Things I Learned This Week in Houston

November 3, 2023

Sweater Weather. Summer appears to be almost over this week in both Houston and Dallas. Parkas came out for a very brief appearance and most women didn’t even have their minks out of storage yet! After very recent warm weather, 50 degrees felt like below zero and I saw people in sweaters for the very first time in years. The overall mood was very mixed. The rig count has been declining all year and appears to have bottomed out in the near term, but there is very little confidence in that statement. Oil hit $80 this week as supply concerns over the Israeli/Hamas war, China’s demand, and pace of economic improvement weigh on prices. Oil will be down for the second straight week. If you remember just five weeks ago, it was at $94 and headed up. Natural gas has been a pleasant surprise at ~$3.30 but Europe is going into winter with record natural gas storage and winter ends every year.

Many Moving Parts. No one is slashing wrists but the slashing, or at least pruning, of costs continues as do the reorganizations of businesses inside companies to better reflect changes in customer demand, make-up, technology and any other differentiating factor that can be named. NOV is reorganizing from three business lines to two. The company’s businesses, products and services don’t change, but how they are marketed and managed does. Everyone is looking for the next novel technology that can improve existing products and services. Strategic directions change, changing the priority of management attention in some areas that will become increasingly non-core and eventually divested. Don’t wait. No one is happy with the valuation multiples but that takes time to change, and strategic combinations can’t wait for investors to understand long-term value in our sector. We are all in very similar boats.

Tough Comps. Earnings continued in OFS with E&P just now starting. Their year-over-year comps are not positive since oil prices are down, with prices in Q3 2023 averaging just $75.90 compared to $103.38 in the same quarter last year, down 27%. That stings. Natural gas is worse, averaging a whopping $8.06 in Q3 last year and coming in at $2.59 for the last quarter. That is down 68% for those who care about numbers. The current price of ~$3.30 is much better than the Q3 average, but as we get closer to winter, that would be expected.

Some Things Never Change. The current Henry Hub natural gas price is sitting on top of the 27-year average of $3.34/Mcf.

Good Looking from a Distance. None of this has been a surprise. It has been a steady decline in both activity and price, and while earnings are down, few companies are missing earnings. But it is no wonder that investors have not found love yet. Volatility of commodity prices? Down 27% and 68% in a year? And the argument that we are at a bottom has been made at some point every year for the past 5-6 years. Are investors starting to realize that energy security is real and the demand for oil and gas will likely rise for the next several years? BlackRock put the head of Aramco on its board. Times are changing. But when you focus just on the investors, who are charged with making money and not just ideological hoping, they aren’t so sure how and when to play. A year ago, it looked like a really good time to get into these stocks. Prices were up, activity was up, and the outlook was golden. All the macros put oil and gas prices higher going forward. Oops. Better understanding? Yes. Investors willing to part with money? Not yet.

Just Say No. First, we should never take investor money when oil is above $110. The likelihood that we can give them a great return on that is very limited. At $50 or $60, take their money all day long. $80??? Down 15% in five weeks and this is the bottom? Promise? And other than to cash out, who needs more money right now anyway? Everyone should be generating free cash flow, after capex. Acquisition financing? It exists. A new revolver in a new relationship? Very tough. Nothing is getting done for cash anyway. Low valuation? So is the target. Do you both deserve a higher valuation? Of course (says every company ever). But waiting for market valuations to improve is like strategic planning based on the daily price of oil or gas. There are so many transitions happening in our business that have nothing to do with emissions and it is amazing. And the best way to increase valuation multiples? Scale and size.

EIA Weekly Oil Report.

Crude Implications: Bearish – build below expectations. WTI backwardation between 1M-12M @ $5/bbl, $2/bbl narrower w/w. Money managers decreased ICE Brent and NYMEX WTI net long positions by ~4% w/w. Geopolitics continue to push-pull with waning fundamentals / seasonality.
U.S. Crude Production: indicated at 13.2mm BOPD, flat w/w, and up 1.3mm BOPD y/y.
Refinery Runs: 15.3mm BOPD, up 62 w/w and down 591 y/y. Utilization at 85.4% due to turnarounds.
Crude Imports (net): 1.5mm BOPD, up 0.3mm BOPD w/w and down 0.8mm BOPD y/y. Brent-WTI spread at $4/bbl, unchanged w/w.
Gasoline: Bearish – build vs expected draw. Demand down 1.9% w/w and up 0.4% y/y. Note August demand recently released by EIA monthly data is 0.3mm BOPD higher than weekly implied demand.
Distillate: Bearish – draw below expectations. Demand down 9.5% w/w and down 13.5% y/y.

Fraudster. Sam Bankman-Fried, the disgraced founder of collapsed crypto exchange FTX, has been found guilty on all seven criminal counts related to fraud and conspiracy. It took the jury 4 hours to decide he was guilty on all charges after a month-long trial. He testified on his own behalf for three days, but the results speak to his effectiveness. I don’t play in crypto. I’m probably missing out but there are parts of this story I have a hard time understanding. At one point, the 31-year-old was worth $26 billion. At one point, his crypto exchange was worth more than half the value of the NYSE. "Sam Bankman-Fried perpetrated one of the biggest financial frauds in American history," said U.S. Attorney Damian Williams, whose office led the investigation.

Clinton was a Piker. “The National Archives has identified 82,000 pages of emails where then Vice President Joe Biden used a fake name, but the Biden White House has only cleared 14 pages in response to multiple Oversight Committee requests for documents related to then Vice President Biden,” Comer told The Post in a statement.

Uncle Ben’s? So, I assume everyone is up to date on the existence of the Rice’s whale in the Gulf of Mexico. The administration continues to target oil and gas activity in the Gulf and nothing else. The NOAA Fisheries denied an activist’s petition to establish a mandatory 10-knot speed limit in large swathes of the Gulf. The National Offshore Industry Association, NOIA, “represents and advances a dynamic and growing offshore energy industry, providing solutions that support communities and protect our workers, the public and our environment”, and their president, Erik Milito, issued the following statement:

“While the decision to deny the activist petition is based on sound reasoning and logic, the Administration continues to target only oil and gas development for restrictions related to the Rice’s whale. While NOAA, the ‘science-based’ agency within Commerce, denied the restrictions, the Bureau of Ocean Energy Management is still pursuing actions targeting Gulf of Mexico oil and gas production. The decision leaves in place offshore oil and gas restrictions, while essentially deferring action on the majority of remaining vessel traffic concerns.
“Instead of singling out offshore oil and gas with measures like acreage removal, lease stipulations, and additional mitigation requirements, the Administration should follow a regulatory process that carefully considers both the economic and national security implications of its actions. It would be prudent for everyone – especially the whales – to place a primary focus on the well-documented habitat area in the Eastern Gulf of Mexico.”

“The NOAA cited three additional steps it would still need to take before vessel regulations could be considered:

Finalizing the critical habitat designation;
Drafting a species recovery plan; and
Conducting a quantitative vessel risk assessment.

Rather than capitulate to the demands of activist litigants and circumvent the regulatory process, the Administration should pause action for all sectors, including oil and gas, until these steps are completed.”

The Fed. U.S. economic growth surged in September by 4.9% but inflation hit a four month high, reversing a trend many thought would last longer. This increases the probability of the Fed hiking rates again. The 10-year risk free rate went over 5% this week. Three years ago, if you could lock in a 5% risk-free return, people would have been fighting to get in. Today? If I take a little risk, I can get 8%-9%, and if I want to take more risk, deals are getting done at a 10% rate. One issue in all of these GDP-type surveys is they report the rate of inflation excluding food and fuel, which are not only essentials but items whose prices have gone up well ahead of everything else with the possible exception of used cars. The current options market shows the expectation of several rate cuts next year.

Too Woke. In the final round of the most prestigious national high school debate tournament, Team A tells Team B that they will not be debating the assigned topic, benefits and costs of the IMF, because transgender people are being killed in genocide by MAGA Republicans, and that is way more important than debating the IMF. They tell the judges that this round "does nothing to the IMF itself" and as such they have decided that "this round is going to be a debate about debate" and the judges' "choice instead is whether to affirm our performance." They proudly declare that they will "occupy the debate space until trans debaters can participate safely." They won the debate.

View From the Field. Ranger Energy Services’ stock fell 11.7% to a nearly three-month low on Tuesday after reporting Q3 results that missed expectations. It was the explanation that is most interesting to us. The company cited reduced onshore drilling and completions activity and lower rig counts. The drop in revenue and income was caused by reduced activity in its wireline and ancillary services segment, while the cost of services increased due to reduced operating activity and inflationary cost pressures. Ranger reduced guidance for full-year revenues, saying lower customer activity prompted the cut.

Another Telling Report. “Despite strong revenue and adjusted EBITDA, both increasing sequentially +31% and +41% respectively, DRQ is facing capacity constraints in the offshore rig market; customers have delayed product orders and service deliveries on rig availability, negatively impacting schedules and pushing activity into spring of next year.”

Pile-Up and Pile-On. Ford joined the pileup and postponed $12 billion in planned electric-vehicle investment, stating that buyers weren’t willing to pay a premium over gasoline cars, even with a $7,500 federal tax credit and hefty state subsidies. “The customer is going to decide what the volumes are,” Ford CFO John Lawler said.

Trendsetter? These headlines were all on one publications page on the same day this week. Notice any trends? This isn’t collected from a week of looking for headlines. This was Wednesday.

Exxon, Shell, SLB Discuss ‘Balanced Approach’ to Energy Transition
Amid Protests, Aramco CEO Delivers Energy Transition Reality Check
Shell Aims to ‘Decarbonize Profitably,’ Its New Energies U.S. CEO Says
CCS Scaling up Globally from North America to the UK to Europe
Forecast Shows Utilities Adding 35.2 GW of Capacity to Power Grids

Just Say No. “North Sea oil and gas production receives “significant boost” with 27 new offered licenses.” This caused the Just Stop Oil people in London to go nuts, saying that the UK policy alone will kill billions. They seem to ignore that their orange paint, superglue, orange vests, glasses and clothes are all made from petroleum. When I asked them if they thought that was hypocritical, they said what they use isn’t important, it’s what is used by everyone else. Oh, right. They say that issuing the additional licenses is a “death project”, and “it’s an act of war against young people”. There are currently 284 offshore fields in production in the UK North Sea and an estimated 5.25 billion BOE in total projected production to 2050.

Picked. Methane detection is a rapidly growing business with the industry not yet decided on what will be the dominant method for detection. One company is already making headway. SLB’s emissions business was selected by Eni to measure fugitive methane emissions and reporting plans for the company's global operating facilities. The project, which is already in progress, aligns with the reporting standards of the Oil & Gas Methane Partnership 2.0, the United Nations' flagship methane reporting and mitigation program. SLB will give Eni an accurate account of its fugitive methane emissions for transparent reporting purposes and inform Eni's efforts to reduce them. SLB will perform source-level measurements and simulations of Eni's emissions across multiple sites in Africa, Asia, Europe and North America in accordance with OGMP 2.0 reporting requirements, assemble and analyze the data, and assist Eni with reporting its source-level emissions to the OGMP. Sounds completely bottled up. Who else is out there?

Rig Count According to Rystad. The U.S. onshore horizontal rig count continued to decline in the third quarter of 2023, touching a low of 552 at the end of September, despite a recovery in commodity prices since July. West Texas Intermediate (WTI) and Henry Hub prices trended upwards in the third quarter, providing some relief after both benchmarks bottomed out in a tumultuous second quarter. However, price volatility at the start of the third quarter removed any semblance of certainty in operators’ minds that the path forward would be smooth sailing. Uncertainty around Chinese demand and repeated stimulus efforts to jump-start an economy that will be a major input to oil demand moving forward weighed on sentiment. Persistent negative news during the quarter also loomed over future pricing prospects. Even so, Rystad Energy maintains a positive outlook for 2024, with the rig count forecast to build on momentum seen in recent weeks.

Convicted. Goldman Sach’s top 25 conviction list included one oil and gas stock, Chevron. “They are leading capital returns and are supported by “a clear cash flow inflection in 2024.”

Blow Hard. “Offshore wind developers debating potential success of planned projects, as Global 2030 targets require a $27B investment in supply chain by 2027 simply to cover requirements for blades, foundations, nacelles, towers and installation” reads the headline. We have been writing for some time about issues with the offshore wind industry including the inability to renegotiate contracts in the face of “soaring costs, construction setbacks and bureaucracy”. Danish renewable energy major and very large offshore wind player, Ørsted, said that its East Coast Ocean Wind 1, Revolution Wind and Sunrise Wind developments are all being negatively impacted by supplier delays and rising costs. Equinor and BP are trying to get additional renewable energy credits to make their Empire Wind 1 and 2 and Beacon Wind farms offshore New York possible. Sweden’s Vattenfall announced it would halt development of its Norfolk Boreas wind farm in the UK southern North Sea after costs had risen by 40%. Siemens warned of an imminent $4.82 billion loss related to problems besetting its wind turbine division. There is a long and growing list of offshore wind projects with negative returns, and many are already being delayed or cancelled. Some trends are hard to reverse.

Beating a Dead Horse.

Orsted takes $4 Billion impairment as it halts two US offshore wind projects.”
The head of BP’s renewables business said the U.S. offshore wind sector 'fundamentally broken'.
BP and its partner Equinor study options to develop huge projects off the coast of New York after writing down $840 million of their value.”
The problems in the United States include permitting, the time lag between signing power purchase agreements and projects being built and a lack of inflationary adjustment mechanisms.
“Ultimately, offshore wind in the U.S. is fundamentally broken," the BP executive told an FT Energy Transition conference in London.

An Educated View. A Norwegian statistics bureau throws cold water on emissions-driven global warming hysteria. "We find that the effect of man-made CO2 emissions does not appear to be strong enough to cause systematic changes in the temperature fluctuations during the last 200 years."

Hydrogen. There are several issues with the expanded use of hydrogen as a fuel source. But the Biden administration has announced the seven recipients of $7 billion in federal grants to accelerate development of regional hydrogen hubs. The recipients included HyVelocity, put forward by Exxon, Chevron, Air Liquide, Mitsubishi Power, AES Corp., Sempra Infrastructure and Orsted. Seven companies for $7 billion dollars. I want to open a hydrogen hub and others can worry about long-term hydrogen embrittlement.

Who? What? And Where? HyVelocity will be developed on the U.S. Gulf Coast of Texas and Louisiana, an area that already contains the world’s largest concentration of hydrogen production, customers, and energy infrastructure, including a network of 48 hydrogen plants connected by more than 1,000 miles of dedicated pipeline. The other regions include:

Mid-Atlantic Clean Hydrogen Hub, up to $750 million; Pennsylvania, Delaware, New Jersey
Appalachian Regional Clean Hydrogen Hub, up to $925 million; West Virginia, Ohio, Pennsylvania
Alliance for Renewable Clean Hydrogen Energy Systems, up to $1.2 billion; California
Heartland Hydrogen Hub, up to $925 million; Minnesota, North Dakota, South Dakota
Midwest Alliance for Clean Hydrogen, up to $1 billion; Illinois, Indiana, Michigan
Pacific Northwest Hydrogen Hub, up to $1 billion; Washington, Oregon, Montana

In addition to the hubs, the DOE will fund:

$1 billion for a Clean Hydrogen Electrolysis Program: using electricity to split water into hydrogen and oxygen which focuses on “pollution-free” power sources like wind, solar, and nuclear
$500 million for Clean Hydrogen Manufacturing and Recycling.

Politics Aside. August set a record for the most southern border crossings for a month at 225,000. That is 3 million people per year. Venezuela has seen over 7 million people leave that country and we are the most attractive choice. Chicago has taken in 15,000 so far and it is screaming bloody murder. New York has gotten close to 150,000 and the governor’s outcry was part of the reason the Biden administration is going ahead with 20 miles of border wall construction. But we are the most attractive option for about 6-7 billion people on this planet, all of whom would come here if they could, in order to “have a better life”. If they do, no one will have a better life. I hope that immigration is an issue forced on the government sooner rather than later. Later may be too late.

I Am Not a Trumpster. But it is stunning to see the show go on. The Attorney General of the State of New York took to Twitter, making statements about the trial of Donald Trump, who is being accused of fraudulently inflating his net worth. This is the transcript of her media presentation on Twitter:

“3 executives have testified. (One) executive was involved in fraudulently inflating the value of Donald Trump’s assets to increase his net worth. On Christmas Eve in 2020, he received a voicemail from defendant and former Trump Organization controller Jeffery McConney. Mr. McConney asked him to come up with reasons to justify a higher value for their Niketown property because their accountant at Mazars needed more information.
Just three days later, documents show that the witness did as he was told and changed the value of Niketown, based on a cashflow analysis he created. This former executive was also involved in conversations about the value of Mar-a-Lago. Since 1995, Mar-a-Lago was legally registered as a social club rather than a private residence for tax and ownership purposes. This executive testified that he knew that it was a club and that Trump paid lower taxes on it as a club rather than a private residence. He also testified that he knew the property was worth much less than it would have been if it were Donald Trump’s private residence. However, when it came time to prepare statements of financial condition, the Trumps continued to value Mar-a-Lago as a private residence. In 2021, Mar-a-Lago was assessed at approximately $28 million. They claimed it was worth $612 million. Again and again, Donald Trump tried to double dip. But here’s the thing with the law: you can’t have it both ways.”

Really??? I have been running comps on businesses for the last several decades. Being asked to update a valuation of a property and having the value of that property change as a result based on a cash flow analysis built in Excel was only done by every analyst alive 100 times a day. And conversations about value? That is a felony now? And he paid lower taxes on a $612 million social club rather than a $28 million residence? And you can say, “well, she meant tax rate.” Agreed, but this is the Attorney General in the state where the active trial is taking place. “Meant”??? And if the rest of it is crystal clear to you, please explain it to me. And again, you would think the Attorney General, blasting a very pejorative statement out through Twitter while the trial is going on, would at least be able to express a clearer thought. You would think she would mention the most damning arguments against Trump. And this was a scripted speech. I am not defending the defendant on any grounds other than this is an absurd piece of theater. They used a cash flow analysis to revise the value of a property. And whether he paid more on a higher rate and lower value versus a lower rate and higher value? It is a social club with active members and has not been his private residence, by registration, for the last 30 years.

Trump bought Mar-a-Lago in 1985, lived there for years as a private residence and then opened it as a social club in 1994. At last report, the club had 500 members and the initiation fee is $200,000. It is a 62,500 square foot mansion with 126 rooms on 17 acres. Marjorie Merriweather Post built the house between 1924-1927 at a cost in 2022 dollars of $118,000,000.

The $64,000 Question About $6 Billion. Blinken specifically said:

"Let’s be very clear about this because it is important. I’m afraid that some people have been misinformed whereas others may be misinforming about the $6 billion… These are funds that accrued from the sale of Iranian oil, over many years, to an account in South Korea, that was established by the [Trump] Administration. The proceeds were to be used under our laws and under our sanctions for humanitarian purposes. Those have never been prohibited by our sanctions against Iran, and indeed, the previous administration set up a mechanism to enable any oil proceeds that Iran was getting to be channeled to accounts where they could be controlled and only used for humanitarian purposes. The money in that South Korean account that accrued from the sale of these proceeds, for technical reasons related to Korean banks, was unable to be used even though it lawfully could be. So, it was moved to an account in Qatar where it could be used for humanitarian purposes, just as the [Trump] administration established another account in another country for these very purposes. The money never goes and would never go to Iran and can only be used for authorized transactions overseen by our Treasury department and only for things like food, medicine, and other authorized humanitarian purposes. To date, not a single dollar has been expended from that account and there are currently no plans to expend a single dollar from that account. And in any event, that money never touches Iran directly."

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.