Things I Learned This Week About New Year’s Eve. Stay Home.

January 5, 2024

Welcome to a Brand New Year! 2024 will be an interesting year. And, of course, we say that every year because being in the energy business is always a roller coaster. Flat spots are rare. The U.S. has become the world’s largest oil producer and, while we grow, OPEC+ cuts production to balance the market. Our production has likely peaked at 13.1mm BOPD, but the goal is to keep it as high as possible for as long as possible in hopes that global demand picks up to allow for a non-restricted free oil market. I hope some of you asked Santa for that. Of course, when we think oil has to go down, it doesn’t. And, when we expect it to rise, like we did most all of last year, it doesn’t. What a fun business! But I wouldn’t trade it for the world! So, the Holidays are over, at least until my birthday, Valentine’s, a wedding anniversary and a few others that I have to remind myself of. This month should be interesting as I get to spend a great deal of time with great friends and great settings. Heck, maybe I’ll learn something.

Europe is Spared Again! Another warm winter has saved Europe from burning furniture to stay warm for the second year in a row. The region’s natural gas storage inventories are at or near record levels, as they have been since last winter when the weather was “unseasonably fair.” Natural gas storage sites were still 86.5% full at the end of December, down from a peak of 99.6% in November. December’s level is the second highest on record and 15 percentage points higher than the ten-year seasonal average. The impact is broader though. One of the largest buyers of natural gas during the shoulder and refill season will be, to a large extent, out of the market, which does not bode well for natural gas prices in Europe or globally.

Energy Stats by PPHB

Commodity Prices: WTI crude oil is currently $72.70 per barrel (up 1.3% week-over-week) and natural gas is $2.45 per MMBtu (up 2.9% week-over-week)
Crude Oil Production: U.S. crude oil production is currently ~13.2 million barrels per day (up 9.1% year-over-year)
Crude Oil Inventories: U.S. crude oil inventories decreased by ~5.5 million barrels week-over-week vs. an estimated decrease of ~3.2 million barrels.
Frac Spread Count: There are currently 240 frac spreads operating in the U.S. (a decrease of 12 spreads week-over-week)
Onshore Drilling Rig Count: There are currently 602 drilling rigs operating in the U.S. (an increase of 1 rig week-over-week)

Cost of Doing Business. Chevron announced that it will take a charge in Q4 of $3.5-$4 billion, mainly for its California upstream assets, citing regulatory challenges that have resulted in "lower anticipated future investment levels in its business plans." Chevron will continue its operation, just at a reduced level. In an interesting twist, the company also said that part of the charge comes from abandonment liabilities by companies it sold properties to who cannot afford the liability. So, the Administration is going back to previous owners to fund the liability. Ouch.

Piling On. Exxon, too, is getting hit by California regulations, planning on a $2.4-$2.6 billion charge in Q4 as well. Their charge centered on the idle upstream Santa Ynez facilities that Exxon has been trying to sell to Sable Offshore who has plans to restart the field after being idle since 2015 due to a pipeline spill. That deal is now expected to close by February 1st.

And When Do We Bill Them? New York City sued 17 charter bus companies that have transported migrants from Texas, saying they should pay the $708 million in costs the city has incurred caring for more than 33,600 people sent from the Lone Star state. We get 10,000-12,000 each day. A group of GOP congressmen visited the border this week. But, it had been cleaned up before they arrived, much like they do when Biden or Kamala visit, which is rarely. Is it a political ploy? Absolutely. Texas gets told its recent law dealing with immigrants is unconstitutional because it infringes on federal jurisdiction, but, since it is federal, that means that all 50 states share in the burden. Either agree to shut the border until a solution can be determined or we keep sending them to other parts of our United States, helping them understand what we have been going through for the last several years. In the past year, there have been more immigrant encounters at the southern border than the those residing in Wyoming, Vermont, Alaska, and North Dakota. And that was just last year alone. Something has to be done.

Getting Carried Away. First, Shohei Ohtani, a 29-year-old from Japan signed a $700 million deal with the Dodgers. Now, a 20-year-old Frenchman, 7-foot 4-inch tall Victor Wembanyama, was drafted by the San Antonio Spurs and may become the first NBA player to amass $1 billion in earnings from basketball contracts alone. So, the CEO making money for investors and keeping thousands employed gets blasted for making $20 million. I guess the money is in entertainment. Bread and Circuses.

Business Development. “Flare Modeling & Emissions Reporting - Keep your facility safe and compliant by fully understanding your flare systems. In these three detailed scenarios, SLB Senior Facilities Engineer Nick Gorzynski demonstrates how you can model your flare system so you can keep your operations safe and compliant.”

Outlooks Continue. Citi gave an interesting view of the U.S. OFS market for Q4 and 2024. RPC, the parent of Cudd Pressure Control and other U.S. businesses, saw their Q4 EBITDA estimate reduced by 18% and, since this is after the end of the quarter, you have to think they have a good up-to-date view. Revenues dropped by 7%, so you can see the under-absorption and pricing issues as well. Both 2024 and 2025 had their top lines dropped by 6% each on weaker completion activity expectations, which dropped the EBITDA forecasts by 13% with the continuing drag on margins. The price target is based on a 3x multiple of 2025 EBITDA. We are looking more and more forward in our crystal balls, trying to find optimism in the outer years. This shows that no one was really sure what Q4 activity would be or how it would hold up in the period now referred to as the “budget exhaustion” quarter. But the expected flow through for the next eight quarters is really the telling point.

And More Opinions on the Future. Carrying on with optimism (sarcasm), JPMorgan released an update on their natural gas outlook this week, considering the futures strip has dropped by 25% for 2024 and 15% in 2025 in the past several weeks. The 2024 strip is now below breakeven in several basins. The surge in U.S. onshore production, warmer than normal weather conditions and LNG start-up delays are given as the main reasons. In November, U.S. natural gas production, with production levels at 105 Bcf/d, was up 2.6 Bcf/d compared to October and 4.6 Bcf/d above last November. December is expected at 105.1 Bcf/d, up again from November. All this is being done with 120 rigs working, down from 156 rigs in November 2022 drilling for natural gas. In 2008, that number was 1,600. The JPM report said that based on a 25% return, the low end of the cost curve is:

SWPA Rich Appalachia: $3.06 per Mcf
Eagle Ford Southern Gas: $3.17 per Mcf
WV Rich Gas: $3.25 per Mcf
SWPA Dry Gas: $3.49 per Mcf
Haynesville - LA Core: $3.49 per Mcf

At 15% full cycle returns, the breakeven values decline by about $0.50 per Mcf.

EIA Weekly Petroleum Report – Evercore.

Crude Implications: Bearish – big holiday week product builds. WTI between 1M-6M has shifted from contango to backwardation. Money managers increased ICE Brent and NYMEX WTI net long positions by 23% w/w, up ~40% in two weeks from a record low. Net spec long positions are closer to ‘normal’ levels. Both gasoline and distillate implied demand weak, impacted by holiday timing.
U.S. Crude Production: Indicated at 13.2mm BOPD, down 0.1mm BOPD w/w, and up 1.1mm BOPD y/y.
Refinery Runs: 16.7mm BOPD, up 0.1mm BOPD w/w and up 2.9mm BOPD y/y. Easy comps vs. Texas freeze at YE22. Utilization rose to 93.5%.
Crude Imports (net): 1.6mm BOPD, down 0.8mm BOPD w/w and up 0.1mm BOPD y/y. Brent-WTI spread at $5.5/bbl, flat w/w.
Gasoline: Bearish – build vs expected draw. Demand down 13% w/w and up 5.9% y/y.
Distillate: Bearish – build above expectations. Demand down 33% w/w and down 5.0% y/y.

A Different Solution. We have written in the past about the immigration issues in Europe and especially in the UK where the Prime Minister has announced a plan to send illegal immigrants in the UK to Rwanda, paying hundreds of millions of dollars to do so. There are still battles to fight. The Supreme Court ruled the policy unlawful, but the bill presses on. Right now, there are more than 33,000 migrants who face deportation to Rwanda. The Texas border gets 10,000-12,000 per day and Texas has bussed thousands to Chicago, New York, now New Jersey and a number of other sanctuary cities, many of whom are rethinking their status. 33,000 and New York complains?

Dividends Increase But Buybacks Fall. That was the headline. We have always thought of buyback as dating whereas a dividend was getting married, showing commitment. Cutting dividends and divorces are both painful. Casual dating breakup? Barely noticed. But it does show the increased optimism by corporate America. They are increasingly making the commitment of “marriage.” Something not taken lightly, especially if you have been “married” before. This is optimism in longevity, not a boom. And that is clearly positive as longer-term issues are addressed well in advance, including planning, supply chain and stable and predictable derivatives. And, if not completely stable and predictable, at least more so. The idea of a long-term gradual up-cycle, in any industry or sector you want to pick, is a really good thing. Now we get to hope they are right.

The War Spreads. The deputy head of Hamas’ political bureau, Saleh al-Arouri, has been assassinated by an Israeli drone strike in Beirut. In Beirut, not Gaza.

Offshore Shines. “The global offshore oil and gas markets are heating up and will be the largest drivers of E&P spending growth in 2024 as the industry quickly runs out of available modern offshore rigs, vessels and aviation assets to support the surge in activity. The industry that is back in focus is one that recently finished a very tough decade.” The shale revolution focused first on natural gas, sending the rig count to 1,600 in 2008 looking for natural gas alone. After the 2008-2009 market crash, shale drilling for oil took off and became the dominant activity. Then, in February of 2014, the major oil companies all had an epiphany – instead of focusing solely on production growth, they shifted to growth in financial returns. And, since 82% of major offshore projects during $120 oil were negative returns, deepwater got hit hardest and first. Then, an over-built, over-levered and not at all consolidated industry fell on very hard times with COVID being the nail in the coffin, causing almost every offshore boat and rig company to restructure. NYSE:RIG is an exception. Leaner, with a great deal of consolidation achieved and de-levered balance sheets, the industry started to recover and some of the recent discoveries made the industry revisit the offshore market since the OFS companies had years to develop more efficient and cost-effective technologies. Now, the goal is Return on Invested Capital (ROIC) with the market continuing to tighten. Deepwater day rates, which bottomed in the low $100,000’s, are now seeing $500,000 day rates. Jackups, 53 having gone to work in Saudi in just the past year, have seen day rates move from the $60K-$70K range up to almost $150K per day. Marketed utilization for deepwater and jackup rigs are around 90%. The longer-term commitment of capital on deepwater projects provides a great deal more momentum and longer visibility than any of the shale plays. We are back. Quotes are from a report from James West at Evercore.

Auto Sales Jump. After declining for two years and the last three years being well below the pre-Covid levels, U.S. auto sales moved up to 15.5 million vehicles. The average internal combustion engine (ICE) vehicle is now $46,000. I paid $5,000 for my brand-new TR-6 after college. The average price of an EV is $65,000 with the cost of battery replacement being a large percentage of that. In fact, one recent story had the battery replacement more expensive than the value of the car. The lack of charging stations is often given as a leading reason for being wary of EVs but, in my experience, economics win out. And not the full-cycle, fifty-year economics, but how much do I have to shell out now and what will my monthly payments be? With the huge economic disparity of new vehicle costs and the eventual cost of battery replacement, it is no wonder that EV sales growth is slowing. The used car market for EVs has caused some European car rental companies to quit offering EVs because the resale is so bad it ruins their economics. Who wants to buy a five-year-old Tesla knowing that its battery only has a few years left at best? Toyota took the lead in global car sales back last year, interestingly enough, on the basis of much higher plug-in hybrid sales. The CEO of Toyota was right. The future may not be all EVs.

The Fed. No more raises! In most businesses, that would not be a good thing to hear but, to a CFO looking at financing costs, it is music to their ears. The Federal Reserve has said that it doesn’t know when cuts will occur, but no additional raises are foreseen. This is one of the main reasons for the strong stock market as “risk on” trades look better with lower rates. The Fed's own projections are for the midpoint of its federal funds rate range to end 2024 at 4.6%, compared to 5.1% in its previous forecasts made back in September. According to one large bank, it is forecasting three consecutive 25 basis point cuts in March, May, and June to reset the policy rate from a level that the FOMC will likely soon come to see as far offside. This would be followed by quarterly cuts to a terminal rate of 3.25% to 3.50%, 25 basis points lower than previously expected. Another has the rate going sub-3% by 2026 with others forecasted that we will hit that level in 2025. Regardless of who is right, directionally we will take it! Just lock in those long-term 5% opportunities now.

And We Didn’t Even Notice. An obviously exhaustive 738-page study that the Marines first commissioned in 2020 said traditional ways of addressing superiors were holding back gender integration. No more “yes, sir” or “yes, ma’am” either. They might be offended by being “misgendered.” But, it was a $2 million report commissioned by the Marines from the University of Pittsburgh that sealed the deal. “Employing gender-neutral identifiers eliminates the possibility of misgendering drill instructors, which can unintentionally offend or cause discord,” the study said. The two-year study also said that “the Army, Navy and Coast Guard effectively de-emphasize gender in an integrated environment.” “By teaching recruits to use gender-neutral identifiers for their drill instructors, Services underscore the importance of respecting authoritative figures regardless of gender.” “Instead of saying ‘ma’am’ or ‘sir,’ recruits in these Services refer to their drill instructors using their ranks or roles followed by their last names,” it said. “Gendered identifiers prime recruits to think about or visually search for a drill instructor’s gender first, before their rank or role.” What if they actually shoot someone in combat and refer to them by the wrong pronoun? Is it still wrong? The issue is that this story is from one year ago and it is the first I have heard of it.

Yikes. American consumers continued to splurge in 2023, boosting the economy with revenge travel and expensive restaurant meals. But a lot of it was funded with debt. Credit card balances in the US increased by about 4.7% to $48 billion in the third quarter alone, pushing the total to $1.08 trillion. It’s the highest total in data going back to 2003. The bills are mounting at a time when the average annual percentage rate, or APR, has soared north of 20% to the highest on record.

Mea Culpa and Great Outlook. 2023 was a mixed bag for OFS stocks as the group lagged the broader market and performed below the middle of the pack of the energy sector. Oil and gas production growth was stronger than we modeled, which placed downward pressure on the commodities and led to lower NAM activity. We under appreciated the impact from significant D&C efficiency gains, increases in lateral lengths and greater than expected DUC drawdowns, which supported much higher U.S. oil and gas output than we modeled. The S&P Oil Services index was up almost 13% for the year but the OSX index was up only 1%. The S&P Oil Producers index was up 7% with LBRT as its largest component. The Baker Hughes U.S. rig count dropped 20% in 2023 which drove a 35% pullback in land drillers and a 21% drop for pressure pumpers.

Consolidation Continues. APA Corporation, formerly known as Apache, is buying Callon Petroleum for $4.5 billion. It will add scale to APA’s current operations in the Permian, with Callon having almost 120,000 acres in the Delaware Basin. This will put APA’s total production close to 500,000 Boe/d. Again, buying inventory to gain runway. Smart.

More from JPM. “In our 2024 OFS Outlook, we highlighted our expectations for the year ahead. We see a mixed macro picture capping the upside on the sector’s prospects given signs of ample physical supply of both oil and gas. While the post pandemic recovery in oil demand has largely played out as expected, the continued intervention from OPEC+ to subsidize the global market suggests more limited upside risk to oil prices over the next 12-months, although it would seemingly protect a floor above $70/bbl Brent. Given the potential for 2024 to represent an air pocket relative to our expectations for higher long-term oil prices on supply side tightness, we favor later cycle exposure.”

Current Betting Odds. Donald Trump has overtaken Joe Biden as the favorite to win the presidency with odds of +125, implying a win probability of 44.44%.

Another Record. The U.S. national debt hit a new record! Maybe we should mourn instead of celebrate. We now owe $34 trillion dollars. That is over $102,000 for each and every person in the country. If you just look at those who actually work outside of the house, estimated to be 158 million people, this amount stands at $215,000. That is what each working person owes. The interest the U.S. currently pays on its national debt is now up to $1 trillion dollars every year. Credit rating agencies are finally understanding, and Moody's recently cut its credit outlook on the U.S. to negative from stable, citing heavier downside risks to the country's fiscal strength. Fitch lowered country’s credit rating last year, and S&P was one of the first agencies to downgrade U.S. government debt since 2011.

GOM Grows. Talos brought two “fields” onto production this week. I highlight the word because each “field” is one well. Nothing wrong with that. The two wells have estimated combined recovery of 20-30 million barrels of oil equivalent (Boe). Estimated daily production is 15,000-20,000 Boe/d and is 40% oil and 60% liquids. The two wells use sub-sea tiebacks to the Ram Powell platform, one four miles and the other 9 miles. The wells were discovered in Q4 of last year. A one year find-to-flow schedule. These low-cost, high incremental margin tie-back wells have been the bread and butter of the GOM for several years now and, as Talos has shown, it still works. Congratulations.

Cool Asset. The Ram Powell TLP is about 125 miles southeast of New Orleans, around 80 miles south of Mobile, Alabama and is in 3,218 feet of water. At the time it went into service in 1997, it was the deepest TLP development in the Gulf. Today, it is the Big Foot development at 5,135 feet. TLPs have been in use since the early 1980s with Conoco building the first in the North Sea. The Ram Powell TLP was owned and designed by Shell Offshore, Amoco Production and Exxon, costing $1 billion (over $2 billion in today’s dollars). It has produced over 250,000,000 barrels of oil. The TLP is secured by 12 tendons, three per corner, each with a diameter of 28 inches and a wall thickness of 1.2 inches. Each tendon is approximately 3,145 feet long and the total weight for the 12 tendons is approximately 10,000 tons. The tendons are attached by the TLP foundation system, comprising tendon receptacles held in place by 12 piles. The piles are 84 inches in diameter and 349 feet-long, weighing approximately 270 tons each.

Data, Not Opinion. JPMorgan – “U.S. shale well productivity remains a focus for investors, as it is one of the key drivers of E&P capital efficiency. Our view remains that U.S. shale productivity has peaked and will continue to trend lower over the longer term.” In their Tracker, they show that oil productivity has trended lower in six of the major liquid-focused basins. The DJ Basin is the outlier. Six-month cumulative production comparisons are negative as well. The recent headlines crediting the U.S. oil and gas industry for its impact on stable and low global prices may not hold up in the long run.

“Running on Empty.*” This shouldn’t come as a surprise. It was 15 years ago when the U.S. oil industry announced it had the deepest inventory of drilling prospects ever that could easily last 15 years. Time’s up. So, the trend? Buy companies with the largest prospect inventory. The word “prospect” for shale is a misnomer, but… Exxon buys Pioneer, Chevron buys Hess and Oxy buys CrownRock. All of these to increase the combined inventory of drilling locations in the core areas. While we were celebrating a 15-year asset, the realization that 15 years has passed is obviously occurring to many companies in the oil and gas industry. *Jackson Browne

Okay, Now I’m Impressed. Valaris, the combination of Rowan and Ensco, signed essentially a 3-year contract (1,064 days) for its DS-4 drillship in Brazil at $488,000 per day. Wow. It was just $200,000 just a few minutes ago! The $488,000 day rate includes mobilization of the rig. $519 million dollars. Half a billion dollars to rent your piece of equipment for three years. Nice piece of equipment. Congrats to Valaris and everyone in the offshore sector for being around to fight another day. And it looks like another day is coming, if not already here. I can almost hear Arnold in the distance. We’re back.

Offshore Wind Farm Installation. We can do that!

Getting a Head Start. PGS, Shearwater and DNV Marine Advisors initiated a new joint industry project (JIP) in late December to define key performance indicators (KPIs) for energy and emission reporting for the seismic sector. The goal is to establish a standardized reporting framework. They will establish common KPIs and standardize reporting in the seismic sector, getting a head start on emissions reporting and providing greater transparency to investors and stakeholders. “To be able to work jointly with the industry to develop relevant metrics to monitor energy and emission efficiency of the work carried out for seismic vessels that can be verified by third parties is very constructive for all stakeholders in the value chain,” said Mikael Johansson, senior principal consultant of DNV Maritime Advisory. Amen.

Renewables. Germany generates about 55% of its electricity from renewable sources. Onshore wind farms were the biggest contributor with 31%, solar was next at 12%, biomass at 8.4% and the rest from hydro and other. Generation from conventional sources was down 24.0% from 2022, with generation from hard coal down 37%. Lignite was 25% lower and electricity produced by natural gas rose by 31%. Total generation from renewables was 7.5% higher in 2023 than the previous year. Clearly, renewables continue to take a larger portion of the generation capacity, but it is the switching from coal to natural gas that catches our attention the most. While solar had issues because of comparatively lower levels of sun in 2023, the reliability of natural gas will keep it in the mix for decades.

Happy New Year to All!

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.