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As Germany unwinds dependence on Russian oil, this stock stands to gain

BENJ GALLANDER, BEN STADELMANN, and PHILIP MACKELLAR


Wednesday April 13, 2022

How has the war in Ukraine affected your portfolio? That’s a question many investors are asking themselves these days, as the Russian invasion has upended stability in Europe, and with it, the global investment landscape.

As the world adapts to this new and horrific reality, certain market trends are emerging. Defence names are in high demand as countries increase military spending, but the biggest spike in prices as a result of the conflict may be in commodities. This is because Russia is a key global commodity exporter. As sanctions wall the country off, the need to find alternate sources for oil, gas, coal, base metals, precious metals, fertilizer and agricultural products is rising, thereby driving up prices in these sectors. This is another reason inflation is pinching.

North European Oil Royalty Trust NRT-N is one of the names that could be best positioned for the current turmoil. The company has been in business since 1975 and listed publicly since 1981. Here at Contra the Heard, we’ve owned it since 2017, when it was acquired at US$6.52. The enterprise’s royalty business structure is simple – hold the land titles, collect cash on oil and gas sales and distribute the funds each quarter to investors, but let industry heavyweights Exxon Mobil Corp. and Shell PLC explore, develop and pump the resources. In 2021, gas accounted for 92.5 per cent of revenue, while sulfur sales and oil made up the rest.

During 2021, the shares soared 244 per cent and the quarterly dividends added an extra 16.2 percentage points to that return, as energy markets tightened. Today, NRT sits at the intersection of even higher energy prices, Russian sanctions and Germany’s energy dilemma. This is because NRT holds royalties covering some of Germany’s few domestic gas fields. According to Germany’s Federal Ministry of Economic Affairs and Climate Action, the country only produces about 6 per cent of the gas it consumes, which makes any domestic production vital.

Unwinding its dependence on Russian fossil fuels will be difficult and costly, but the calls to do so are growing – domestically, from allies, and from Ukrainian President Volodymyr Zelensky. He regularly argues that economic pain for German citizens is a small cost compared with the ultimate price his citizens and country are paying. According to the BBC, the European Union has spent €35-billion (about $48-billion) on Russian fuel since the start of the war – compare this with €1-billion on weapons to Ukraine, as of April 6. The truth is in the numbers, and these figures look terrible and lopsided given the situation in Ukraine. While countries such as Poland and Lithuania have ended or are set to end their use of Russian energy, Germany has made no such commitment and is dragging its feet.

The Germans are aware of all of this, of course, but they need to balance it against keeping the lights on. As such, they are considering a raft of measures, from nuclear and renewables to diversifying gas imports and increasing domestic fossil fuel production. If more domestic production does occur, NRT and its owners will benefit.

However, there are risks to this thesis. Exxon Mobil and Shell are the parties who control exploration, development and production in Germany. In the past few years, neither company has engaged in exploration or drilling. Calgary-based Vermilion Energy Inc. had an option to explore, but that option lapsed with nothing done. This said, higher prices and government pressure could incentivize more drilling.

The reserve life presents another risk. In 2015, the net gas proved producing reserves (that is, economically viable reserves) were 14,400 million cubic feet (mmcf), but last year they had declined to 5,431 mmcf. With production of 882 mmcf last year, this means the operation has about six years of life left, barring more exploration or the reclassification of uneconomic reserves to proved producing reserves.

Even if more drilling does not occur or the economic reserves don’t expand because of higher energy prices, today’s gas prices are still good enough to increase NRT’s quarterly dividend payouts. The most recent was 25 US cents, triple that of two years ago. The upcoming quarters will likely be higher again.

Income-focused investors interested in this name should also be aware of this stock’s variable dividend. Each quarter, the distribution changes depending on the price of gas and how much the corporation collects in royalties. Though this generates generous payments in a bull market, it is not as lucrative in bear markets. This volatility may be a turnoff for some dividend investors who need or want payout consistency. Still, over the past decade, it has only been less than a dime three times and reached as high as 56 US cents.

NRT’s stock is currently trading around US$17.50, versus our purchase price of US$6.52, and our initial sell target is between US$23 and US$24, far below the US$34 where the stock traded about a decade ago. This means we’re happy to ride the trend, hold our shares, and look for more gains ahead.







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