Things I Learned This Week at Christmas Parties

December 15, 2023

The Soiree. This week was the 15th anniversary of the Annual Christmas Soiree Luncheon, which started out as a lunch for some of my very good corporate friends. Many are now my retired corporate friends. We did have some new blood this week. Everyone showed. Thirty people around one big table. We sat at smaller tables once, but John Huff complained that it made it more difficult to throw dinner rolls at people. In addition to telling lies and exaggerating about one’s golf game, we actually discussed the industry as well.

The Bets. Every year, we bet on what oil and gas prices will be at next year’s luncheon, which is always in early December, by writing on a $20 bill. Then, you pick the highest crude oil price over the next twelve months. This bet pays double. On the day of the lunch last year, crude oil was $78 and natural gas was $6.50. We are an optimistic group. The lowest guesses for both oil and natural gas prices were the winners this year. But the winning guess for gas was still $1.85 too high. After 15 years of luncheons, I can attest as the scorer that the industry has no clue whatsoever as to where commodity prices will go. We were terrible at picking prices last year and have been for years. But all of these executives and board members are reminded every year, for over a decade, how wrong we can be about the one thing that drives our industry more directly than anything else. Commodity prices. The bets for next year have been placed, but they stay confidential till next year’s luncheon. Almost everyone took the “over” on the 2024 futures for oil, which is about $69 right now. No surprise.

Her Parents are Embarrassed as Well.

And the Ballot Says… E&P was voted to be an easier business to manage and make money in than in OFS companies. In a down market, your oil is now worth $50 instead of $100. So, your value is cut in half, and you still have all that oil. But in a drop in oil prices from $100 to $50, the value of an OFS company’s rig falls to that of a boat anchor. Geographically focused operations, a homogenous product market and dramatically lower operating logistics are only some of the factors. One OFS CEO had just spent the last week marketing in the Ohio/Pennsylvania market and said that, although he got a good reception, most were worried about the macro. Over the last 18 months, the leader in U.S. onshore activity has switched from private to public E&P companies as they sought to be the next big acquisition target. Even after all the consolidation that has been done, there is still that goal, but higher interest rates and little access to capital have caused the private E&P companies to take a back seat. Chevron and Exxon have already announced budget increases in the Permian for next year against most analysts and OFS companies looking at activity staying consistent with current levels through next year. That means that the preferred customers will be the big boys who are increasing what they spend and less from the “checkbook writers” in private companies.

Predictions. It is hard to make a cogent or believable argument about a future outlook when you don’t understand the current one. Ten weeks ago, oil was $93 and headed north. Even natural gas was above $3, and the futures strip held it there or higher for years. OPEC+ has about 3.2 million barrels shut in. China is slowly coming back but this is three-month-old news. It was posited that the extreme volatility is caused by the inordinate amount of commodity futures trading done by algorithms and quant perspectives, not the physical markets. We have had trading in these markets for years and, in the past, oil was traded by many more entities. So too much trading today is impacting oil prices to this degree? Maybe. But doesn’t that equally impact the oil price as the pendulum swings? The answer was ‘yes’ and that is why we should be bullish. I want to believe, I really do.

EIA Weekly Petroleum Report.

Crude Implications: Supportive – draw above expectations. WTI between 1M-12M shifted from backwardation to contango (bearish). Money managers cut ICE Brent and NYMEX WTI net long positions by 13% w/w, a new YTD low. Market is increasingly worried about the supply side (non-OPEC) threat to balances in 1H24 (inclusive of voluntary OPEC+ actions).
U.S. Crude Production: indicated at 13.1 MM BOPD, flat w/w, and up 1.0mm BOPD y/y.
Refinery Runs: 16.1mm BOPD, down 0.1mm BOPD w/w and roughly flat y/y. Utilization recovered to 90.2% post turnarounds.
Crude Imports (net): 2.7mm BOPD, down 0.4mm BOPD w/w and up 0.2mm BOPD y/y. Brent-WTI spread at $4.6/bbl, down $0.7/bbl w/w.
Gasoline: Bullish – build below expectations. Demand up 4.6% w/w and up 7.3% y/y.
Distillate: Neutral – build above expectations. Demand up 0.4% w/w and up 0.1% y/y

Free Choice. Last week, we wrote about the 3,000 car dealerships across all 50 states that had sent a letter to President Biden asking him to ease up on the EV mandates, being controlled by the EPA under the Clean Air Act. Manufacturers were making EVs that the dealerships couldn’t sell, and inventories were piling up. We got a reaction. This week, the U.S. House voted in favor of legislation that struck down federal regulations targeting gas-powered vehicles. The administration pushed the mandates as a way to accelerate the transition to all EVs but neglected to take into account the demand and economics. The Choice in Automobile Retail Sales (CARS) was passed with bipartisan support. Tim Walberg of Michigan and Andrew Clyde of Georgia introduced the legislation in response to the EPA proposals, which, if finalized, would require 67% of new sedan, crossover, SUV and light truck purchases and up to 50% of bus and garbage truck purchases to be electric by 2032. "The passage of the CARS Act is a massive victory for every consumer and the entire American auto industry," Walberg said. "Biden’s mandate has always been unrealistic, and a textbook study on how central planning and Bidenomics simply do not work. Mandating EVs has never been a responsible or affordable solution." "Americans should always have the option to buy whatever car suits them the best and the House has taken a massive step toward ensuring that opportunity still exists," he added. Trying to influence choice by political force rarely holds up. The CARS Act now moves to the Senate, where it has already received bipartisan support. However, the White House said in a statement on Monday that President Biden would veto the CARS Act if it were passed. From Walberg’s website – “According to recent research from CRES Forum, the average EV owner’s household income is over $100,000, which only equates to about 31% of U.S. households, making electric vehicles an unrealistic option for the majority of American families.” Elitism at its best.

Round Trip in Two Years. When we were recovering from the last big crash in the spring of 2020, all the big OFS companies announced that their growth focus was going to be international with U.S. operations getting no new growth capital, and there was little expectation of any real growth potential aside from increases in market share. The CFO of Halliburton said that the shift of company culture away from the 50+ year focus on market share was one of the hardest things he’s ever done. But they did it. SLB distanced itself as quickly as possible to unwind the chasing of a bigger U.S. presence than the previous management. Of course, they were wrong in the short term, with Permian activity taking off. Prices went up, returns improved and new technologies were deployed, but the companies held on to that discipline and didn’t chase the right count. After the COVID crash, all of the OFS companies decided to focus on international growth. By December 2021, oil was back to $69 per share. Today, two years later, we are pretty much in the same place. But, in the meantime, we saw oil prices at $123 in March 2022, only 18 months ago. And, contrary to the volatility and continued weakness that had been expected, we saw a round-trip in oil prices over the last two years. Now, both oil and gas are expected to be lower than today through 2024 and the rig count is already dropping.

A Growing HOT Button. I have never been a “border hawk”, feeling that we need to better control our borders. Then, this week, a pundit says that the international community is horrified by how badly we treat immigrants at the border who are just seeking a better life. Hogwash. The people I know overseas think we are idiots for having an open border, the only country to do so. There is a total of 7 billion people on this planet who would want to come here if they could, all of whom would be “seeking a better life.” That isn’t how it works. It is hard to slight the Republicans in the current funding fight. What politician could pass up using such amazing leverage? My only comment is that it isn’t just people from Mexico and Central America anymore.

Evercore’s Take. “2024 Outlook: Want International and Offshore Leverage for this Next Leg of the Upcycle.” Great headline. The small font headline reads, “Staying Bullish as Confidence Builds in the Long Duration Upcycle.” Their top picks for 2024 – “We favor stocks that have greater exposure to the continued international recovery and the continued return of offshore development. Offshore remains an important source for reserve replacement, production growth, and capacity additions. Therefore, our top picks are SLB, HAL, BKR, WFRD, FTI, NE, VAL, and RIG.” More below.

Quote. “SpaceX and Tesla have noticed a meaningful degradation in the capability of U.S. college graduates over the past several years.” – Elon Musk

Not Everyone Will Get This.

We Aren’t Alone. A recent poll in the UK showed that immigration currently ranks as the second most important issue facing Britain after the economy. Remember, when Britain left the EU, it was over controlling its own borders and ending the free movement of people. 2022 was a record year with 745,000 new arrivals, many from Ukraine and Hong Kong. So, the Prime Minister comes up with an idea. The Rwanda Plan. If you come into the country illegally after January 1st, 2024, you will be sent to Rwanda. In Africa. And Britain is paying Rwanda to take them! $270 million so far. Can we ship a couple of New Yorkers?

The Value of Water Rises. The governor of New Mexico has been bitten by the water treating bug. New Mexico has had droughts and is having one now. The governor decided to do something about it and like the U.S., made her announcement in Dubai at the COP28 conference. Some of the state’s reservoirs and groundwater sources are critically low and not recharging fast enough, so the governor is going to spend $500 million on treated brackish and produced water to build the “strategic” water supply. This is big. We have long said that, if the industry would get its water cleaned up enough for agriculture, it would be the Holy Grail. This is a start. The governor thinks that the water supply strategy will help provide resources for creating green hydrogen, storing energy produced by wind and solar and manufacturing electric vehicles, microchips, solar panels and wind turbines. Governor Lujan Grisham blamed global warming for the water shortages in the Southwestern U.S. Proposals for companies interested in pursuing a contract can be submitted early next year. The oil and gas industry produced over two billion barrels of produced water last year, with 60% injected into SWDs and the rest treated.

Move Over China. Several months ago, India’s Prime Minister, Narendra Modi, visited Washington. While going to my Indian friend’s store, Modi’s name came up. My friend raved about him, sharing how fabulous he was for India and his popularity in the country. Earlier this year, India’s population eclipsed that of China. Economically though, China has been the world’s driver for years, leaving India in the dust. The growth mantle appears to be shifting. India has a well-educated, English-speaking democracy and their economy is now taking off as the Chinese economy stumbles with the stumbling only getting worse. A couple of recent headlines for India:

As 2023 draws to a close, India is set to be the fastest growing economy in the G20 grouping of large nations.
India is set to become 3rd largest economy by 2030.
India's massive expansion is expected to be a driver of global growth.

One Can Hope He’s Right. “Consensus now seems to be that U.S. shale companies have lost discipline and will flood the market, that oil demand is terrible and that the OPEC+ deal is nearing collapse, and they will flood the market to regain lost market share. I do not believe any of this. Yet, with all of that bearish narrative, 2024 WTI strip is $70.31. This is what the energy sector looks like on a relative basis at $70 (and at $80 WTI which is still our base case for 2024).” - Eric Nuttall.

One opinion. “If U.S. GDP doesn't grow by 3.0%+ and China's GDP by 6.0%+ in 2024, oil & gas-focused funds are doomed.”

Finally. An NYU student who tore down posters of Israeli hostages complains that she's been suspended from school, had her scholarship rescinded and will be kicked out of campus dorms next semester.

There is Still Time Before Christmas!

The Climate Deal. There was a lot written about the two-week climate meeting in Dubai. It was UN-sponsored and many people were upset that oil and gas companies were even there, much less in charge of the conference. There were rocks thrown every day, talking about how it was just a meeting for oil companies with a few other people around. Fossil fuels account for 80% of all the power generated for use in the world and the idea that the 80% should not be represented has more things wrong with it than I can count. In the end, it was grandstanding. 200 companies made non-binding agreements to reduce emissions. Wow. The UN leaders tried to get countries to agree to “phase out” fossil fuels but that didn’t get much traction. The less developed countries that still use fossil fuels say that the developed world needs to spend trillions of dollars to get them where they need to be. They don’t want to give up cheap energy that is fueling their industrial revolution and, if they can squeeze some money out of the rich along the way, why not? Instead, the push was for tripling the amount of wind and solar, effectively displacing oil demand. Far be it from me to mention that wind turbines and solar panels have parts, and lubrication, supplied by crude oil. China and India chose not to be a part of the group that signed the non-binding “commitment.” It was “a great deal of sound and fury signifying nothing.” The agreement calls for “transitioning away from fossil fuels in energy systems, in a just, orderly and equitable manner, accelerating action in the critical decade.” The oil and gas industry promised to continue reducing emissions in all of their operations and President Biden picked the conference to announce the new methane rules. But the industry had expected that and has been preparing for a couple of years. It looks more and more like a transfer-of-wealth play, considering that the U.S. and the EU would foot most of the bill with China, India and Russia not playing. Keep your hand on your wallet.

Full Disclosure or Don’t Play in the Sandbox. Bernard Looney, the former CEO of BP, will lose $40 million in compensation because he did not disclose all of his dalliances with company employees over the year. I like Bernard and he had some great ideas related to actually finding oil. But his downfall? Too many to keep track of. $40 million. Wow. That would solve most of my near-term financial issues.

Opportunity. Venture Global LNG has done very well as of late, racking up over $14 billion in sales this year. And they have made money doing it, selling LNG cargoes to the highest bidders in the market. The only problem is that many of those cargoes were promised to BP. So, BP is asking FERC to intervene. Venture argues that it hasn’t started the BP contract yet and when it does, BP will get their gas. But, first, there is this buyer offering a premium today…

Be Ready. Usually, when oil companies combine, there are asset sales of the projects that don’t fit or don’t work. And the independents get a giant dose of new opportunities. The Oxy/Crown deal is rumored to already have identified the parts of Crown that it will sell. Exxon and Pioneer. Chevron and Hess. I understand that all the properties matter to someone, but… The smaller oil companies, family offices and brave individuals will be busy with those secondary market transactions for the next 1-2 years. Best of luck.

The Fed Pivots! An inflection denotes a change in direction, regardless of the force of the action. The Fed this week noted that it was likely to begin lowering rates next year with expected cuts of three-quarters of a point. The high(er) cost of capital has constrained spending in every industry, including energy. It’s like when you are sick and every day you get worse. And then one day, you aren’t worse. And the next day, you feel a little better. While you are still a long way from “well,” not feeling worse and starting to feel better is monumental. A recession appears to have been avoided. The drop in oil demand from an economic recession has been a concern of the market for some time. I’m not ready to break out the champagne just yet but I have ordered some party hats.

Stool Pushers Instead of Tool Pushers?

Spending/Activity Forecast. Evercore is out with their forecasts of global E&P spending and it, too, confirms our comments about international vs. domestic. Yes, I know everyone knows that but growth in the U.S. dwarfed international growth this year. It is expected to reverse in 2024.

1). “The International Outlook For 2024 Remains Healthy. Global E&P spending is set to increase by +5.0% in 2024, decelerating from +10.8% in 2023, with the globally coordinated upturn extending into a third year. NAM spending growth is expected to moderate to +2.2% in 2024, following robust growth of +19.3% in 2023. As expected, spending has shifted to international and offshore markets, with international growth excluding Russia anticipated to rise by +10.1%, slightly decelerating from +11.0% in 2023.”

Price decks for budgets move around for E&P companies, whereas they are pretty fixed on an annual basis by majors with majors becoming a larger part of U.S. activity, intensified by the recent spate of combinations.

2). “Moderate Risk To 2024 Budgets. Operators have increased their oil price outlook since our Mid-Year 2023 survey and are using $77 WTI and $3.10 Henry Hub decks for their 2024 budgets. Average oil and gas prices of $105 WTI and $5.07 HH were cited for budgets to revise higher, while $64 WTI and $2.23 Henry Hub were cited for budgets to revise lower. A modest drop in oil prices could prompt downward revisions.”

Inflation is hitting everyone, including the oil and gas business. It has a major impact on our world because of the field-level people requirements as well as the capital equipment and repairs.

3). “Service Costs Expected To Increase In 2024. Service costs remain at #3 as a determinant of E&P budgets, but service availability has slipped from #4 to #7 in 2024, which was the most cited potential bottleneck for E&Ps to miss their production targets last year. Higher service pricing that materialized in 2023 is expected to broaden in 2024, with pricing increases anticipated for fracturing/stimulation, transportation, and completion equipment. Operators called out subsurface completion and production and land drilling as areas in need of greater technological innovation.”

We have long preached consolidation as the most likely and smartest thing that can happen in our industry, especially now in light of our forecasted slower growth.

4). “More M&A Is Anticipated For 2024. 67% of survey respondents anticipate an increased likelihood of industry consolidation in 2024 compared to 2023, with a majority identifying growth/geographical expansion and favorable valuation as the primary drivers behind industry consolidation.”

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.