Things I Learned This Week From Santa Claus

December 22, 2023

As the year draws to a close, I would like to first thank all of you for reading my weekly piece. Or if you just scan it before you delete it, that works, too. Thanks. It is a great way to stay in touch with friends. And, on that note, I would like to wish all of you a very Merry Christmas, Hanukkah, Kwanzaa or anything else you might celebrate over these holidays. Regardless of greeting, may you all have a very safe, loving, fun and happy holiday! I will give next week a miss as kids coming home for the holidays take center stage. Love, smile, cherish, be kind and generous where you can be! Happy Holidays!

The New Year? Well, oil and gas markets were a roller coaster this year, very similar to the roller coaster of last year. Remember $9 natural gas? $115 oil? And, the fact that the prices are back to where they started last year is telling. Europe dodged a calamity last year with one of the warmest winters on record. And, this year, Europe goes into the winter with 97%+ storage levels. Another reprieve. There are about 3.2 million barrels off the market by OPEC+ that will bleed back into the market as the price rises which will stunt any momentum. Activity rose and then dropped, but the OFS industry did not go nuts adding capacity this time which should make a fairly flat 2024 a little easier to get right. We now know that oil can go to $93 with little effort and back down to $67 within weeks just as easily. That kind of volatility breeds caution and that caution is seen as discipline by both investors and industry participants. This is a good thing. The U.S. is not a growth market in terms of activity, but the maintenance of our record levels of oil production will see every effort to have it continue. And that is good business.

Immigration Hot Button. Remember when we had a problem with Mexicans crossing the border? Not good, but they were generally hard workers, sending money back to their families in Mexico from the work they did here. Then, it was the face-tattooed El Salvadorians who didn’t seem to work, other than dealing drugs and causing violence. Honduras and Guatemala were not to be left out, with many making their way north. But lately, the majority are fleeing Venezuela, Cuba, Nicaragua and Haiti. In 2012, 85% of immigrants at the border were from Mexico. Today, that is barely 20%. And, in 2022, the percentage of single adults, most of them male, was 91% with family units at 5%. As of 2022, none of the countries in the world officially have open borders and they still don’t. “People are just looking for a better life.” That sounds noble until you understand that there are 7 billion people on this planet who would come here if they could “for a better life.” Why not? We give them $2,200, a cell phone and a bus ticket and tell them to come back to court in a couple of years. We are, by far, the only country on the face of the planet who has this kind of policy. And when I see someone on MSNBC saying that people all over the world look at us with embarrassment, it galls me. They think we are idiots for letting anyone in the country who can say the word “asilo.” Embarrassment? Yes, but for different reasons.

The Dallas Federal Reserve Oil & Gas Survey. Activity in the oil and gas sector was essentially unchanged in the fourth quarter of 2023, according to oil and gas executives responding to the Dallas Fed Energy Survey. The business activity index, the survey’s broadest measure of conditions of energy firms, remained positive but slipped from 10.9 in the third quarter to 3.6 in the fourth quarter. The business activity index was 7.5 for E&P firms versus -4.2 for services firms, suggesting activity slightly grew for E&P firms and declined slightly for service firms.

Oil production increased but at a significantly slower pace compared with the prior quarter, according to executives at E&P firms. The oil production index remained positive but fell from 26.5 in the third quarter to 5.3 in the fourth. Meanwhile, the natural gas production index edged up from 15.4 to 17.9.
Among oilfield services, the input cost index remained positive, but slipped from 33.4 to 21.3. Among E&P firms, the finding and development costs index rose from 18.3 to 24.4. Meanwhile, the lease operating expenses index moved down from 25.6 to 22.6.
Oilfield services reported modest deterioration in nearly all indicators. The equipment utilization index moved down from -4.2 in the third quarter to -8.4 in the fourth quarter. The operating margin index was relatively unchanged at -32.0. The index of prices received for services turned negative and fell from 2.1 to -6.2.
The company outlook index turned negative in the fourth quarter and plunged 48 points to -12.4, suggesting some pessimism among firms. The company outlook for E&P firms changed more drastically, as the company outlook index for these firms fell sharply from 46.8 to -9.0. The overall outlook uncertainty index jumped 39 points to 46.1, suggesting mounting uncertainty.
On average, respondents expect a West Texas Intermediate (WTI) oil price of $78 per barrel at year-end 2024 with responses ranging from $51 to $110 per barrel. Survey participants expect a Henry Hub natural gas price of $3.09 per million British thermal units (MMBtu) at year-end. For reference, WTI spot prices averaged $69.77 per barrel during the survey collection period, and Henry Hub spot prices averaged $2.48 per MMBtu.
E&P Firms Pull Back on Capex Growth Plans. That is the headline of the next section of the Fed survey, focusing on the outlook. The survey suggests small firms will see 2024 as a time to grow production while large firms will focus more on M&A. Roughly one in three E&P executives say they intend to grow their capital expenditures in 2024, a drop from 3 months ago spurred by spikes in uncertainty and caution.
It also shows that a number of producers in Texas and parts of New Mexico and Louisiana have already lowered production growth goals. While the survey showed that in September, half of respondents planned to increase capex next year, the latest survey shows it is only 30% now.

Risk On. So, the Fed is signaling that rate hikes are probably over, and the market expectation is that that rates could see three 25 basis point drops next year, supported by the recent reports of inflation continuing to slow. That means that the risk trade is back on. The broad market set records over the past week and investors are willing to step out on the risk curve. “We’re not going to do it right away,” said Philadelphia’s Patrick Harker said. Right away doesn’t matter. The market is a discounting mechanism by definition. It reflects expectations of the future and the ‘when’ matters, but the ‘if’ is the real problem. That now appears to be addressed.

Positive, Almost. Citi is staying on the sidelines of energy, with a market weight recommendation, which in my day was a Hold or Neutral. Semantics. Citi did note that valuations remain attractive and positive earnings are expected for 2024 as whole and relative performance could be bottoming. However, “more confidence in oil prices is needed for us to upgrade,” analysts said. Crude oil futures have dropped almost 5.3% in the last month with Brent down about 4%. That doesn’t help the caveat of higher prices, much less with any confidence. But, equity analysts are generally optimists by nature so price or total return targets, noted here, continue to look very attractive. Come on, oil prices!

These are the top buy-rated stocks, ranked by Expected Total Return:

Piling On. We have written extensively over time about the positives, negatives and unknowns of the Electric Vehicle market. It is starting to look like everyone is piling on. GM bought out half of its 2,000 Buick dealerships because they refused to sell EVs. Buick is having one of its best years with sales up ~30%. They were given the choice to invest $300,000 each to sell and service EVs. Buick management has the ambitious plan of being all-electric by 2030. Good luck with that. GM required its dealerships to invest $1.2 million each to accommodate sales and service of EVs but has eased up on the requirements as the company adapts to the changing EV market. Ford said that half of all 1,550 Ford dealers chose to sell electric vehicles in 2024—down from two-thirds that said this time last year that they would opt in to sell EVs for 2023. This is after 3,000 dealerships across the country sent a letter to President Biden, asking him to ease the EV manufacturing mandates since EVs are stacking up unsold and resale values are down. Then, to round it out, Ford said earlier this month that it was reducing the planned number of produced F-150 Lightning EV trucks by half starting next year, saying that it would match production with customer demand. That means production drops and it has.

GoM Lease Sale. Bidding in GoM Lease Sale 261 saw total high bids of $382 million, a large increase over the last sale. 251 was originally scheduled for 2022, but the Biden administration killed it. Senator Manchin of West Virginia made sure, in his agreement to the Inflation Reduction Act, that the lease sale would be held. And it was. Companies seem to focus on deepwater blocks in the Green Canyon and Mississippi Canyon areas. 26 companies submitted 352 bids for 311 tracts. The BOEM had offered more than 13,000 tracts. Shell bid on more blocks than any other company. Smaller companies teamed up for bids, putting Beacon Offshore, Red Willow, Westlawn, Houston Energy, Kosmos and others into the mix. "Lease Sale 261 has been a long time coming, and the fact that it is happening today despite the administration’s attempts to cancel, shrink and delay this sale is a testament to the importance of the IRA for our energy security," Manchin said in a statement on December 20th. From NOIA’s President – “Today signifies a critical point in American energy policy. Without congressional intervention, this is the final lease sale until 2025. In our forward-thinking industry, securing new lease blocks is vital for exploring and developing resources crucial to the U.S. economy."

Yikes. Over half of U.S. teenagers spend at least four hours per day on YouTube, TikTok, Instagram and Facebook, according to a recent Gallup survey.

Round Trip Example. Rystad Energy has identified 562 started frac operations in North America for December. Only 71 of these fracs have been reported to FracFocus or to provincial authorities in Canada, while the remaining 481 are based exclusively on our analysis of high-frequency satellite data. Given that there are a few more days remaining in December – and taking into account previous satellite data outages – we estimate that another 502 frac jobs would start by the end of the month. This brings the total count to 1,064. It would mean a substantial decline in activity, further extending a slowdown seen last month when fracking touched its lowest point since the beginning of the year.

Charif Souki Has Left the Building! Several years after starting Tellurian in 2016, a vertically integrated LNG company, Charif has exited after a couple of years of failing to gain investor interest. He was the founder of Cheniere, the largest, most profitable and oldest LNG company in the business.

Canceled. Panasonic, one of the larger EV battery manufacturers who supplies Tesla and others, has decided not to build a multi-billion dollar battery plant it had planned for Oklahoma.

What About Us? The Biden administration has ordered banks not to deny loan applications based on citizenship status. The Administration has warned that denying these loans would be discrimination. We’re now at a point where our government is doing more for citizens of another country than they’re doing for Americans. No doubt, as this continues, it will eventually cost Americans more. From the DoJ website – “The Justice Department and Consumer Financial Protection Bureau (CFPB) issued a joint statement today that reminds financial institutions that all credit applicants are protected from discrimination on the basis of their national origin, race and other characteristics covered by the Equal Credit Opportunity Act (ECOA), regardless of their immigration status. The Justice Department and CFPB are issuing this statement because consumers have reported being rejected for credit cards as well as for auto, student, personal and equipment loans because of their immigration status, even when they have strong credit histories and ties to the United States and are otherwise qualified to receive the loans. While the ECOA allows a creditor to consider an applicant’s immigration status when necessary to ascertain the creditor’s rights regarding repayment, creditors should be aware that unnecessary or overbroad reliance on immigration status, including when that reliance is based on bias, may run afoul of the law.”

Populations. The U.S. population grew by 1.6 million people in 2023 with three quarters of those being migrants coming into the country, putting the U.S. population at 334.9 million. It’s the second year in a row that immigration powered the increase in population. 87% of the growth came from the south, defined by the census bureau as stretching from Texas to Maryland and Delaware. The south? South Carolina won the mantle by increasing 1.7%, topping all other states by adding more than 90,000 people to the state roles. Florida had the second highest increase, bringing in more than 365,000 people. New York had the biggest rate of population decline with over 100,000 residents leaving the state. California, with 38.9 million residents, lost 75,000 this year to other states such as Texas. Texas came in second as the most popular state with 30.5 million people.

Politics? The Democratic Republic of Congo (“DRC”) is holding presidential elections shortly before the end of this year, and there are currently 20 candidates running. The country is also experiencing a very severe food shortage. It’s gotten so bad that the UN security council is withdrawing the peacekeeping force from Congo because of the expected violence caused by the election. Why should we care? Because over 67% of the world’s cobalt comes from the Democratic Republic of Congo, a place where child labor and child mining still occurs (read Cobalt Red). OPEC currently supplies the world with about 28% of its oil and look at the leverage it has exercised over pricing in the past decades. Now imagine the DRC having three times, scratch that two and half times, the market leverage of OPEC in the cobalt markets. Here we sit worried about violence and their elections amidst a wave of poverty and starvation. How could this end badly?

Irony? The newspaper today has the headline, “Air Strikes Killed Dozens Across the Gaza Strip,” and next to it is a picture of a humanitarian aid truck that’s been completely taken over by Hamas, more than likely to the detriment of the Palestinian people. It has been in Hamas’ best interest to see as many Palestinians killed as possible. It always got to me that there were comments about indiscriminate attacks by Israel. They’ve had over 5,000 missiles shot at them over the last three months and these launch sites are located near mosques, schools and hospitals in an effort to win public opinion through the slaughter of the civilian population. We have got to learn to separate the supporters of Hamas from the supporters of the Palestinians . The only problem is the women and children that we are seeing constantly on the news are the wives and children of the Hamas fighters. And, while they may be “innocent civilians,” they are still being used as human shield by the group that slaughtered 1,200 Israelis in a surprise attack in October.

With Apologies to My Harvard Friends.

It Always Happens. An oil company buys another oil company and a great deal of plans and activity for both companies change. Exxon buys Pioneer. First, where are they spending money and drilling? Do they want to spend that money and drill those wells? First thing? Put plans on hold. Who goes, who stays and who gets the money to drill are all the questions that have to be answered. This has happened continually throughout my career. But, rarely have we seen so many very large E&P mergers such as those we have seen this year and that means a larger number of projects are being put on hold than normal. The other issue is prospect preservation. Depth of inventory. How long will your Permian Party last? Let’s drill what we really need to now, those that have the highest return, and lets maximize the duration and quality of our future production. It all gets shaken out eventually, but the wave of M&A is expected to continue this year. This is more uncertainty than the OFS sector had expected or planned for.

Government to the Rescue! The Canadian federal government published a draft plan last week to implement a cow burp credit trading system. We all know cows burp a lot. They have four stomachs to digest what they eat and that digestive action results in a bunch of gas, most of which ends up being expelled in the form of burps and farts. But mostly it’s burps. The Environmental Minister has called it a crisis and, now, they are looking for ways to fix it. The department is proposing financial incentives for farmers in the form of offset credits they can sell, in lieu of cutting enteric methane emissions from their beef cattle operations. Each credit represents one ton of emission reductions and the credits can be sold to facilities to help them meet emissions reduction requirements or to other businesses to meet their climate commitments, the government said. “The point of this new offset protocol is to reward ranchers and dairy farmers for using feed additives that help cut down on the methane from their cows,” said the Ministry. Next up, the Ministry of Silly Walks.

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.