will prevent the bank the $100 loss that comes once every 5 to 10 years. But most of the time, some short sighted bankers see risk management as a cost without understanding the benefit. The following applies to those banks.

These banks deserve their losses, well and proper. Actually any bank which defers to their glorified Relationship Managers against the protestations of a proper risk analyst, deserve their losses, well and proper.  Any bank that does not have a proper trained risk analyst, adequately compensated, is doomed to sustain the $100 loss that can wipe out an entire year’s worth of earnings.

ISSUE NO 2 – Deloitte

The second issue has to do with Deloitte. Deloitte Audit has some serious issues in South East Asia.

Didn’t Deloitte in Malaysia look the Malaysian Cabinet in the eye and said 1MDB was not a fraud case when even a junior auditor who was simultaneously high, drunk and slipping in and out of consciousness could point it out. And now, the Singapore Deloitte office has decided to join their Malaysian counterparts infamy by not uncovering what appears to be an elementary case of accounting fraud when all the risk indicators should be bright red – high turnover, low profit margin, multiple banking relationships, affiliated subsidiaries, poor accounting controls, family run business AND exposed to a highly volatile markets, which had a recent history of large bankruptcies like OW Bunker .

As they say in Malaysia: MAMPUS!

For the record, of the 4 big audit firms in South East Asia, only PWC and Ernst and Young (EY) have any value in my opinion. The Malaysian offices of both these firms told 1MDB to go fly kites and refused to audit their financial statements. Their reputation is intact.

ISSUE NO 3 – OK LIM’s misreading of the oil market.

Over the weekend of the 8th of March, Saudi Arabia decided to launch an oil price war. When markets opened for trading on Monday, 9th of March, WTI collapsed by about $10 to $30 a barrel. At that time, two very important elderly readers (related to the author) sought our opinion on what the price of oil would be. We said cooly, it was going to drop below $20 a barrel. And as of today, WTI prices are $10 a barrel and there is probably little hope that prices could touch $20 a barrel anytime soon.

But OK Lim had misread the market, thinking that the Coronavirus could be beaten. We actually saw the following a) Collapse in global air travel , b) Collapse in motor gasoline demand and c) Massive overproduction. To be honest a) and b) and c) were blatantly obvious to any right headed oil analyst. One way that this was obvious was to look at the stock prices of oil companies over the last 1 year. They were trading horribly in the 4th quarter and only managed a short gasp of air in the first 2 months of the year when the financial markets were going crazy and Dow Jones 30,000 was just one or two trading days away. The last point is actually quite important. Some of the best money managers say that the best reading of the economy could be found in the “bowels of the stock market”.

OK Lim however was on the wrong side of this development. He believed that oil prices would recover and probably nobody in his company would want to challenge the opinion, seeing that he had lost his mind by agreeing to do the accounting fraud.

There is some truth in the markets ability to make sector predictions, because in the case of the oil market, its doom was quite evident since last year and the stock prices reflected its doom. The oil sector has been a downturn ever since 2017. ExxonMobil which used to be trading at $90 a share a couple of years ago is now $40 a share. Occidental, which used to be trading at $80 , is now $12. I kid you not, some folks actually said that oil could crash to $2. Our view is that oil will be under $20 until May before recovering in June. The Covid-19 situation is beginning to end.

Actually, if Hin Leong’s owner, OK Lim did not do accounting fraud, he could actually be earning a risk free reward of up to $70M a month by just renting out his sprawling 14M barrel of oil facility for about $5 per barrel.  The key thing now is storage, and Hin Leong had a lot of storage in the form of Universal Terminals. Pity, though because once you do this thing called fraud once, it usually has a habit of biting you back and leaving the fraudster with NOTHING.

JP Morgan just reported their 1Q20

results and here is our run down.

• Tangible Book Value Per Share is $61, little changed from last quarter. The stock is trading at $95. The difference is the minimum overvaluation of JPM. The reason is that we are entering a mega world depression and all that provision for credit losses is going to hit there.

• Allowances  for the Credit Card 💳 portfolio increased from $5.6B to $15B. Provision increased from their community bank portfolio increased from $1.2B to $5.7B. Ok some semantics here. You provide for a loan when the credit risk has increased substantially, as they are on Basel. The difference between the allowance and the provision basically means that the bank is expecting things to get a whole lot worse. ( That’s a really simple explanation and avoids the entire issue about contra assets and things like that. Remember we are dealing with Politicians, big game decision makers and not microscopic Accountants.)

• Accrued interest on JPMs loan book increased from $72B to $122B. So what does this mean? In normal times, there is a timing difference between when the bank actually gets paid from the time it recognises it as revenue. So for example, you have a loan for $100 that is charged a monthly interest rate of 1.00%. The bank closes its books at the end of the month and records the $1 of interest as interest income. But you pay the $1 on the 15th of the next month. From the 1st to the 15th, this $1 is carried as accrued interest and when you pay your $1, it ceases to become accrued interest and becomes cash. During normal times, this figure is quite constant and in JPM’s case, it ranged from $70B to $90B over the last 1 year. Now it’s $120B from $70B. Is it a bad thing? Quite possibly if you make the hypothesis that a lot of it is from interest on interest. If that is the case and those loans turn bad then the extra $50B accrued will become a $50B write off.

• Credit quality slipped a bit but that is a lagging measure. After all, a bank will only know if you defaulted 90 days from now. But the good thing is that it did not look bad. But this is a lagging measure. Which means that it will hit in 3 Mths time.

For now.

And WeWork has not defaulted yet and with that collapsing the New York commercial office space. For now, as well.

Undrawn commitments refer to credit lines granted by banks that can be suddenly drawn down unless the bank chooses to stop it, either by cancelling the line or claiming the Material Adverse Clause (“MAC”) clause. In the case of JP Morgan, there is more than $1 trillion of undrawn credit lines as per the table below.

Click for details

First, readers should understand that never in the history of banking has the United States suddenly gone from maximum full employment to maximum unemployment in just 5 weeks.  The issue with this is that consumers and corporate customers like the Boeing could have drawn down on their credit lines within the 1 month time frame before banks even knew what hit them.

This represents a big issue because we have a situation where the US is facing an economic depression. So, we could have and there is already evidence of mass defaults in the consumer side. For the corporate customers, or what is called as the wholesale side, the credit ratings of many firms can get downgraded, and some already have. There could also be a mass wave of defaults by corporate customers, like those in the energy sector, airline sector, REITs and of course the WeWork.

So for this reason, I am quite concerned about US banking sector, because of JP Morgan. JP Morgan’s capitalization ratio is not as “iron clad” strong as Morgan Stanley. And JP Morgan did not hedge its entire credit portfolio like what Morgan Stanley did. More to  come after we finish analyzing JP Morgan’s 10K. Stay tuned.