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Jim Chanos Calls SolarCity A 'Financing Scheme,' Says Oil Pain Not Over

Jim Chanos Calls SolarCity A 'Financing Scheme,' Says Oil Pain Not Over
  • In a report issued Tuesday, James Chanos of Kynikos Associates looked into energy investments after the fall and asked: "Opportunity Or Slippery Slope?"
  • The expert went over some themes present across the energy sector and analyzed some stocks in more detail.
  • Shares of SolarCity Corp (NASDAQ: SCTY) were down 7 percent over the last two days.

About The Energy Complex

Chanos explained that high oil prices and cheap credit drove a ramp in energy exploration and production, while the OPEC cracked and tensions increased on the back of pressured budgets.

The expert then went into the U.S. shale revolution, which changed the game dramatically.

He explained that U.S. crude oil production increased by 55 percent between 2009 and 2014, while net crude imports declined by 20 percent. This made the US the world’s largest oil and gas producer.

However, the problem with unconventional wells was that production was really high at first,  then declined steeply – up to 70 percent in the first year, 50 percent in the second and 30 percent in the third.

Moreover, Chanos noticed, the boom in production has outpaced demand, thus driving oil prices downwards. Consequently, most investors and analysts were expecting to see a decline in production to balance the market.

Instead of cutting production, U.S. E&P companies optimized their cost per barrel and trimmed 2015 costs by 30 to 50 percent. As a result, U.S. production is now anticipated to surge by 6 percent in 2015, even though the rig count fell almost 60 percent over the past year.

Nonetheless, production for 2016 is finally expected to decline 4 percent...but pains are not over in the sector.

Chanos said, “US oil and gas supply currently cannot tap global demand (…) [and] High yield producers are challenged to fund capex in a low price oil environment.” Moreover, investors and management teams are focused on production growth rather than economic returns, not noticing that E&Ps are actually not generating cash. “Despite significant investment, proved reserves have not grown meaningfully for most companies,” he continued; but “E&Ps benefit from tax deferrals as long as drilling continues.”

About SolarCity

The expert the went into SolarCity, which he argued is “Really A Financing Scheme.” In fact, the Elon Musk effect has led investors to conceive SolarCity as a solar company, which is not entirely accurate.

Chanos pointed out several problems with SolarCity.

The company does not enjoy scale advantages; other smaller peers offer similar installation costs. In addition, lease rates are falling faster than costs on the back of increasing competition.

The investor explained that a solar lease becomes a liability when selling a home, and that, "Recent changes [including 30 percent ITC expires and a reduction of net metering in several states] undermine the business model."

Furthermore, returns on invested capital based on lease revenues stand below 8 percent. The company says its leasing business boasts margins above 30 percent, but the business still needs "outside capital to build new systems."

Finally, he noticed that free cash flow was negative in the second quarter, and that management uses "6% discount rate to calculate the net present value of 20-year residential leases."

Latest Ratings for SCTY

Nov 2016DowngradesHoldSell
Oct 2016UpgradesSellHold
Aug 2016DowngradesStrong BuyMarket Perform

View More Analyst Ratings for SCTY
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