March 1, 2024
Things I Learned This Week Staying at Home
Natural Gas in the Gutter. I got my wife into SJT a couple of years ago. I’m on the couch. I remember several years ago when an OFS CEO stated that the situation at the time was “not sustainable.” He was right, but it took all of three years before he was finally right. 12 quarters of “not sustainable.” A favorite quote – “the market can stay irrational longer than you can stay solvent.” John Maynard Keynes. Today’s natural gas prices do not make any sense at all! Except that demand is lower than expected and production is higher than expected. Other than that… Adjusted for inflation, natural gas hit its lowest level since it began trading on the Mercantile Exchange 34 years ago. Ouch. One of my favorite stories is how the industry went from 1,600 rigs drilling for natural gas in 2008 to hitting 79 during COVID. And U.S. natural gas production is going up every year. Now we have the end of flaring, which just a year or so ago was putting 1.2Bcf/d into the air that will now go into pipes and the fact that GORs go up aggressively over time in Permian wells.
Buy ‘Em a Drink. And all of this with a huge amount of Appalachian gas that could come on the market if the pipelines could get approved (think election). Many U.S. population centers are having their mildest winters in 70 years. In terms of natural gas storage, we are 22% ahead of the 5-year average so even if it got cold from here, it wouldn’t matter much. Chesapeake is making the smart decision of scaling back budgets and production by 20% this year. Save it to fight another day. So, all of you oily guys, next time you see a friend in the natural gas business sitting at the bar, buy him a drink. Or two.
Mantra. I have two slides in my latest presentation that I really like, one at the very front and the other at the very back. On the front, “Moderation.”
“Observe due measure; moderation is best in all things” – Hesiod 700 BC
“Moderation in all things is the best policy” – Plautus 250 BC
“Moderation in all things, except moderation” – Oscar Wilde 1900 AD
Mark Twain, Benjamin Franklin, Socrates, and Voltaire have all been credited with similar comments as well
Synonyms – restraint, balance, composure, fairness, patience
The Slide at the Back? “Practical Reality beats Ideology every single time. Just not as quickly as we would like.”
An Example of Moderation. The point of this is that the extremes rarely occur, since there are always too many dynamics pushing things back into moderation. This is true for both sides of the political spectrum as well as the long-term realities. The far left can say shut down oil today and the far right says drill baby drill. The same has been true of Electric Vehicles (“EVs”). The government effectively mandated the conversion of U.S. transportation to EVs and the naysayers noted the cost, supply chain, disposal and other horrors that would also end life as we know it on the planet. Sanity prevails. It doesn’t get there as soon as we would like, but it gets there. EVs will continue to be part of the global automobile industry, but it will not be as the mandated, required, no-option vehicle of the future for all. They are fast and fun to drive. So is a Porsche. But you can choose that one. I find myself almost conciliatory about the subject, feeling a little sorry for the guys who tried so hard and worked at their dream. It was noted this week that Rivian, who lost about $125K on every truck it sold last year, and Lucid, a much smaller company, announced “dim outlooks” for their sales due to lack of interested buyers. Lack of interested buyers is rarely a good thing in business. And this is the millionth (exaggeration) story out so far this year casting doubts and dispersions on the business. We had noted that over 3,000 dealerships sent a letter to the President urging him to delay his mandates and it worked, so far, with the administration agreeing to delay their implementation. Half of the U.S. dealerships for several different car lines opted out of selling EVs, citing the cost of the equipment to service and repair as well as swelling current inventories. Doubled insurance rates, lack of charging stations, time it takes to charge, the $20K additional cost to purchase, concerns about resale and cost to replace the battery don’t even look at the financial and humanitarian costs of producing the required materials and efficiently disposing of spent batteries. Moderation. Normalize back to the center. It all works out in the end. Just not as quickly as we would like.
Rodney Dangerfield. I was thinking today about the businesses in our industry that have really made the most amazing impact. We all have our favorites and opinions. My two? Seismic and land drilling. Prior to the mid-1990s, there was no such thing as 3-D seismic. Limited by computer horsepower and equipment, we could only collect enough data to estimate. Imagine having a couple of 2-D slices of an elephant. And then interpolate between slices what it might have looked like; one across the rump, one across the shoulder. Then draw a picture of what it looks like. You don’t know. The insight, experience and intuition gave some geophysicists a better understanding and better interpretations. But we still drilled from 1950 to 1975 and the industry success rate was about 60%. Twenty-five years. We went up to the mid-70%’s for the next twenty years. Then 3-D seismic got commercialized. The IO System 2, by Input Output, a seismic equipment manufacturer. We immediately jumped up to 90%+. Dry holes became almost something of the past. While having a market cap of $2+ billion almost 25 years ago, the company went bankrupt last year after not earning its cost of capital for most of those years.
Rodney 2. The second victim is the contract land drillers. We went from 28 days to 21 days to 14 days to 7 days and we can now drill a well in 4 to 5 days! Wow! Isn’t that cool? Except for the guy who owns the rig. Instead of getting paid for 28 days of work, he gets maybe a week? They have improved the economics of drilling and production dramatically, and while completions now cost more than drilling, drilling is still in second place. And the land drillers reward? Nothing. They might get picked to drill the next well, too. It has led to the dramatic bifurcation of rigs and their efficiencies, which is good for the people with the really good rigs, but not good at all for the people that don’t. And as one rig company executive put it, the U.S. rig count is in secular decline. So, the large amounts of free cash flow getting generated, return some but keep some dry powder to shop for version 2.0.
The Problem with “Real Time” Data. The following is a view published by an accomplished analyst but contributes to what I call the least impactful thing in my inbox. There are some good points. And then there is the rest. “ The U.S. horizontal rig count has remained stable at 560 for a third week. Gas rigs have been swinging between 95 and 99 for the past few weeks after an uptick seen late last year. The oil rig total has hovered between 460 and 470 for the past five months. This week, the Permian added one rig, reaching 301, while the other major oil regions increased by three to 138. The Eagle Ford posted one rig addition and the SCOOP/STACK posted a gain of two. The total oil rig count increased this week by two reaching 465. Gas rigs declined by two.”
My Summary:
My Better Point is “So What?” I have lived through the much-anticipated weekly natural gas injection or withdrawal number, where billions were gambled on a weekly number that meant virtually nothing in the grand scheme of natural gas supply or demand. One public company reports their rig count daily. Daily? Us analysts love data, and the argument has always been that you can’t have enough. If your daily updated rig count in your model is required to calculate something important, it is not important or it doesn’t work. When I was running an energy fund at Carlson Capital, we reacted to incremental news as quickly as almost anyone, but I also saw the reams and reams of printed material that no one read. 80-page weeklies with every available statistic updated for the week. That no one read. When you get 800 emails a day, and that is after the very effective corporate spam detector, you really get to appreciate how many words are written that only take up time and space. I often exhort the industry to pay more and more attention to the technology of how to make their business, not so much their products, much more efficient. Management time and attention is rare. A soapbox for “always try and be more efficient in all that you do.” And we exist for more than just hedge funds.
The Other Part of the Report. “With the Henry Hub natural gas price staying below $2 per MMBtu and WTI below $80 per barrel, the market has remained relatively bearish, as operators await stronger price signals to step up drilling. With a step-up in merger and acquisition (M&A) activity in the U.S. onshore space, with several multi-billion-dollar deals over the past few months, the demand for rigs is expected to remain low as companies consolidate their portfolio of operations.” We have had this discussion several different times. It has been years since Conoco, Phillips, Amoco, Mobil, Gulf and many others existed as stand-alone companies, all consolidated up over the years and countless smaller ones. It is just that it hasn’t happened in several years and we seem to have forgotten. Equity markets were easy, money was free, everyone was growing. Why combine? There were a few but not a wave. Last year set a record for the highest E&P M&A activity. It may have only been a few companies, but this is a matter of combined budgets, not the number of companies. Inevitably, when two E&P companies merge, the equation for capital spending goes to 1 + 1 =<2. Properties deemed “non-core” are already hitting the markets and the early projected budgets for all those properties just evaporated. People invariably leave and, in the geoscience world, that is not easily “subbed out” awaiting replacement. Competing priorities in overlapping regions where management competition forces conservative behavior. All of this points to some slowdown in what had planned to be spent this year. The argument now is that, while it will start slowly, activity and all it drives will pick up throughout the year. Before you start congratulating the insights, remember that the first quarter is historically the lowest spend quarter and the rig count is usually going down. Activity stabilizes in Q2 before starting to move up, till about Thanksgiving, and from there is dependent on one month’s “budget exhaustion.” That is the historical seasonality of U.S. onshore activity. Adding to the second half strength will be the start of pickup post combination pause, but that pause, and pickup, could be slow. We are talking Exxon and Chevron here. Great companies and bureaucracy as difficult as any.
EIA Weekly Petroleum Report.
Crude Implications: Neutral – build above expectations. WTI 1M-6M backwardation at $3.9/bbl, $0.5/bbl wider w/w. Money managers increased ICE Brent and NYMEX WTI net long positions by 4% w/w, pushing net positioning above average levels over the past year. Refinery runs are set to improve as turnaround activities conclude and BP Whiting returns to service.
U.S. Crude Production: indicated at 13.3mm BOPD, flat w/w, and up 1.0mm BOPD y/y.
Refinery Runs: 14.7mm BOPD, up 0.1mm BOPD w/w and down 0.3mm BOPD y/y. Utilization at 81.5%.
Crude Imports (net): 1.7mm BOPD, down 0.03mm BOPD w/w and up 1.1mm BOPD y/y. Brent-WTI spread at $5/bbl, flat w/w.
Gasoline: Bullish – draw above expectations. Demand up 3.3% w/w and down 7.1% y/y.
Distillate: Bearish – draw below expectations. Demand down 10% w/w and down 7.8% y/y.
Hold My Beer. China is not the only country focused on generating power as cheaply as possible and proud of it. Coal-fired generators produced a record 112 billion kilowatt-hours (“kWh”) in January 2024 up from 91 billion kWh in January 2022, the Ministry of Power shows, and have still managed to amass a record amount of coal for inventory as their coal mines ramp up production and coal movements to power stations across the rail network have been made a priority. The generators had 44 million tons of coal on hand at the end of last month, up from 26 million tons at the end of February 2022. 44 million tons. That is 88 billion pounds of coal, waiting to be burned for electricity. Think there will be any dramatic reductions any time soon?
WE WERE ALL RIGHT!? A buy-sider I have known for decades has a fund now and I just became a recipient of his firm’s publication. “Success has many fathers, failure is an orphan.” It turns out that just about everyone, other than politicians and political types who didn’t take any economic, business or science classes in college, predicted the failure of EVs. Being right is the success. Everyone is taking credit. Heck, I was going to since I started writing about it years ago but it seems I was one of only 200,000,000 people who said the same thing. So, I’ll pass. The piece also made an interesting observation. Again, this is one I make in presentations, so it isn’t brand new and dramatic but succinct. “Mitigating carbon emissions is central to the case for electric vehicles.” So, since EVs aren’t going to change or take over the world, the goal remains the same, but we have to find another way to achieve it. And we do that by making our current operations as “clean as possible,” improving efficiency, reducing all forms of pollution and mitigate carbon emissions – at the beginning of the process instead of farther down the use chain, where impractical mandates go away.
The Example. The report used Norway as an example of how all this works. Norway gave incentives of up to $27K to buy an EV and about $8K in annual operating costs. As a result, EVs made up 80% of all Norwegian new car sales in 2022 and currently account for 20% of the total car fleet. But it comes at a cost. Norway spends as much on EV subsidies as on total highway and public infrastructure maintenance. The subsidies have eased due to rural vs. urban and other issues. When Sweden ended their subsidies, EV sales dropped by 20%. The thing that will get pointed out to most is that, following this effort, the reduction in gasoline and diesel demand dropped by only about 4%. While the population grew by 11% since 2010, the total number of passenger cars grew by 25%, and the number of ICE vehicles still increased. The increase in EVs raised electricity demand by 20% but overall energy consumption went up 5%. With over 200 hydroelectric plants and an average income over $100K, Norway is not the best example of how the energy world will transition and it has STILL been a mess.
The Cost of Politics. California, in an effort to run even more companies and people out of the state, is implementing a new $20 hourly minimum wage, but not for everyone. You are exempt if you are a restaurant that bakes and sells bread, excluding, of course, those non-bread items of bagels and croissants? But why would there be such an odd carve-out and who could it possibly help? Oh, wait. Panera restaurants, all 24 of them in California, are exempt from the new law. Governor Newsom must be a fan. He described the bill as “part of legislative sausage making.” Of course, the owner of Panera is a long-term donor to Newsom. Strictly coincidentally though, he does admit to numerous meetings to plead his case on the legislation. McDonalds estimates it will raise costs by $250K per location and Chipotle is looking to raise its prices. Who wins?
All This and a Job, Too? A phone, a prepaid card, a place to live. And now the state of New York will hire you too. “Governor Kathy Hochul's administration recently agreed to a proposal that could make it easier for migrants to get temporary jobs in state government. Approved earlier this month, the Civil Service Commission is working with agencies to implement the changes, which include dropping typical application requirements, like proof of a high school diploma or proficiency in English.” This after the mayor of Boston said anyone in the world is welcome to come live in Boston. They have no idea. These aren’t families. They are fit, military aged men.
Right Up There With Student Loans and EVs. Regressive taxes. People who didn’t borrow money, didn’t go to college or paid back their student loans all get screwed when student loans are “forgiven.” They aren’t forgiven. Instead of it being your liability, it is now a liability to all of us. Only the wealthy can really afford EVs, costing on average about $20K more, so wealthier neighborhoods will have clean air and the poorer neighborhoods, where people can’t afford to drive EVs, will live in smog. Now, California is screwing any who don’t play in solar. The new California Rooftop Solar Incentive is expected to cost non-solar customers an estimated $6.8 billion this year alone, according to the Public Advocates Office. So lower income households who can’t afford to have solar will now subsidize those who do. Seems fair only in California. Many people took advantage of the incentives before they ran out and the state above-market rates buying excess power from solar. EVs will fail due to lack of demand but just distributing money to the rich at the expense of the poor is a very different issue.
Better Understood. Over the last 11 years, Solar and Wind have grown tremendously, with Solar up 1100% and Wind up 277%. Huge growth in both. When we combined Wind, Solar, Other Renewables, Biomass and Biofuels, they have grown by 36% in their percentage of power generation, while Oil, Natural Gas and Coal have declined by 4% from almost 80% to 76%. But it can be a bit misleading. Total energy demand has grown by 13%+ over that period of time and yes, Renewables now have a larger percent of the mix but demand for Fossil Fuels has still grown by 8.6% over that period of time. So, while it has a smaller percentage, the actual amount being used is higher. I had seen a presentation that dealt only in percentages, so the reader was left to believe that renewables should be 100% and fossil fuels would be zero in short order. But the underlying reality is that more fossil fuels are being used – demanded and consumed – than last year and has been the 10+ year trend. Rule of small numbers has really helped Wind and Solar, and clearly the money spent in those areas. We should be shocked if it didn’t have this effect, even if it is not currently economic or economic without subsidies.
Them Too? How many of you knew that Apple, the phone and watch people, were making an electric car. They have had 2,000 people working on this project for a decade and spent billions. When you look at all Apple has done, this is technology, right? Well, Apple is throwing in the towel. It was planned to generate billions in revenue for the company. Virtual reality headsets and AI are still in the works, but this try at EVs is done.
From Science Direct.
Making a Statement of Some Kind. Aaron Bushnell was a 25 year-old active duty pilot who wanted to protest what is happening in Gaza. Not the attempt to free ~200 hostages taken on the day 1,200 civilians were murdered or to urge Hamas to free the hostages and quit using Palestinians as human shields. No, he wanted the world to know that he did not support the U.S.’ role in Israel’s war on Gaza. “I will not be complicit in genocide,” he said. So, he did what any rational, emotionally stable person did who disagreed with the actions of a foreign government. He set himself on fire in front of the Israeli embassy and died. A martyr of Hamas. How horribly misguided.
Convoluted. Venezuela cuts a deal with the Biden administration to supply additional oil and get millions more in their coffers. It makes such an impression, the power of oil, that Venezuela decides that the Treaty of 1899 wasn’t really valid and Guyana, or large parts of it, actually belongs to Venezuela. Troops move, sabers rattle. Completely separately, Chevron makes a bid to acquire Hess, who also has oil production in Guyana, and all appears on track. Now, Exxon has decided it has the first right of refusal to buy Hess’ Guyana interest. Now, the Chinese national oil company says it has first rights as well. Convoluted? Of course. It’s the oil business. The solution? Who knows. And Venezuela has little to lose by trying.
Can’t Be Baseload. Germany is determined to be renewably generating at least 80% of electricity by 2050. Below is a chart showing the volatility of wind and solar generation sources. So it would seem that all you have to do is grossly over-build to get the baseload stable. Except you can’t. No matter how redundant you are, there are days when the sun doesn’t shine at all or the wind doesn’t blow at all. So, you realistically have to build a 100% natural gas fired backup. That is a redundancy that will make energy that much more expensive.
Headlines.
Beyond Meat surged 58% premarket after it reported strong international sales.
Illegals demanding MORE free housing shut down a Seattle City Council meeting.
Getting “Rich” Gets Harder. In the U.S., if you aspire to be in the top 1% of the wealthiest people in the country, you need to be worth about $5.8 million. Of course, inflation has caused that number to be 15% higher than just a year ago. I like hanging with my friend from Monaco, of which I do have nearly enough, with about $13 million needed to put you in the top 1%. It’s easier to be rich in the U.S. but inequity still exists, as it always has. Monaco’s gross domestic product per person of roughly $240K is more than 900 times greater than that of East Africa’s Burundi, according to World Bank data. Extreme ends of the spectrum.
Get Rich but Where?
Consolidation Spreads. It turns out that there are other oil basins outside of the Midland area. Who woulda thought? Joining the consolidation spree in U.S. shale, Chord Energy has agreed to acquire Enerplus in a cash and stock transaction. The transaction marks Chord’s largest purchase since its formation in 2022. Based on Chord’s reporting, the deal pegs Enerplus at an enterprise value of $3.9 billion as of its announcement. The move comes barely two weeks following the emergence of market talk that Devon Energy was interested in buying Enerplus.
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.
