April 12, 2024
Things I Learned This Week in Midland and Houston
First, The Oil Industry is Doing Well. I was introduced just this week by someone saying I would NOT predict oil prices. I immediately told him he was wrong and that oil could go above $80 any day now. I stand by that. So there, Marshall! Oh, wait. It’s what now?? Never mind.
“If You Can’t Make Money at $75 Oil, You Shouldn’t be in the Business.” Okay, so now the test begins. The companies that are making money need to have plans to make their operations more efficient since we are in a mature, broadly zero growth industry. Companies that aren’t making money better have plans to start making money soon and make up for lost time. If you lose money, your equity value declines regardless of cash flow. That is a statement of fact. Not an opinion. So, you have to make a profit. If you aren’t, it better be around the corner.
Midland. This week, PPHB held a breakfast in Midland at the Petroleum Club. We had about 50 attendees. I moderated a panel of exceptional people. Sean Rice from SCF Partners and Matt Schovee from Black Bay, both private equity guys, Sam Sledge, the CEO of ProPetro, a Permian focused frac company and Greg Mabee, a fifth-generation local landowner with a very active water business.
Come Back. One question centered on what needs to happen before investors start coming back to the sector and capital is more available. The answer was “continue to perform”. That means maintaining capital discipline, making an actual profit and growing returns. We get impatient. The sector was a terrible investment for ten of the last thirteen years. We have a lot of trust and confidence to rebuild, and you don’t do that in a day. On road shows, portfolio managers are coming to the meetings but not buying the stock. At least not yet, but just having them come to a meeting is an improvement. Cash flow is critical to running a business. Free cash flow is what’s left in the end. But profit, a positive net income line, is now being seen as the most critical valuation metric, since, in a mature, slowed growth industry, profits and capital returns are expected.
Symphony. There was a great deal of discussion about the continued growth in U.S. production. As we have written, when production hit 13.1 million barrels in November, that was the top and we were expected to roll over from there. But we didn’t. Production is expected to hit 13.2 million barrels this month. But how? The rig count hasn’t moved, DUC activity hasn’t changed, EIA data says production productivity is declining. How? The result of a multitude of digital technologies and analog practices that are getting much more integrated and efficient. Every company in the industry, large and small, has been working overtime to make their tool/program/equipment the “Best!”. As all of these leading-edge technologies come into the market and supply and service chains are optimized, the orchestra only improves. Production moves up. It isn’t the advent of some new whiz-bang technologies. It is the result of all the new technologies we have, now operating at a much higher level of cooperation. Getting the kinks out of the digital systems, reducing human exposure. Optimizing the entire system, rather than just drilling the well in six hours less than planned. Optimization of the “enterprise,” which is a wide definition.
Strategy. From a strategic perspective, it was viewed that consolidation was positive and that rational long-term thinkers are what the industry needs, likely feeding off of consolidation. The point was also made that the efficiencies being seen today in the industry are not just the impact of technology but the entire new mindset creeping into the industry of making sure we are helping our clients produce oil and gas as cheaply as possible, and that technology is the enabler of that mindset.
Pick One. On the topic of oil, natural gas or water, where would you rather play? Many were surprised at the size and potential of water, normally thought of as a costly and cumbersome byproduct, not as an actual economic opportunity. There are few guarantees in the world, but the fact that water production in the Perman will continue to grow is one of those guarantees and in an industry that is realizing it is a mature, slow-growth industry, chasing one of the few growth drivers is increasingly critical.
Powerball. The discussion of power was interesting as the idea of a nuclear resurgence gained steam. As we wrote last week, FANG is looking at a Small Modular Reactor to power its Permian activities. While we will take the “under” on the near-term likelihood, just the fact that it is being discussed is a positive to me. Highline power has been used by some pressure pumping companies, primarily Halliburton, but that fleet can pull 30-40MW of electricity, which is enough to power a small town so few participants on the panel expected that to become very widespread, at least not yet. And remember that the oil and gas industry is not the only one looking to electrify and that the trend is already over five years old.
Big Daddy Data. Levering and optimizing data continue to be a critical issue and huge opportunity. For years, we have collected data that we can’t make complete use of yet, due to computer limitations. Those limitations have fallen away over time, but the complexity of the problems expand as well. Big Data AI was talked about as a next big thing. Yes, AI will change many parts of the industry and our lives. It will take efficiencies to new levels. It will have a tremendous impact on our industry. One impact will be the enormous energy needs this will bring along. AI chips consume 4x-5x the power of regular chips, and AI chips are going to go in everything.
U.S. Energy Markets Update with Key Highlights from PPHB:
Commodity Prices: WTI crude oil is currently $85.44 per barrel (down ~1.3% week-over-week) and natural gas is $1.89 per MMBtu (up ~6.8% week-over-week)
Crude Oil Production: U.S. crude oil production is currently ~13.1mm BOPD (up ~6.5% year-over-year)
Crude Oil Inventories: U.S. crude oil inventories increased by 5.8mm barrels week-over-week vs. an estimated increase of ~0.9mm barrels
Frac Spread Count: There are currently 257 frac spreads operating in the U.S. (a decrease of 3 spreads week-over-week)
Onshore Drilling Rig Count: There are currently 600 drilling rigs operating in the U.S. (a decrease of 1 rig week-over-week)
Fading Fed Cut Bets. All the encouraging economic data recently has tipped bets toward fewer Fed rate cuts this year. Markets now favor just two reductions in interest rates, with swaps implying around 60 basis points of easing. That’s weighing on Treasuries with yields on 10-year debt within striking distance of the key 4.5% level some watch to determine whether rates revisit last year’s highs. Comments from Federal Reserve Bank of Dallas President Lorie Logan added to the more hawkish picture, after she said it’s too early to consider cutting rates at all. On Friday, the chance of a third cut was still above 50%.
Tension in the Middle East. There are two big political issues currently impacting oil prices and the world. The first is the concern that Iran will strike back after a drone attack by Israel killed one of Iran’s top generals who was advising Hezbollah in its attacks across the region. Iran said it asked the U.S. to “step aside so that you don’t get hit.” No one is dead sure what “step aside” means, but the threat of some additional Middle East violence appears inevitable. The U.S. asked Iran not to hit American targets, but no comments from Iran have been made public. NBC, citing two unnamed U.S. officials, said the Biden administration is mainly concerned that any attacks would be inside Israel, and specifically against “military or intelligence targets, rather than civilians.” The Islamic Republic has said it will deliver a “slap” to Israel. Hezbollah’s leader, Hassan Nasrallah, said a response from Iran is undoubtedly coming but that his group won’t “interfere in such decisions.”
Number Two. The other point made to me this week was the risk of assassination of MBS in Saudi. Very anxious to sign the recognition of Israel and entering a joint defense treaty with the U.S., MBS looks like he was on the wrong side of a couple of situations, and he has five brothers who “know” they can do a better job. This was brought to my attention this week, and it makes sense. Saudi dropped all preconditions on the Israeli deal and wanted to hurry the signings, and it is popular theory that Iran ordered Hamas to attack Israel with the singular goal of getting the agreements cancelled. Ergo October 7th. Predicting Black Swans is important, so this may not be one of those!
Headlines.
Europe Needs €800bn to Meet 2030 Climate Targets, Says Industry
The Planet Has a Record 2,781 Billionaires Who are Worth a Record $14.2 Trillion
Venezuela’s Government Sent an “Anti-Fascism” Bill to Congress that Will Tighten the Crackdown on Its Opponents Ahead of Elections this Year
Iran Tells U.S. to Step Aside as It Readies Response to Israel
Tehran Warns U.S. “Not to Get Dragged Into Netanyahu’s Trap”
Islamic Republic Says It’ll Respond to Syria Consulate Strike
Interesting Observations. “Despite the stark reduction in Texas activity levels year over year, both Permian & Eagle Ford production remain resilient. Based on data from the most recent EIA drilling productivity report, Eagle Ford oil & gas production are up ~2.1% and ~5.2% year over year. For the Permian, which includes New Mexico here, oil production is up ~9% year over year while gas is up ~12%. Both basins continue to draw down DUCs. We estimate the current Eagle Ford DUC count of ~349 is down ~20% year over year (Feb-24) and the Permian is down ~15% to ~883.” - Timm Schneider
Is the U.S. Oil Production Boom Fading? M&A Activity Suggests So. Rextag, part of HartEnergy, said that so far this year, the E&P sector has seen $55 billion in transactions versus $190 billion last year, the highest ever for the Energy Sector. Why, because the big companies buying the smaller companies will impose disciplines on them that will likely reduce production or at least production growth. On average, the five largest private E&P companies represented one-third of the annual crude production increase in the Permian since 2019, according to Rapidan Energy. Rapidan makes the argument that the large increase in oil production last year came from three main things – 1) more oil from small companies, 2) better drilling techniques and 3) DUCs. They don’t think that can be repeated and that the one million barrel per day increase in production last year will amount to just 300,000 in incremental growth this year. But with the rig count where it is and production still growing, many are rethinking their outlook.
Call and Raise. Citi Research published its Value Creators Focus List of small and mid-cap stocks. In Energy, the winners were:
Fluence Energy Inc. (FLNC): Price Target: $32, EPS Estimates for 2024: $0.40
Nov Inc. (NOV): Price Target: $25, EPS Estimates for 2024: $1.72
Shoals Technologies Group (SHLS): Price Target: $20, EPS Estimates for 2024: $0.61
Hate This. Scottish Police receive 8,000 ‘hate speech’ reports, one every minute. A new hate speech law was put in place in Scotland at the beginning of the month. It seems that someone misgendering a trans person can be sentenced to seven years in prison should it be considered “stirring up hatred.”
PR Move. So Saudi Arabia announces that, instead of cutting another million barrels of production, it was going to slow down its efforts to add another one million barrels to production, with the goal of getting oil prices higher on the same volumes and make money based on a statement. It was brilliant. Now, we see 12 of the 93 jackup rigs working in Saudi get “suspended” as part of this effort. But the offshore sector of Saudi is after natural gas, not oil. For the companies that were working on the gas directed drilling offshore, they will likely slow down. For the companies working on maintaining existing production and growing oil production, it could still be business as usual.
Bulletin. Earlier this month, Antifa and far-left extremists confronted people protesting a proposed mass migrant center in Dublin, Ireland. Antifa were beaten up in the brawl and reportedly dropped some of their electronic devices while fleeing. The phones reportedly show close cooperation between Antifa operatives, media and nonprofit workers.
The Bugaboo. The following chart shows the expected trajectory of carbon in the atmosphere, where it makes up 0.4% of the air.
Regulation Time. The SEC has adopted the Climate-Related Disclosure Rule, which will require large publicly traded companies to disclose climate action, greenhouse gas emissions and the financial impacts of severe weather events. The rule will be phased in, beginning in 2026. The SEC Fact Sheet states:
The final rules would require a registrant to disclose, among other things: material climate-related risks; activities to mitigate or adapt to such risks; information about the registrant's board of directors' oversight of climate-related risks and management’s role in managing material climate-related risks; and information on any climate-related targets or goals that are material to the registrant's business, results of operations, or financial condition.
Further, to facilitate investors' assessment of certain climate-related risks, the final rules would require disclosure of Scope 1 and/or Scope 2 greenhouse gas (GHG) emissions on a phased-in basis by certain larger registrants when those emissions are material; the filing of an attestation report covering the required disclosure of such registrant’s Scope 1 and/or Scope 2 emissions, also on a phased-in basis; and disclosure of the financial statement effects of severe weather events and other natural conditions including, for example, costs and losses.
The final rules will require a registrant to disclose:
Climate-related risks that have had or are reasonably likely to have a material impact on the registrant’s business strategy, results of operations, or financial condition.
The actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook.
If, as part of its strategy, a registrant has undertaken activities to mitigate or adapt to a material climate-related risk, a quantitative and qualitative description of material expenditures incurred and material impacts on financial estimates and assumptions that directly result from such mitigation or adaptation activities.
Specified disclosures regarding a registrant’s activities, if any, to mitigate or adapt to a material climate-related risk including the use, if any, of transition plans, scenario analysis, or internal carbon prices.
Any oversight by the board of directors of climate-related risks and any role by management in assessing and managing the registrant’s material climate-related risks.
Any processes the registrant has for identifying, assessing, and managing material climate-related risks and, if the registrant is managing those risks, whether and how any such processes are integrated into the registrant’s overall risk management system or processes.
Information about a registrant’s climate-related targets or goals, if any, that have materially affected or are reasonably likely to materially affect the registrant’s business, results of operations, or financial condition. Disclosures would include material expenditures and material impacts on financial estimates and assumptions as a direct result of the target or goal or actions taken to make progress toward meeting such target or goal.
For large accelerated filers (LAFs) and accelerated filers (AFs) that are not otherwise exempted, information about material Scope 1 emissions and/or Scope 2 emissions.
For those required to disclose Scope 1 and/or Scope 2 emissions, an assurance report at the limited assurance level, which, for an LAF, following an additional transition period, will be at the reasonable assurance level.
The capitalized costs, expenditures expensed, charges, and losses incurred as a result of severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise, subject to applicable one percent and de minimis disclosure thresholds, disclosed in a note to the financial statements.
The capitalized costs, expenditures expensed, and losses related to carbon offsets and renewable energy credits or certificates (“RECs”) if used as a material component of a registrants plans to achieve its disclosed climate-related targets or goals, disclosed in a note to the financial statements.
If the estimates and assumptions a registrant uses to produce the financial statements were materially impacted by risks and uncertainties associated with severe weather events and other natural conditions or any disclosed climate-related targets or transition plans, a qualitative description of how the development of such estimates and assumptions was impacted, disclosed in a note to the financial statements.
Now Eclipses and Earthquakes are Racist.
Panel Questions Asked at PPHB Midland Breakfast. Something to Think About…
Please Come Back. You have investors and clients that wonder what catalysts are needed to get capital and interest back into the Oil & Gas world?
Symphony. What technologies do you see coming up in your respective businesses that you are most excited about and will make some real difference to your business?
Pick One. We love oil, don’t love natural gas (right now) and are dealing with increasing amounts of water. Which of those three commodities excite you the most?
Powerball. High-line power, battery banks, turbines and now nukes? How does the Electrification of All Things impact your business today and going forward? Who wins in the provision of field power?
Regulation Time. Is this a cost or an opportunity?
SLB and ChampionX, Patterson and NexTier, Dril-Quip and Innovex. Will the consolidation binge currently underway impact you? How do you play in that game?
What Motivates You? Do you run your business with ROIC targets or CF targets or any other performance metrics? Where would you like to be?
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.
