Moses and the Wildcatters: An Oil Option

Amid the decimation that is the oil patch, it may be time to look around for value.  Genie Energy is an unconventional oil story if there ever was one.  A reseller of retail electricity and heat in the Northeast, it also is sitting on potentially billions of barrels of oil shale — not shale oil — in of all places Israel.  Given the value of Genie’s core business, at current prices — though they move around quite a bit — it seems like shareholders might get some highly speculative but very large oil reserves for free.  And the company is also drilling in a near-term conventional oil play that might be a big hit.  However, the location of that field — in the Golan Heights — underscores that this is not a stock for the faint of heart.

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It’s been a rough nine months for both crude oil and the State of Israel. If someone had been bullish on either in the middle of last year, they would feel pretty beat up right now. But with the crashing oil price annihilating the market for energy exploration stocks and with the rockets from Gaza having for the moment stopped, it may be the time for value investors to look around for opportunity. For a possible free option on the future of Israeli oil exploration, it’s worth doing the work on Genie Energy (NYSE: GNE), a US listed stock that may provide just that.

For the entire twentieth century, “oil” and “Israel” were not often spoken in the same breath. Israel was abundant in oranges, philharmonics, and advanced technology, but hydrocarbons: not so much. Golda Meir famously lamented that Moses led the Israelites for forty years in the desert to the one spot in the Middle East without oil. That all changed with the discovery of a large gas field offshore of Israel and Cyprus by Noble Oil in 2010, since named the Leviathan Project. Less well-known is a massive unconventional oil shale play onshore at Shefla, controlled by a Genie subsidiary, as well as a more conventional oil discovery in the north in the Golan Heights that it also owns.

Genie began its public life as a spin-off in 2011 of IDT Corporation, a telecom concern controlled by the entrepreneur Howard Jonas, the chairman and CEO, who owns forty-five percent of the shares. The company’s core business is not oil and gas exploration at all, but rather a gas and electricity marketing company based in the northeastern United States. The company was set up in 2004 to take advantage of the deregulation in the $240 billion retail energy market. By law, local utilities must allow Genie to access their infrastructure to resell at competitive rates and are required to take care of transmission, billing and service. In most instances, the local incumbent even guarantees a customer’s receivables for a slight fee.

It works a bit like this: a salesman, either by phone or door-to-door, convinces a customer to switch to Genie, which buys the heat or power in the spot market, adds a margin, and often provides some sort of incentive such as a gift card. The real value proposition is that the customer realizes a rate that tracks the actual spot price, not a hedged fixed cost or one that is burdened by excessive overhead. Some of the customers find this a winning proposition, others do not, leading to a fairly high churn rate. Nonetheless, the sales pitch often works, as utilities are generally not beloved by their customers and often (unfairly) blamed for price spikes. Absent huge volatility in usage or price, Genie itself takes very little commodity price risk under this model. In 2013, over 420,000 meters generated for Genie over $250 million in revenue and $26 million of EBITDA.

The winter of 2014 proved to be a disaster for Genie, however, as it did for most other energy providers in the Northeast. In New York and the surrounding areas, where Genie has 10 percent market share, the unexpectedly extreme cold snap known as the Polar Vortex wreaked havoc, causing energy price spikes of as much as six hundred percent. Even those utilities who had hedged were exposed because usage also went through the roof. Genie made the decision to absorb some of this price spike for their customers in what is traditionally the most important quarter -- but customers nonetheless took out the brunt of their frustration on whoever their provider was, including Genie.

Not surprisingly, Genie’s already high quarterly churn rate spiked dramatically to 6.8 percent and its customer base swan-dived from 427,000 meters at year end 2013 to around 363,000 by June, where it stayed through the end of 2014. Including $5 million of one-off payments to customers made in an attempt to retain them, the reselling business generated just $7.5 million of cash flow on $275 million of revenue. To add the icing on the cake to the company’s woes, the fourth quarter also saw a highly unusual below-cost pricing in the natural gas market by incumbent utilities in many markets, forcing Genie and its brethren to match money-losing rates and temporarily experience negative gross margins in that business line.

Genie believes 2014 was an annus horribilis and makes a good case that this business has stabilized, albeit at a lower level. Absent any surprises – weather-based or competitive – Genie is guiding for between $15 and $20 million of EBITDA and modest growth in meters through a disciplined marketing spend in 2015. Moreover, the company has bought some brokerage businesses, including an Avon-style pyramid marketer of the same services, which it believes will make its customer base both more sticky and itself less dependent on the spot market.

As noted above, however, the excitement is not really in the Northeastern United States. Where things get really interesting is in the highly speculative but potentially large oil plays, particularly those already mentioned in Israel. The company’s subsidiary Genie Oil & Gas (GOCAS) owns potentially billions of barrels of oil from conventional and unconventional resources in various early stages of exploration. Serious investors including Jacob Rothschild, Rupert Murdoch, and Michael Steinhardt, who serves as the division’s chairman, together own nine percent of this oil and gas subsidiary. Its advisory board includes Vice President Dick Cheney, former CEO of Halliburton. But the company’s greatest asset may in fact be its chief scientist, Harold Vinegar, who filled the same role at Royal Dutch Shell. Vinegar has 295 patents to his name and owns 10% of the Israeli projects.

Of greatest near-term interest is a conventional oil play the company stumbled upon that is held in GOCAS’s eighty-eight percent owned Afek Oil & Gas subsidiary. While prospecting in the north in the Golan Heights, the company discovered signs that oil was flowing at an unusually shallow level, indicating some sort of geothermal event that might indicate the presence of a large resource – one that could be recovered at decent prices. “We believe there could be a very significant resource in our license area,” Howard Jonas remarked on the company’s recent year-end earnings call. “If our working premises prove to be correct, it could be a game changer for both Genie and Israel.” Genie's geologists believe that this resource could add up to millions of barrels of oil and its commercial team believes that there is enough evidence to merit a methodical exploration program.