April 5, 2024
Things I Learned This Week About Scale
To Start the Week. “Oil prices were steady on Monday near five-month highs as markets expect tighter supply from OPEC+ cuts and attacks on Russian refineries while upbeat Chinese manufacturing data supported an improving demand outlook.”
Size Matters. No matter how big or small you are, everyone wants to get bigger and bigger still. Scale matters. Filling under-utilized supply channels, improving buying power, access to capital. And we think it is a great thing and really matters. Small companies should combine with other small companies, so they grow into bigger companies and bigger companies can always benefit from getting bigger. This has been demonstrated lately by the string of mergers, in both E&P, midstream and OFS. But this isn’t just anyone. This is Schlumberger, whose name commands respect even after they changed it.
Gasoline. Sedona, Arizona. Damn.
Just Wow! The world shook this week when SLB, the company formerly known as Schlumberger, announced it was buying ChampionX for $7.6 billion. Billion. In 2018, Apergy was spun out of Dover Corp. into a separate public company with a $2.9 billion valuation. “Soma” Somasundaram continued the leadership of the company post-Dover. In 2020, Apergy bought the Champion upstream energy and chemical business of Ecolab in a deal valued at $4.4 billion. Champion was comprised of the former Champion and Nalco chemical lines. Apergy then changed its name to that of the Ecolab business, ChampionX Holdings. This deal consummates all of those efforts. Soma has done an excellent job taking the company in different directions by applying leading-edge science and monitoring to what has been strictly a production equipment company. It was an all-stock deal, as all the oil mergers have been. Real consolidation, not just buyouts and changed names. According to Spears & Associates data, SLB’s leading global market share in artificial lift was 21% in 2023 while CHX held a 5% share. BKR holds a 14% share in this market for second place while WFRD is third at 8%. In production chemicals, CHX holds a leading market share position with a 23% share followed by BKR at 19%.
SLB CEO, Le Peuch.
“Our customers are seeking to maximize their assets while improving efficiency in the production and reservoir recovery phase of their operations.”
“This presents a significant opportunity for service providers who can partner with customers throughout the entire production lifecycle, offering integrated solutions and delivering differentiated value.”
“Our core strategy remains centered on meeting growing energy demand while accelerating decarbonization and emissions reduction through innovation, scale and digitalization in our core oil and gas business. This acquisition will expand SLB’s presence in the less cyclical and growing production and recovery space that is closely aligned with our returns-focused, capital-light strategy.“
This deal comes after SLB agreed to pay about $430 million to purchase 80% of Aker Carbon Capture Holdings in March, that will be added to the SLB existing carbon capture business, with an additional $150 million earnout. SLB also announced that it will return $7 billion to shareholders over the next two years.
One of My Favorite People. David de Roode and I continue to record podcasts with the most interesting people in the business. One of the most recent just went live. Melissa Cougle is one of the finest and most fun “managements” I have seen. “Charting the Course: Melissa Cougle on Leadership, Risk-Taking, and the Evolution of Ranger Energy Services - An insightful journey through Melissa Cougle's transformative career from the vibrant Baton Rouge to the forefront of the oil and gas industry. Join us as the CFO of Ranger Energy Services shares her profound experiences, from embracing change and overcoming challenges to her pivotal role in strategic mergers and fostering a culture of resilience. Discover Melissa's unique perspective on leadership, the value of taking calculated risks, and her unwavering commitment to her team and the broader industry evolution.”
You can find links to the episode here.
Missing Barrels. The EIA has reported that U.S. crude oil production rose strongly last year, raising expectations for this year. The EIA claims U.S. crude production was up 930,000 b/d year-on-year, while natural gas liquids added another 600,000 b/d. The natural resource investment group of Goehring & Rozencwajg puts out work that I have mentioned before. I have known Leigh Goehring for 25 years. While usually bullish, he has always done excellent work. They don’t agree with the EIA. First, they make the case that the production efficiencies at the beginning of the shale boom weren’t the reason for the rapid production growth but that the companies were drilling their best rocks first. To me, it is a combination of both. As a geophysicist, you would always go for the highest economic probability wells first, and the services industry has made some amazing advancements. But it doesn’t matter. Some technologies can reach diminishing returns and yes, we are down to Tier 2 acreage in many areas. Regardless, from here, G&R have done a great deal of work, looking at the data more closely, and see a “strong reason to believe it is simply incorrect. Instead of accelerating growth, our analysis suggests U.S. liquids growth is overstated by nearly 30% while crude growth is overstated by 40%. Most importantly, our analysis tells us growth slowed dramatically throughout 2023 and is at risk of turning negative on both a year-on-year and sequential basis as early as March or April.” “By the end of 2023, production may be lower by nearly 1 million barrels per day. U.S. crude production could fall by 470,000 barrels per day for the entire year compared to 2023. Although NGLs will likely grow, we do not expect it will be enough to offset crude declines. Total U.S. liquids production (including NGLs) could average 19.3 million barrels per day this year, unchanged from 2023.” If they are right, the oil bulls will celebrate but with WTI currently at $85, I think the party has already started.
Discipline? So, OPEC met this week. Numbers can creep up on you. According to one source, OPEC+ has taken 3.8 million barrels per day off the market in the last 12 months. So now, with Brent at $90, can you hear the taps getting ready to be turned on????? It appears to be no. The Joint Ministerial Monitoring Committee meeting, instead of discussing putting oil on the market, urged Iraq and Kazakhstan, who hadn’t implemented their cuts in full, to come into compliance and provide details by the end of the month on how they will remedy their production failures. The next full OPEC+ meeting is in June. No telling what they will do but whatever it is, they won’t do it until June. So, how high can it go by then??
No Impact? When Saudi announced that it was slowing its pace of production growth, more companies immediately said, usually with a wink and a nod, that they wouldn’t see anything change. So far, Aramco has suspended 12 of its 90 rigs working offshore. There was service work being done on all those rigs. Although suspensions allow for the return to work of the rig by some time, with the lost time added to the original contracts. They aren’t terminations but that means the warm-stack costs are higher. Some of these suspensions are being discussed as lasting 12 months. Only a few of the rig companies have acknowledged any impact but it would seem inevitable at some point with the only real question of how much?
Getting to the Trucks. So, we all now know about the EPA mandate for allowable auto emissions, which basically forces manufacture of EVs. Of course it will end badly, but in the meantime, the EPA has now rolled out new emissions standards for heavy duty trucks, which will force the conversion, costs be damned. Electric heavy-duty trucks make up less than 1% of all heavy trucks, with California responsible for most of that 1%. 60% of new urban delivery trucks and 25% of long-haul tractor sales are required in the state by 2032. An electric semi uses about 7x as much electricity on a single charge than the average house uses in a day. In six years, electric trucks are expected to use 11% of the entire state’s electricity capacity. 15,000 charging stations for these trucks will have to be built every year to reach the EPA mandate. The EPA made the point that with the passage of the Inflation Reduction Act, there are now hundreds of billions of dollars in subsidies for EVs now. I loved this comment – “the EPA projects the new rule will “avoid” one billion metric tons in CO2 emissions from 2027 through 2055 – about as much as emissions from China and India rose last year alone.”
Colorado Won! State Bill 24-159 called for the banning of new oil and gas drilling. It lost. It would have banned new drilling in June, July and August. Existing production would not be affected. And it lost. The oil and gas industry contributes about $2 billion a year to Colorado’s state coffers. Where would the shortfall be made up? Colorado has a balanced-budget requirement, something I wish every state and the federal government would adopt, but that means $2 billion from somewhere else and you are already taxing pot and mushrooms. But this is a good sign of rational thinking over activist ideology. Well done, Colorado.
Pulled Back from the Brink. The odds were high that the Fed would cut rates three times this year. It was a solid bet. Now, maybe not so much. The Minneapolis Fed said rate cuts may not be needed this year. Wow. There goes the bet. Inflation readings in the first two months of the year were termed “concerning”. If inflation doesn’t continue down toward the magic 2%, and the economy stays robust, the Fed may not cut. Hold on to your hat!
Perry Mason. If you remember, the SEC’s new emissions rules were blocked by a judge who granted the stay based on arguments by Liberty and Nomad, two oilfield service companies. The Fifth Circuit court, who issued the stay, is turning it over to the Eight Circuit Court, meaning the stay was lifted but both companies refiled with the Eighth, with the U.S. Chamber of Commerce joining in the fray with its own motion for a stay.
EIA Weekly Report.
Crude Implications: Mixed – build vs expected draw, however WTI 1M-12M backwardation at $9.5/bbl, $2.5 wider w/w. Money managers kept ICE Brent and NYMEX WTI net long positions flat w/w, with net positioning remaining 9% below the peak of Sept/23. OPEC rolled cuts and next JMMC meeting 6/3.
U.S. Crude Production: Indicated at 13.1mm BOPD, unchanged w/w, and up 0.9mm BOPD y/y.
Refinery Runs: 15.9mm BOPD, down 0.035mm BOPD w/w and up 0.3mm BOPD y/y. Utilization at 88.6% improving post turns.
Crude Imports (net): 2.6mm BOPD, up 0.1mm BOPD w/w and up 0.7mm BOPD y/y. Brent-WTI spread at $4/bbl, $0.5 lower w/w.
Gasoline: Bullish – draw above expectations. Demand up 6.0% w/w and down 0.6% y/y.
Distillate: Bearish – draw above expectations. Demand down 13% w/w and down 18% y/y.
Other Energy Market Updates.
Frac Spread Count: There are currently 260 frac spreads operating in the U.S. (a decrease of 5 spreads week-over-week).
Onshore Drilling Rig Count: There are currently 601 drilling rigs operating in the U.S. (no change in rigs week-over-week).
Sell High, Buy High? The DoE canceled the latest tender for crude oil, to rebuild the capacity in the SPR. Why? Prices are too high. Last month, they bought 2.8 million barrels at $81 per barrel, which was higher than its self-imposed ceiling of $79 per barrel. “We will not award the current solicitations for the Bayou Choctaw SPR site and will solicit available capacity as market conditions allow,” the department said. “We will continue to monitor market dynamics.” The government sold 180 million barrels of crude out of the SPR at an average price of $96.25 per barrel.
Nukes! I don’t know how they get around the government red tape but this is a great thing to see. We have long been championing Small Modular Reactors, thorium reactors that can’t go critical. If we can put them on a submarine, it doesn’t have to be Commanche Peak. So, now we are taking electrification to new highs. Remember the discussions of turbines just a year or so ago? Check this out from World Oil. “Small nuclear reactors could make sense as a low-cost, low-carbon, high-reliability alternative energy source for a company like Diamondback whose energy needs continue to increase,” FANG CEO.
Valuation. The Big Four trade at 8.2x this year’s EBITDA and 7.3x next year and Weatherford is still the cheapest of the group! The order is SLB first at 9.8x, with BKR in second at 8.8x and Halliburton coming in third at 7.7x. That is a lot of slippage between them. The pressure pumping companies are trading at 3.2x this year’s EBITDA forecast and 2.9x next year’s. Among the equipment manufacturers, this year is 7.2x and next year is at 6.9x, with Cactus and Technip leading the pack. Are these depressed multiples versus years past? Yes, but then the outlook for oil and gas is very different now than just a few years ago. If you truncate the DCF early, you get a truncated value. As more people understand, the valuation will expand. It just takes time.
Boys and Girls. During El Niño, trade winds weaken. Warm water is pushed back east, toward the west coast of the Americas. El Niño means ‘little boy’ in Spanish. South American fishermen first noticed periods of unusually warm water in the Pacific Ocean in the 1600s. The full name they used was El Niño de Navidad, because El Niño typically peaks around December. El Niño can affect our weather significantly. The warmer waters cause the Pacific jet stream to move south of its neutral position. With this shift, areas in the northern U.S. and Canada are dryer and warmer than usual. But, in the U.S. Gulf Coast and Southeast, these periods are wetter than usual and have increased flooding.
La Niña means ‘little girl’ in Spanish. La Niña is also sometimes called El Viejo, anti-El Niño or simply "a cold event." La Niña has the opposite effect of El Niño. During La Niña events, trade winds are even stronger than usual, pushing more warm water toward Asia. Off the west coast of the Americas, upwelling increases, bringing cold, nutrient-rich water to the surface. These cold waters in the Pacific push the jet stream northward. This tends to lead to drought in the southern U.S. and heavy rains and flooding in the Pacific Northwest and Canada. During a La Niña year, winter temperatures are warmer than normal in the South and cooler than normal in the North. La Niña can also lead to a more severe hurricane season.
Going Green. The Palisades Nuclear Generating Station in Western Michigan is 50 years old and has generated 232,297 gigawatt hours of carbon-free, reliable and affordable baseload power from a single 805 megawatt reactor. Over the last 20 years, this one facility generated the equivalent of 35% of all the solar electricity produced across the entirety of the U.S. over the same period. The rule of thumb for the solar industry is that each 1 megawatt of capacity requires 10 acres of land and, with 25% capacity, it would require 29,000 acres of solar to replicate the annual output of the Palisades plant. This is the clean transition??
Likes. Neil Mehta, a Goldman Sachs managing director, said in an interview that he is very constructive on the Canadian oils, naming Canadian Natural Resources, ConocoPhillips, Devon Energy, Magnolia Oil & Gas and Kosmos as his top five oil stock ideas in exploration and production.
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.
