Things I Learned This Week on the Border

February 2, 2024

There are many different ways to hunt quail. One of my favorite things to do is hunt the ever-elusive upland bird. I have been blessed by several good friends whom I have gotten to hunt with this season, joined by two outriders on horseback looking for birds. This week, on a truck, watching amazing dogs run, work and point, was a different experience. The picture below is one of me, in full hunting regalia, standing on the southern U.S. border shooting any quail who crossed into the U.S. But, this was no on-and-off hunt, exiting the truck only when the dogs go on point. This was chasing the dogs as they worked hard and looked for birds. The first day we walked 16 miles. Across rock-strewn, thorny countryside, up hills and down into ravines. For those of you who count steps, that day was 32,000. The next day we took it easier, at least from a distance point of view. The following day was 13 miles of brush, rocks and steeper hills. We got one bird. It was a great birthday present, and one that made you realize that this is not your 25th birthday! Came home and had one of the most appreciated pedicures and foot massages on record. The rest of the world did not have as much fun.

Moving Mosaic. The first big jolt was the Administration’s announced “pause” on LNG export terminal approvals. The next was word that Saudi Arabia was backing off on their production expansion plans. We discuss these in great detail below, but those two caused an explosion that left the sector’s earnings reports to back page news. The third big whammy is less straightforward. Three American soldiers, all from my home state of Georgia, were killed, and 25 injured, in a drone attack on a base in Jordan by a terrorist group considered a proxy for Iran. Again, we discuss this, too, in greater detail, but the major point is that the oil & gas industry is back on the front pages. And none of the events, or their solutions, are very well understood. Predictions had been for fairly flat oil and natural gas prices, with U.S. activity flat to slightly down and international up in the low teens. We called it a “transition year” for the industry, having nothing to do with the oft-mentioned “transition” dealing with climate. This was all politics. So, it will not be a boring year. With so many volatile kickers, it will be hard to keep track. We are a resilient industry, and we are likely to be tested this year.

EIA Weekly Petroleum.

Crude Implications: Bearish – build vs expected draw. Money managers increased ICE Brent and NYMEX WTI net long positions by 8% w/w. Crude production recovered 70% from freezing January temperatures, but the refining utilization rate declined further reflecting both weather impact and turnarounds. Heavy turnarounds expected in 1Q24.
U.S. Crude Production: Indicated at 13.0mm BOPD, up 0.7mm BOPD w/w, and up 0.8mm BOPD y/y.
Refinery Runs: 14.8mm BOPD MBPD, down 0.4mm BOPD w/w and down 0.1mm BOPD y/y. Utilization at 82.9% reflecting the impact of recent cold weather and scheduled turnarounds.
Crude Imports (net): 1.7mm BOPD, up 0.6mm BOPD w/w and down 2.1mm BOPD y/y. Brent-WTI spread at $5/bbl, flat w/w.
Gasoline: Bullish – build below expectations. Demand up 3.4% w/w and down 4.1% y/y.
Distillate: Bullish – draw above expectations. Demand down 0.7% w/w and up 1.8% y/y.

The Pause. President Obama asked the National Security Agency (“NSA”) for their opinion and analysis of the exporting of liquified natural gas (“LNG”) from the U.S. The approval to export oil had taken the Department of Commerce almost a year to evaluate. LNG took about three weeks. The idea that we could export huge cargoes of energy to our friends, or potential friends, over the next few years, is huge. American ingenuity, again, kicked into high gear, and we are now the largest LNG exporter in the world. It has shifted the global energy situation. When Ukraine was invaded, our LNG helped offset the loss of Russian imports and President Biden assured Europe that we could be counted on to help even more in the future. But, with an election looming and approval ratings for the current administration sliding, something had to be done, and that something was to appease the young and uninformed activists who were still upset over the approval of the Willow oil project in Alaska. It was noted in the press that the administration was going after the TikTok crowd. Younger voters were deemed to be needed for an election win. A couple of years ago, Biden said he would be the adult in the room while making critical decisions, but this time, influencers on social media held sway. Adult?

Implications. Our friends in Europe feel they are being stiffed, after the President's promises of help. Our pause is a significant boost to the economic and political ambitions of Russia and Iran, who will likely pick up the slack. The thousands of workers on projects are now getting pink slips, but their votes were not deemed to be in the Administration’s favor anyway. So, the political cost was low. We currently have about 12 Bcf/d of export capacity and that has been expected to increase significantly over the next several years, providing growing demand from U.S. gas producers, pipelines, logistics and a clear economic growth driver for the U.S. economy.

An Interesting Point. The “pause” is on LNG export applications to non-Free Trade Agreement (“FTA”) countries. The DOE announced that it would conduct a review during the pause to “look at the economic and environmental impacts of projects seeking approval.” The problem is that about 80% of current exports are to non-FTA countries. Remember, the export approval was intended to be used as leverage with cargoes of energy to friends and countries that might be friends. Many of the fastest-growing demand markets are in non-FTA countries. From EWTC – “the U.S. currently has a two-tiered system for LNG permit approvals. One is for approval to build a facility, which is obtained by FERC, and then, if the facility plans to export to a non-FTA country, an additional analysis is required by the DOE to determine whether the exports are in the “national interest.” It is this second analysis that the current pause will affect. While DOE did not name particular projects that would necessarily be affected, we believe that the likely targets are Sempra Infrastructure, Commonwealth LNG, Energy Transfer and Venture Global.”

Saudi Arabia. A stunt? Deep strategy? Indication of lower reserves? Knee-jerk reaction? Actually, a very astute move. The country already has 1.5 million barrels offline and still can’t get Brent to stay above $80. A return optimization decision. It worked in the U.S. Slow down your growth and make more money. But Saudi doesn’t have a dire inventory. So, why not slow down, spend less and make more, all without having to cut another million barrels of production today to hold up prices? Sure, they cut a million barrels off the growth that was expected but Aramco will likely make more money. So, who loses? The oilfield services sector. If Saudi spends $1 to $3 billion less than had been expected a couple of weeks ago, some companies will miss their previous expectations. Someone has to.

But Surely There’s More? Of course. We live in a complicated industry. Why would a public company slow down its growth a bit, pushing out an already long-term terminal value, in order to make more money and generate higher returns? In the U.S., we would call it a liquidity event. Word is that the government is planning to go to market with a stock offering sometime in February. But what company, or industry, would try to optimize returns and value? Only the smart ones. One analyst viewed this as a confirmation of price being a higher priority than defending market share. Sound familiar?

“It’s a stunt.” “Don’t believe it.” “Way overdone.” Those were some of the comments made by analysts and many companies. Jackup stocks and stocks with Middle East exposure all got hit while many of the U.S.-centric OFS companies reported decent numbers and benefited from the rotation. But, the reality is that the one market that was supposed to grow this year was international, including offshore. Deepwater has continued on its same trajectory, gradually up. The Middle East and Saudi, in particular, were supposed to be the growth drivers of the market. Companies have reaffirmed guidance but it's probably too early to really know. I don’t know of a single instance where an oil company made a strategic decision based on whether it would be good or fair to the service sector. That is with no offense to my E&P friends, but that is how it works. You have a great relationship with an industry where any contract can be terminated in 30 days. We will see through this year. As we said above, someone has to be impacted.

Bad Day for Some. On the day of Saudi’s announcement, the OFS sector got hit and it was a good thing to be home. A few examples:

Gainers:

Helmerich & Payne (NYSE:HP): +14%
Liberty Energy (NYSE:LBRT): +7%
Patterson-UTI Energy (Nasdaq:PTEN): +7%
ProFrac Holding (Nasdaq:ACDC): +6%
ProPetro Holding (NYSE:PUMP): +6%

Losers:

Borr Drilling (NYSE:BORR): -12%
Weatherford International (Nasdaq:WFRD): -10%
Brooge Energy (Nasdaq:BROG): -10%
Schlumberger (NYSE:SLB): -8%
Shelf Drilling (OTCMKTS:SHLLF): -10%

The S&P Energy (E&P) Sector was up +0.55% and the Energy Equipment & Services was down -5.18%.

Production and Price. Even though U.S. drilling has slowed down, production hit a new record of 13.3mm BOPD in November 2023. Faster wells, longer laterals and better completion science are all driving continuing efficiencies. It isn’t good, politically, since it forces other producers to cut back to accommodate growth in a flat or even growing market. We have now seen Saudi’s move. “The critical question is how much longer efficiency gains can keep driving significant output growth without an increase in prices and drilling.” The forward strip is $73. Lower 48 production increased by 0.9mm BOPD, or 9%, compared with the same month last year. And there was no sign of growth decelerating significantly. The future’s strip for natural gas is $2.60. Gas production has slowed, but very little, with 102.5 Bcf/d expected for this year, or about 2.5%. Of course, much of that increased natural gas production is from higher gas-to-oil ratios of wells as they age with associated gas being the lion’s share of the production increase.

Senior Junior Statesman. Toby Rice of EQT, one of the most eloquent and knowledgeable advocates of our industry, wrote a very interesting and detailed letter to Jennifer Granholm, the Secretary of Energy, making the industry's argument against any “pause.” (The title is a dig on his age if there was confusion. He’s done amazing things in few years.)

Perspective – From Citi. “U.S. Oil & Gas Equipment and Services - Is the OFS Cycle Over? Additional Perspective on the Saudi Plan Change. Is the OFS cycle over? This was the top inbound yesterday. The 2024 impact appears limited. The primary change appears to be deferment of incremental FIDs offshore, while active projects continue. SLB sees little risk to other projects although BKR noted risk to onshore maintenance spending. For the latter, the downside risk to upstream spending appears modest (we estimate a $1-$2 billion cut in Saudi would reduce international spending growth by growth plans changing course and believe there’s sufficient growth offshore to still drive overall upstream spending growth in 2025. We also believe it’s premature to call for a decline in 2026, although SLB/BKR’s stock now appear to already reflect a view that EBITDA will roll in 2026.”

Must Watch. My good friend, Robert Bryce, is a brilliant guy, and he obviously works 24 hours a day doing his research. I would know. He has a five-part docuseries, “Juice: Power, Politics, & The Grid.” It takes viewers from Texas to Tokyo to show how politicians and corporate avarice have weakened our electric grid and why we need fission to fix it. The five episodes, linked below, are each a 20-minute episode that includes really interesting pieces and interviews with more than 30 top thought leaders, including journalists, political scientists, civil rights leaders, nuclear activists, authors, former IEA directors and others. The electricity sector is a $5 trillion a year business. Highly recommended.

Episode 1 - Texas Blackout

Episode 2 - Undermined By Enron

Episode 3 - Green Dreams

Episode 4 - Nuclear Renaissance

Episode 5 - Industrial Cathedrals

More Farmer Protests. It started in Sri Lanka when the President at the time banned natural gas-derived fertilizer, which cut yields by 30%. He escaped the country as the crowds stormed the capital. Then, it was the Netherlands, with tractors blocking roads while protesting similar issues. It proved to be contagious. Now, they are active in Germany. Thousands of farm tractors have blocked roads throughout the country, including the capital. Next is Brussels, the capital of the EU. They descended on the city to push for EU leaders to do more to help them with taxes, rising costs and cheap imports by throwing eggs at the European Parliament, starting fires near the building and setting off fireworks. Their revolt is fueling a narrative that the EU is riding roughshod over farmers. Don’t forget.

France. The Farmers’ Union is unhappy as well, wanting improved pay, less red tape and protection from foreign competition. The latter is most interesting. The “competition” is a new trade deal with The Southern Market, a South American trade bloc that goes by Mercosur, an old Portuguese term, and includes Argentina, Brazil, Paraguay and Uruguay. Macron has promised to veto the deal.

Who Wins? The below chart shows the average 12-month cumulative oil by current operator, with each operator colored by the basin in which they primarily operate. 14 of the top 25 are in the Permian. RBN Energy.

Snippets.

IRS employee Charles Littlejohn was sentenced to 5 years for releasing Trump's tax returns.
Single issue bills are a great strategy. Americans can appreciate legislation they can understand.
The critical question is how much longer efficiency gains can keep driving significant output growth without an increase in prices and drilling.
The United States is planning to station nuclear weapons in Britain for the first time in 15 years as the threat from Russia increases.
Diversification. Norway's $1.6 trillion sovereign wealth fund, the world's largest, reported on Tuesday a record profit of 2.22 trillion crowns ($213 billion) in 2023, driven by strong returns on its investments in technology stocks.

Finance. Both the U.S. Federal Reserve and the Bank of England kept interest rates unchanged. The Fed said, that while it is likely to lower rates at some point, that is not now. Six out of nine members of the EU Monetary Policy Committee voted to keep rates at a 15-year high of 5.25%. At least nothing is raised. But Europe still battles inflation at a higher rate than the U.S.

Picking a Side. Tankers of Russian oil have continued sailing through the Red Sea largely uninterrupted by Houthi attacks on shipping and face lower risks. One day this week, the U.S. military struck up to 10 drones in Yemen that were preparing to launch. Iran and Russia have a mutual agreement of support, with Iran supplying drones for the Russia/Ukraine war and Russia opening its kimono on nuclear.

I am very sorry for this one, but…

Honest Media. MSNBC host Joy Reid got caught cursing on a hot mic while playing a clip of Biden saying he would close the border if Congress unlocks more money to Ukraine. “If that bill were the law today, I'd shut down the border right now and fix it quickly,” Biden said. While the clip played, with the mic on Ms. Reid was heard to say “starting another f**cking war.”

Competition Heats Up in Politics. A super PAC, Future Forward, has committed $250 million, a quarter of a billion dollars, to run ten weeks, from the Democratic convention up through the election. The priority states are Arizona, Georgia, Michigan, Nevada, North Carolina, Pennsylvania, and Wisconsin. "The stakes of this election could not be higher, and by Election Day, every battleground voter will know it," said Chauncey McLean, the president of Future Forward. "We’ll run a cost-effective and data-driven program of unprecedented scale to reelect Joe Biden."

Stress on the System. The governor of Massachusetts, Ms. Laura Healey, issued a video where she announced the conversion of the Roxbury Recreation Center to a new shelter for illegals. She wasn’t happy. She was crying in the video. Under the “we have to put them somewhere” edict, and being a declared sanctuary city, who can you turn away? The ‘Immigrant Support Alliance’ in Massachusetts is now openly asking and giving the opportunity for their residents to house illegal immigrants in their private homes. “Exploring the Host Home Experience.” Right. In Chicago, a city alderman said that Illegal Immigrants are to get vouchers for $9,000, food, housing, a driver's license, free childcare and insurance. According to studies, the U.S. spends $113 billion each year on illegal immigrants. The percentage of illegals in Massachusetts is 4.3%, versus 8% for Texas and 3.2% for the U.S.

Soapbox. Starting February 5th, Denver will impose limits on the days migrants can stay in shelters due to the strain caused by an influx of nearly 40,000 migrants over the past year. Those exceeding the shelter stay limit will be directed to the streets. Mayor Mike Johnston estimates the city will require $100 million in 2024 to cover housing, schooling, health care, and other services due to the unexpected influx. The city, with a population of just over 710,000, has become a top destination for migrants arriving from the U.S. southern border. So, every two weeks, the number of immigrants coming through the southern border equals the population of Denver.

Politics. This is a picture taken this week in Judge Engoron’s courtroom, awaiting the decision on Donald Trump’s case. Thoughts?

Upcoming Events (where I hope to catch up with good friends).

The 2024 North American Frac Sand Conference & Exhibition is being held February 12th through the 13th at the Marriott West Loop by the Galleria.

The THRIVE Energy Conference, held by Daniel Energy Partners, is a huge event on February 20th to the 21st at Minute Maid Park. Everybody. Everybody.

March 20th is the Petroleum Club of Houston’s Distinguished Speaker Lunch. They host many, but I am the speaker this time. Distinguished is just old.

As an early reminder, the annual meeting of the Energy Workforce and Technology Council is being held on April 24th to the 25th at the JW Marriott Camelback Inn Resort & Spa in Scottsdale, Arizona. The organization is a combination of the former PESA and Association of Energy Service Companies (AESC) of Canada. It is Oilfield Services. The largest conference of its kind in the industry.

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.