April 19, 2024
Things I Learned This Week Knocking around Texas
Drum Roll Please!! Pull out the crystal balls and the hard questions. It’s earnings season! This is when you find out how right, or how wrong, you were. Too optimistic on revenues? How does that flow through? The incremental margin formula didn’t quite capture the nuance of three months of field operations in far flung regions? If non-recurring charges keep recurring, isn’t that just part of operations? Yes, it is earnings season. To all of my corporate friends, all the best. Tax accountants have very little on you and you have to do this four times a year, not just one. Don’t waste time reading the press release. Anyone who matters has read the press release. Tell us what the most important things in the press release are, in three bullets. No one has a crystal ball. We get that. But you are boots on the ground and we are in office buildings looking at computers. Give us some color for our own crystal balls. And, as always, be blunt and honest. Good or bad. Then you can explain till the cows come home, but blunt and honest first.
Investors. No company’s management should ever run their business on a quarter-by-quarter basis. That is purely reactive, and management strategies should be proactive. Understand that the quarter is a part of a process, not an event. It is 25% of the recipe for the year. And not every quarter will be perfect, but the final product is the goal. And even that is a short-term goal. To expect anything more is to be invested in a company that will not maximize shareholder value. Business is fluid and dynamic, and the broader the scope or geography, the more complex those dynamics become. Good management keeps track of all processes and now has the tools to. But to take a snapshot of any three-month period can only give indications of the future, and the company management can’t spend all of their time analyzing every snapshot every moment. Strategy questions are the fairest game. Strategies can change, and changing a corporate strategy has dramatically more impact on the future of the company than the snapshot of last quarter’s result. Strategies change more frequently than philosophies, but little changes there can matter and it never hurts to ask if the philosophy has changed. You have the opportunity to ask senior management two questions, in front of God and everyone, and that is an opportunity that should not be wasted.
They Walk Among Us.
Big Time. Last week, the Maguire Energy Institute at SMU awarded its annual L. Frank Pitts Award to Kelcy Warren of Energy Transfer fame. Past recipients included Vicki Holub, Jeff Miller, Boone Pickens, Scott Sheffield, Rex Tillerson and others. It is considered an August award. In addition, former CEO and Chair of BP Bob Dudley won the Pioneer award. It turns out that Bob was THE FIRST SMU energy finance grad we had! I first met Bob several years ago when the awards banquet we were attending was invaded by the Extinction Rebellion crowd. Bob and I were commiserating about our home state of Mississippi. Never a dull moment. Good to see you, Bob, and thanks for the plugs, and, of course, congratulations on the award. Ken Hersh moderated a panel before being the interviewer of Kelsy at lunch. He is a very capable guy. He went to work with Richard Rainwater while studying at Stanford. Lots of positive there. He did a masterful job in all his duties. There were a few interesting points and questions made by the morning panel before the lunch.
1) Can the energy transition really happen without a resurgence in nuclear? Great question. We have tons of natural gas, but the mix is being forced from the political top rather the practicality at the bottom.
2) An issue. System operators are tasked for reliability of power but have no new baseload power generation built in more than 10 years. So, the push is in fixing the grid so it can transmit power, but few are paying attention to the sources of energy supply, especially reliable supply. If we don’t have the input, an improved grid still won’t fix the problem.
3) China’s manufacturing industry will flood the market with cheap products since their energy costs are low. Coal. So, as energy prices rise, China exports more, but the U.S. would slap on tariffs. The developing world would see their micro economies get killed. China is seeing a reverse migration with people now moving out of the cities after years of the reverse. Jobs are drying up and the economy is slowing down. Jobs leave, local demand drops, exports increase.
4) Over the last 150 years, the price and reliability of energy mattered most. Period. Now, you have governments forcing the economics to be worse. It won’t hold.
Unintended Consequences. What happens if the U.S. dollar is no longer used for buying oil? Catastrophe and a growing risk. China has created a digital currency, incentivized its use in Asia and now represents 28% of commerce in Asia, even though the percentage of transactions globally is only about 5%. BRICS are doing the same. Russian sanctions accelerated the trend, forcing India and China to use currencies other than the U.S. dollar. Strength of the dollar is how we can have $34 trillion in debt. If the dollar weakens, as its previously mandated use fades, it magnifies issues with our debt. Pay attention to the global use of non-U.S. currencies.
Oh. Wait. International tensions continue to rise. Concerns about supply chains are running very high. There are incidents and situations coming every day now as domestic securities issues abound. What if we lose access? What if supplies are cut off? The solution? Focus on domestic production. Keep it inside our borders to ensure security of supply. In today’s world, it makes great sense. So, what’s the Biden administration’s role? Should the government get rid of or reduce needless rules and regulations? Promote the U.S. doing this. Right now on land and sites so we can keep production here. Provide significant subsidies and incentives to pay for infrastructure and equipment and to ensure these domestic companies don’t lose money! And the really good part is that, right now. He wants to make sure that one of the most critical, important and strategic commodities continues to provide our country with what society needs most to maintain our standard of living. Computer chips. Samsung is getting $6.4 billion from the Biden administration to build a computer chip facility.
Fire Away! You can’t not have AI. Military? Everything in the military has to have every advantage, no company can afford NOT to use AI in as many ways and in as many applications possible. In order to compete. ESG had to be embraced, even though it gummed up the work of business and resource allocation. AI is even more required than any ESG idea since it actually improves efficiencies and optimizes returns rather than being a burdensome cost. When ESG was first implemented, it took two to three years before it became THE topic. AI is less than a year old. Try to imagine where we will be in three years when AI has become a core part of every single part of every business. And, as the learning increases over time, it will get better and better. Brave new world.
It's Early Yet. It’s not hot yet in Dallas. 82 yesterday. Houston, being farther south and a former swamp, is warmer. The sun is shining, the wind is blowing. It’s “shoulder season.” Not hot enough to jack up commodity prices due to weather, similar to early fall. The state of Texas should be flush with energy! It’s not 17 degrees or 113. No pipes are frozen, no power lines are down. Smooth sailing. Except for that pesky request by the Electric Reliability Council. Please postpone your scheduled maintenance to help alleviate tight conditions. Excuse me? This is when we do maintenance, in the shoulder season, when power is flush. If not now, when? First, an additional 475,000 people have come to Texas in the last year, more than any other state. Remember all the concerns about power use for mining bitcoin? It died out after bitcoin crashed, killing the mining economics. Well, it’s back and in the same places, using more power than mining used in a couple of years. And the latest big deal - data centers. An AI chip consumes four to five times that of a conventional chip and look at the AI stocks. There are going to be AI chips in everything. Data centers used about 2.5% of U.S. electricity in 2022 and are expected to reach 20% by 2030. So huge growth in electricity needs for data centers, additional electricity for the conversion to EVs, the expansion of crypto mining, the production of hydrogen and tens of millions more people. And the grid is strained now?? No wonder skeptics abound.
Full Circle. In 2022, Norway’s wealth fund dumped $1 trillion of energy stocks out of its portfolio, saying it had enough energy exposure through its production and that it was in keeping with the effort to get Norway to net zero quickly. Norway has over 200 hydroelectric dams and, with renewables, it has been able to mandate that all taxis in Oslo have to be electric now, and other future mandates. So, it is very easy for them to be “net-zero” while producing oil. Scope 2 versus Scope 3 perfectly. The fund then proceeded to get killed through 2022 and into 2023 as energy stocks outperformed the market. But the pendulum swings. The wealth fund announced a record $109 billion in Q1 profits from its exposure to tech stocks and the continuing boom in artificial intelligence. How is that for a transition??
Coming Up Short. Short interest on energy stocks is up in March. Apache and EQT were the most shorted, Conoco the least. Traders see that the XLE Energy index is up almost 15% YTD and the S&P is up only 7.4%. So, what to do? Short the winners!
Stocks with the Greatest Swing.
APA (formerly Apache) was the most-shorted energy stock, with 22.1 million shares sold short as of March 31, or 5.98% of the shares float.
EQT was second with 5.85% of shares short, followed by Oxy, with a short interest of 5.58%, and Valero with 3.35%.
Conoco was the least shorted stock, with 12.9 million shares sold short, or 1.10% of the shares float, followed by SLB and EOG, with short interests of 1.36% and 1.68%, respectively.
The top two contributors to the energy index, Exxon Mobil (XOM) and Chevron (CVX), had short interests of 2.65% and 2.87%, respectively.
Energy Equipment and Services (OFS) was the least shorted sub-sector, with 2.07% short interest as of March-end, up from 2% at February’s end.
EIA Crude Oil Inventories. EIA’s weekly Petroleum Status Report was modestly bearish for crude oil, showing a small further build in crude oil storage and implied product demand remaining anemic, despite modest product draws for gasoline and distillates. Other key takeaways include no inventory change at Cushing, increase in crude exports, no change in Lower-48 production and an increase in refinery throughput, but small decrease in utilization rate as the EIA adjusted the operating capacity estimate. Commercial crude oil inventories increased 2.7mm bbl, while SPR inventories increased 0.6mm bbl. This marks the fourth straight week of crude oil inventory increases. – ATB
This is Our Timing Model. We first developed this almost 20 years ago. It looks at drilling activity. We first used it when people panicked that the start of every new year, the rig count went down! Of course. Winter weather, road load limits and no budget urgency all contribute to the first quarter slowdown, and then we gain momentum through the year. We are putting this out now, so when companies make bold announcements about increases in activity, you can remember that it usually gets cold in the winter as well.
Stymied. At the beginning of the year, the odds were that the Fed would cut rates four times this year. Recently, it was looking much more like three. Now, the Fed is coming out and saying there may not be any cuts this year. The good news? The economy is doing great. The bad news? We increase our debt by $1 trillion every six weeks.
I Didn’t Know. Arctic LNG 2? I missed that. It seems that Mr. Putin is building this enormous LNG liquefaction facility in the Arctic, a vast region with lots of hydrocarbon potential that hasn’t been well exploited due to technology, or a lack thereof, and disagreements over boundaries. Then the Arctic LNG 2 project. It seems that the U.S. is not satisfied with oil sanctions. Now, it wants to cut off another potential source of Russian revenue by stalling its LNG expansion, and Mr. Putin wants to triple his LNG export capacity over the next several years. That looks increasingly unlikely. The U.S. has now issued four different sanctions on Russia’s business, citing the operators, the shipping companies and all companies involved in the project, making it very difficult, if not impossible in the short term, to expand his business. Only one of a proposed three trains at Arctic LNG 2 have been built, and companies are declaring force majeure on deliveries because of this U.S. pressure. In case you aren’t convinced, “our role is to ensure that Arctic LNG 2 is dead in the water,” a statement made by a U.S. official. We all knew about Russia selling its oil now to China and India, albeit at a discount to the current market, but selling nevertheless. But I didn’t realize that the Biden administration holds the domestic U.S. oil and gas industry and Texas in the same light as the Russian industry, shutting down energy export capacity and punishing them for their views and actions.
Anyone for Nuclear? Do you have a solar panel on your roof? Are you doing your part to save the planet by putting up solar panels? Good for you! At least those who are still doing it. Or maybe not. Not when the state with almost 40% of residential solar panels have their excess sales price cut by 80%. That could almost change your economics (that was sarcasm). All that probably means you don’t have solar panels and it turns out, you are not alone. California, as one would expect, has 37% of the countries solar. Did you ever wonder why that state was pushing storage batteries more than anyone else? Because when the sun is shining, California generates too much energy, that puts capacity strain on the distribution. So the state has to spend billions on expanding the grid, just to account for the highest potential load. So, store it rather than expand the grid. Now the state has cut the price of what they will pay for that gas, to try and curtail supply, all while legislating continued increases in capacity. But as we are finding out with EVs, government mandates may affect production, but it has a much harder time controlling consumption, without real price incentives, which cost money. Demand drops or at least adoption slows. In EVs, the latter, and solar the former. And dropping it is. Over 100 solar installation companies have gone under, 20% of the industry. Homeowner installation is expected to be down 13% this year and accelerating. California generates about 33% of its power through renewables now, with plans to be at 60% in six years. The issues are high interest rates, reduced subsidies and incentives and tight credit. But the point of all that is that the economics of installing solar panels on your roof have changed, and changed dramatically, and changed the direction of demand. Trying to go from 37 miles an hour to 60 miles an hour and your engine starts to sputter? Never a good indicator for winning the race.
Headlines.
Google Fired 28 Employees Who Staged Protests Against a Joint Contract with Amazon to Provide AI and Cloud services to Israel.
Wall Street Bets Against $100 Oil.
Congress Imposed Sanctions on Chinese Financial Institutions for Purchasing Iranian Crude, Part of a Package in Response to Iran’s attack on Israel.
The Fallout from Credit Suisse’s Collapse Keeps Coming. UBS’ Capital Needs May Rise to About $20 billion Under New Rules, a Person Familiar Said.
Opinions Shift Up. Oil is at $85 and Iran has bombed Israel. There is a war premium in oil and, while there is no telling how long it will last or how high it will go, there will be some impact to activity. Major oil companies virtually never change budgets mid-year but E&P companies, who have operated on a cash flow basis more than anything, could increase short term activity and still stay well within cash flow but even as quickly as we can drill, complete and hook up a shale well, oil prices can move more quickly. But there are a myriad of variables and, since I am no longer in the business of recommending stocks, I can at least share the outlook of a sector analyst. How good the recommendations are, we have no insight. But someone believes. One analyst at Morgan Stanley believes that higher oil prices will help, that additional LNG trains, increasing demand by more than 2 Bcf/day, will be online shortly and he is raising his price targets by ~5%. Direction often matters more than amplitude.
Heading into 1Q, we highlight constructive near-term views for HAL, SLB, GTLS, HP, RIG, while we're more tactically cautious on TS, ACDC, NBR.
We reiterate our robust '24-'26 int'l/offshore capex growth outlook — while this is a wide consensus, we still prefer global players — BKR, HAL, NOV, SLB.
We think we may be nearing a point where it's time to lean back into NAM stocks — in shale markets, our short-term preferences favor drillers over pumpers.
Upgrade industry view to Attractive on favorable cyclical positioning, cheap valuations, a potential OSX catch-up versus crude and recent MS energy sector U/G.
It’s Still Real. We have written for some time about the $2+ trillion in real estate debt that must be refinanced in the next couple of years, with the debt currently held by regional and community banks. It is the regional community bank sector that has been seeing the most difficulty and problems in terms of liquidity and financials. It’s been a year now, but a couple of regional banks have already gone under. Then comes the headline today that the tech giants are trimming office space across the country and primarily in coastal cities. The point of the article is that it leaves the landlords in a lurch with low occupancy. Remember that the city of New York has been pleading for companies to bring their employees back to work instead of letting them work remotely because of the loss in tax revenue the city is experiencing. That tax revenue also means rental revenue for the landlords. There have been stories of hotels in downtown San Francisco being turned back to the lenders for the face value of the note. My daughter is a credit analyst at PGIM and she said activity is picking up a little bit, but it’s mainly on refinance. It was talked about a great deal nine or so months ago, and then it seems like it’s been forgotten. But the only thing that’s happened is that the deadline has gotten even closer. Real estate is the one asset that everyone always believes can go only one way – up. The commercial real estate market, especially office space, is getting ready to prove that axiom is no longer true.
Quick Chronology. BlackRock, the asset manager, says one January 2nd that, in keeping with the green wave, they were no longer going to invest in oil and gas. An immediate backlash occurred by state agencies in states that had oil and gas, demanding their managed money back, which was in the tens of billions at least. BlackRock said they were horribly misunderstood and what they meant to say was that their investors were more interested in making more than with being green with their money, and that was their goal too. Just so everyone would recognize the “penitent man” that BlackRock had become, they put the CEO of Aramco on the board. Aramco is the national oil company of Saudi Arabia. Now comes the news that BlackRock is hunting for investing opportunities in Saudi Arabia. It’s been quietly increasing its presence after becoming the first major global investment manager to open an office in Riyadh. As the world turns was just a soap opera.
The New Warfare. I could just leave it to the picture, but I have to say something. The country of Iran, not one of its proxies, fired missiles, drones and cruise missiles at Israel. Tens of missions of dollars of munitions. A cruise missile alone can cost $1 million. One girl was injured. One. No one died. Welcome to modern warfare. We are going to spend millions blasting your infrastructure, that will cost you millions to fix. But get your people out of the way first so no one gets hurt. And you don’t think these conflicts are being served up for media consumption, eventually fed to us. Wow.
Nail in the Coffin. Shallow water drilling activity in the Gulf of Mexico peaked 25 years ago, with almost 100 jackup rigs working in the Gulf of Mexico. Today, it is 18 and new regulations may cut that number as well. We have seen over the past couple of years, the Bureau of Ocean Energy Management (“BOEM”) has been going after companies in the Gulf, even if they got out of the Gulf decades ago. If all subsequent owners of a problem have gone under, they go after you. This week the BOEM announced a final rule that requires the industry to raise nearly $7 billion for decommissioning offshore platforms. $7 billion. They also amended existing regulations by substantially increasing the level of financial assurances that operators must provide in advance. The key metrics? Your financial health and your reserve value. No sense in suing anyone if they don’t have any money. Companies without an investment-grade credit rating or sufficient proved reserves will need to provide supplemental financial assurance to comply with the new rule. Under the new rule, BOEM estimates the industry will be required to provide $6.9 billion in new financial assurances and that, to be more helpful, the BOEM will allow current lessees and grant holders to request phased-in payments over three years to meet the new supplemental financial assurance demands required by the rule.
Power Play. I’m not sure if you have noticed, but nuclear is gaining steam. A poll in 2022 had 51% of Americans in favor of expanded nuclear and it is easily more now. The number of times it is now mentioned in print or at meetings and conferences is dramatically higher than just two to three years ago, as more and more people have gotten educated on the subject. Small modular reactors (“SMR”) are becoming a hot item. Westinghouse, NuScale and Terrestrial Energy are the three big manufacturers. NuScale has had their design certified by the Nuclear Regulatory Agency in 2022 and is approved for use in the U.S. That has spurred oil companies such as Diamondback to at least consider it as an alternative to diesel or natural gas. They are already in use in Russia, China and India, which should tell you something about the technology and its relative cost, three more are under construction, and 65 are in the planning stage. If you can fit it on a submarine or icebreaker… it might be the next big thing. One can hope.
Any and all comments, arguments and rebuttals are welcome!
In addition to my association with PPHB, I serve on three private company boards. Merit Advisors is a property valuation company and I have long been a fan of optimizing how a business is run, not just the tools we make. Merit is in the business of savings companies’ money, actual cash, by doing a much more in-depth and realistic view of equipment and reserve valuations and I am very impressed with their work. I am also on the advisory board of Preng & Associates, a leading executive search boutique that specializes in all things related to Energy & Power. Nova is a gas compression company run by a very dynamic CEO with a very strong board and ownership.
I serve on the Advisory board of the Energy Workforce & Technology Council (formerly PESA), the National Ocean Industries Association (NOIA), and the Maguire Energy Institute at SMU my alma mater.
jim
214-755-3914 | james.wicklund@pphb.com
Leveraging deep industry knowledge and experience, since its formation in 2003, PPHB has advised on more than 180 transactions exceeding $11 Billion in total value. PPHB advises in mergers & acquisitions, both sell-side and buy-side, raises institutional private equity and debt and offers debt and restructuring advisory services. The firm provides clients with proven investment banking partners, committed to the industry, and committed to success.
