Things I Learned This Week in Galveston

August 18, 2023

The Beach. I stayed at the updated Grand Galvez Hotel, a 100-year-old masterpiece overlooking the Gulf of Mexico. Dinner at Guido’s was spectacular. (Thanks David!). Summer is winding down in Galveston, which is probably the best time to go. Why was I in Galveston, you ask? The Energy Workforce and Technology Council, the major trade association for the OFS industry, held its 2023 Safety & Technical Conference this week and I was flattered to have taken part.

Meetings. There was a big focus on HSE, Health, Safety and Environmental. That is what we called it before ESG came along and made it political. You can’t get five guys from the oil industry in a room without having a safety moment. We lost over 50 people last year in the industry. The importance placed on HSE by this industry cannot be understated. Well servicing, completions and wireline were all well represented. NexTier, SLB, and Lockton were the main sponsors.

People. One of the most interesting comments was the need to bring back shop and woodworking in our high schools. One company is working with the state of Wyoming to begin vocational training classes. Start giving a head start since we are short of good people now due to the negative media slant on our industry. The continuing need for technology in a sub-sector that is one of the most basic. But productivity gains and improved recoveries are key. Reducing manpower is tough with a two-man crew. From an emissions side, it isn’t in the same league as frac spreads and drilling rigs, so any further improvement on that would be very marginal and at an unlikely-to-be marginal increased cost. Labor costs have risen dramatically in the last few years and the incoming talent pool continues to shrink. Companies are shifting their recruiting strategies, but all of this pushes automation even faster.

Reality. Everyone in our industry understands we will be needed for a very long time, and they are coming to understand that while that is true, it won’t be the go-go growth of the industry’s past. Right now, this is being viewed as a small correction and not a crash or cycle. They are very likely right. And it’s easier to say that when oil is $85, and it was much harder at $60. No drunken sailors, no one out over their skis, no ‘drill-baby-drill’. There is a renegade or two, but the industry as a whole has shifted to a very different direction than in the past. And that should be a very good thing for our industry. Fast growth? Some kind of tech that can be levered? The base of the industry? 3-4% growth may be all we get for a while. That just sharpens the focus on generating high ROICs and returning cash. Heck, we are already there!

Chilly. As if it wasn’t already a known issue, China’s top energy official is stepping up secrecy of information to “protect national security in an increasingly hostile international environment”. The U.S. and China are not yet in a “cold war” but at least a “chilly conflict”. Export controls on technology, supply chain alternatives and investment limitations all aimed at China fall below the radar of us common citizens, but the hostility between the countries is stepping up and keeping their energy use, consumption and production numbers private exacerbates the situation.

EIA Weekly Crude Report

Crude draw was above expectations. WTI backwardation between 1M-12M is $5.30/bbl, $1.30/bbl narrower w/w. SPR was higher by 0.6 MMBBLs. Money managers’ net long positions in ICE Brent and NYMEX WTI are 7% below their recent peak in April suggesting market positioning is less of a tailwind moving forward. WTI is $3/bbl lower w/w and $2/bbl below the April peak.
U.S. crude production: indicated at 12.7mm BOPD, a post-pandemic record high, up 0.1mm BOPD from the previous week, and up 0.6mm BOPD from the same period last year.
Refinery runs 16.7mm BOPD, up 0.2mm BOPD w/w and 0.3mm BOPD y/y. Utilization at 94.7%. A peak of seasonal demand is imminent but hurricane and fall turnaround season are on tap, reducing refinery runs.
Crude Imports (net): 2.6mm BOPD, down 1.8mm BOPD w/w and up 1.4mm BOPD y/y. Brent-WTI spread at $4/bbl, up $1/bbl w/w.
Gasoline: Demand down 4.8% w/w and down 5.3% y/y.
Distillate: Demand down 3.0% w/w and down 7.1% y/y.

Snippets.

Barbie is now Warner Bros. Discovery's highest-ever grossing domestic movie, topping $537mm at the box office to date
U.S. natural gas pipeline exports to Mexico set monthly high in June. We ship 6.8 Bcf/d of natural gas to Mexico
Forgoing steaks may be one of the most efficient ways to reduce our carbon footprint
Russia just publicly accused Deep State actors and Big Pharma of manufacturing the Covid pandemic to take over the world; they even listed Obama, Clinton, Biden, and Soros, of being the main “Ideologists” behind the plot

Investor Sentiment? The Vietnamese electric car company VinFast has sold 740 cars in the U.S.; their total production of only about 18,000 vehicles so far doesn’t make them very large. Recent valuations put the value of this company higher than General Motors or Ford at over $65 billion. Their revenues last quarter were $65 million and no, they’re not making money. But if you wondered where investors are interested, this demonstrates it, a Vietnamese car company worth more than the combined value of the top three or four oilfield service companies who have been around for decades. The company was formed in 2017. Right now, they have to import all their vehicles into the U.S., all 740 of them, but they do plan to build a $2 billion factory domestically. All that sounds rosy, but they’ve already noted that sales have begun to fall. This is a trend. We’re seeing situations across the industry where there was a big rush to buy, the manufacturing companies rushed to build, and then demand flattened and started to go down. Sound familiar? But this is what is hot today for investors in spite of all the evidence. Why? The government. The number of programs that are having tens of billions spent on them today would not be economic without government support. It was an economic industry. There was a recent interview with several major oil company CEOs in Europe, and they all raved about the Inflation Reduction Act and are shaping business units around it to take advantage of its largesse. They all admit it wouldn’t be economic or even close without the IRA subsidies. But they’re smart enough to realize that if somebody’s going to spend money, we should be smart enough to sell them something. The problem is right now what they want is not what we have. But hype only lasts for so long and in the end reality takes hold. We’ll see.

Crack? PCP? Coke? Ludes? Now Captagon. It is an amphetamine type of drug that trigger bursts of energy, productivity, delusions, euphoria, and a sense of invincibility. Oh great. Now the fun part. It comes from Syria and is mainly used, for now, by poor and lower-class workers in the Arabian Gulf region. Estimated to have generated over $10 billion in sales over just the last three years, it will start hitting our shores soon.

Key Industry Insights. We have written about how E&P inventories of Tier 1 wells are dwindling; depth of inventory is a critical variable, and productivity per well has been edging down. Enverus published a report that agrees with us. That is always nice! “The U.S. shale industry has been massively successful, roughly doubling the production out of the average oil well over the last decade, but that trend has slowed in recent years,” said Dane Gregoris, report author and MD at Enverus. “In addition, we’ve observed that decline curves, meaning the rate at which production falls over time, are getting steeper as well density increases. Summed up, the industry’s treadmill is speeding up and this will make production growth more difficult than it was in the past,” he said.

Their key takeaways were:

Even though recoveries from the average U.S. shale oil well have doubled in the past decade, production profiles for the average well have steepened more than half of a percentage point annually since 2010.
In the Permian, home to most U.S. oil output, the average Midland Basin oil production profile has steepened by half of a percentage point each year since 2014. The Delaware Basin has steepened even more since that time.
EIR expects Permian-type curve shapes to continue to steepen over time as the basin gets more densely developed. As a result, average breakeven prices will rise.

Flared. Around 80% of Venezuela’s gas production is associated with the production of crude oil, and the country is expected to flare an average 2.1 Bcf/d in 2023, according to Gas Energy Latin America, down from 2.6 Bcf/d in 2022. That is 53% of the country’s natural gas production going up in flames. The entire U.S. flared that much at its peak. Gas Energy estimates that only 7% of Venezuelan consumers have direct residential gas access. This compares to around 70% in neighboring Colombia.

Automatic. Nabors has successfully converted all four of its Hess Corporation drilling rigs working in the Bakken to highline power. Nabors installed its Canrig PowerTAP Highline Power Transformer Module to enable direct power from the utility grid. Backup onsite generators ensure power goes uninterrupted should an outage occur. Over the next five years, Hess expects this fully electric Bakken drilling fleet will reduce greenhouse gas emissions from its Bakken drilling operations by approximately 50% and energy costs by approximately 70%. Powering drilling operations with electricity also reduces noise and truck traffic. Hess said during the project’s pilot in 2022, the use of electricity as the primary energy source increased rig reliability by providing a secondary power source. Hess expects electrification of its rigs and access to highline power to also reduce downtime.

Smart. Finally, someone seems to understand reality. “Expectations of a linear global transition have been shaken as climate goals coexist with priorities around energy security, energy access and affordability," said Joseph McMonigle, Secretary General of the IEF, in a press release. "Instead, a ‘multidimensional’ approach is required that is inclusive of different situations in different parts of the world, reflecting varied starting points, a diversity of policy approaches; and is equitable.” The principal finding in a new study titled, “Shaping a Living Roadmap for Energy Transition” is that the energy transition is far more complex than has previously been thought, and is proceeding on a non-linear progression involving multiple transitions in different parts of the world. The study is a collaboration between S&P Global and the International Energy Forum. The goal was to capture views and information from those with firsthand knowledge regarding the direction of the varied energy transitions in widely disparate regions of the world.

Sticky. Those pipeline workers aren’t coding yet. For all the talk of a clean-energy future, few U.S. workers leave fossil-fuel industries to move to a green job—especially older employees and those without college degrees. Researchers at Wake Forest and Penn universities analyzed job changes in more than 130 million profiles and found fewer than 1% of all “dirty job” workers seek greener pastures.

Blowing It Out. Global oil demand has surged to a record high amid robust consumption in China and elsewhere, threatening to push prices higher, the International Energy Agency said. World fuel use averaged 103 million barrels per day for the first time in June and may soar even higher in August, the agency said in a report. As Saudi Arabia and its partners constrict supplies, oil markets are tightening significantly. The IEA forecasts continued, albeit slower, growth for oil demand in 2024, pointing to “lackluster economic conditions,” new electric vehicles and the “post-pandemic rebound running out of steam.” “Oil demand is scaling record highs, boosted by strong summer air travel, increased oil use in power generation and surging Chinese petrochemical activity,” the IEA said. “Crude and products inventories have drawn sharply” and “balances are set to tighten further into the autumn.” Oil this week touched a six-month high above $88 a barrel in London amid the post-pandemic resurgence in fuel use and supply restraint by the Saudi-led OPEC+ alliance.

Energy Shift. The energy transition looks set to have an impact next year, when global demand growth will roughly halve to 1 million barrels a day due to improved vehicle efficiency and the adoption of electric cars, the IEA said. But for now, the world markets are tightening, leaving oil inventories in developed nations about 115 million barrels below their five-year average, according to the report. Global stockpiles are set to deplete by a hefty 1.7 million barrels a day in the second half of the year, and preliminary data appears to confirm declines in July and August. Major consuming nations have criticized the Saudis and their allies in OPEC+ for constricting supplies, warning that a renewed inflationary spike would squeeze consumers and endanger the global recovery. Nonetheless, Saudi said it could deepen current cutbacks if necessary. Global oil demand is expected to increase by 2.2 mb/d to 102.2 mb/d this year, continuing the recovery from Covid, with China accounting for more than 70% of growth. With the post-pandemic rebound running out of steam, and as lackluster economic conditions, tighter efficiency standards and new electric vehicles weigh on use, growth is forecast to slow to 1 mb/d in 2024.

Money. Mortgage rates are at a 20 year high. Sounds amazing until I realize my first mortgage was at 12% and I got a deal!

Real Estate Crash. So Evergrande failed, with $331 billion in debt in 2020. The market stabilized over the next year, and now another Chinese real estate developer is about to go under. Country Garden has four-times the housing units of Evergrande. They missed their bond payment on a tranche of USD denominated debt. The developer built over 3,000 housing projects across China, compared to 700 projects Evergrande has across the country. We just always assume China will keep plugging away, giving bad information and still operate a very strict centralized government. But the wheels are coming off. Country Garden, a 31-year-old company, saw their sales drop 60% in July. It is expected to lose a record of almost $8 billion in Q2, before the sales drop. Country Garden said its profit margins had shrunk, property projects have lost value, apartment sales have declined for four straight months and refinancing had become harder. That is the Full Monty! According to the CIO of Kaiyuan Capital “The (real estate) market is now substantially un-investable.” The systemic risks are dramatically larger than previously anticipated. Think of all those empty cities we saw on the news? China has been the growth engine of the world for the last several years. Now they are having a crash in their real estate market. Not tech stocks. Real estate. That is a much deeper devaluation. Will this be what causes the long-rumored recession to hit? We have grown somewhat immune to any news about China. Too complicated in something we don’t care about. But that is starting to change. The focus on the likelihood of China making some move on Taiwan has definitely increased but the day-to-day diplomacy efforts are ignored. This is something we should tune into and pay attention to. A rethink on supply chains?

Pipe??? U.S. Steel surged premarket after it rejected a $7.25 billion takeover from Cleveland Cliffs that promised to create one of the world’s biggest steelmakers.

More China. China’s troubles worsened as shadow bank Zhongrong missed payments on dozens of products. Adding to concerns, authorities asked some mutual funds to refrain for a day from selling more onshore shares than they buy, people familiar said. That never works. If China’s economy is really in trouble, what does it mean for everyone else? The alarm from officials in the west is growing deafening. U.S. Treasury Secretary Janet Yellen said the slowdown was a “risk factor” for the American economy, while President Joe Biden evoked a “ticking time bomb.” News coverage has been full of references to Japanification — the notion that China, like Japan more than three decades ago, could slide from strong growth and an overheated property market into years of deflationary slump.

Still Hot. British inflation slowed in July to its lowest annual rate since February 2022, although there were more signs of pressure in core and service prices. Annual consumer price inflation cooled to 6.8% from June's 7.9%, while core inflation remained at 6.9%. Services inflation picked up to 7.4% from 7.2% in June.

Slowing. U.S. production is on track for its first two-month decline since 2022 as operators dial back shale drilling. The drop is led by the Permian Basin in West Texas and New Mexico, where output will fall for a third month to 5.8mm BOPD, its lowest level since February.

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.