Things I Learned This Week

March 10, 2023

It’s 2023. Wow. George Mitchell sold his company to Devon in 2002, which was the real start of the shale gas boom. Twenty-one years ago. In mid-2008, fifteen years ago, the natural gas shale boom peaked, but coming out of the financial crisis, we decided to turn our shale experience to oil. The crude oil rig count went from 154 in mid-2009 and peaked at 1,592 in late 2014. A 10x increase in activity in five years. One of the best runs ever. But a 10x increase in demand resulted in investment in equipment with 6–20-year design. Four years later, the rig count was down 80%. So, peak in 2014, plummet to 2018. (Is there any question that we have had great excess inventory of equipment for the last few years?!) That was just five years ago and arguably, the oil shale boom is about 14 years old. That is 14 years of getting increasingly better at what was demanded - get as much oil out of the ground as quickly as you can. In dog years, it is 98 years old. Time flies and all that. We have been drilling and expanding core but over 14 years we have drilled more core wells faster than the core itself has expanded. It is obvious that we aren’t and won’t be the swing producer again but that isn’t all bad. Demand for oil and gas will continue to rise and we will find and produce it. The industry has always hopped from good basin to good basin. But like us all, fields age, even big ones. For the last couple of years there have been NO rigs running in the Barnett. And it’s now 20 years old. Time flies.

Waited Patiently on the Sidelines. Now we know why offshore has been picking up lately. At the CERA meeting, several CEOs talked about where they will shift focus to as the U.S. production growth is grinding to a halt. The Permian will be a critical and busy place for decades, more production enhancement than any big increase in drilling activity. International, offshore and Canada pretty much covers the entire world, but international opportunities are always being presented. It looks like West Africa activity could pick up and Brazil is already seeing it. Guyana is booming, and the Middle East is always the first area mentioned. Gas development in Canada is years behind the U.S. on the shale inventory scale and the first Canadian LNG facility is under construction. Offshore production is the lowest emission per barrel of any other production. A bold statement but true, with studies done by NOIA and others, and it will still matter even with any ESG backlash. Technology development has lowered costs. Offshore activity died in early 2014 as the major oil companies shifted their focus from production growth to growth in financial returns. That was 9 years ago. That’s a long time in the barrel.

Crystal Ball. So where will we be in another 9 years? Too far out to forecast? Is 3-4 any easier? But there are some trends to watch. Offshore should continue to improve. Easy to say since they operate on longer term commitments and backlogs, but still. Saudi has put almost 150 jackups to work while that same number is the drop in U.S. GOM activity. Guyana’s oil system should continue into Suriname, which is already being drilled. Exxon set a record for deepwater field development going from discovery to first oil in four years. The historical average had been seven. A dramatically improved ROIC. Exxon has booked 11 billion barrels so far. Reserves and production at scale. Brazil has already started announcing awards and many of the drillers have announced increases in backlog and even deactivation of equipment. What’s not to like.

It’s Everywhere, It’s Everywhere! In the Middle East and not just Saudi. UAE, Kuwait, and Qatar are all pushing hard with the infrastructure and the equipment to increase production. Unlike the U.S. with massive pipe, fueling, equipment and hiring infrastructure, these projects in the Middle East require building an island to put everything on, building roads to the location, hiring and housing workers, and we haven’t even started drilling yet. It will have significant momentum, with international having less call-out and spot work versus term contracts. That said, these countries are very sophisticated in how they are run and the people who run them, making it a very collaborative market rather than just supplanting a NOC’s technical staff, which was the model in many parts of the world. That model is significantly more attractive to OFS companies, allowing longer term supply chain and logistics planning, forcing a culture of working together rather than “let me show you how to do this” attitude.

All Grown Up. The U.S. will be a big and lucrative market, just don’t expect it to grow. We matured conventional production and are now seeing the maturing of unconventional. Innovative technologies will always see growth above the industry average. There is innovation potential in most everything we currently do in our industry, from how we manage the business, perfect our products, improve efficiency and more. We have always done that but now it is against a backdrop of the market not helping you, but you helping yourself. Methane detection and remediation is a booming business. Recycling, after being talked about for years, is accelerating. The changing trends in a flat spending market have to involve greater efficiency, in everything we do. Identifying the trends, correctly, is always the challenge.

CERA Week! All the heavy weights in the global oil and gas business are at CERA Week. I must not be a heavy weight since I am not there, but attendance lightens your wallet to the tune of $8,500. We note some highlights but literally every topic in any way connected to energy is being presented or queried and every major company CEO is there as well.

Rational Thought. At CERA, Exxon CEO Darren Woods said he views the Scope 3 emissions measurements relevant on a macro level but at a company level, it had “significant downsides”. He said that every ton of LNG produced by Exxon backed out coal somewhere else in the world, transitioning to cleaner energy. Practical and true but under-appreciated. “If I had a Scope 3 target and tried to limit my Scope 3 emissions, that means I make less gas. That means somebody else supplies coal out there and emissions for the world goes up,” Woods said. He noted that Exxon’s refinery segment is one of the lightest offenders in the industry. “So, asking us to stop investing or producing diesel and gasoline which continues to be demanded by society just means that somebody else out there who is less efficient, more emissions intensive will meet that demand, make that gasoline and diesel. And again, the world does not benefit from that,” Woods said. The unintended consequences? The oil and gas companies are not going away anytime soon. Whether monetization is buying dividends or buybacks or a strategic buyer or an IPO, continued growth appreciation is a harder sell. And reality is starting to be better understood.

Get What You Can. The CEO of French Total took a different tact at CERA. He said he welcomed the U.S. Inflation Reduction Act (IRA) and praised it as a way to speed up the energy transition. But it isn’t just the U.S. money. He called on European governments to increase their “incentives” and instead of complaining about U.S. subsidies, he recommended to not “complain but do the same”. He said he would invest capital where it is more efficient. The Europeans majors have been much more “green forward” than their U.S. peers. Exxon has taken the least green approach and has been the best stock performer, a point not lost in Europe. “We say to European governments, if you want us to invest in Europe you have to put the same incentive scheme [as] in the U.S. or even more because we have a question of competition,” he said. “On one side you have one continent, the U.S. with energy, natural resources, considered low cost and the other side, the Europeans, we are dependent, or importers of energy like Japan and off course it’s at a higher cost because in fact the European economy was subsidized with Russian gas, and U.S. LNG when and if it comes is more expensive because LNG and pipe-gas are different costs.” So, the Europeans are now – “we will be greener if you subsidize our efforts like they do in the U.S.” Oh great.

The First Sand IPO in Years. Smart Sand went public 7 years ago and to my memory, it was the last sand IPO. Now Atlas Energy Solutions (AESI) priced their IPO this week and while it priced below the planned range, they could build at book. Atlas is a Midland-based sand and logistics company that has some of the lowest cost sand production in the area and just raised $325 million to be used to build the company’s dream asset, a 42-mile sand conveyor from their mine to a central staging area, reducing per ton costs and giving ESG bragging rights while doing so. The stock priced 19% below the mid-point of the planned range and traded down slightly in the open market. Congratulations guys! I wish someone would give me $325 million to do just about anything.

Chinese Checkers. Virtually all of the bullish oil price forecasts key on China’s ramp back up after three years of a zero tolerance Covid policy. And of course, post Covid lockdown, activity, business, and energy consumption are all very likely to rise, just like other countries have done when they came out of the worst of the Covid pandemic. And if we lived in an absolute world, the answer would be easier. But we don’t. China just released it expected growth rate for the year and it was the lowest in over 25 years. It is 5%, which isn’t bad, on an absolute basis, but it’s also the lowest in 25 years. The redundancy was intentional. Models that show China demand snapping back to where it was, will be wrong. And as a centrally planned and managed economy, they will likely be exceptionally close to their target this year. It’s not a forecast but a plan. Not being a Debbie Downer here, just noting that there are many numbers of nuances, that constantly change, for commodity price forecasts to be terribly accurate. And if one of the primary variables changes, the impact can be significant. The consensus is that oil prices will be higher in the second half of the year. I hope so too. Hope springs eternal.

You’re Having a Bad Day? The money you put in the oil stocks made some money and they will only be higher in a couple of years. Altria, the owner of Juul vapes, fully believed in their investment in Juul as well. I mean, nicotine is addictive. What could go wrong? So, five years ago, Altria paid $12.8 billion for 35% of JUUL. It sold it at the end of last year for around $250 million. Wrong direction on that trade. But never say never. Lost 98% of their money in five years. Some would stay away. Altria has now spent $2.75 billion for a start-up e-cigarette company. You have to wonder whether companies like Altria will try to roll up marijuana businesses as more states approve its recreational use. Broader, established distribution and command of shelf space.

Advertisement – “In February, nearly 300 energy thought leaders gathered on campus for “Energy Outlook ’23: Stewarding a Sensible Energy Future.” The event finished strong with the SMU Cox Maguire Energy Institute’s annual L. Frank Pitts Award Dinner, which serves in part as a student scholarship fundraiser. Vicki Hollub, the president and chief executive officer (CEO) of Oxy, was presented with the L. Frank Pitts Award for Energy Leadership, which honors ethical leadership. Daniel Yergin, Pulitzer Prize-winning author, business leader, and vice chairman of S&P Global was honored with the Maguire Energy Institute Pioneer Award for his trailblazing career in the energy industry.” My alma mater and I were involved. Excellent event. Plan on next year.

Headlines.

The United States should change its "distorted" attitude towards China or "conflict and confrontation" will follow, China's foreign minister said.
Roger Pielke Jr.’s Iron Law of Climate Policy, which says that “When policies focused on economic growth confront policies focused on emissions reductions, it is economic growth that will win out every time.”
Silvergate also didn’t help, dropping 42% on its plans to wind down the bank.

Supply Problems?? New England’s aggressive effort to decarbonize is a tangled web. Over the past several years, the six-state region has replaced oil and coal-fired power plants with natural gas-fired ones but most proposals to build new gas pipeline capacity have been rejected. It’s also made ambitious plans to add renewables — especially solar and offshore wind — to its power generation mix but many of the largest, most impactful projects have been delayed or canceled. And now there’s a big push to electrify space heating and transportation, which will significantly increase power demand, especially during the winter months when New England’s electric grid is already skating on thin ice. -RBN Energy. Something about reap what you sow??

Misleading a bit. “Oil companies are starting to plough cash into projects to capture and lock away carbon dioxide, to retool refineries for making biofuels, and produce low-emission hydrogen, all supported by the IRA’s green subsidies.” They aren’t getting subsidized in their oil businesses but are now pursuing the same tax credits afforded to wind and solar but in areas where they have knowledge and expertise, such as these major capital projects. It appears the IRA is affording that in one of its few favorable moments.

No Trend. Bumping is when there is no discernable direction change, just a whole lot of jittering. "The process of getting inflation back down to 2% has a long way to go and is likely to be bumpy," Powell told the Senate Banking Committee. "As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes." Inflation in Germany and the UK had trend-reversing spikes. Ours is persistent. We have written about the Fed’s comments of “we will raise rates as long as the stock market goes up”. We get close and now the latest data shows more economic strength, ergo inflation, than had been expected or reflected in the last Fed raise. This was likely the last chance Powell has to warn investors of a potentially greater hike than before with the blackout period starting prior to the March 21 Fed meeting.

An All-Too-Common Movie Scene. Mexico. Two groups are fighting to control the fentanyl and methamphetamine trade in Matamoros, battling it out only blocks from the U.S. embassy. Stumbling onto the scene while driving to see a plastic surgeon (seriously), are a woman and three men, having just crossed the border. Bullets fly, the car crashes, it is surrounded by heavily armed men wearing bulletproof vests. The crashed Chrysler Pacifica, one dead bystander. The four are shoved in into another car and speeds away. Silence in the streets, the police drive up, and they are too late. They finally find them after four nights. Two were alive and two were not. I personally have seen that a dozen times. But this wasn’t a movie. It was this week in Mexico. A mile from the border. This cannot continue.

Wide Awake. A research paper from Baylor and the Copenhagen Business School noted that “wokeness” in the corporate world is driven by middle managers looking to carve out areas of responsibility that enhances their job security. The report showed that mid-level bureaucrats have an “outsized” role in in what the WSJ said was “spreading this left-wing ideology to corporate culture”. Intern, worker, foreman, supervisor, vice president - they are all broadly tied generationally as well. So, you get your news from the Financial Times while the new sales guy uses Twitter, or worse. There are actually people who get their news from Instagram and Snapchat. The study showed that “the promotion of corporate wokeness limits viewpoint diversity”, and “it’s typically bad for creativity and innovation. This is why developing a loyal and constructive corporate culture is so important.

Unnecessary. So, Thursday, Texas state senators filed a number of bills designed to restrict construction of renewable energy sources and encourage further development of fossil fuel energy. It was stated the effort was to ensure natural-gas power plants will be developed. Our Lt Governor Patrick is leading the charge, saying it’s a “focus on how we balance fairness and equity and the competitiveness between renewable and thermal (natural gas)”. Texas now leads the nation in wind power, which has contributed to the state’s power generation. We fully understand that the sun doesn’t always shine, and the wind doesn’t always blow, but that is becoming much more broadly understood by all. Germany set coal use records this winter since Russian natural gas was not available. The UK learned that reliable electricity requires some source to supplant renewables, which is leading to natural gas being considered “sustainable” by the EU. I understand the intent, but just as wind and solar are having to improve their economics and understand reliability, the effort by the Texas senate is unnecessary. We complain about over-regulated markets, but we endorse this? Market forces and economic reality are what drives, and should drive, our energy development, not rules that put the political finger on the scales to achieve what is already being recognized as a responsible future.

Unacceptable Behavior. Five nooses were found at an Exxon refinery in Baton Rouge between 2016 and 2020. This made news due to a lawsuit filed against it last week by the EEOC. Obviously, this has no place whatsoever in our industry, as reports like this are wiping out a thousand “atta boys” we get from the general public, which are meager to start. This ended a few years ago, which is good. We are all responsible for not letting it happen again.

Money Money. 345,000 millionaires. 59 billionaires. Welcome to the Big Apple. New York wins the mantle for where more rich people live. Houston has 132,000 millionaires, 25 billionaires, and 315 people worth more than $100 million. I checked and, on my block, we are scraping to find someone with a couple hundred bucks. That’s 5,300 millionaires for every one billionaire. I have almost given up on the idea of becoming a billionaire by the time I’m 30.

Mine’s Bigger. There is an increased speculation on China following their economic forecast and budget announcements. Economic growth of 5%, the lowest in 25 years, and a military budget increase of 7.2%. A couple hundred basis points means a lot, and as we all know, it reflects the priorities of “management”. China now has 400 nuclear warheads. I don’t ever remember a movie that showed hundreds of nuclear bombs and missiles all in the air at the same time. That is double the count in two years. Priorities. While military spending has been trending higher for 20 years, it has doubled in the last ten. Acceleration. We live with it every day, so we don’t notice. But it really does appear to have grown worse, or “hotter”. Now we blithely mention Taiwan, but China fully intends to TAKE IT BACK, believing they are one country, even if the Taiwanese don’t agree. Sound familiar? Ukraine went from not-at-war to at-war in one day. Takeaway? Pay a little more attention to it.

The Pitch. I understand it is ultimately an advertisement, but I thought some of the numbers were interesting. According to ESG Analytic, the Inflation Reduction Act included a Methane Tax. “According to our analysis, the law may cost the upstream oil & gas industry $579 million in 2024, with smaller producers bearing the brunt of the impact. In fact, over 80% of producers under 10kboe/d will be affected, compared to less than 40% of producers over 100kboe/d. On average, affected companies could face fees exceeding $3 million each. “Our analysis doesn't even account for the potentially thousands of smaller producers that may be exposed under the EPA reporting threshold of 25,000 Mt CO2e per facility/basin.” Just one impact analysis. Others may differ, but you have to wonder, by how much? The reality is that rules, regulations and restrictions on the oil and gas industry are increasing. And who is surprised?? The industry has always seen costs rise under democrats, but as costs go up, so do the oil prices, and there are many ways to gain scale. We chafe under the rules, and it does negatively impact pure economic performance, but it comes as no surprise.

The Oracle. "A top climate scientist is warning that climate change will wipe out all of humanity unless we stop using fossil fuels over the next five years." - June 2018 Greta Thunberg

Where to Stay. Leisure travel is through the roof, but business travel is not, with Zoom and Teams meetings taking the place of meetings, conferences, and business travel. The issue though is debt related. Due to low occupancy, valuations are down which is causing banks to tighten their lending standards, requiring more equity from already strapped hotel companies. This follows several Covid years of government money and understanding lenders. By the end of next year, 30% of the $101 billion securitized hotel loans in the U.S. come due. The debt de jour has been 3-year floating rate loans, rather than offices and retail that have debt terms measured in decades. The weakest? Middle America. In Illinois, Indiana, Minnesota and Ohio they account for 40% of delinquent loans. Kind of like being an oil company that doesn’t hedge with Mississippian production. The Peninsula might lower its rates.

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 service 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.