June 21, 2024
Things I Learned About Drilling This Week in Madrid
The Week. The IADC, the International Association of Drilling Contractors, held their Annual World Meeting this week in Madrid. 500 people all associated with drilling and drilling services were there, from every country and every kind of rig. There were some excellent presentations from which we have put together commentary below. It was difficult duty. The temperature soared to 75 some days and with no clouds and a gentle breeze, it was weather I won’t see at home till probably November. We did go to the oldest restaurant in the world, operating since 1725 and since it was Hemingway’s favorite restaurant, most had his favorite dish, suckling pig. Sangria and tapas were several of the other meals. It was a great time, I saw many friends and learned a great deal. Thank you, Shane and Andy, for the help and hospitality.
Snippets Heard.
International Oil and Gas companies are now International Energy companies.
Oxfam: “It’s not just about ending fossil fuels , it’s about doing so in a fair way.”
760,000,000 in the world still don’t have access to electricity.
In the UK, 12% of workers are under 30, 54% between 30 and 49, with 34% are over 50.
The most critical obstacle to scaling drilling automation is the mandate to show tangible financial gains.
In conclusion, AI can revolutionize operations, but a whole list must be taken into consideration, such as safety, to revolutionize the drilling business.
Where’s Waldo. In discussions about the industry’s great challenges, people were a real priority. WSJ in 2023 reported a 75% drop in energy and geoscience enrollment since 2014, with UT down 42%, A&M down 63%, both in petroleum engineering, Texas Tech down 88%, Colorado School of Mines down 88%. According to the Society of Petroleum Engineers, the average age of the Geoscientist is over 65. Retention ideas, automation and AI were all discussed in some detail as the “solutions” to the problem. Automated drilling systems were discussed widely, with varying specialities for each system. The coordination and efficient use of data and information was a big focus, with AI expected to have significant impacts to many segments of the industry. The recognition and need of increased efficiency in every single step and process was presented.
Interesting Slide, From a Contractor.
Rystad. Two years ago at this conference, oil was $120. A year later, $71 per barrel. Now $79. They believe there is more downside than upside to oil prices in the short to medium term. $60 oil seems sufficient to incentivize oil to meet the incremental demand call.
Westwood. The global offshore rig market was discussed in some detail. Saudi’s dropping of 22 jackups for 1 year is being felt with some companies such as Borr Drilling willing to look for other work rather than just waiting, since the rates and terms were not overly compelling, especially as utilization everywhere else in the world has moved up. Drillship supply increased 27% in two years through reactivating and newbuild/ stranded rigs. Semis are down 8%, demonstrating the stronger need for drillships. It was noted that dayrates in the $850k-$950k per day are needed for new drillship construction and due to capacity issues, delivery would take 5 years. As a result, no one thinks new construction is in the cards for a very long time if ever. The Noble/Diamond merger was discussed, which made another consolidating transaction by RIG less likely, and Seadrill is not noted as the next potential target. They also noted that US drilling activity last year declined by 21% due to energy transition strategies, industry consolidation, rising well costs, and reduced activity in former hotspots, according to Westwood Global Energy Group.
Getting Paid for Value. We made the point that rig contractors’ efficiencies, as well as ancillary services that aided them, has robbed them of revenues. If the average well used to take 20 days, we now drill it in 5-7. That is great for the operator but the rig contractor sees a 60% drop in revenues. We are doing more with less and unless drilling contractors are getting paid for the myriad of efficiencies seen, introduced, and used in the last several years, they lose out. Performance-based drilling was discussed by many as a potential solution. I think this is an excellent idea and it will weed out the weaker players and force further consolidation. It was also recommended that the drilling contractors think outside of their previous box and rethink what additional services and products they can acquire or develop that provides more capture of value. While several contractors noted cash flow and free cash flow as their primary performance reference, several speakers noted that strong cash flow but negative bottom line earnings reduces equity value. Since that is math, not opinion, many paid attention. Now we realize that the goal isn’t to drill a well but to make money drilling a well. Optimizing returns. The ROIC of the major oil companies was compared with the same metric in the tech sector, and at 4x-6x higher, it makes it easier to understand the stock moves of tech stocks and the gradual recovery in energy from low and sometimes negative numbers. The focus on ROIC was mentioned by several speakers and the audience generally understood and believed.
Electricity. According to calculations by the DOE and EIA, by 2030, ALL solar and wind generating electricity will be needed to power AI data centers. All. So the rest of our energy sources will be used for everything else. The EIA says that oil and natural gas production will have to increase through 2050. Think about this. We have written about how AI chips use 4x-5x the electricity of conventional computer chips. While previous chips operate on a sequential basis, solving one problem after another at a very fast rate -CPUs - AI uses GPUs to solve problems simultaneously. A video showing the difference is interesting. CPUs are like a paint gun, firing very rapidly, one shot at a time, to make a picture. AI can paint the Mona Lisa in less than a second. We have covered much of this before but the total consumption of all renewables needed in six years to power computing power that didn’t exist before was a surprise to us as well in terms of the real scale involved. Obviously, this is positive for natural gas and nuclear, which seems to be staging a comeback.
Dead Calm. As an industry, we are used to booms and busts. Adding people and assets as day rates and activity moves up or cutting people and stacking rigs to conserve cash, when times are not good is how and what we have managed for decades. What we don’t know how to do is manage FLAT for any period of time. Several executives noted the lack of experience in such a market. But when you don’t know if the next move is up or down, and neither is happening yet, is a situation we are not trained for. And the idea that it could be flat for extended periods, one has to find other services and products that will allow some profitable growth even in a flat environment. And with the US effectively flat for one of the longest periods of history, it can no longer be ignored, nor can one just wait it out. It will be interesting to see who does what and who wins.
Headlines.
The CBO lifted its estimate for this year’s US budget deficit by 27% to almost $2 trillion.
China, which lent around US$120 billion to Latin America and the Caribbean between 2005-2023, isn’t expected to resume the mega oil-backing loans of yesteryear as the focus turns to debt negotiations.
Total Austral begins development drilling program at Fénix gas field offshore Argentina. (Another Guyana?)
Chevron kicks off exploration in uncharted “ultra-deep” waters offshore Angola.
Rising fuel inventories hit crack spreads, likely signaling refining slowdown ahead.
Rig Monitor: Horizontal rig count drops approaching late-2021 levels.
An IPO?! Akastor ASA owns 50% of its “affiliate” HMH Holding B.V. ("HMH") and plans to launch an IPO. There have not been any in ages but a very few. Wow. An OFS IPO! The size and price range for the proposed offering have not yet been determined.
It’s Electricity, Not Power. “Texas' ERCOT power needs to nearly double over next six years. As coal plants retire in Texas, natural gas will carry more of the Lone Star State’s energy load”, ERCOT’s Kristi Hobbs.
Impressive Profile. ADNOC Drilling owns and operates 137 rigs, one of the largest active fleets. It has transformed into a fully integrated drilling services company. This was the point made in one presentation. If you just operate drilling rigs, you are in a segment of secular decline. Drilling contractors must integrate more and more drilling services into its offerings. PTEN was mentioned as one example, now a pressure pumping company, a drill bit company, a directional drilling company that owns a fleet of super spec rigs. It was a very constant theme at the conference. Abu Dhabi has 220 billion barrels of unconventional oil and is now attacking those reserves with Western unconventional technologies. This will be a growing trend in the Middle East and beyond. ADNOC Drilling also has the added benefits of an almost endless number of wells to drill and operating on 15 year contracts, with its only customer also being a shareholder. The development of such an integrated model for a national oil company has been a fairly recent development that appears to be gaining momentum. PTEN and SLB just announced partnerships with the company to accelerate their efforts.
Hot Topics. Automation and AI were two topics addressed in many different forms at the conference. Efficiency continues to be the primary focus since adding new capacity is not likely anytime soon. We have written about how the advent of Landmark Graphics workstations revolutionized seismic interpretation, doing the work of a cadre of geophysicists with more consistent results. AI will be the next major step change in all the geosciences. It will also be a major part of the mechanical aspect of our industry as well. The big push into automation is several years old and will be greatly accelerated with AI. There were several presentations made, covering many different aspects of our business, about the impact and influence of AI. The oil and gas industry is an incredibly complex business. Seismic data processing is one of the most computer intensive activities using super computers, along with weather forecasting and airline scheduling. The industry was slow to adapt to desktop computing because for the first ten years or so, none were powerful enough to run the computations needed in reservoir simulations, 3-D visualizations and engineering calculations. Now one of the first quantum computers will be installed with Aramco. The most powerful quantum computer today has more processing capability than all the current computers in the world. It will dramatically improve operations, especially when paired with AI chip technology to make operations more efficient, put fewer people in harm’s way, and make our industry even greener and cleaner. It is truly a brave new world.
Great Story. “The green revolution is in trouble. The rise of the nationalist right in much of the Western world has placed huge question marks over commitments to transition out of fossil fuels to fight climate change. In France, Marine Le Pen’s far-right National Rally, forecast to win the most seats in legislative elections starting June 30, has pledged to roll back key parts of the 27-nation EU’s Green Deal.” Bloomberg (not a known conservative information source).
They Made Their Point. If you remember, several months ago, a group of activists sued Exxon, insisting on additional items to be voted and included in their filings. Exxon disagreed and said so, so forcefully, that the activists dropped their suit. Exxon counter-sued the activists, and continued even after the activist’s suit was dropped. This week, a US district judge dismissed the lawsuit as he noted that the activists had dropped their suit and agreed to not submit any future proxy filings at the company’s annual meeting. Everyone. The dismissal without prejudice which is legalese for “Exxon can refine the case in the future”.
Only a Start. We have mentioned in the past that a gasoline station worker from the late 1970’s won a $720 million dollar judgement against Exxon, claiming his work at the station caused his cancer almost 50 years ago and Vermont has passed a law, with New York State also considering, making oil companies pay for the state’s climate mitigation efforts but no one has yet proposed any penalty on the users of our products. The first will likely be dismissed on appeal and since any state can come up with a number for their “climate disasters”, it may not withstand legal challenges. But the fight isn’t over.
Analyst View of Midstream. Midstream Snapshot: “Its the Economy... The week started out strong for midstream, but the group is now on pace to close just negative. Midstream specific news flow was light and we can't blame commodity this week; crude is on pace to close up >3% and Natgas closed >$3/mmbtu twice this week. So that leaves the economy where good news is bad news for midstream lately. Specifically, core CPI inflation was much softer than expected, paving the way for Fed rate cuts (Midstream has been a pro-inflation trade). And while the FOMC lowered guidance to one rate cut this year; Chair Powell's comments indicated guidance is already stale as most officials didn't incorporate softer than expected inflation data. Our US Economic team believes the Fed likely delivers three cuts (beginning in September); the high jobless claims announced Thursday seem to support that view”. – Citi
One Opinion. We wrote last week about the IEA report that says we are “comfortably supplied” with crude oil, probably through 2030. If your first thought is propaganda, they also note that crude oil demand will likely rise through 2050. As we noted above, basically all renewable energy, or its equivalent quads generated by some other means, will be needed by 2030 just to power AI data centers. In the last decade, the International Energy Agency has morphed from the energy research arm of the OECD into an unapologetic cheerleader for overcoming the supposed horrors of Climate Change. “The core activity of the IEA is providing policy advice to its member states and Associated countries to support their energy security and advance their transition to clean energy. Recently, it has focused in particular on supporting global efforts to accelerate clean energy transition, mitigate climate change, reach net zero emissions, and prevent global temperatures from rising above 1.5 °C. All IEA member countries have signed the Paris Agreement which aims to limit warming to 1.5 °C, and two thirds of IEA member governments have made commitments to emission neutrality by 2050.” That quote doesn’t square with their energy forecast, which means some level of understanding and rational thought has seeped in. Several pundits have argued a more bullish stance than that of the IEA but think about it. We are now arguing how much fossil fuel power will be needed, not whether it will be needed at all, and by a group described by one pundit as “an advocacy organization, with a specific approach to essentially one side of the Climate Change issue in mind.” Everyone has an opinion, and the smart people listen and consider them all.
The Reality. The IEA says we are comfortably supplied. OPEC agrees in the very near term but is more bullish into next year. Everyone has opinions on the oil price. My point is that whether it is $75 or $100, activity will be very similar. The wave of consolidation has a negative near-term impact as plans are reevaluated but should pick up later this year. PTEN as an example, is trading at 2x-3x EBITDA with a 14% free cash flow yield. Should you own it? Yes. Will it go up tomorrow? Maybe not but it will going forward. I like deep water and production since we will keep US production at least flat for years. I would be long but pick my spots.
U.S. Energy Markets Update by PPHB with key highlights listed below:
Commodity Prices: WTI crude oil is currently $80.71 per barrel (up ~3.1% week-over-week) and natural gas is $2.97 per MMBtu (down ~1.3% week-over-week)
Crude Oil Production: U.S. crude oil production is currently ~13.2 million barrels per day (up ~8.2% year-over-year)
Crude Oil Inventories: U.S. crude oil inventories decreased by 2.5 million barrels week-over-week vs. an estimated decrease of ~2.8 million barrels
Frac Spread Count: There are currently 250 frac spreads operating in the U.S. (an increase of 3 spreads week-over-week)
Onshore Drilling Rig Count: There are currently 569 drilling rigs operating in the U.S. (a decrease of 3 rigs week-over-week)
California to the Rescue. The increasingly likely outcome of the Democratics running someone else for President after Biden is forced by Obama and others to step down. Gavin Newsom is the most often cited likely candidate. I was surprised in that he will win California but a lot of people won’t vote for someone from California and the bad press he will get will be amazing. But what do I know about that. But one more issue for everyone to note about California. The state just issued significant new gasoline regulations for brokers, traders and refineries. It was passed through an emergency rulemaking loophole and it says that all refiners and importers of gasoline and diesel into the state must follow the new regulations. It is called the Gross Refining Margin and Marine Import Reporting Regulations. Gross margin? The Tech companies in California have gross margins 4x-5x that of refiners and importers but I haven’t seen any rules passed on what they can charge and what margins are allowed. The kicker? The rules say that any importer of record or owner of “reportable cargo” must file a new California Marine Import Report before pulling into port. Not sure Texas, Oklahoma, and Louisiana are going to support the creator of that rule with votes. But those in the industry don’t know better. Adjusted for inflation, gasoline has been basically flat for 20 years, but we are an easy target. But Newsom?
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.
