Things I Learned This Week in Punta Mita

November 10, 2023

Reality. Investment bankers, company CEOs and a number of board seats were all my companions for a weekend of golf in Mexico. I am the worst golfer of the group, but all it costs me is the small amount we bet and I get to play with the big boys! Okay, we are all old and there are no golf “big boys”. A 220 yard drive is celebrated in this group. We had the normal discussions about the industry, and it was decided that the E&P operators are having a great time while the OFS industry is taking it in the shorts. When your customers get discipline, it hurts revenues. It is like picking up religion. Your bartenders mourn your decision. The E&P industry has demonstrated exceptional discipline to the point where we think a 700 U.S. rig count is a really good thing. The OFS industry hasn’t had the chance to show that discipline. Oil doesn’t wear out, whereas, a pump or rig or other tool used by the OFS company needs to be replaced. If I don’t drill that well today, the oil will still be there. If I don’t replace my pump, it will eventually wear out, and I won’t have the money to replace it. One of the greatest challenges to the industry is the realization that domestic oil production is not a growth industry. We will be pumping oil and developing reserves forever. But growth? Not in the cards. Oil companies have adapted. OFS has yet to demonstrate the same.

Complete Agreement. My friend, Josh Young, has come a long way in his career, and in pretty short order, at least for us old guys. He has an investment firm, Bison Interests, that deals almost exclusively with oil and gas, and I have always valued his opinion. I have also been a fan of Weatherford and its management, knowing the potential and scope of its three basic business silos that were a confusing mess for some time. Just because someone agrees with me, it doesn’t make me right. But I feel better. Josh discusses the potential upside for Weatherford:

Weatherford International is an unexpected winner in the oil field services boom, with strong earnings and projected double-digit revenue growth.
The company offers differentiated services with higher margins and has the capacity to meet incremental market demand.
Weatherford is undervalued compared to its peers, presenting an investment opportunity with potential for significant upside.

Honesty. As I was writing the above paragraph and title, I thought of an old saying that has won me many drinks in bars. Everyone knows the saying, “great minds think alike,” and, considering the above paragraph, you can see why this struck a note. It is the second half of the saying that virtually no one knows and has served me so well, usually Scotch. But you have to read to the end to see it.

Remember China? You know the “one part Stalinist police state” that we are on the brink of war with over everything from computer chips to artificial islands and that has Taiwan trembling? The government is funding a U.S.-based computer chip manufacturing expansion due to concerns of China taking Taiwan, with whom we have a mutual defense pact. I won’t go on about the spying and hacking, they are too numerous to mention. But as it turns out, “the only way we can solve the climate crisis is to continue our long-standing cooperation with China,” said California Governor Gavin Newsom on a recent trip there. China opened over 100 new coal-fired power plants just last year and put more pollutants in the air than anyone. But, collaboration with China “is the “only way” to solve a “crisis” that is an “existential problem.” Really? He completely forgot to ask about the California pastor imprisoned in China since 2006. Grandstanding is hard work. But he isn’t alone in sucking up. Canadian Prime Minister Trudeau said in 2003 that “there’s a level of admiration I actually have for China. Their basic dictatorship is actually allowing them to turn their economy around on a dime.” Yeah, dictatorships have a way of being able to “turn on a dime” when you can make the people do whatever you want them to do. And he admires that? Thanks to Lloyd Billingsley for some insights.

Climate Justice? Did I Miss Something?

Money for Nothing? “Wages for U.S. oil workers climbed for a third straight month, setting a fresh record as paychecks prove resilient amid slowing shale activity.” Average hourly earnings for front-line oil-and-gas workers is $43.63, according to a Labor Department, up 5.7% from last year. While pay went up, fewer people played. The jobless rate for the sector hit 6.1% last month versus 0.8% last year, obviously higher than the overall U.S. rate. There are an estimated 119,000 people working in the industry. So, while the jobless rate went up, wages went up, drawing more people into the sector. But not all have found jobs yet. Drilling activity is down 20% so far this year. It appears U.S. shale production has peaked, at least for now, at just over 13 million barrels per day. The EIA says it will decline through the fall which is not a surprise since wells are less productive as most of the best rock has been drilled. “The upstream E&P industry is in a slow-to-no growth environment where the appetite for capacity expansion throughout the hydrocarbon value chain is low,” said ProPetro CEO, Sam Sledge.

ESG Updated. We started addressing ESG first as an analyst and then on a couple of trade associations’ ESG committees. As I have said many times, the idea of ESG is a good one. Corporate transparency and responsibility. It became a tsunami over the last several years as the mantra became increasingly loud. Colleges, universities, endowments, pension funds and others thought this was a very noble goal and pushed money managers to make “ESG” friendly investments. And since the corporate proxy season was dominated by three big institutions, one of whom, BlackRock, took the most vocal step, saying they were going to limit or eliminate fossil fuels from investment portfolios, it created a firestorm. First, several states said that if you boycott a critical industry of ours, we will pull our money out of your firm. Then, the SEC stepped in and told BlackRock to start letting individual investors vote during proxy season. The recognition was setting in that ESG funds under performed with energy leading the market for two straight years. Then the back pedaling started. BlackRock said “no, we were misunderstood. We really like energy.” Few believed. And, then, last month, BlackRock selected a new board member - the CEO of Aramco. While ESG will still matter, the pendulum has swung back to what the financial markets care about - returns. Diversity, equity and inclusion (“DEI”) is being downsized across corporate America. ESG still matters, but as an investment tool to optimize returns, it has failed. There is no going back to those extremes of the past, even as the pendulum swings.

Solar? What Solar? “Investor sentiment on solar stocks remains poor, driven by persistent industry issues, continued market uncertainties and, of course, recent stock performance. Some of the main concerns continue to be: 1) the higher for longer interest rate environment negatively impacting demand for residential solar, 2) distributors working through high levels of inventories (at costs that are higher than current prices), 3) the implementation of NEM 3.0 in California (reducing compensation for excess power sent to the electric grid) and the necessary education process for both salespeople and customers to understand the new market and adapt to solar plus storage and 4) a substantial demand reduction in Europe mainly due to broad macroeconomic conditions. These factors have combined to form the perfect storm for the industry throughout the year; solar stocks have been largely impacted even after the passage of the Inflation Reduction Act last year, the most significant climate legislation in U.S. history.” - James West, Evercore.

Wow! A new study of over 1 million vehicles sold from November 2022 to October 2023 conducted by iSeeCars.com finds EVs losing 49.1% of their value over the first five years of life, compared to just 38.8% for all vehicles combined. Man, nobody could have seen that one coming, except for pretty much everyone who hasn’t been hopelessly brainwashed by the glorious EV narrative pushed by our legacy media, the Biden administration and the industry itself. “The good news is that all used cars hold their value better than they did five years ago,” said Karl Brauer, iSeeCars executive analyst. “But not all used cars retain value equally, with trucks and hybrids among the best segments and electric vehicles the worst. Hybrids have a nearly 12 percentage point advantage over EVs in value retention, which translates to thousands of dollars in higher market value after five years.”

New Digs. NYC rents are slipping from record levels—but probably won’t retreat to pre-pandemic levels anytime soon.

New Manhattan leases signed last month averaged $4,195, down from a peak of $4,400 in July and August, according to Miller Samuel and Douglas Elliman.
Brooklyn and Queens saw more pronounced declines. In Northwest Queens, the average price fell 9.4% to $3,198. Brooklyn dipped 5.7% to $3,490.
Pricing has been reset to pre-pandemic seasonal trends, Miller said, but rents remain roughly 20% higher than before Covid.

From the White House. The Administration will develop the first-ever U.S. National Strategy to Counter Islamophobia in the United States. “We look forward to continuing our work with community leaders, advocates, members of Congress and more to develop the strategy – which will be a joint effort led by the Domestic Policy Council and the National Security Council – and counter the scourge of Islamophobia and hate in all its forms,” said White House Press Secretary Karine Jean-Pierre.

Climate Change? No. Pollution. India's Supreme Court ordered authorities in the states surrounding New Delhi to stop farmers burning crop residue, as the air quality from smog engulfing the world's most polluted capital during the past week reached hazardous levels. Delhi city will restrict the use of vehicles next week to curb rising pollution.

Managed. Two of my favorite companies were in the news this week. Halliburton and Oil States announced a strategic collaboration, combining two award-winning technology sets to release “innovative deepwater managed Pressure Drilling (MPD) solutions.” SLB, NOV, Weatherford, who was very early, and Nabors are generally thought of as the leaders in the sub-segment, with HAL having some product orders, but the agreement between these two make for a very formidable market participant. A recent study of the issue showed that the Global Managed Pressure Drilling Market size was valued at $2.70 billion in 2021 and at $2.84 billion in 2022, growing to $4.26 billion by 2030. It is a nice growing niche that is attracting attention.

Headlines.

The U.S. currently has around 2 million more retirees than predicted.
Top-ranked MBA programs including UCLA, Yale, Stanford and Harvard are losing favor among U.S. applicants. At least 17 of the top 26 programs have had long-term drops in applications, continuing into 2023.
Biden Checks His Latest Poll Numbers to See If Israel Still Has The Right To Defend Itself.
The Fed’s hiking cycle looks done as the job market cools.
Air Product's carbon capture facility is being built at its existing hydrogen production plant and will serve Exxon Mobil Corp. and other customers when it comes onstream by 2026.
Shell rises to a record in London as higher energy prices and the company’s new CEO pivots towards greater oil and gas investment, boosting investor optimism.

Finally. The Supreme Court of Canada ruled that Bill C-69, the "no more pipelines bill", was largely unconstitutional. This ruling could mark a significant turning point in Canada's approach to oil and gas production (for the positive), helping to remove the political risk discount applied to Canadian energy stocks.

Energy Talking Points. Alex Epstein is a Researcher, Author and Speaker who is an advocate of reliable, economic power. His goal is to give true, powerful and succinct talking points on today's most important energy, environmental and climate issues. He notes in a publication that there are 7 Energy Truths and, while I list them here, the sub-points give a great deal of detail and backup to the Truth statement.

#1 To decide what to do about fossil fuels and other forms of energy, we must carefully weigh their benefits and side-effects.

#2 Fossil fuels will remain a uniquely cost-effective (affordable, reliable, versatile) and scalable source of energy for the foreseeable future.

#3 The more cost-effective and scalable energy is, the more human beings can flourish on this naturally deficient and dangerous planet.

#4 Given that the vast majority of the world is energy-poor, the world needs far more energy as quickly as possible.

#5 Any negative climate side-effects of our massive fossil fuel use so far have been completely overwhelmed by their climate mastery benefits—as evidenced by the 98% decline in climate disaster deaths over the last 100 years.

#6 Mainstream climate science predicts levels of warming and associated climate changes that human beings can continue to master and flourish with.

#7 A policy of energy freedom, including but not limited to fossil fuel freedom, is the fastest path both to more plentiful energy and to more cost-effective alternatives.

Tread Lightly. “While the U.S. banking sector is stable, growing vulnerabilities leave at least some institutions under a near-term threat of funding pressure and capital shortfalls, according to a post by Federal Reserve Bank of New York staff. The risks to the system are rising—albeit only modestly, they said. That’s in large part because the biggest banks are less exposed to capital shortfalls, an analysis of models through the second quarter of 2023 showed.” – Bloomberg

More Issues. “EV makers resort to discounts to combat waiting demand.” Auto makers and dealers are slashing prices of electric vehicles and giving discounts to clear out unsold inventory with growth slowing for battery powered models. Japanese automakers say future events in China are looking at whether to cut their losses and focus resources on warding off Chinese rivals in other markets. It is becoming increasingly clear that the electric vehicle market is running into a stall. It could just be a stall before taking off again, but there seems to be increasing headwinds cropping up every single day. Ford and General Motors have already slowed down their plans to switch to electric. The CEO of Toyota almost lost his job due to activists who were upset with his claim that electric vehicles won’t be the norm but that hybrids are the best choice. He kept his job and he’s right. There are now too many interesting situations and concerns that the EV market is hitting a rough patch to write about. Will they come back? Will government mandate force the sale of EVs to consumers?

How Big? Novo Nordisk, a Danish company that makes the new blockbuster weight loss drugs, has demonstrated investors’ interest in losing weight. The market cap for the company is now $440 billion, which is larger than Pfizer, Lockheed Martin, Marietta and Starbucks combined. Weight loss drugs. Now if we could just figure out how to lose weight from an oil field services stock.

We Don’t Use It, Just Produce It. The COP 28 conference is scheduled for the end of November in Dubai. This is the event where all the nations agree on actions to reduce emissions and keep the heating of the planet below 1.5 degrees Celsius. It’s always nice to have a goal. But having this meeting in an oil producing country has some people on edge. How can the organization issue statements on phasing out fossil fuels in the coming years when that is virtually all of your country’s value? Another interesting point is a report that came out this week by the United Nations Environment Program, and the nonprofit Stockholm Environment Institute. Clearly, these are not stooges for the oil and gas industry. The study analyzed 20 different countries that produce 80% of the world’s energy. By 2030, the U.S. expects to cut coal production by 43% and China expects to reduce production by 15%. So while the host country of the conference is boosting production, they are doing it in a much more efficient and clean manner. Now the activists will say that’s more fossil fuels that are being produced which will generate emissions, but that’s the issue of the end-user. We just supply a product that is in critical demand, and the only businesses that we can improve directly are our own.

Active Prosecution. In light of the FTX founder, once worth $26 billion, now being broke, guilty and headed to prison, he doesn’t seem to be alone. One would think that enforcement is being stepped up. You look at some of these people and their crimes, and it isn’t small potatoes or because they were hungry. Does it mean there are more sneaky grifters than before? No, it just means in today’s world of the internet, you don’t just “sell” locally, but to every person who has and uses a phone. Oh, wait. That’s everyone.

Never Mind. Several months ago, we wrote about a new technology in the super conductor industry. A paper was published in a noted, peer-reviewed publication that said superconductivity at room temperature has now been made possible, which would revolutionize everything we know about energy transmission, power and connectivity. Put that on hold. The discovery claim has now been retracted. It seems that while this guy got his paper published in an August journal, the fact that it was all BS was only discovered later. This just goes to show that whenever you read a headline that was amazing or sensational, be sure to follow up and make sure that that’s actually what happened.

Falling on Hard Times. The world’s largest oil company, Saudi Aramco, reported earnings this week. With the drop in prices, net income dropped to a measly $32.5 billion. Poor guys. This time last year, with higher prices, they racked up $42.2 billion. Also, keep in mind that Saudi Aramco has cut 1 million barrels a day until the end of the year in an effort to boost prices. Now we can see what being the swing producer can cost you.

The Right Way. The state of Ohio held a constitutional election this week and enshrined abortion rights in the state’s constitution. This is a victory for the Supreme Court. This was the point of the ruling from the very beginning. It wasn’t to ban abortion. It was to tell the states that they have to make the decision on whether to allow or ban abortion, instead of the federal government. The state of Kansas held a statewide referendum very early on, and other conservative states voted by over 80% to not restrict abortion. Ohio is the latest, and I trust it will be more. It has drawn on very regional, rather than political, lines. But it is a good thing. This is the way it is supposed to work. Will some states approve and some states deny? Of course. We have different state laws for murder as well. It is nice to see confirmation of how the laws are supposed to work.

Volatility. Investors continue to dump oil and distillates as the risk of a Middle East war fades, which is a good thing as long as it continues to fade. But concerns about the overall economy are not good and that is one of the reasons for the dumping. Hedge funds and other money managers sold the equivalent of 73 million barrels in the six most important petroleum futures and options contracts over the seven days ending on October 31. Fund managers have sold oil in five of the last six weeks, reducing their position by a total of 274 million barrels since September 19.

Round Trip. These are dreaded words for investors, basically telling them they screwed up and wasted time and money. Round Trip. To round trip in stocks is to buy it low, watch it go up and then watch it go back down to where you bought it. It is the equivalent of starting over again. In the last 18 months, we have seen oil prices, natural gas prices and the U.S. rig count all round trip, up and back down. So, today, we sit where we were a year and a half ago but without the expectation of everything going up again. We get another bite of the apple. I so wished it worked the last time. It just means lower returns, greater frustration, acknowledgement of uncertainty and a host of other issues. But if you are starting from scratch today…..

“Great minds think alike, fools never differ.”

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.