November 22, 2024
Things I Learned This Week While Moving
Starting from Scratch is Interesting. About 2.5 years ago, the Lakehouse at Possum Kingdom Lake burned down. While I was there. Exciting and depressing. Then, the builder died the day after we poured the foundation. Snake bit. But this week was move-in day. Buying everything from toilet paper to mayonnaise, and all the spices. One day empty, the next day full. Two hours door to door. Can you say 2nd home? It’s a Lakehouse, with a fish cleaning spot behind the garage and a great view from the grill. Now, being away will also be home, and this week, with no airplanes, was a blessing.
Next week is Thanksgiving and I have two 20-somethings in town, so unless something dramatic happens or they leave their old man to go play with friends, anything I Learn Next Week might stay with me. Have a fabulous Thanksgiving Week. It isn’t a day, it’s a season!!
Money? It’s Baaaaaccckk. You hear things from different people with different connections. It is always nice as an analyst to try and put things into perspective. A recent Hart’s article quantified some numbers and the implications are interesting. Oil, natural gas and midstream development have gotten hot. Quickly. In the last 10 days of October, almost $20 billion of private equity funding was raised. For the last three years, the annual average has been closer to $3 billion. That isn’t just improving, that is a step change, or two, and in 10 days. From 2010-2019, private equity raised about $21 billion every year. 2020 hit, with Covid, and the industry saw a 80% drop in sequential revenues, and private equity dried up to about $3 billion. That is either a huge aberration or it’s back. It is the well-established players who are fueling this increase. EnCap companies account for 45% of that raise but it really is different this time. 40% of the capital commitments are from new institutional relationships, which means we are losing the pariah image a bit, and funds are looking more for returns than politics. EnCap Managing Partner, Doug Swanson, also credited large family offices, which, over the last couple of years, have emerged as large providers of capital, many times in direct competition with the historical idea of private equity. The remaining 55% was raised by Quantum companies. So, while it seems that two companies dominated this amazing bump in capital availability, I think it is more of the next level down, and there are groups and families who actually parted with their money in the current environment. Funds spending money is nothing new. More “grassroots” willingness to invest in energy is new, or at least has been for the last several years.
The Real Story. Helmerich and Payne is an onshore drilling rig contractor, very strong in the U.S. market and they recently made the acquisition of KCA Deutag to increase their international exposure. They reported earnings recently and analysts lowered numbers and reduced capex, saying that FY25 capex guidance of $290mm - $325mm was down ~$190mm from FY24 and meaningfully lower than our $325mm - $350mm expectations and the $450mm consensus. The most important thing to me, though, is the capex guidance. Guiding down capex through 2025 is not an expectation of industry growth. When a company chooses to reduce its capex, in a business where its primary assets are multi-million-dollar assets that last for 20 years, the decision to defer is significant. And while the company will have its plate full while integrating KCA into the fold, the reality still is that capital invested in the company will be less than previously expected. This is in no way picking on HP, which is an excellent company with an excellent balance sheet. But, it is indicative of the current mindset in the industry.
Reality 101. We live in a hyper-cyclical industry. Over the last 50 years, when the rig count was up or down from the previous year, the average change either way was 20%. Over the last 13 years, since 2010, in up years, the rig count is up 28% and in years when the rig count was down, it averaged down 35%. And the opinion that we will hit bottom by the end of 2025 may be right, but your chances of actually being right is like winning the lottery. Luck. I, like everyone else, can build models and show proof from my quantitative analysis and learned experiences but EVERYONE was saying that a year ago. Never give up hope, but from a pragmatic side, you can’t expect investors to flock to, and invest in, an industry that is reducing exposure to its own business, as noted above from HP.
Reality 201. So, mainstream investors are not likely to take the risk that, in 15 months, things will be better. It might be. I certainly HOPE so, but we all know the adage of that not being a strategy. Access to capital markets will be limited but under-spending on capex improves its internal cash flow, maximizing receivables. That is the correct strategy immediately. But there needs to be a broader understanding of the dramatic changes in our industry. We help find and produce this valuable asset, while making gobs of money, and using less and less of the service industry. The OFS sector has always been the tail end of the whip. The service industry provides dramatic efficiency to oil discovery and production. If a producer’s efficiencies outpace the demand growth, oil prices go down. But even with this decline in prices, since the efficiencies are greater, oil companies can maintain and grow margins. And with the lower oil price, they spend less. Without meaningful consolidation, we risk becoming a cottage industry.
What’s it Worth?? Canada. The red-headed bastard stepchild of the North American oil business is still alive. With its first LNG facility being developed, a natural gas drilling boost for Canada would be good, and lighter oil is always in demand. The argument for the last few years was based on the relatively under-valued E&Ps in Canada. Way too cheap according to some, but we haven’t seen a dramatic change in multiples. Two recent acquisitions in the Montney provide some measurement. For 2025 and 2026? EV/EBITDA multiples of 3.8x and 3.5x were paid, with the two deals having a total value of about $4.4 billion, so meaningful.
Important. The National Marine Fisheries Service (NMFS) issued a proposed critical habitat designation for the Rice’s Whale in the GOM last summer. The proposal is to include a vast expansion of the recognized habitat area that runs throughout the entire Gulf of Mexico from Florida all the way around to the Texas and Mexico border. Every trade association objected. The problem is that the Rice’s Whale actually is endangered. Previously known as a “Bryde’s whale,” it is an endangered species with fewer than 100 in the Gulf and they are nowhere else. The NMFS is expected to issue a final decision on December 2nd. Stay tuned.
Earnings Review. Michael DeFazio is a top analyst at RBC. His thoughts.
Who had the best earnings? XOM, CVX, TRGP, FTI, BKR, EQT, COP, EOG, SHEL.
Who disappointed most? LBRT, XPRO, AESI, TDW, HAL, BP, APA, CRK, WES, CVI, NOV.
Landman!! We are still cool. Remember John Wayne in the Hellfighters? Giant? Dallas? And now the AAPL gets its own show! Well done guys. Billy Bob, Demi Moore, Jon Hamm. An august crowd. I loved the TV show, “Dallas.” Having gone to SMU, we all knew the family they were dramatizing in the first season when “around town” stories were incorporated into the show. Traveling internationally a great deal had other benefits. For years when you told someone you were from Dallas, their response was “you shot JFK.” The TV show came out and all that changed. “J.R.!!!” became their response. I was in Bamako, Mali on the day the show announced who had shot J.R. Even with no internet or cell phones or satellites, within 15 minutes it was all anyone in the hotel could talk about. I have one of his hats. He and Boone Pickens. Amazing examples of our industry, real and imagined.
From the promo – “Deep in the heart of West Texas, roughnecks and wildcat billionaires try to get rich quick in the oil business as oil rigs begin to dominate the state. Crisis executive, Tommy Norris, tries to bring his company to the top during a fueling boom.” And before you scoff, remember that the writer and creator of this show bought the 6666 Ranch here in Texas for $320 million.
PPHB – U.S. Energy Market Update Highlights.
Commodity Prices: WTI crude oil is currently $68.75 per barrel (up ~0.3% week-over-week) and natural gas is $3.39 per MMBtu (up ~11.1% week-over-week).
Crude Oil Production: U.S. crude oil production is currently ~13.2 MM BOPD (no change year-over-year).
Crude Oil Inventories: U.S. crude oil inventories increased by 0.5 million barrels week-over-week vs. an estimated increase of ~0.4 million barrels.
Frac Spread Count: There are currently 222 frac spreads operating in the U.S. (a decrease of 5 spreads week-over-week).
Onshore Drilling Rig Count: There are currently 568 drilling rigs operating in the U.S. (a decrease of 1 rig week-over-week).
Still Slipping. We have been writing for some time about the economic weakness in Europe and especially in Germany. Germany has been the engine driving the EU since its formation. It was the strongest economy and the most dominant political voice. Now, it is in recession, it is losing some if it’s high-end, specialized manufacturing to China. Due at least in part to China’s cheaper power costs. Germany had cheap Russian natural gas, which deferred updating much of its manufacturing, with the idea “if it ain’t broke, don’t fix it.” And much of its manufacturing infrastructure is outdated with no money to upgrade it now. It also has the highest labor cost in Europe. Both Mercedes and VW took write-downs in Q3 and lowered expectations, due to weakness in China and at home. VW has already laid off thousands of people and shut down several manufacturing plants. Now, Ford is laying off 4,000 people in Europe, which is not an easy or cheap thing to do. Unlike the U.S., you don’t get to just “fire” people. Cutting 4,000 jobs is not done on a whim, or just as a short-term measure. And it isn’t the first time this year. Several months ago, Ford laid off about 3,00 people, which tells you the situation is getting worse, not better. Over 70% of the layoffs, to be implemented by 2027 (it takes/costs almost 3 years), are in Germany, with the UK seeing 20% of the reduction. VW is very likely to see another wave of layoffs and plant closures, dropping tens of thousands.
Deja Vu. Part of the issue is the same as here. Governments mandate EV manufacturing quotas, but consumers don’t want them. Significant expenditures have been made for what was expected by many to be a very hot and growing market for EVs for years to come, if for no other reason than government mandate. As EV sales slow for a myriad of reasons, China is twisting the knife by dumping their surplus EVs on the European market at very low prices, even after the tariffs, which range from 7.8% for Tesla to 35.3% for Shanghai Automotive. These tariffs are in addition to the EU's standard 10% tariff on all car imports.
Snippets.
No one in the oil and gas industry can be a climate denier. Midland was once at the bottom of an ocean.
The U.S. has a 25% tariff on imported light trucks, which applies to pickup trucks, vans, and SUVs. It has been in place since 1964.
Remember how unions were created to protect workers from exploitative corporations? Yet millions of government employees are unionized—so who exactly are they being protected from?
EIA showed a 240,000 bbl/d drop in U.S. oil production, likely a function of about 400,000 bbl/d of production shut-in for the first four days of last week from Hurricane Rafael.
Imagine where natural gas prices would be today if we had built all those Northeast pipelines.
Another Comeback? Skip Matt Gaetz and Ukraine. This is BIG (in many ways). “If federal employees don’t want to show up, American taxpayers shouldn’t pay them for the Covid-era privilege of staying home.” This from the “DOGE,” the new efficiency team of Musk and Ramaswamy. I was in Washington last month and during the week, it looked dead empty, with entire buildings and lobbies empty. Mostly government employees. And the Trump administration sees this as an early action item. About half of the 2.3 million U.S. government workers are eligible to work from home. And for this group, about 40% of their time is spent at home. It is one quick way to reduce the size of the workforce with an expected 25% preferring quitting over coming back. The unions will fight this tooth and nail. It should be fun to watch, and I wish the DOGE the best of luck.
It Is Entertaining. I remember the clip of Nancy Pelosi talking about Donald Trump, “this man won’t be President!” And of course, she was wrong. So, I will go out on a limb and say that Matt Gaetz won’t be the Attorney General. Every show, every editorial, every commentator is consumed by Gaetz. There is nothing else to talk about. It may be one of the best misdirection’s I’ve ever seen. The speaker has said “no” to calling a recess and while Mr. Trump’s expectation of complete loyalty is strong, not every Republican senator can vote “yes” after the background check is done. Everything everyone is saying is true. He is a terrible choice. But what if he isn’t really the choice, or at least doesn’t remain as the choice? Will Trump continue to support him in light of what a senate hearing and FBI investigation uncovers? And this is without the House providing their report, which the American people have every right to see in this circumstance. Or does he cast him aside, as a sacrificial lamb, getting him out of the House and the public eye, while few pay much attention to the other potential appointees? My conspiracy theory of the week.
Update: Matt withdrew. Earlier/sooner than I expected. And while there were concerns that Trump would name Ken Paxton, sanity prevailed and he nominated the former AG of Florida, Pam Bondi, a 59-year-old and a long-time insider, to be considered as AG. Gotta be better.
Headlines.
Exxon targets $200mm to expand plastics recycling operations at Texas plants.
Trump announces former WH officials Nikki Haley, Mike Pompeo will not be in his next administration. Damn.
Really? Exxon has withdrawn from an oil-exploration block off the coast of Suriname, not far from its Guyana finds. Exxon will transfer its 50% stake in the block to Malaysia’s Petronas, the project operator. Foreshadowing??
Hear Hear! “The Wright Stuff. President-elect Trump has nominated industry veteran Chris Wright of Liberty Energy as his Energy Secretary, which we view as a strong pick.” – Capital One. We agree.
Competing Opinions. It is old news that one of the primary reasons for weakness in the oil markets is due to anemic demand from China. Expected to bounce back, it hasn’t, and the outlook of many is more of the same, or worse. I am in that camp. So, I was surprised when I read one analyst who said that “some positive news finally came from China, with oil demand in October flipping and showing y/y growth of 1.6%, bucking a six-month trend. The October datapoint improves the outlook for Q4/24 also.” I love to take up for the underdog, but this is challenging. All the headlines below were published this week. Don’t expect China demand growth to bail us out just yet!
China's surplus crude oil eased in October, but this is still bearish.
EIA details factors behind declining gasoline consumption in China.
Demand: China's October Liquids Demand Drops 5% on Year, Much of That Structural.
Oil settles down 2% on weaker Chinese demand.
Wheeling and Dealing. Realignment of assets continues. Not just E&P. So, ONEOK buys Medallion and a controlling interest in EnLink, spending about $6 billion. Now, ONEOK is selling three pipeline networks for a total of $1.2 billion. “This transaction will align and enhance our capital allocation priorities within our integrated operating footprint,” said ONEOK CEO, Pierce Norton. “Align and enhance our capital priorities.” Under the rubric that everything rolls downhill, look for the biggest to get bigger and the smaller to get bigger, at least in relative terms.
A GREAT Idea. From the WSJ – “Australia is taking aim at the dangers social media poses for kids, introducing legislation that would ban children younger than 16 from accessing platforms like TikTok (BDNCE), Facebook and Instagram (META), Snapchat (SNAP), Reddit (RDDT) and X.” The law, which is expected to be passed by the end of the year, will make platforms responsible for not taking “reasonable steps” in preventing kids from holding social media accounts. Any "systematic failures" can result in fines of up to $32.5 million, and exemptions would not be granted for pre-existing accounts or cases of parental consent.
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.
