Things I Learned This Week in La Vaca

January 12, 2024

2024. Welcome to the Waiting Room. At a gathering of oilfield people this week, the conversation included opinions on oil and gas prices and our favorite stock. Oil? Most everyone suggested $50 to $70 oil prices this summer, with one thinking $90-$100. Natural gas was more interesting with estimates from $2.65 to $4. The argument for $4 was well thought out. A few LNG facilities that, at one point, were expected to be delayed are actually ahead of schedule. Production is waning and demand continues to be strong. We reconvene in late June to settle the bets.

Who Wins? The stock selection ranged from Antero to Permian Resources to Bic, the French maker of pens. Activity, year average over year average, is expected to be down in 2024 in the U.S. and Canada. Little guys are merging with littler guys and big guys are buying smaller companies, though that “smaller” can still be $60 billion. But the agreement was that scale matters, no matter what size. That consolidation needs to continue and not just by the oil companies but by the service companies as well. Everyone’s service and product offerings have changed dramatically in the last ten years. We call everything the same but the technology, efficiency and reliability are all dramatically different. That means the companies offering these goods and services have had to change as well. And, as technology continues, and it will, especially aided by the ever-improving AI, these companies will continue to change and fit together with different pieces of the puzzle than would have been the case ten years ago and before. Rigs with Rigs. Boats with Boats. But that is no longer the case. What a rig will do today versus 10-15 years ago is unbelievable. Fracking tight source rock was not possible for much of my career, and now, it is about all we do onshore in the U.S. The puzzle pieces are dynamic as are the companies. That means staying in your lane and doing what you’ve always done is no longer a productive option.

Can I have an AMEN?

Unavoidable Slowdown. When oil companies combine, budgets get rationalized. The first thing you do is suspend non-contracted activity while decisions are made about organization, responsibilities, overlaps, redundancies, methods and technologies. This is as all the financials are combined and reviewed from an operational perspective rather than just valuation. That causes budgets to stall and drop. This is common, and the longer-term benefits of consolidation help everyone. It is that pesky beginning that always sucks. So, with so many big combinations of companies involving U.S. basins, where almost all activity can be cancelled within 30 days, expect a slower start to the year. But that is relative. Typically, the U.S. rig count declines after year end as urgency of spending budgets is gone, winter weather increases the costs and hunting season still affects some areas. The rig count generally declines till about May when it reverses course and starts moving up through the rest of the year. So, any combination/budget related slowdown might be missed as the industry makes its seasonal adjustments. The impact on 2024 will exist, although only temporarily. However, everything is usually back on track within a year, making the future look brighter than it otherwise might.

Comparison. An interesting point was made that was a pleasant surprise. As a point of reference -

We had 254 frac spreads operating a year ago this week compared to today’s 240. Not bad, really, except for the wild ride in between, with the count hitting 295 spreads within 90 days, before dropping by 19% from May through year end. The U.S. rig count, according to Baker Hughes, ended the year at 622 rigs, compared to 772 the previous year, decreasing 14%. It was Chinese water torture, with the high point of 772 followed by a long, continuous trip south for the rig count. In conversations this week, we heard that E&Ps had seen only about 5% service cost pricing decline, hitting 10% in rare cases.
Usually we crash, not glide. 5%-10% declines in service cost pricing won’t foster increased drilling, but, in a $70 oil world, every million counts. For services, pricing only dropping single digits is always a positive. But the looming questions? How long will it last and will it get worse? We never know those answers in advance, so we take every day that margins hold up as a victory! But with years of retirements, utilization remains tight in the U.S. for most OFS lines. One surprise was hearing how well compression is doing, having become a popular business line. Amazing.

Off the Front Page for a Week. The incessant bashing of all things EV appears to have slowed. Nothing positive, but just a slowing of the negatives that have been getting more and more attention lately. Resale values, price of battery replacement (they are linked), lack of charging stations, the impact of cold weather on mileage, the cost of battery materials, the child mining and the abuses associated with producing battery needs, the fact that most people who wanted one have bought one, that all the car manufacturers, except Tesla, are still losing huge amounts of money and bringing value to scale to fix that is challenging in a slower demand environment. That isn’t a complete list, but it’s a start. The media has decided to pursue other issues this month. Similarly, oil and gas isn’t on the front page much lately either. That is usually a good thing.

It's So Sad!

But Not Completely Dead. We wrote recently about how European car rental companies were discontinuing EVs because the resale value ruined their economics. It has now spread. Hertz Global said it’s selling one-third of its EV fleet and more ICEs. The company noted lower demand for electric vehicles and elevated repair costs as reasons for it to make the EV reversal.

So, Oil is $70. In September, it was $93, and four months before that, it was $70. A year ago, almost everyone was calling for oil prices to move and stay higher. What happened? The answer? We are good. OPEC+ cuts 3.2 million barrels per day of production to prop up prices and, in the U.S., we continue to grow production. It is true the administration turned a blind eye to sanctions while Iran increased production by 2 million barrels per day. We were trying to buy their “good will”. Obviously, that didn’t work. And will U.S. production continue to grow? Maybe not but maintaining 13 million barrels per day is still one heck of an accomplishment. And Alaska, the GoM, and other areas continue to put new production online. There is too much oil in the world today. But the market is a discounting mechanism, usually with a view about six months in advance. So, while there is likely to be too much oil for the next six months, ergo the $70 price, what will the market be discounting six months from now? Therein lies the critical question and, considering how wrong everyone was a year ago, don’t expect many heroes on forecasting 2024 prices.

Snippets.

Average gas flows to LNG plants in 2023 totaled about 13 bcf/d versus 11.8 bcf/d in 2022 and 10.7 bcf/d the previous year, recording a second consecutive year of 10% growth
“Don’t be fooled, snow is becoming a thing of the past.” Bloomberg
U.S. Carbon Emissions Fell in 2023 as Coal Use Tumbled to New Lows
Texas regulators limit oil and gas disposal wells in bid to reduce earthquakes in West Texas
U.S. oil and gas production growth starts to decelerate

The Chart is Simple. It shows the Permian rig count versus Permian production. Nothing dramatic, no 2nd or 3rd derivatives. We saw the same effect as shale gas matured. We went from 1,600 gas rigs in 2008 to 120 today. This production has gone up every year but one and is going up again now. We have gotten very good at this. Technology. Efficiency. Service. And the ability to manage them well. All it takes, right? Okay. It is the oil business. A whole lot of luck and some help with timing sure would be appreciated! Not ESG, but TES.

EIA Weekly Petroleum Report

Crude Implications: Bearish – another week of huge product builds. WTI between 1M-6M backwardation is $0.60/bbl. Money managers cut ICE Brent and NYMEX WTI net long positions by 20% w/w. Products dragging complex lower, crude sentiment bad.
U.S. Crude Production: Indicated at 13.2mm BOPD, flat w/w, and up 1.0 mm BOPD y/y.
Refinery Runs: 16.5mm BOPD, down 0.2mm BOPD w/w and up 1.9mm BOPD y/y. Freezing temperatures may hit refineries next week. Utilization is high at 92.9%.
Crude Imports (net): 2.9mm BOPD, up 1.3mm BOPD w/w and down 1.3mm BOPD y/y. Brent-WTI spread at $5.5/bbl, flat w/w.
Gasoline: Bearish – build above expectations. Demand up 4.7% w/w and up 10% y/y.
Distillate: Bearish – build above expectations. Demand up 29% w/w (holiday impact) and down 10% y/y.

LNG Growth Snippet. More than $235 billion has been invested in the coming slate of projects since 2019. According to Baker Hughes, the U.S. will see a 70% increase in LNG liquefaction capacity by the end of the decade. Chesapeake appears to be playing the long game.

Poetic Justice. The Everett LNG import terminal sits in Boston Harbor, visible from many of the buildings I have visited in that city. But it imports fossil fuels, and they are bad. So, the governing body decided not to renew the contract for the power plant that is fueled by the LNG, the largest in the state, which means the export terminal will shut down. Activists win. Kinda. Now, FERC says shutting it down would compromise the stability of the northeastern U.S. energy grid. Oops. One source cites that with record natural gas production in the U.S., New England is facing significant challenges in finding enough natural gas. Wow! Really? Nothing a couple of pipelines wouldn’t fix. Don’t worry. They will figure it out. Late but…

And the Winner is… Citi has put out its Thematic Equity Strategy report for 2024. They picked 30 stocks and, according to the reports, these 30 stocks will have sales growth greater than the Russell consensus. Their upwards 2024 consensus sales revisions will be above the Russell 1000 consensus, price-to-earnings growth or enterprise value to EBITDA growth below the Russell 1000 and their 2024 consensus EBITDA or EPS growth above their expected sales growth. Only one oil and gas stock made the cut. Congratulations, Clay and team at NOV, with an expected return of 41%!

Another Merger and It’s Gas! The deals announced so far in the latest E&P consolidation run have been for oil. Now, we are starting to focus on natural gas. Chesapeake is acquiring Southwestern in an all-stock deal valued at $7.4 billion, combining significant acreage and production in Appalachia and the Haynesville, with 7.9 Bcf/d of production. In the first point made in the company’s release, the deal gives Chesapeake 15 years of drilling inventory. Depth of inventory drove all the oil deals and now, this shows the same interest and priority on gas. Operational and overhead synergies are estimated at $400 million.

Research. A leading OFS analyst and friend of mine put out his outlook this week. Just a few highlights. “In accordance with our updated OFS activity outlook forecasts, we are making estimate updates to many of the companies in our OFS coverage universe. We have taken a more flattish view of U.S. activity throughout 2024, with more modest expectations for 2025. We do anticipate another year of annual growth for both international and offshore activity, albeit at perhaps a more modest pace than the double-digit growth registered in 2023.” In no surprise, U.S. land-based activity is the most negatively impacted. Thanks, James R.

Ask Belichick, Dynasties Fall. China has been the go-to place for investment by other countries for the past several years as its economy grew like a weed. The problem is, with all that growth, most portfolios of Chinese companies have been losses and now, with the growing losses and issues with real estate, the bailing continues. An analysis covering 14 pension funds with investments in Chinese stocks shows most of them have cut their holdings since 2020, with some larger players doing so for a third straight year. Then there is the severe corruption scandal inside the military ranks in China, which should actually be a positive since it most definitely would delay any planned invasion of Taiwan.

A Seasoned Veteran. Geoff Jay, the E&P analyst at Daniel Energy Partners, went to the Goldman Sachs Clean Energy & Technology conference. He had some very insightful views.

Efficiencies, better completions and ever-longer laterals were discussed. This, of course, drove part of the ~900 MBOE/d growth in the U.S. last year. One large E&P believes that U.S. oil growth will be much lower in 2024. But it needs to be, given volume gains elsewhere. Bottlenecks remain, with notable mentions for compression, water handling, gas gathering and electrification.
Investors we spoke with were generally ambivalent about the group, with some expressing concerns that valuations weren’t terribly cheap at mid-cycle prices. Not expensive, mind you, just not cheap. No one we spoke to expected prices to improve much this year, despite geopolitical risks and an increasing need for energy security. The contrarian in us wants to believe that’s bullish, but we admittedly don’t have a compelling thesis for sustainably higher oil and gas prices in the near term.

Straight from the London Telegraph. The appointment of Munroe Bergdorf as a UK champion for UN Women has been criticized. Munroe was born a man and some groups do not think it is appropriate for the UK champion for UN Women to be a man. Or a transgender person. S(he) is a proud LGBTQ campaigner, activist, and model. She was awarded the Hero Award at the 2020 Attitude Awards and dedicated her award to trans youth. Her role in her new job is to help improve gender equality. A letter sent by Fair Play for Women on behalf of 17 UK campaign groups slammed the decision, registering their “dismay and disappointment.” The campaigners frequently misgendered Bergdorf, referring to her on several occasions as “male.” The group also claimed that Bergdorf’s “well-publicized activism is not pro-women.” Bergdorf is also claimed to be “not a positive role model,” and “entirely unsuitable” for the ambassador role. She is also demeaned as “a male whose presentation as a “woman” is an extreme, sexualized version of femininity.”

Hollow Protest. British MP Chris Skidmore is standing down “as soon as possible,” in protest at the government’s green policy. The introduction of the bill would allow for the issuance of new oil and gas drilling licenses in the North Sea. The UK accounts for 1.2% of global emissions. He was leaving anyway since his seat is being abolished in a redistricting. They will hold a by-election, but the winner will only serve a few months until the next election. He is one of the leaders of the “net zero” move by the UK which appears noble but also impossible without dramatic changes in lifestyle for hundreds of millions of people.

Speaking of Deals. Stewart Tubular Products, who provides mission critical high tolerance downhole components and threading services, and a portfolio company of private equity group Aterian, has been acquired by Pelican Energy Partners, a well-known Houston-based firm specializing in strategic investments in small to middle market high-growth potential energy and industrial businesses. The high point? PPHB advised Stewart in the deal. Well done, team.

All of Energy. Midstream and Energy Infrastructure is expected to experience a challenging year with U.S. and global economies preparing for the potential of a slowdown which could temper energy demand. Oil and gas demand could also experience a loss in share of the overall energy demand growth as renewable fuels gain more traction. There are three big issues, really the potential growth opportunities, for the sector right now.

Gas processing in the Permian
LNG liquefaction capacity—a continuing growth story
Regulatory clarity could drive gas infrastructure

The top six public processors who account for close to two-thirds of the total processing capacity in the basin announced plans to increase capacity by more than 12% in 2024 and about 5% in 2025. Part of the gas production growth is being driven by higher GORs in the basin, with reports saying that it is up by more than 25% in five years. The fourth-quarter expansion of the Permian Highway (PHP) and Whistler gas pipelines adds a combined 1.05 bcf/d of egress capacity. The expected completion of the 2.5 bcf/d Matterhorn pipeline in third-quarter 2024 is expected to provide capacity to move the residue gas from the processing plants to the end-markets.

Our Representatives. Even self-appointed congressional fire alarm Jamaal Bowman (D-NY) got in on the action, claiming that Gay’s ousting was an attempt to intimidate other black men and women who aspired to positions of power. “This isn’t about plagiarism or antisemitism. This is about racism and intimidation. This makes no one safer. The only winners are fascists who bullied a brilliant and historic black woman into resignation. 2024 will be a battle for truth, democracy and our shared humanity,” he said. Bowman was censured by the House last year after he pulled a fire alarm to interrupt a vote.

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.