This article explores financial leverage ideas in oil exploration;
Assumes some investment prior knowledge in resource cycles.
Dividends are taxed at different rates and cash is exchanged at varying rates which can affect % returns.
Exploration companies are volatile and cyclical and need pre-planning to capitalize on returns.
Strategy: In Canada/USA you can use monthly Dividends to offset risk in owning Exploration stocks by collecting cash that covers holding risky resource stocks to term.
How: First you hold a Dividend Payer and you use the income generated monthly to accumulate assets that are leveraged to upward moves in a commodity that has greater upside in % upon an increase in reserves
from discovery of resources or an increase in production numbers.
Example:
Find a $3.00 Stock pays $0.026 cents cash each and every month.
Say you hold 1000 shares of XYZ Energy Inc. and earn the CASH PAYMENT of 1000 * 0.026 = 26 dollars each month. You now have +75% of the value of a 3 cent Junior earned for free, reducing your investment risk on 1000 Shares of ABC Junior Energy Inc. by -75%. With 25% at risk and 4X leverage to a warrant you have 1/4 on the risk side and 3/4 on the return side, a good bet odds-wise.
Q. How do I buy shares in a good risk in Exploration?
A. You might not find value at 3 cents, in terms of a Share Price, however you can find "Warrants" which give you more leverage than shares with changes in USD/CAD and USD Oil Price moves plus give you time to play a narrative that over time should offer exit strategy to return capital and generate a return.
Q. What is a warrant and how do they actually work?
A. A warrant is like a downpayment on a lease to rent an apartment. It gives you the right to buy/rent at a certain price for a known period of time without coming up with all the money at once.
Q. Explain a warrant in resource companies?
A. Say you see a warrant for TAO.WT priced at $0.015 - you can buy 10,000 warrants for $150
and it gives you the right to 10,000 shares of a company at $0.90 purchase price upto a certain date in the future so you leverage $150 to control the right to buy 10,000 x $0.90 = $900.00 that is 4X leverage on your $150 of risk.
Q. What if the share price is lower than the $0.90 price right now, wouldn't it be safer to just buy the stock and hold it while it rises and not risk the loss if the warrants expire?
A. Right, I see your angle, however the reason you buy exploration is for attracting outsized gains due to finding something in economic size that is brand new and increases the value many 100% in a few years. When in risk investing don't play not to lose, play to win...the difference being HOW you take the risk determines how you earn the return.
Yes, you can just buy the shares, but the 4x leverage offered in warrants can workout really favored if you get a discovery before the warrants expire, plus the discovery raises a lot of new cash into the business from people who exercise the warrants and this new capital launches the business into a new stage of investment which attracts other peoples money and since you got in early with leverage you stand to gain in more than one way if you were to hold the warrants and exercise them.
Q. So give me a real world example of how i can do this in Canada or the USA?
A. Fine, look at symbol GXO on tmxmoney.com its past history shows paying under 3 cents per month. Next look at TAO.WT and see its 1.5 cents and expires in March 2019 this will be our first example . You also wanted a USA example, I will give you PBT as the dividend payer (yields around 5-6 cents every month) and i will use the exchange rate gains on the dividend to buy the same TAO.WT warrant in canada to show how you can use the USD/CDN rate to your advantage.
So GXO | TAO.WT is $3.00 share and $0.015 warrant in $CDN
TAO.WT and
PBT is $9.00 USD and pays $0.05 USD which converts to $0.06 CDN when paid out which gives you Qty of 4 - $0.015 warrants for each 6 cent payment per month. Like saying each 1 GXO share pays you 4X leverage in TAO.WT
If Oil rises and PBT increases you gain there plus the cash dividend might be worth more over time if they grow.
If Oil rises and GXO increases in share price it too might pay higher dividends over time.
A warrant is speculation on Oil price and Share Price over time, so TAO.WT is based on TAO which is $0.40 at Jun 15, 2018 and needs to rise to $0.915 for you trigger both the $0.90 Warrant Exercise Price, and pay for the $0.015 premum paid on owning the warrant.
The shares of TAO need to 2X in less than a year and for that to happen you need a narrative that can work out for that company and in that time frame. For this to happen could be external to the company ie: geopolitical tariffs, oil in europe reacting to Euro breakdown, traders reacting to Singapore Crude futures in Yuan which convert to trade in Sept 2018. Or, The company may acquire assets in a country like Australia or NZ and double reserves or size to reach the 90 cent level.
Say you have $1000 to risk, you put 850 into PBT and get nearly 100 share, earning $6/month for 8 months
that is $48 in earnings, you get nearly $200 (4x) of leverage in TAO.WT which gives control of $1800 of TAO shares and that means you have a upside opportunity to play if TAO performs, rather than 40 cents at risk with stock you have 1.5 cents at risk with 60X leverage to 90 cents from 1.5 cents.
Said another way you can take a 90 cent future position with 1.5 cents at risk today.
The asymmetric or lopsided odds are contrarian to the market and that is sometimes a opportunity missed by the crowds.
Summary: A barrel in the ground is worth less than a producing barrel, but the cost of that barrel to lift from the well to surface and get to market is the key. New Zealand is not like other markets it has unique isolations that when working for you are very lucrative and offer 20% cushions to north american markets. Getting leverage on a barrel in the ground at a discount into the future before its lifted is one way to get financial leverage. Offsetting that risk with paid off infrastructure on a existing producer that can afford a dividend is a great way to offset risk.
Buy GXO, Buy PBT and hold Warrants for upside leverage to the tune of 4X upto 60X depending on how you view the numbers.
Tullii