Things I Learned This Week in South Texas

January 19, 2024

One Down, Hundreds to Go. SLB kicked off earnings and the dissection begins. What you did last year doesn’t matter. It’s the future we care about! Just be right. Yeah. Sure. E&P companies will preach discipline, as they should, but will complain about valuations, giving a host of reasons why the business isn’t going away anytime soon. They are right, but who cares? What are you doing for me lately? The OFS crowd has it harder. The E&P consolidations are negative in the near term for OFS, and commodity prices, the strip, don’t inspire confidence on their own. So, I have done all the appropriate work and research leading into earnings season. Quail hunting. When the going gets tough, go shoot something. Not meaning to be cruel to some but… a 17-covey morning! Thanks, Falfurias, Corpus and Beeville for a great week. And to all those friends I promised would not see their comments from the back of a quail truck in print, you won’t. Your secrets are safe with me. What happens on a quail hunt, stays on the quail hunt. Thanks, guys.

U.S. Operating Statistics

U.S. rig counts were 619 this week, down -0.32% versus last week and are down -20.13% versus last year
U.S. oil rig counts were 499 this week, down -0.40% versus last week and are down -19.90% versus last year
U.S. gas rig counts were 117 this week, down -0.85% versus last week and are down -22.00% versus last year
Rig counts in Canada were 212 this week, down -6.19% versus last year

View from the Top. There are good analysts, and then, there are those that I have trained. One particular analyst recently left the research ranks to do IR for Baker Hughes. The following is the Baker Hughes “view of the world” for 2024. Sorry it is so long-winded, but thoroughness is always a good thing.

Several themes for 2024 are clear: The U.S. land market will experience a decline in activity; International land growth is poised to continue—especially in the Middle East and in certain pockets of Latin America and Asia; and offshore momentum will be on full display. Those companies leveraged for growth in offshore—where assets are in short supply, technology is dominated by a select few and consolidation has already unfolded—are best positioned to significantly grow earnings, cash flow, margins and maximize shareholder returns.
North American activity growth began to slow considerably in 2023 with companies maintaining capital discipline. Natural gas activity softened with high inventories and low prices. M&A activity grew.
Consolidation in the E&P space is a net negative for oil service providers, at least in the near term, as capital budgets following transactions tend to be optimized, resulting in lower oilfield service (OFS) equipment utilization and sometimes pricing declines. The M&A announcements last year and in the beginning of 2024 have been very large. The loss of market power for OFS will likely be felt as industry activity declines this year. The oil service industry needs to refocus on consolidation.
The benefits of a consolidated market are clear in subsectors such as land drilling, pressure pumping and offshore drilling, where major changes to market structure have led to better economics and returns across the board. When your customers consolidate faster than you, you are deconsolidating and may not realize it.
The international land markets remain strong, particularly in the Middle East where the desire to restore productive capacity, produce more natural gas for internal consumption and raise production capacity are driving all-time highs in E&P spending and rig counts in many countries. Saudi Arabia, Iraq and the UAE are targeting a total 4 MMbbl/d of new oil production capacity by 2027. That represents an average 47% increase from current stated capacity. Kuwait is similarly targeting to invest in 1.9 MMbbl/d of new capacity by 2040 — 68% of its current maximum.
The global offshore oil and gas markets will be the largest drivers of E&P spending growth in 2024. Offshore asset values are surging and day rates have jumped considerably. Many of the offshore negotiations for assets are happening directly, reflecting the desire of the oil industry to quickly and quietly secure assets for many offshore drilling programs.
The major oil companies and NOCs recognize the need to replenish baseload, low-decline rate oil production while international independents are attacking prospects divested by the majors in prior years. There is also a shift towards increasingly targeting natural gas in the Middle East to replace oil in electricity generation and in many other regions to supply the major LNG facilities currently under construction. Energy security concerns are a driver of this trend, as well as the desire for lower carbon fuels.
For the year, we anticipate solid free cash flow generation across our coverage universe and more capital to be returned to shareholders through buybacks and dividends as the cycle continues. Most companies have announced shareholder return frameworks. The industry is also in an enviable position to help drive the energy evolution and the de-carbonization of oil and gas.

Cogent Thoughts. Against a backdrop of potential rate cuts, energy stocks piqued the interest of some investors last fall, given the FCF yields on offer. So, what explains the poor performance so far in 2024 relative to crude prices? First and foremost, the discussion regarding risk-to-reward has swung negative. Last year, the consensus view was that a combination of demand recovery in China and within air travel presented an upside skew to oil prices and, consequently, energy stocks. Today, the consensus is shifting towards oil prices being rangebound due to excess spare production capacity, with more downside risk than upside potential. This reflects the likely need for OPEC to retain spare capacity for some time and presents downside risk if OPEC cohesion evaporates. Second, the higher yield of energy equities can be explained by higher volatility, although midstream screens are relatively attractive at $70 WTI. - Citi

Observations. Efficiencies, better completions, and ever-longer laterals were also 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. – Goeff Jay, DEP

Headlines.

The world is heading for massive LNG oversupply.
EVs accounted for 19.5% of total vehicle sales in Delhi last month.
U.S. Oil is Booming and It’s Upending Global Markets.
JPMorgan Chase fights off 45 billion hacking attempts each day.
Global coal generation hit record high in 2023.

Victory for Chefs (And Hack Cooks Like Me)! We have a slide in our deck that reads, “Pragmatism beats ideology every single time, just not as quickly as we would like.” So, today, I read Berkeley's natural gas ban failed. If you remember, Berkeley famously banned gas stoves in new buildings, requiring them to be electric, which is generated by burning natural gas. And ask anyone who cooks which they prefer. I’d take bets on 95-5 at least. But, a California court has ruled it unlawful. Of course, 130 other localities adopted the same idiotic rule. All of which will be ruled unlawful. Rational thought becomes action. It’s a victory in several ways.

Historical Stats. The rig count at the end of September was 623, as it was this week. In fact, since then, no weekly rig count has been more than 1.3% off the 16-week period. It was mentioned to me that this is the most stable the rig count has been – ever! While this appears to be slightly right, we warned not to start counting chickens just yet. The rig count was flat for the first five months of 2020, before dropping off a cliff. That was leading into COVID and, while it was the reason for the drop, today we have inflation, a weak China, wars breaking out all over, a much more restrictive administration and the overhanging specter of recession. We can argue which is worse, but you are arguing about pennies out of thousands. The historical seasonality of the U.S. rig count shows that the rig count generally declines from yearend until late April or early May, and the historical volatility of the rig count is stunning. This century, the average annual decline in drilling activity is 34%. Granted, it has only been down 7 of 22 years, but 34% annual moves down are tough to plan for. Four of those seven drops saw a decline between 42% and 51%. And, the years that the rig count was up, it was up an average of 24%. Up years ranged from increases of 6% to 70%. Those numbers add up to volatility. Going forward through 2024, the expectation is for flat to weaker counts from current levels with the backdrop of U.S. drilling being in secular decline. This brings up another argument. Are we at mid-cycle? Or is this closer to a peak?

Cooked. I was watching a presentation by one of the presidential candidates where an attendee went off on climate change, claiming the wildfires on the West Coast and around the country were worse than ever! Maybe not. Hate to see facts get in the way of ideology, but…

Real Testimony. Robert Bryce, who I consider a friend, was recently asked to testify in Washington on the topic of electric vehicles. Robert writes and speaks, and we often cite similar sources. I agree, frankly pretty much down the line, with his views. Views that are based on data, not opinions on whether some agreement is or isn’t a challenge or issue. He recently addressed three major points:

EVs have never lived up to the media hype.
Auto dealers call EV mandates “unrealistic;” Half of EV sales are happening in heavily Democratic counties.
EV mandates will make the auto industry dependent on China. One portion struck me and it is a point I have made several times and he writes it very well.

In November, nearly 3,900 automobile dealers from across the country sent a letter to President Biden telling him that EV demand is “not keeping up with the large influx of BEVs arriving at our dealerships prompted by the current regulations. BEVs are stacking up on our lots." The letter, which has now been endorsed by some 4,467 dealerships, continued, saying EVs are “not selling nearly as fast as they are arriving at our dealerships — even with deep price cuts, manufacturer incentives, and generous government incentives. While the goals of the regulations are admirable, they require consumer acceptance to become a reality. With each passing day, it becomes more apparent that this attempted electric vehicle mandate is unrealistic based on current and forecasted customer demand.”

Snippets.

Scientists warn that heating your home could be responsible for the rise in deadly blood clots.
Global consumption of petroleum and other liquids hit a record high last year and is forecasted to increase further in 2024.
The mullet is back! The “modern day” mullet largely originates from David Bowie’s genre-defining and gender-norm defying persona, Ziggy Stardust.

Frigid. The latest frigid cold snap gave another warning that the electric power grid may not be as reliable as needed. For Colorado and their campaign against all things hydrocarbon, the voters have gotten what they wished for. Now, they have to restart open-pit mining for copper!

Amen Brother! It was a year of reckoning, in which humanity finally began to understand that it faces an existential threat. A threat unlike any we have ever faced before and one that will wreak havoc on our fragile planet if we fail to stop it — and it may already be too late. We are referring, of course, to pickleball. Nobody knows where it started. Some scientists believe it escaped from a laboratory in China. But, whatever its origin, it has been spreading like rancid mayonnaise ever since, with pickleball courts now covering 43% of the continental U.S. land mass and subjecting millions of Americans to the inescapable, annoying pop of the plastic ball. And, the even more annoying sound of boomers in knee braces relentlessly telling you how much fun it is and demanding that you try it. – Dave Barry

Scholarly View. As such, our key themes for the year ahead in 2024 point in a new direction. The reality of the new versus old energy economy, with its focus on decarbonization, electrification and renewables is, by now, well understood. The energy transition has made great strides in some areas but is still struggling with the scale and scope of the global challenge, as the COP meeting in Dubai acknowledged. Hydrocarbon demand globally continues to rise, even as progress in new energy technology and the renewables build-out gathers steam. But the fact that oil and gas markets appear to be focused beyond near-term supply risk (oil) and tight fundamentals (European gas) suggests security of supply risks have been partially eclipsed and are no longer the sole dominant theme. Instead, sustainability through green energy is emerging as a key component of strategies that incorporate security of supply, industrial policy, climate diplomacy and international relations. For hydrogen, the story is one of perpetual running to catch up. Unrealistic, upgraded European targets on electrolytic and CCS-enabled hydrogen show little sign of being met, which means that blue hydrogen derived from methane reforming will dominate the industry in Europe for longer. For hydrocarbons, the fundamental picture is complex. - Key Themes for the Global Energy Economy in 2024 (Oxford Institute for Energy Studies)

Chill. Relaxing on a sunny beach lowers your blood pressure? It’s scientific, not just an excuse to drink beer in the morning. High blood pressure kills 10.8 million people each year, making up 19% of all deaths. Cold weather raises blood pressure and warm weather lowers it. Florida or Texas anyone?

Chilly. Cold kills 9 times more than heat - 4,600,0000 people die every year. – ClimateReanalyzer.

Goodbye. John Kerry resigned as the “climate czar” this week, right as a massive cold front envelopes the country. Midland, Texas, at 6 degrees? Might they be related? Preaching global warming right now does not enhance your credibility, or show that you had none all along. But a hypocrite? No, a believer. He believes so much that the coasts and beaches are going to be destroyed by climate change to the point he only spent $17 million for his Oceanside home, bought in 2017. The pendulum swings.

Biomass Greenwashing 101 (From X, Formerly Known as Twitter).

Clearcut native Pinyon-Juniper forests in Nevada.
Grind them into pellets & dry them with natural gas.
Ship them 5,000+ miles to Denmark.
Burn them in a power plant.
Call it green energy.

Governor Joe Lombardo of Nevada, “stop this madness!”

Karma? This reminds me of what happens when I try to predict the oil price.

Electric. HartEnergy ran a story with the following headlines, touting the move to electric from diesel by some of the largest companies. “The Completions Package: NexTier, ProPetro Electrify Frac Fleets. NexTier and ProPetro’s respective electric frac fleets are touting a newer, cheaper and more sustainable approach to hydraulic fracturing through electrification.”

Research. “Predictions are difficult, especially if they are about the future.” – Niel Bors. A recent analyst report struck us. I have always maintained that only one or two qualifiers can make absurd statements true. I am the best-looking guy who lives at the northeast corner of Cornell and Abbot. Absurd, but true, with only a little qualification. The comment – “As a result, the stock could do well from current levels, but this trade is speculative due to its reliance on ongoing economic strength and OPEC supply cuts.” An OFS analyst’s closing statement regarding a drilling company. I wonder why more people are investing in the sector, with only two small caveats of risk!

Real Intelligence. Juniper Networks is getting bought for $14 billion, focused on its Mist AI capabilities. What are they? Mist AI will “optimize user experiences from client-to-cloud, including automated event correlation, root cause identification, Self-Driving Network™ operations, network assurance, proactive anomaly detection and more”. Now, I don’t feel so bad when someone tries to explain biomechanics to me. It sounds good, but I have no idea what they mean. And, for $14 billion, something concrete would be nice, considering that entire sub-industries of drilling and producing oil and gas aren’t valued at $14 billion today. Keep working on those digital tools!

Count On It. We have been worried about a credit recession for the last year. Billions in real estate debt will need to be refinanced in the next two years with fragile regional and community banks, U.S. office occupancy at a 40-year low of 80%, all of the Chinese property companies having gone under and credit card debt moving to record highs. But it’s all okay. The Federal Reserve has things well in hand. Other than that little thing about them losing $114 billion last year, and to put that into perspective…

Just Stop. What do you do when everything you do to accomplish your goal only succeeds in getting a wide range of people to hate you? This just in. Supporters of Just Stop Oil have joined the March for Palestine in London.

DEI Dying. Dr. Sherita Hill Golden is the head of Diversity, Equity and Inclusion for John Hopkins University. She is a black woman, as are many DEI officers in corporate America these days. Dr. Golden writes a monthly piece, and this month, she noted that “privilege” is the “diversity word of the month.” The message was emailed directly to all employees, from the DEI office - “Privilege is characteristically invisible to people who have it.”

“In the United States, privilege is granted to people who have membership in one or more of these social identity groups:”

White People
Able-bodied People
Heterosexuals
Cisgender People
Males
Christians
Middle of Owning-Class People
Middle-aged People
English-Speaking People

John Hopkins walked back the statements from the DEI office of the university, saying it was exactly the opposite of the University’s philosophy. Then, we have the woman, who is the New York City Attorney General, leading a rally with the cry of “too male, too pale, too stale” The AG of the largest city. Yikes.

Rev It Up. To be fair, Alberta does not generate enough electricity for its own needs and relies on other provinces for help. But, before your victory dances, Alberta gets only 10% of its power from renewables, so they have virtually no impact. 36% comes from coal and 54% from natural gas, but Alberta relies on neighboring provinces for power. However, the brutal weather there is limiting the amount of power available to Alberta, so no renewable-bashing. The adjacent provinces got hit with the same artic blast and didn’t have enough spare power to send to Alberta. That points to problems on several different levels.

The Foundations are Shaking.

Turkey launched airstrikes in Iraq and Syria, destroying bunkers, shelters and facilities. The strikes were in response to an attack on a Turkish military base in Iraq that left nine Turkish soldiers dead.
Pakistan launched missiles at Iraq in retaliation for missile attacks on them.
The U.S. continues to hit Houthi targets in Yemen as they continue to attack ships in the Red Sea.
Iran has seized a U.S. tanker, making the Straits of Hormuz less viable for shippers.
U.S. installations have seen more than 100 missile strikes since Hamas’ October 7th raid on Israel.

Presidential? A couple of months ago, I mentioned that Michelle Obama is my bet to be the Democratic presidential candidate. Today, Biden has a 33% favorable rating and, according to virtually every poll, Trump would win the election if it were held today. Then, there is the question of who is running the country now. Joe Biden? Setting foreign and domestic policy? Really? This week - former first lady, Michelle Obama, said she’s “terrified” about the potential outcome of the 2024 election, listing November’s presidential contest as among the fears that keep her awake at night during a podcast interview released Monday. “What’s going to happen in this next election? I’m terrified about what could possibly happen, because our leaders matter. Who we select, who speaks for us, who holds that bully pulpit, it affects us in ways sometimes I think people take for granted.”

Oil Monitor - Sell Rallies in Early 2024, Before the Storm Hits in 2025. “We update our oil balances for 2024 and extend them into 2025. 2024 continues to look finely balanced, assuming OPEC+ holds 1Q’24 output constant through 2024, which is our new base. However, 1Q’s balanced market is expected to transition to a weak 2Q. Brent is expected to moderate during 2Q to $73/bbl (currently $78/bbl). 2025 balances look bearish to very bearish in most scenarios, with a base case 1,200 MBOE/D surplus and Brent dropping ~25% versus forwards of $55-60/bbl by 2H’25. We model a significant 2025 surplus even if OPEC+ holds cuts to end-2025, meaning little room for OPEC+ to raise supply 2024-25, owing to slowing demand growth and solid non-OPEC+ supply growth. Thus, we recommend oil producers consider longer-dated insurance against substantial downside price risks over the 12-24 month horizon.” - Citi

Misguided. Environmental activists go to all sorts of lengths to bring awareness to their cause. In the case of one group in the UK, that means deflating tires on SUVs. Evidently, the group doesn’t discriminate and will supposedly flatten tires on electric cars as well. It doesn’t appear to have considered all of the additional outcomes as a result of its actions. The group in question calls itself the “Tyre Extinguishers” and says that it makes it “impossible to own an SUV in the world’s urban areas.” Don’t say that in Dallas or Houston. It goes on to say that it does this “for climate, health and public safety.” Notably, there’s no question that pollution caused by combustion cars has a negative effect on health. Perhaps that explains why the group’s flyers appear to harbor a distinct animosity toward “gas guzzlers.” However, somewhat ironically, one of the vehicles they allegedly vandalized in a Clifton neighborhood in Bristol, UK, happened to be a Tesla. They deflated the electric SUV‘s tires and left the same flyer on the windshield. This leaflet, as noted by the BBC, bore the title “Attention: Your gas guzzler kills.”

And the Winner Is… Anthony Fauci testified in front of Congress this week and admitted that the six-foot social distancing rule was completely made up, having zero scientific basis. He made $7.6 million during the pandemic, raising his net worth to $11 million, according to Forbes.

Rates Reversing? We have recently published the betting odds that the Federal Reserve would lower rates in March. Push that back a little, could you? Stronger than expected retail sales and higher inflation have resulted in some comments by the Fed that they might not be done raising yet. There is now only a 50% chance of a March cut, down from almost a given a couple of weeks ago. That hit the stock markets and dropped them. The two-year Treasury note’s yield, more sensitive than longer maturities to Fed moves, has risen 18 basis points since last week to 4.32%.

Go Green? The Green Party in Germany started in 1993. It had great appeal to the younger generation, but that younger generation is now almost thirty years older. According to Steppenwolf, the 60s musician, never trust anyone over thirty. That appears to be the case now in Germany. The Green Party has agreed to destroy a German village to expand a lignite coal mine, and for some odd reason, that has gotten the climate people upset! So, there is a growing rift between the Green Party and climate change activists who originally played to the younger generation. Do they take over from here? Does the thirty-year-old Green Party become more conservative as they grow older? They will figure some of these things out. There is a growing issue between the ideology of twenty-something’s and the reality of grown-ups.

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.