Things I Learned This Week in Northern Europe

May 26, 2023

Common Mistake. Many people, outside of Sweden and Norway, refer to “the Scandinavian” countries. Not so here. The Swedes and Norwegians have been fighting each other and owning and controlling each other for centuries. When Sweden and Norway were finally separated in 1905, Sweden got all the good farmland and Norway got mountains. That didn’t help the mood. Then in the 1960’s oil was discovered in Norway and there has been no looking back. Sweden, with its farmland, has no oil. Poetic justice. Today, Sweden has one of the top 3-4 highest tax rates in the world and Norwegians pay about 22%. So, if someone mentions “Scandinavia”, know better. Of course, I am of Swedish heritage and the wife is Norwegian. The odd thing is, she has all the money too.

Basics. I was reading a piece recently by a known observer. He was making the case that the Grand Transition has been a bust because fossil fuels still account for a large and fairly stable percentage of energy generation in Europe. He is right on the percentage of energy. We have written about it. Remember that fossil fuels have gone from 84% of global generation to only 82% in 2-3 years. “Only”? I am prejudicing my case with that word. 2% of global energy is a very large number. And even if that percentage number declines, the absolute use may go up as the global population rises and more people are moved out of poverty. Usually energy poverty. We understand that as well.

Evolution. But saying the Energy Transition is a bust is too short-sighted. First, the industry has been very actively transitioning throughout my career. 2-D seismic and 300 feet of water was considered deep. We took 1,600 rigs drilling for gas down to 100 and still boosted production. To me, we are continuing the transition. And yes, we are going to be using fossil fuels for a very long time. Government announcements don’t change the laws of physics and only affect economics in the short-term. One day, China and India will start using less coal and more environmentally friendly forms of energy. The rest of the world will continue to improve efficiency and safety, in all aspects of the enterprise. We will continue doing what we always do. We have never been able to control demand or price. How is that different going forward? Hysteria about mandated electric vehicles? Another president’s EPA will fix that. Shortages of critical materials? We will adapt. Extremes rarely happen. There are too many dynamic variables that shift to keep the train on the tracks.

Realism. I don’t know what oil demand will be in 27 years and I don’t know what the oil price will be next month. Neither does anyone else. I spent 30 years building predictive mathematical models. No one is ever right, and you can use them to argue any case. From a 30,000-foot view, global energy demand will continue to increase, due to an increase in both population and per capita use. The amount of wind and solar power generation will increase. Oil and natural gas will continue to be the dominant non-coal source of energy, and coal will unfortunately be with us for a very long time, and we should continue advocating for its demise. We will have both EVs and ICEs on the road, the former newer and the latter older. Technology in all things will continue, with unexpected jumps, and will be put to use in the most practical applications.

Picky. A key variable will be governments. An elected democracy can shift towards moderation over time, with economics being a critical driver. For a non-elected government, a centralized planned government which owns and controls commercial enterprises, all bets are off for the short and intermediate term. This can be seen across the world and rarely has it been beneficial to anyone. But as a global industry, we get to pick and choose where we work and with whom we work.

Fatalist. So, one of the best places to be, regardless of the future percentages or who is in power, is our industry. We have displaced so much coal in the country, we are the only nation meeting the edicts of the Paris Climate accord, and we continue to increase our ability to expand that globally. We are finding large oil deposits in the industry’s most emissions efficient market, bringing entire countries out of poverty and setting records at the speed of putting production on-line. Even the current administration understands, even if they can’t say as much, but demonstrated it by the approval of the Willow Project in Alaska (!) that won’t start to flow oil for several years, because we will need it in the future.

All Energy. So, is the Grand Transition a bust? Maybe the “Grand” part, but transition or evolution, with the latter being preferred since it better recognizes past efforts, will continue. Disposal of windmill blades or uncapped wells. Non-economic wind or 10 years of oil and gas losses. No industry is perfect, including ours. Rather than discussing why things shouldn’t be, our industry should focus on what we do and do well. We should embrace any form of renewable energy where we can provide goods and services. The train is already moving so it is smarter to jump on it than try to stop the train. Our evolution as an industry will continue to embrace wider and wider challenges. It’s why we all work in
this industry, and it is going to be vital for a very long time.

Not Worth a Dollar. China and Russia have agreed to use the Chinese Yuan in trading transactions along with India who will start trading in Rupees now. China and Brazil are on board as well. This is the BRICS group that is trying to replace the U.S. dollar as the world’s reserve currency and by mutual acceptance across the alliance, it begins to carry more weight. In the instances above, the dollar would have been the cross-border transaction currency. India now has 18 countries that have agreed to accept the Indian Rupee. It has the effect of devaluing the U.S. dollar which would negatively impact our borrowing and payments for U.S. companies. There was some discussion of a “petroyuan” that China is pushing since all global oil transactions are currently done in U.S. dollars. Even Saudi said it was ‘open’ to the idea of trading in non-U.S. currency transactions. This has been tried many times in the past but now with a group of countries, the BRICS, there is more substance behind this effort.

Critical Issue. Depth of inventory and ROCE are two of the most critical issues in the energy market today. The Exxon for Pioneer rumor made some sense. When we started drilling horizontal wells in areas that used to be nothing but the Sprayberry, we were giddy and rightly so. We had 15 years of top tier drilling locations, which was stunning in an era of conventional exploration and production yielding 40% success rates. With a 100% success rate, you know the oil is there and we have identified enough Tier 1 acreage to last 15 years!! Amazing statements for the time. But here we are, 12-13 years later, drilling and completions are no longer so novel, and those Tier 1 locations are shrinking in number. Sure, technology has made today’s Tier 2 look like yesterday’s Tier 1, but that was so last week. Known and done. So, what now? Find another play? Tough. Drill Tier 2 wells? ROCE will drop until oil prices rise but they are rarely in lockstep. Capital discipline will remain and while a 25% ROCE is fabulous, a 17% ROCE is still pretty damn good. But to ensure a positive cost of capital going forward, more depth of inventory is needed by all. Some have more, some have less. The first are targets, the second are sharks
or are out of business. Just the way it works.

Shifting Winds? Both Shell and Exxon were in the news this week as both companies made statements about only proceeding with some “greener” efforts if they made money. For Shell, the annual General Meeting was marred by Just Say No to Oil activists, rushing the stage, shouting profanities and general disruption, but also telling its renewable power businesses that they need to become more profitable and not just green for the sake of green. Exxon stated this week that achieving net zero by 2050 would be “highly unlikely”, stating that it would require a drop in living standards which that would not be accepted. The IEA‘s net zero emissions scenario, which models a phaseout of most fossil fuels by 2050, has little bearing in reality, Exxon said. Exxon has a net zero “ambition” by 2050 but is investing heavily in new projects — both fossil fuels and low carbon — that it believes will provide the flexibility to respond to multiple energy transition scenarios.

Slam the Brakes! Again. The market has been thinking that the Fed action of raising rates might be coming to a close. Dallas Fed President Lorie Logan said she's not yet in favor of pausing rate increases based on current data, with the next opportunity at the June 13-14 meeting. The probability of a 25-basis point rate hike increased to 37.8% from 10.7% a week ago, according to the CME FedWatch Tool. That would be the Fed's 11th straight rate hike. Fed Governor Philip Jefferson said a "considerable amount of data on economic activity" for April and May has yet to come in before a decision is made. He said he's considering monetary policy's "long and variable lags", uncertainty over tighter lending standards, slower GDP growth, and the policy's muted effect on the labor market so far. And now, the CEO of the St. Louis Fed, James Bullard, and Neel Kashkari, the CEO of the Minneapolis Fed don’t seem to be on board with slowing down. Bullard said this week that he backed two more increases, while his Minneapolis colleague said if the central bank pauses, it should also signal that tightening isn’t over. Keeps us on the edge of our seats.

This Wasn’t Expected. A warm winter and lots of wind have made electricity so cheap that the newest nuclear plant in Finland has been cut back significantly. "Electricity production must also be profitable for nuclear power plants, and when the price is particularly low, there may be situations where output is limited," TVO communications manager, Johanna Aho, said. On Wednesday the market price for electricity dropped below zero cents per kilowatt-hour (kWh) and for hours after that the price was only 0.3 cents per kWh at its highest, according to the country's grid operator, Fingrid. The nuclear plant went online last month, 14 years later than originally planned. Historically, hydro power was the swing provider but oddly, floods are negatively affecting power generation. Janne Kauppi, an energy markets advisor at Finnish Energy, said "There haven't been many situations where nuclear power output has been regulated specifically because of low prices.” About 500 megawatt-hours of new wind-generated electricity went online this year alone.

Consolidation. Again. And this time, instead of E&P companies merging, this is a super major increasing its focus on U.S. onshore activity. That alone speaks volumes. Chevron will acquire PDC Energy in an all-stock deal valued at $6.3 billion. Chevron cited strong free cash flow, low breakeven production, and development opportunities adjacent to Chevron’s current position in the Denver-Julesburg and Permian basins. Including debt, the enterprise value is $7.6 billion. The deal should be accretive within the first year after closing and will add ~$1 billion in cash flow at $70/Brent and $3.50/Henry Hub. Run-rate cost savings are estimated to be ~$100 million in the first year.

Buy and Sell. And to help pay for this acquisition, Chevron is putting its Congo assets up for sale, expecting to garner $1.5 billion in proceeds. The company prefers to operate with a newer focus and more profitable production.

Change of Face. BlackRock won support from investors at its annual meeting as the fight over ESG policies continues. Two shareholder resolutions raising climate concerns won less than 10% support, while a third resolution from a Black conservative group that targeted BlackRock's diversity policies won less than 1% support. One resolution focused on BlackRock’s efforts and proxy voting to "engineer decarbonization in the real economy." In a complete 180-degree change from 18 months ago, before the SEC and shareholder lawsuits forced them to let investors vote their own shares, CEO Fink said that is not BlackRock's role. "We have clients who wish for that, but we also have clients who are not interested in that, and our job is to be working with our clients.” Wow, it is a brave new world and a more democratic one.

Another One Gone. Paradox Resources, LLC, and its affiliates filed for Chapter 11 bankruptcy. The affiliates filing as co-debtors are: 

Capital Commercial Development, Inc. 
Four Corners Energy, LLC 
Four Corners Pipeline, LLC 
Neuhaus Barrett Investments, LLC 
Paradox Midstream, LLC 
Paradox Upstream, LLC

Paradox operates over 150 wells and 270 miles of pipelines on approximately 98,000 net acres near and around the Four Corners area, with the Lisbon gas processing plant, which focuses on dehydration, NGL and helium recovery. Demonstrating that focus is its assertion that it is the “only plant in the region capable of processing high nitrogen and CO2 gas with helium purification and liquefication capabilities.”  To demonstrate diversity, there are between 1,000 and 5,000 creditors and liabilities between $50-$100 million. That isn’t very big in today’s world.

EIA Weekly Data

Crude Issues: Bullish – a draw versus an expected build, 1.6 MMBBLs released from the SPR with 14 MMBBLs released since March. The DOE offered to sell 26 MMBBLs from the SPR from April to June and intends to purchase 3 MMBBLs for SPR refill as early as June.
Crude Trading: WTI backwardation between 1M-12M is $4/bbl, $1/bbl wider w/w. Money managers cut net long positions in ICE Brent and NYMEX WTI by 40% over the past 4 weeks, now at levels closer to late March, pre-OPEC+ deal.
U.S. Crude Production: 12,300 MBPD, up 100 MBPD from the previous week, and up 400 MBPD from same period last year. U.S. oil rigs have declined by over 50 or 8.5% from last November and lower 48 oil production hasn’t been growing since February. Onshore oil production growth may stall or even decline, but growth in the Gulf of Mexico is likely due to Mad Dog 2 and Vital, absent hurricane impacts.
Refinery Runs: 16,069 MBPD, up 79 MBPD w/w and down 200 MBPD y/y. Utilization at 91.7%.
Crude Imports (net): 1,301 MBPD, down 1,249 w/w and down 844 y/y. Brent-WTI spread at $3.7/bbl, flat w/w.

Rigs. For the week ended May 12, Baker Hughes showed a decline of 16 rigs drilling for natural gas to 141, the largest one-week drop in more than seven years. But in a disappointment for bullish investors, the Baker Hughes natural gas rig count was unchanged for the week ended May 19, which could mean that drilling activity is not slowing down so far after all, and that production rates could stay higher throughout 2023.

OMG. The NYC mayor just came out with his prescription for handling the sky rocketing retail theft in the city.

Burn Baby Burn. We have written a number of times about different governments restricting the use of gas stoves and California has been very active in instituting these rules. Palo Alto, in the heart of tech country, is one of those jurisdictions. But as it turns out, those rules are for us regular people though I completely agree with the argument made. The city will make an exception to the rule after a well-known chef threatened to leave and take his menu with him. World-famous chef José Andrés said the restaurant relies on "traditional cooking methods that require gas appliances to achieve its signature, complex flavors," said Anna Shimko, a lawyer representing the group that owns the shopping center where Mr. Andres has his restaurant. Two sets of rules, one for us, one for them. We just have to figure out how to be more like them??? No. We just have to learn the art of exceptions.

The Headline Was Irresistible. “Why Waking Up Early Is Rooted in White Supremacy.” It seems that waking up early is often associated with productivity, success, and a strong work ethic. The idea that waking up early is a sign of a superior work ethic and a key to success reinforces racial inequalities, from placing blame on the individual rather “the systemic barriers that hinder the success of marginalized communities”. Promoting the idea anyone can achieve success if they simply work hard and wake up early “ignores the structural racism that has created and maintained these inequalities.” So, hitting the snooze button would make you less racist and working hard does the same. Wow. No wonder “quiet quitting” is a thing. Quotes by Anthony Bernardi.

Clean Up. Reduction of Scope 1 and 2 emissions remains the top ESG priority for energy and natural resource companies (88% rank emissions reduction in their top three issues) - Bain Capital. Bain’s third annual survey on the energy transition “State of the Transition 2023: Global Energy and Natural Resource Executive Perspectives”, finds executives are increasing investments in low-carbon businesses, but remain skeptical of consumers’ willingness to pay more.

Executives believe their companies are outperforming the rest of the world in reducing emissions but expect the rate of decarbonization to slow down over the next few years.
Companies expect to deploy about a quarter of their capital on new growth businesses in 2023, many of these focusing on low-carbon technologies.
Respondents say they aren’t concerned about accessing capital for low carbon businesses, but need to ensure adequate returns on those investments.
·Talent shortages are impeding growth, especially for technical experts, as well as frontline workers in North America.

Blow Hard. How could California pay $800 billion in reparations? The state currently faces a $31 billion shortfall this year, its $100 billion high-speed rail project is inert, and income tax rates are already the highest in the nation. Its sales taxes, electricity rates, and gas taxes and prices are among the steepest in the country. It is now considered not safe to walk alone in any major California city after dark. Shoplifting and smash-and-grab theft are no longer treated as crimes. The result is the mass flight of brand name stores. That destroys the tax base. Hundreds of thousands of people are leaving the state each year, which is another nail in the tax coffin. 27% of the state’s residents were born outside of the United States and have no American ancestors. The state is the most racially diverse in America. There are several real and practical reasons why it won’t happen, but no one would give it any more attention than any other unrealistic and absurd idea. Thanks Victor Hanson.

Speaking of Reality. In a pair of recent stories, publicly-held oil majors ExxonMobil and Shell exposed a pair of the most popular myths that have become a part of the overarching narrative of the “energy transition,” which is quickly turning out to be more of an “energy diversification” or “energy addition” than any sort of transition. Exxon has taken issue with the idea that after 2050, their oil and gas assets will have no value so they should begin writing them off as Stranded Assets starting now as “asset retirement obligations (AROs)”. Exxon disputed the issue and in a May 17 filing with the SEC in response to the 2023 Glass Lewis Proxy Report Feedback Statement. I have written several times in the past that this stranded asset narrative is an overblown concern that few executives in the industry itself take seriously, for good reason. The simple fact is that the global community is not remotely on a pace to achieve the net-zero by 2050 goal, and even if it were, a robust level of global demand for the products supplied by oil and natural gas companies would continue to exist, perhaps at even higher levels than today. This is essentially the theme of ExxonMobil’s response to the Glass Lewis Report, with the company pointing out that even the energy transition boosters at the International Energy Agency (IEA) admit the world is not on pace to meet the 2050 target.

An Authority. We can talk about what might happen in the global energy markets over time and there is little question that much of the world expects to live in one without oil and natural gas by 2050. Most of us know better, but it is a different animal when Exxon makes the argument in a legal brief and spells out its expectations. If we were to be gone by 2050, some or many of the assets will never get developed and will require significant adjustments that will be considered a material change in value.

Exxon’s Argument -

“In their analysis, Glass Lewis states that AROs could represent a material financial risk to the company. We are unable to understand how they have arrived at this conclusion. In accordance with GAAP, we do not incorporate into our financial statements those types of risks that are as remote as the IEA Net Zero (NZE) path. Glass Lewis apparently believes the likelihood of the IEA NZE scenario is well beyond what the IEA itself contends: that the world is not on the NZE path and that this is a very aggressive scenario.” The company goes on to state its belief that “it is highly unlikely that society would accept the degradation in global standard of living required to permanently achieve a scenario like the IEA NZE.

Gas-lighting. The following blurb was put out by Bloomberg. Does anyone really believe that companies will now start dumping barrels of toxic materials in the local marsh? Do you think that what was seen by many as over-stepping definitions when it made “wetlands” to be anything that might have water on it one day, is the only rule or law in the land that covers such actions? And we have to mention “Republican-appointed” because we are trying to be less divisive? De-legitimizing the Supreme Court because after years of a liberal bend, it is now conservative. Words matter and even the “news” throws in triggering biases and hear a few of them in only two sentences.

“The Supreme Court put new limits on the Clean Water Act, slashing the power of federal regulators to protect wetlands in a long-sought victory for a couple seeking to build a house near an Idaho lake. With one member of the court’s six Republican-appointees defecting as to the ruling’s reasoning, the conservative majority has potentially given companies a freer hand to discharge pollutants.”

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.