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More Spring cleaning: out goes Contango Oil & Gas (MCF)

April 20, 2012

I’m on a roll. Once the first sale is made, the next comes easier. This one was tough, though. I hate to part ways with a wonderful company like Contango Oil & Gas (MCF). It has all the makings of a buy and hold investment; high insider ownership (but not to high), no debt, an ingenious low overhead business plan and it’s the low-cost producer. What’s not to like? The problem is, I know nothing about oil and gas, well, except for the fact that natural gas is currently at historic lows. What does this mean for MCF? I don’t really know exactly, though I can surmise Contango will not be enjoying peak earnings with gas at historic lows. Even a brilliant business strategy can’t overcome the inevitable fluctuations of commodity pricing. And since I have no idea whither gas prices tomorrow, next week or next year, I really can’t predict how well Contango will do financially over the next couple of years. Recently I’ve read that smart money (whose ever that may be) is going into natural gas investments because prices are now at the bottom. Really? I don’t know anyone who has made only one fortune forecasting the price of oil and gas, and, in any case, I’m sure that it won’t be me making that fortune in the oil (or gas) patch. Exiting Contango now is even more painful since it is down some 10% over the past month. In fact, the whole thing with Contango and me is a case study in what one should NOT do in investing.

First let’s go back to my investment thesis. In June of 2010 the company came out with news that their estimated and proven reserves had been revalued down by something like 20%. The shares quickly sold off from $60 to around $40 over the next two months. I figured this was just Mr. Market overreacting and that the shares would bounce back. After all, this was a great company with great management. So I took a position towards the end of August and, indeed, the shares did bounce back to the $60 range by November. Did I take my profit and run? No…  I had had my eye on Contango for a couple of years and decided that the opportunity to buy in at an artificially depressed price was just that, a golden opportunity, and that I should hold for the long-term (or at least for long-term capital gains treatment). The shares then proceeded to trade in a range between $55 and $65 over the next 9 months. I wasn’t worried. I had calculated the intrinsic value at around $75-80 a share. My wait was going to be rewarded. But when the 12 month mark came around and my shares were still only trading in the $65 range did I sell? no way! I wanted my full intrinsic value and besides the economic recovery was on its way and that would help push the share price higher. But was I paying attention to the natural gas market? Certainly not enough. Prices were eroding fast, and here I was focused on my intrinsic value calculation of a year ago. Still, I couldn’t bring myself to part ways with Contango. I dilly-dallied.

It was only after Wexboy’s post on Spring cleaning (the same one I referred to in my last post) that I capitulated. And once I did, all my investment reasoning came flooding back. It’s like I subconsciously blocked out my investment thesis for an entire year! Yes, I know. I sold at the bottom of the stock’s trading range over the past year. Maybe I left money on the table. Maybe if I’d just waited a bit longer (ah well, I’d been singing that tune for a while). Really, I had to sell the moment I realized there was a divergence between my investment thesis and what was happening. I didn’t sell just to punishing myself, just so I won’t be so dumb next time, though maybe this experience will help me remember. The point is, if you have an investment thesis, YOU HAVE TO FOLLOW IT LITERALLY. You can’t rethink it after the fact. Hindsight bias is terrible for investing results. Yes, you have to continually critique your thesis as you go along, but, above all, you do have to have the courage to pull the trigger when something goes awry. I’m lucky this time. My Contango adventure will still provide a tidy profit (albeit reduced) even though I didn’t follow my investment discipline. Oh, and let’s not forget how I let the question of taxes cloud my investment reasoning as well. My takeaway? FOCUS ON PROCESS.


From → Positions Closed

  1. GlennC permalink

    Natural gas is extremely extremely low but Contango doesn’t derive a lot of its revenue from natural gas now that it is so low. Most of its revenue comes from natural gas liquids and a little bit from oil.

    It has massively outperformed natural gas futures (e.g. UNG) and has outperformed many of its peers. I definitely don’t see it as overvalued… and now the CEO is pretty darn excited about investing in natural gas assets now that everything is really cheap. There is very very little competition in the GOM because people have been investing in shale instead and it’s been very hard to get permits to drill (so drill rig rates are very low).

    The best time to invest in commodities is usually when the price is very low and everybody is depressed about the market.

  2. GlennC permalink

    As far as gas prices go, they “eventually” have to be much higher because shale plays are not economic at this price. (Then again, people like Contango’s CEO were making this argument last year. He though that natural gas would be between $3-$6.)

    With positive cash flow, no debt, and a small cash reserve Contango should be able to ride out the storm and capitalize on distressed assets. Whereas some/many of their leveraged competitors may be selling their assets cheap to avoid going under.

    • Glenn,
      I agree with you on all the above and think that Contango is a fantastic company. It’s just that I don’t know enough about the oil and gas sector to know whether this is the right time to be invested; if the CEO of Contango can’t forecast gas prices why should I be able to? The point of my post was that I let my investment thesis slide because I was invested in a ‘good’ company instead of focusing single mindedly on it.

      Thanks for the comments.

  3. Jay, great post on sticking to your original reason for buying.

    It’s a lesson I have also learned but find I have to remind myself of often.

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