HNR : A commodity/inflation play

Harvest Natural Resources (HNR) is an oil producer whose major oil producing assets are located in Venezuela, where it is subject to confiscatory taxes or outright nationalization by Hugo Chavez. Its major attraction is it cash-rich and debt-free status. HNR has approximately $2.85 per share in cash free and clear. The rest of HNR’s value derives from possible cash flow from its Venezuelian assets, as well as oil exploration projects now ongoing in other parts of the world.

HNR has been extensively written up previously (see this excellent article at Seeking Alpha, as well as writeups at Value Investing Club), and I agree with the central theses of these articles. In a nutshell, although contract law does not exist in Venezuela and cash flow is likely to fluctuate according to the whims of Chavez, it is unlikely to drop to zero. In other nationalizations that Chavez has ordered, the companies have been reasonably (but not lavishly) compensated for their losses, and have generally found it desirable to continue operations at low to moderate levels of profitability, if only to extract residual value from their now annexed assets. Chavez is a power-hungry thug, but he also understands that he needs foreign expertise to continue to extract money from Venezuela’s natural resources, and he is intelligent enough to realize that if he wants somebody to work for him, he has to pay them at some level.

My main purpose for investing in HNR is that it is a low-risk high reward way to hedge inflation risks and ride any upside in oil price. HNR should not fall past $3 due to its cash, but can possibly ride up to $10 or more depending on prevailing oil price and Chavez’s whims. I believe China will now vigorously diversify away from its huge US dollar exposure by aggressively bidding for commodities as well as commodity-producing assets. Rather than buying gold (a non-productive asset, and one in which China found impossible to accumulate holdings of any size without moving the gold price), China could stockpile crude oil (a productive asset, and one with a much deeper and broader market) and build a Strategic Petroleum Reserve much like the US has done. Stockpiling an essential input to its economy at historically cheap prices makes a lot of economic and military sense. Along the same lines, I also have positions in ZINC and MEOH, both of which are premier companies in their industries and should serve as excellent inflation hedges.

I now hold HNR at an average buy-in price of $5, and am unlikely to liquidate this position without hitting at least $8-10.