Things I Learned This Week About Banking

March 24, 2023

Passing of a Giant. David Demshur died. 67 years old. Western Geophysical bought Core Labs in 1987 and seven years later David bought it. David and I both worked at Western Geophysical. He rose through the ranks to Senior VP of Petroleum Services, of which Core Labs was a part. It was a product used for primarily for R&D, so not a robust business. Western bought it to calibrate wireline tools for the Atlas division, and Western was focusing on growing its marine seismic fleet so they let the manager of the division do an MBO, which were in vogue at the time, with backing from an international fund in the Netherlands, who out up most of the $35 million. David later saw its market cap hit $12 billion dollars. What David did is worthy of the best of Harvard case studies. As an analyst, we were great friends, but I was the bane of his existence because I would ask questions about things no one else knew about, which would complicate his job! He will be missed. Condolences Laureen.

By People Who Know Better. “Climate change attacked crucial Arctic Sea ice thickness in two sudden big gobbles instead of steady nibbling, a new study says.” The difference between weather and climate is a measure of time. Weather is what conditions of the atmosphere are over a short period of time, and climate is how the atmosphere "behaves" over relatively long periods of time. So two “sudden” shifts cannot, by definition, be attributable to climate, but to weather. If it nibbled for years, then it would be climate. Whereas weather refers to short-term changes in the atmosphere, climate describes what the weather is like over a long period of time in a specific area. Different regions can have different climates. There are five different classifications of the Earth’s climates: tropical, dry, mild, continental, and polar. Some say there are seven and include highland and split tropical into two categories. That is the extent of the disagreement on the definition. Weather is what you experience when you step outside on any given day. In other words, it is the state of the atmosphere at a particular location over the short-term. Climate is the average of the weather patterns in a location over a longer period of time, usually 30 years or more.

Dropping Shoe. Okay, the Fed raised rates by 25 basis points and warned of further increases. Move on. Some didn’t agree with the move and political radio is fueling the flames of that disagreement. 25 or 50? Got a coin. By definition, higher interest rates slow economic growth. Slower economic growth means either fewer jobs created, or some jobs lost. Free money isn’t around anymore and the rest of it is expensive. For our industry, that means aggressively reducing debt and focusing on the highest return opportunities. That isn’t news. Neither is the rate hike. Everyone get back to work. Nothing to see here.

Wild Ride. We were skiing along, feeling good, feeling strong and then the world gets hit by a pandemic. The largest drop in global demand ever by more than 2x. The recovery from Covid was slow and uneven, with China shutting down its economy much longer than expected to contain the spread of the virus. But the rest of the world came back, and prices rose, as did everyone’s bottom line. All of that helped fuel the rampant inflation in the overall economy, but since inflation actually helps our business in many ways, energy stocks out-performed the broad market for two straight years. We see oil go from minus $37.65 to positive $119, all within 24 months. Then we have the warmest winter in ages, as does Europe, helping cause natural gas prices to tank to a level that will result in 30-40 fewer rigs drilling. But everyone is bullish on oil, and it would really start to be seen in the 2nd half of the year. Consensus. Then a couple of banks fail. A risk-off trade is where you sell your most volatile stocks. And now, after talking about a recession for almost a year and skiing along the edge of cliff, thinking you have made it and wham! Another cliff. Now we are REALLY going to go into recession. Expectations of demand growth get cut ever so slightly, but to the downside. But oil seems to be hanging at $70 and if you can’t make money at $77/bbl, you shouldn’t be, but it sure isn’t the oil price that generated 15% free cash flow yields. We think the longer-term median price is $84, but that is a line that has a great deal of volatility in it. So what do we do? What we always do which is stay optimistic and persevere. Oh, and try really hard to avoid taking on debt! This industry is volatile enough without that.

As For Gas… Natural gas has the weather issue, a very large LNG facility offline and some reduction in industrial demand. But getting Freeport back online just gets us to where we were. Europe has established increased lines of supply from Libya, Algeria and others. We have been tracking 22 regassification facilities under construction in Europe. Storage is seasonally very high due to the warm winter and in the U.S., we are over-supplied. With only ~170 rigs drilling for natural gas, we can over-supply the market which right now is around 100 bcf/day. We are adding LNG capacity which will boost natural gas demand, and Canada is putting in its first LNG facility on their West Coast. Pipeline approvals appear more likely. All of that is positive for natural gas demand and we are bullish long-term on demand but for now, rigs are coming off and Freeport is opening up, but these things take time and there is likely to be a “timing issue” as the transition is made, and some think that when that timing issue occurs, prices will spike. Maybe so. Extremes never seem to happen. But clearly, while we are over-supplied now, it isn’t by much and there is a great deal of momentum in natural gas these days after endorsements by the EU and others. But 18 to 24 months of waiting for the incremental liquefaction to come online, for European regassification infrastructure is up and working. That’s tough. The lower the gas price, the longer it seems. No one likes it but everyone knows these facilities aren’t built overnight. Patience is tough. Being ready to move and move quickly to respond to price changes is the critical issue. Natural gas is going to be very interesting for a long time. Again, longer term, there is really only upside to natural gas prices from here. How high and how long? No clue.

Progressive. Uganda's parliament passed a law making it a crime to identify as LGBTQ, handing authorities broad powers to target gay Ugandans who already face legal discrimination and mob violence.

California Reparations. There were some 100 recommendations made by a city-appointed committee on reparations, and the San Francisco Board of Supervisors, hearing the report for the first time this week voiced enthusiastic support. One idea? Payments of $5 million to every eligible Black adult, the elimination of personal debt and tax burdens, guaranteed annual incomes of at least $97,000 for 250 years and homes in San Francisco for $1. All of this “to atone for centuries of slavery and systemic racism.” Now I am not sure what “eligible” means but I am going to start checking on my family’s California heritage. I’d hate to miss out! Several supervisors said they were surprised to hear pushback from politically liberal San Franciscans “apparently unaware that the legacy of slavery and racist policies continues to keep Black Americans on the bottom rungs of health, education and economic prosperity, and overrepresented in prisons and homeless populations”. Since there are no conservatives in California, they had nothing to say.

Long Run. Much is being made about the Credit Suisse transaction but what some people may have missed isn’t the last five months depositors had pulled out $170 billion out of the bank. It’s a liquidity crisis and this is sentiment. If you believe it’s going to crash, it will, and if you don’t believe it’s going to crash it won’t. Show the mood of the people really matters.

How Does a Company Go Bankrupt? Slowly over time, and then all at once.

Leakage. And now banking overall is taking a hit. The oil and gas industry saw the number of banks that would play in each space cut in half over the last four years and now that’s going to happen to the general population. Maybe not to the same extent but it’s definitely going to happen more across-the-board, and one could argue especially in tech. That means that technology innovation will probably slow down a bit and what there is out there will either be developed or bought by the big guys, closer to Skynet.

Tag, You’re It. Russia surpassed Saudi Arabia as China’s biggest oil supplier as refineries take advantage of cheap oil from Russia. Now with the Zero Covid mandates, the Chinese economy is expected to get back on track, increasing oil demand. China imported 1.72 million barrels per day from Russia last year and is now running at 2 million barrels per day. That is the equivalent of $36 billion a year at $50 oil. There have been discussions about the EU lowering its ceiling on Russian crude since it is now selling well below it, but it doesn’t appear likely.

Is She Related to Al Gore? Greta Thunberg reportedly deletes 2018 tweet claiming ‘climate change will wipe out all of humanity’ by 2023.

One Opinion. Hedge fund manager Pierre Andurand of Andurand Capital said the recent fall in oil prices due to banking jitters is speculative and oil will hit $140 a barrel by the end of the year. Still, electric vehicles will eventually sap gasoline demand and cause oil demand growth to slow in the coming years. Demand will peak around 2030, he said, adding: "Even when we peak, oil demand won't fall down so fast. We will reach peak demand towards 110 million barrels per day and then a slow decline from there."

Ruh Ro. Swiss authorities-imposed curbs on bonus payments for Credit Suisse employees, a move that will penalize bankers after a multi-billion-franc state rescue of the bank.

End of an Era. There is a condition referred to as the “oil curse” that has affected many countries in the world, and especially in Africa. The country, often some former colony, with somewhat decent centralized management but still very tribal, finds oil, or rather the oil company that has taken a concession, finds oil. The country owns 51% since it owns the acreage, and the oil companies pay the bills. The volume of money that is suddenly generated is staggering, especially in these lesser developed countries. So instead of developing industries and businesses, they rely on the oil. And then the different factions fight tooth and nail to control the money. The Ivory Coast was a beautiful, peaceful tourist spot with great hotels and the Mamba brewery. The Seme oilfield was discovered, and they had 20 years of civil war. I mention this because one of my favorite countries in Africa is Senegal. I met several Senegalese in Paris years ago and when traveling there, I even got “stuck” for a couple of days and spent them at the Club Med. It is a former French colony, that is very peaceful with several developed industries because before a recent natural gas discovery, oil and gas had never been found in the country. Now the first floating LNG facility is sending out its first cargo. My fingers are crossed that we have learned better over the years.

Snippets.

We observe a median FCF Yield of 5.6% in 2023 and 7.3% in 2024 for our E&P coverage at recent strip prices ($69/$65 per bbl for WTI and $2.84/$3.58 per Mcf for NYMEX gas in 2023-24). Citi Commodities lowers its 2023 gas price forecast to $2.50/MMbtu. - JPM
Citi Equities remains bearish natural gas producers (sell ratings on CRK and CTRA) and foresees further downside to OFS rates.
Sempra told Bechtel to get started on its EPC contract for the Port Arthur LNG Phase 1 project.
NYC was voted the priciest city for business travel last year, with costs up 8%, for a rate of $796 per day. Geneva was 2nd at $700.
Russian President Vladimir Putin and Chinese leader Xi Jinping spoke for more than four hours and enjoyed a state dinner at the Kremlin, warmly praising each other as a "dear friend".
Woof. The global pet economy is projected to be worth $493 billion by 2030, putting creature caring on par with cybersecurity and fintech.

Confidence Crisis. A systemic credit event has replaced stubborn inflation as the key risk to markets, according to BofA’s latest global survey of fund managers. They say the key risk is in U.S. shadow banking, followed by U.S. corporate debt and developed-market real estate. “The shadow banking system consists of lenders, brokers, and other credit intermediaries who are outside of traditional regulated banking and is generally unregulated.” – IMF.

Use Everything. An Egyptian startup is aiming to turn more than 5 billion plastic bags into tiles tougher than cement as it tackles the twin problems of tons of waste entering the Mediterranean Sea and high levels of building sector emissions. "So far, we have recycled more than 5 million plastic bags” -Javier Blas.

This is One I Like. I heard it posited this week that the reason that SVB failed was due to an excessive attention to ESG. How bad a guy can ESG be? He caused a banking crisis on multiple continents! Okay, I understand the point on attention to ESG, but the bank did business with more than 1,500 renewable and green energy companies. I understand the irritation with management who would take such risks and all in the name of ESG, but the 1,500 companies are trying to jump on the big bandwagon going by and were more than happy to work with a gullible or starry-eyed banker. An opportunist, by definition is a person who exploits circumstances to gain immediate advantage, and this includes in renewable and green energy. Instead of getting all riled up because ESG brought down a bank, understand that the reality is greedy bankers and needy tech companies found a “loophole” to exploit and it happened to be ESG related this time. It’s a frame job.

Celebrating What? Champagne sales worldwide crossed a record €6 billion ($6.5 billion) last year, boosted by a jump in sales to Gulf nations.

Best Buds?? China's President Xi Jinping and Russia's President Vladimir Putin set their sights on shaping “a new world order” as the Chinese leader left Moscow, having made no direct support for Putin's war in Ukraine during his two-day visit. Europe and the U.S. against the Russians and Chinese. When everyone picks sides, a game is sure to follow.

More Weather. The Intergovernmental Panel on Climate Change, the IPCC, released its 6th report on climate and it calls for dramatic effort to avoid hitting the tipping point on climate, after which we will be powerless to avoid the results. Whatever they may be. I am not at all making light of climate and climate change but accomplishing that will be a challenge. The head of the UN said “What the media SHOULD be making clear: To have ANY CHANCE of staying close to 1.5C & avoiding the likely death of BILLIONS means IMMEDIATE & RADICAL changes to what we value as a society and individuals and transforming how pretty much all of us in the global north live our lives. We could cut 40 to 70% of projected 2050 emissions with end-use measures," said Kaisa Kosonen from Greenpeace, who was an observer at the IPCC approval session. This includes “shifting to plant-based diets, avoiding flights, building more walkable and bikeable cities," she told BBC News. I’m hoping for a technology break-through. I have too many friends who love a good steak.

Conundrum. At the CERA conference, the U.S. secretary of Energy said that unclogging the (permitting) system is a priority of the Biden administration. What? She said it was crazy, that tax credits were for 10 years and the permits were taking that long. Who is this woman and what did she do with Secretary Granholm? Whether reality is creeping up or she confirmed that she is a politician who will say anything? “We can do this!” she shouted to great applause by the audience at the conference. Granholm said Biden has directed the DOE and federal permitting agencies to “use our full authorities under the Federal Power Act to significantly speed those permitting timelines.” Please live up to your word.

New Job. Last Tuesday, Rewiring America announced that it has hired Georgia politician Stacey Abrams to help the group “launch and scale a national awareness campaign and a network of large and small communities working to help Americans go electric.” Her title will be Senior Counsel. She said she is “excited to join Rewiring America to share the benefits of electrification and ensure families get their fair share. I look forward to working together as we build the tools that will transform everyday Americans from energy consumers to energy moguls.” No comment at all.

Headlines.

The Excellence of Kamala Harris Is Hiding in Plain Sight.
Victoria's Secret to bring back fashion show after 4-year hiatus.

Spring Chickens. These are two world leaders. Not their children, but the leaders. We aren’t used to recognizing anyone younger than 70 on the U.S. or world stage. Keven McCarthy is a youngster at 58. Bill Clinton is 76, McConnell is 81, Durbin is 78, Schumer is 72, Trump is 76 and Biden is 80.

The two guys in the picture above? 42 and 45. Looks interesting. We should try that sometime.

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.