Second Hand, First Rate: Sable Offshore $SOC

More drama than you can fit in an oil rig

I am back in Tampa after hurricane Milton collided with a cold front and spared us all the worst case scenario.  I have several days of yard cleanup ahead of me, but the house is only missing a bit of metal flashing and some soffit.  About half of our county still doesn’t have power, but we were very fortunate to be in the tiny minority that didn’t lose theirs.  My father-in-law was unenthusiastic to have pasta for dinner two nights in a row, but we had to remind him that the grocery stores are mostly empty, and people are lining up to fill gas cans for generators at the few gas stations that received a fuel delivery.  My father-in-law has many fine qualities, but suffering in silence is not one of them.

By popular request, I want to write about Sable Offshore Corp (SOC), but this research project is not originally mine.  I learned about it from Ben Kelleran at

Kontrarian Korner

, and Lake Cornelia Research.  There is a lot of noise out there, but I have found Lake Cornelia to be more signal than noise.  When I had found Transocean (RIG) through my own efforts, I came across Lake Cornelia’s work on Tidewater (TDW).  At the time, I liked my own idea better, and stayed with RIG, but if I had been a little more cognizant of the effects of shorter contract lengths, I could have entered and exited Tidewater with plenty of time to still not be too late for Transocean.

One of the problems in writing about Sable Offshore is that there is just too much going on, so in the immortal words of Inigo Montoya, “Let me sum up.”

Exxon Mobil spent 15 years in the 1960s and 1970s consolidating offshore oil leases in California and grouping them together into the Santa Ynez unit.  This collection of three offshore platforms and a pipeline to an onshore processing facility is a slow-decline oil field with decades of life remaining.  It produced 30,000 barrels of oil a day at a cost of about $17 a barrel until it was shut down after a pipeline rupture and oil spill in 2015.  The asset itself, slow decline, long life, low cost, is the sort of thing that doesn’t come along every day, and this is making investors’ mouths water.

The 2015 Refugio oil spill was somewhere around the 174th worst oil spill in history at 3,400 barrels of oil.  It would take over 300 Refugio spills to equal the sinking of the Exxon Valdez in 1989, or about 1,900 Refugio spills to equal the Deepwater Horizon blowout of 2010.  Americans will use anything for scale except for the metric system.  But more importantly, this relatively small spill was on the favorite beaches of some of the wealthiest and most litigious Americans, Santa Barbarinos.  The risk of regulatory overreach and death by frivolous litigation will never really go away completely, even with the offshore platforms in federal waters.  

The photo below is from the student newspaper at Stanford.  The platforms can be seen from the beaches where the modern American aristocracy vacations.  These precious eyesores will forever attract crusade after crusade of zealots who won’t have their prefrontal cortexes develop until age 25 to help them understand the nuances of environmentalism vs. energy needs. They might not win, but they will never give up. 

Exxon sold the Santa Ynez unit to Sable Offshore for $643 million, which Exxon self-financed with an in-kind coupon debt at 10% which has now grown to be about $750 million.  In selling Santa Ynez, Exxon suffered a $2.5 billion writedown in book value, and book value often understates as it does not adjust upward with inflation over time.  What would an operating Santa Ynez be worth?  The roughest back-of-the-envelope math is probably somewhere around $7 billion, and SOC is trading at a market capitalization of $1.6 billion.

Not only that, but having been frozen in time since 2015, technology has marched on, and oil extraction methods have improved.  There are good odds that with limited capex, production could be increased from 30,000 barrels per day to 60,000 or even 100,000 in the most bullish scenario.  California oil and natural gas sell for more than they do in Texas due to the lack of pipelines between them, so if Santa Ynez does go back into production, everything sells at a premium.  Also, the fields have an enormous potential for natural gas which was never emphasized in the past, and SOC has onshore land leases that can be used for data center power generation, or even carbon capture.  The most aggressive estimates put the value of the natural gas data center potential at equal to the current SOC market capitalization.

If you have a few years to wait, at $80 Brent, and $17 per barrel costs of extraction, 2029 production of 60,000 barrels per day would equate to over $1.3 billion in revenue with $300 million in projected capex.  Leaving some aside for interest expense and SG&A, Sable Offshore could return $800 million to shareholders in 2029.  That could be in the form of $8 to $10 in dividends, give or take, depending on how much debt has been retired, how many share buybacks have occurred, etc.  Not bad for a stock trading at $21 today. Any increase in oil prices would only improve these numbers, however, tier 1 assets are not purchased for torque to commodity prices.

The current CEO is the largest shareholder, Jim Flores, who has a long and storied career in energy, and is making his final hurrah through Sable Offshore.  However, due to the initial structure as a SPAC, there is an enormous amount of warrants outstanding.  The bad thing about the warrants is the imminent dilution, but the good thing is that they should raise enough capital to bring SOC to production without any other fundraising efforts, assuming all regulatory and legal hurdles are overcome.

Without getting into the nitty gritty, it does look like after a ten year legal journey, the Santa Ynez fields will be brought back into production relatively soon.  The market has increasingly believed this as the share price of SOC has climbed from $10 in April to $25 in September.  If you want the blow by blow fight commentary of the legal battles, you would have to do more digging on your own.  I found myself down a research rabbit hole where my lack of legal expertise left me feeling that more research was only giving me more false confidence.  

At some point, even if the pipeline to shore is blocked by legal battles, the oil extraction in federal waters could be brought to land by oil tankers.  It would be more expensive, but with such a low cost of production, the oil would still be highly profitable.  If this were to be the outcome, the added time would add more to the Exxon debt burden, and who knows if $200 million to $300 million with current liquidity plus warrants would cover the whole transition.  But the worst case scenario is probably a transition to oil tankers bringing the oil and not that the oil is never extracted at all.  

Due to the California jurisdictional risks and litigation magnet of having visible oil platforms on the Santa Barbara coast, I have to size this position small.  My best estimate is that Sable will win, and bring production online, but with so much legal overhang so far outside of my competence to evaluate, the possibility of a bad surprise is too large.  Ben Kelleran has sized this position enormously in his portfolio, but he has spent many more hours digging into 8-Ks and convincing himself that he can predict the legal outcomes.  For me, I am not against buying here at $21 a share, especially after the recent dip down from $25 after an aggressive short report was published, but I wouldn’t go over 3% of my portfolio weight.