Last week my wife and I met with our financial advisor to discuss the performance of our investment portfolio for the year, and you can imagine how that went. At meeting time, all major domestic stock indices were down 20% - 30% YTD and the bond funds, although better, were still awful. Even our alternative positions, that were intended to buffer market gyrations, had suffered. All the numbers in my portfolio were red… that is, except for those in the recent Five States funds, specifically FSPA 2020 and FSEI 2021. Those funds have performed exceedingly well so far in 2022 and investors in those funds will enjoy reading about them in this issue of The Producer.
Now to be fair, oil and gas properties are diminishing assets and over time, as we produce and monetize reserves and distribute profits to investors, production naturally falls off and likewise we expect cash flows to decline. Because of this “behavior”, investors who enjoy cash flow generating investments like Five States’ funds may choose to reinvest some of the cash flow from one fund into future funds… essentially creating a “fund ladder”. But this strategy begs some questions.
First, when will be the next opportunity to participate in a Five State fund? Our latest oil and gas fund closed to new investors in July and about 65% of its capital is deployed, but our next fund is right around the corner; we plan to issue FSEI 2023 early in the first quarter of the new year.
Second, given that oil and natural gas prices have fallen off highs seen earlier this year, and in the face of a possible global slowdown, is now the right time to invest in this segment or is it too late to jump in? The answer to this depends on an investor’s perspective and risk tolerance. We believe it is still a very good time to “join the party” based on our observations of the market:
With respect to items 1 and 2 above, we are still seeing a good amount of deal flow in the size and with the quality of assets we target. Case in point, the Wyoming asset package we acquired in August for FSEI 2021 was a $6 million purchase that we conservatively priced to yield an unlevered PV18. In this case, Five States was invited by an operator to buy a significant fraction of a larger package. Note that “invited” is an operative word; Five States was invited to join this deal because our funds have investment capital ready, and once we got comfortable with the asset, there was complete certainty we would have cash-in-hand at closing time. Without a doubt, it was Five States’ reputation for certainty and speed of closure that brought this opportunity to us. I have mentioned frequently in prior Producer letters and webinars about the underinvestment in oil and gas development since 2015 and the cash-starved environment it has created; this is an example of how the current environment is working to the benefit of the Five States business model.
Regarding item 3 above (the sustainability of oil and natural gas prices), just about every metric used to forecast prices suggests that there is upward pressure on prices over a prolonged period of time. The one major factor currently running counter to this and putting downward pressure on prices, is the slowing of the global economy. While this cannot be ignored, a slowing economy could reduce prices, which should lower property values, which in turn could yield more and better deal flow (items 1 & 2 above), so that when the economy recovers, we are well positioned to benefit from that recovery. Our 12-year fund cycle allows our funds to weather these downturns and take advantage of the economic recovery. Having seen this many times in the past, our hope and expectation is that the Five States business model can and will prevail in the form of very good financial performance. Regardless of what the future holds, the Five States team will continue to work every day to maximize the performance of our funds on behalf of our investors. We thank you for being among them.