October 11, 2024
Things I Learned This Week About Children
This week was a “child’s crusade”. I went to Boulder to visit the youngest, a junior at the University. $300 to refill the refrigerator and a few nice meals, out of reach of the college budget, were small prices to pay to see one’s son grow up so well. I was beaming when I left. Then, on to DC, where the oldest is having more fun than I thought possible, all while doing a great job as a Credit Analyst with PGIM. There is a huge amount of relief, and satisfaction, in seeing your children happy and doing well. I will still keep my fingers crossed though.
Slow Week. It was a mixed week for the industry. The Middle East conflict and the U.S. elections are dominating the media coverage and impacting all markets. Obviously, the oil markets are volatile, with Iran now exposed as the provocateur of violence in the oil-prone area. But the “terror premium” doesn’t seem to stick. The industry will balance and recover but we don’t know when or at what level. So, expect another round of layoffs from the OFS companies, E&Ps and technical staff to get rid of redundancies. Letting people go is the hardest job any boss has. We don’t envy them, but it must be done. Technology is still at the forefront, though, it would be more accurate to call it increased efficiency. That is what is pushing activity down and production up. In your product and service offerings as well as in how you run your business. Positive returns supply capital, both internally and not, and the industry is always in need of capital. So, the secret? Improve returns.
PPHB – U.S. Energy Market Update Highlights.
Commodity Prices: WTI crude oil is currently $72.98 per barrel (up ~4.1% week-over-week) and natural gas is $2.73 per MMBtu (down ~5.5% week-over-week).
Crude Oil Production: U.S. crude oil production is currently ~13.4 MM BOPD (up ~1.5% year-over-year).
Crude Oil Inventories: U.S. crude oil inventories increased by 5.8 million barrels week-over-week vs. an estimated increase of ~2.0 million barrels.
Frac Spread Count: There are currently 236 frac spreads operating in the U.S. (a decrease of 2 spreads week-over-week).
Onshore Drilling Rig Count: There are currently 566 drilling rigs operating in the U.S. (a decrease of 1 rig week-over-week).
Everyone’s Talking. The ChampionX/SLB deal was sizable, and both companies were public, the deal was accelerated by the thinking that WFRD/CHX might be imminent. Otherwise, most OFS deals have been small. But now there is one of size who has announced “exploring strategic alternatives”. Helix. Helix Energy Solutions Group to be more accurate. There is no guarantee a deal will get done, the basic boilerplate comments, but I don’t remember many that didn’t transact after the announcement. Helix is a global offshore contractor focused on well intervention, whether being worked on or plugged and abandoned. There are only a few competitors around the world, so consolidation within the subsegment has been very limited. I’m sure any deal will sound great when announced, but there is going to have to be some thinking outside the box to really get there. Best of luck, Owen. Great job and story with Helix.
Headlines.
Wimbledon scraps line judges after 147 years in favour of artificial intelligence.
@AlArabiya reporting that #Iran’s Supreme Leader Ali Khamenei “has been transferred to a secure location, with heightened security measures in place.”
From Twitter. “16 pet cats have suddenly disappeared in Bangor, Maine. No remains were found. Experts don't believe an animal did this. Bangor just had an influx of Haitians.”
A Great Perspective.
“After wrapping up another round of meetings in Houston last week, I headed south to witness the progress of several infrastructure projects funded by the Infrastructure Bill and the IRA Accelerator. The most impressive was Tesla’s massive Lithium Refinery, which has been under construction for over two years - well before the current ‘gold rush’ surrounding next-gen lithium brining processes which are now being pursued by oil and gas companies.”
“As we passed by renewable natural gas storage tanks near legacy ones, rusting wind farms near miles of large and smaller transmission lines, near the orphaned wells, cattle, and miles of flat land, I realized how much Texas has changed from the place I remember as a little girl. Today, South Texas is at the forefront of the energy transition, building critical infrastructure both above and beneath the surface. And within just a few miles, Cheniere’s LNG export plant expansion keeps moving ‘full steam ahead’ despite the Biden Administration's previously announced pause for DOE's review process of LNG Export Facilities.” - Emily Easley from "The Bridge" offering a unique perspective on traditional and alternative energy markets from Washington, DC and covers the rapidly changing market dynamics, technological advancements and strategic partnership.
Oh No!! The United Nations Environmental Program (UNEP) report says that incremental change is “no longer an option” and that avoiding dangerous levels of warming will require a “wide-ranging, large-scale, rapid and systemic transformation.” A response from the Climate Survivor Solutions – “That is what we have been saying for years. Glad that the UNEP has finally awoken to reality. Too bad it is decades too late.” If it is indeed too late, wouldn’t it be better to have a great party and go out with a bang rather than just surrender to the supposed inevitable? First round is on me.
Real Urgency. The energy issue, unlike many of the environmental concerns, is much closer to reality. Before we can hit environmental goals in 2035, we might already have a shortfall of 30% by 2032. I’m the first to admit that when I started reading about this over the last couple of years, it just became quiet background noise. After our freeze a couple of years ago, when Texas lost power in part due to freeze offs on natural gas wells, the reliability of the Texas grid has been a very hot topic of conversation. And controversy as well. But we never look around and see what it’s like everywhere. Human nature says that what happens around us is more important than what happens beyond our vision. And while we can push out environmental mandates, something that’s already happening, we can kick the environmental can down the road. The discussion of energy scarcity, really electricity scarcity, across the U.S. has become somewhat white noise as well. But it’s in our face and this isn’t an opinion of policy. This is the reality of physics. We always say that practicality beats out ideology every single time, just not as quickly as we would like. That’s demonstrated here. When you look at where additional capacity investments are being made, they are in regulatory environments that are favorable to them and starving capital in areas where political regulation and environmental concerns are high. And then there’s the addition of solar and wind, which is a good thing, but it does not provide a level of reliability that many industries require. There are some excellent power source applications for both wind and solar. And the power sources that provide the most reliable generation of power are those that are being regulated away. But we have all been working on the power demand expectations of everything from LNG to data centers and pretty solid numbers have been generated. But that’s industry participants who know their business. The regulatory environment is political and almost by definition, doesn’t know our business. But that can’t continue. People want their lights to stay on. Their freezers to keep freezing. Their air conditioning to continue working. Peak energy demand is between one and 5:00 PM central standard time. With a 30% power shortfall, everything would go dark for several hours centered around 1:00 PM to 5:00 PM. And it’s easy to see how the two lines of capacity and demand skew apart. We wrote about it a bit ago. We wrote about the Pennsylvania utility that priced its capacity for the end of next year up 900%!! They said that was the price they needed to be able to provide constant power based on the cost to build out that additional capacity. The rules, regulations, red tape, and the forced focus on renewables, as well as the urgency, have made that the price. I know it is never as extreme, but a 30% shortfall? I’ll take the under. Maybe just a small 10% shortfall? So we would only be in the dark for 2.5 hours in the middle of every afternoon. Naps? I just suggest that we all start paying more attention.
Do We Play?? This is also an opportunity. Building out the energy infrastructure of the future. Old hat. It’s been going on for years. There would just be a couple of the pushbacks but there would be many opportunities. I think this could be getting ready to accelerate sharply. You have the confluence. If you’re in the upper Midwest, you have almost constant wind, and lots of open land.
E&P Comment & Stats. Bernstein Research recently published a report, looking at the 42 E&P companies they have under coverage. Bernstein is unique in that it doesn’t do investment banking, just research. Their lead comment, and one that is very close to my heart: “Operators are staying disciplined and keeping their spending controlled to drive healthier cash flows.” The “discipline” is now pretty much codified in the compensation structure for senior execs in the business. So, now for some stats from this 42-company review. Second-quarter cash flow of $21/boe was up about $1/boe from the first quarter, and oil prices were also up too as WTI increased to $81.77/bbl versus $77.60/bbl in the previous quarter. Another specialty firm said that if OPEC does boost output, oil could drop below $60 per barrel. The head of OPEC said that if its members don’t stay in line, oil could hit $50. That will make capital discipline a bit more difficult but as long as the industry doesn’t outspend cash flow, they can’t get in too much trouble. E&Ps reinvested around 58% of their cash into operations in Q2, down from around 61% in the first quarter. For 7 out of the last 12 years, the industry has outspent cash flow, and when it did, it then went broke. We are only a couple of years into a period of managing our domestic business in a brand-new way and some front-end turbulence is to be expected. What choice do we have?
A Hart Energy Headline: “The E&P sector is working to win back investors by giving them what they want - cold, hard cash.”
Hurricane Season. We get hit early in August and then nothing for 6-7 weeks. Then two in a row. Climate change!!! Well, actually no. But the level of damage could be the result of man. Chris Martz made some very good points in a piece the other day that I really hadn’t thought much about. “There are high-rise 30-story condos and resorts that didn't exist a century ago. Heck, many of these didn't exist 30-40-years ago. The same theme is exhibited in other coastal cities like Tampa (which is imperative for Hurricane Milton). But this drives home my point. Increased placement of waterfront properties along our coastline increases societal exposure to natural hazards (e.g., hurricane-force winds and storm surge) which have always existed. Natural 𝒉𝒂𝒛𝒂𝒓𝒅𝒔 are now often natural 𝒅𝒊𝒔𝒂𝒔𝒕𝒆𝒓𝒔 because there is simply a lot more stuff to destroy now. Even if we assume a perfectly stable, non-changing climate where hurricane frequency and/or intensity at landfall are not increasing or decreasing, then so long as we continue to build stuff along the coast, there'll be more hurricane damage. Landfalls will still come with a higher price tag due to greater economic losses linearly traced to increased exposure.”
Gang Warfare. With the heading either, why would I want to know this or how did you find this out? I saw an interesting piece the other day. Gangs in America. Hearing more and more about them. In my day we had a couple of motorcycle gangs, but that was about it. The U.S. has 41,500 gangs with just over 730,000 members. Los Angeles is considered the gang capital of America with 450 active gangs with 36,000 members. These numbers are from the Department of Justice and though they sound like big numbers. In the 90s, those numbers were 1,300 gangs and 150,000 members. Who would've thought? Aurora, Colorado, is the third largest city in the state, and it has 36 gangs and about 1,400 gang members. They're everywhere, they're everywhere. But how do you define "gang"? A sewing club? For purposes of the numbers above, Gangs are involved in a variety of criminal activities, including robbery, drug and gun trafficking, prostitution, human trafficking and fraud. 730,000. Wow.
That Hurts. A federal district court froze development of a 5,000-well oil and gas project on federal lands in Wyoming after it determined the Bureau of Land Management may have underestimated that project’s impact on groundwater.
There has been some discussion lately that the larger oil and gas companies, who have been making these large acquisitions, might not sell pieces of it off like they have in the past because the value of undrilled inventory is so high. Interesting point, but too early to tell. But big deals still happen. We discussed what has happened with all the majors selling out of Canada. Now you have Chevron selling a billion dollars’ worth of properties in the Haynesville. With natural gas prices so low but the expected future call on Haynesville natural gas for LNG export, few deals were getting done. No one wants to sell this strip, and no one wants to pay up. Maybe not. TG Natural Resources is buying 72,000 acres, with five producing wells, from Chevron in the Haynesville. With TGNR being a majority owned Tokyo Gas company. That is an awful lot of future opportunity, and remember that a lot of our LNG does go to Japan, giving Tokyo Gas in on the front end of the value chain. $14,000 per acre. With natural gas just above $2. A blank slate of contiguous acreage with significant running room. Nice.
Deal Time. Imperative Chemical Partners announced the acquisition of Performance Chemical Company ("PCC"), a leading provider of specialty chemical solutions primarily serving midstream and production operators in the oil and gas industry. This marks Imperative's second acquisition of the year, following the successful integration of Western Chemical, and represents a key step in expanding its depth and breadth of services, primarily to midstream customers throughout the United States. Terms of the transaction were not disclosed. PPHB represented PCC. We continue to see increased activity in the chemical space. “This acquisition is a strategic milestone, expanding our operations to provide best-in-class specialty chemical solutions to our nation's critical midstream and producing infrastructure and enables us to continue delivering the highest level of customer service by further scaling our operations," said Ryan Havens, CEO of Imperative.
We Lost This One. The Supreme Court declined to block the Biden administration’s methane rule. This ends the discussion on the legality of the regulations. The EPA’s methane rule requires companies to curb methane emissions from oil and gas production and storage and many processing and pipeline operations. The goal is to slash methane emissions by 80% between 2024 and 2038 by minimizing the size and frequency of gas leaks. The regulations also target the routine flaring of natural gas. This is “game on” now for the methane detection and leak remediation businesses in the industry, even if it is a pain to operators.
It IS Deer Season!!
The Internet. Most of us take it for granted, especially when we're at home. Rarely do routers need to be reset these days, they just continue to operate in the background, and we just assume they will always have us connected. People who live in more rural areas don't have that same level of connectivity, so the government decided to step in and help. The 2021 infrastructure bill dedicated $42.5 billion to supply broadband to "unserved, mostly rural communities.” It sounds noble. We will connect these people in rural settings. Think of Wyoming, North Dakota, South Dakota, Montana and many more states. Those are just a few in the central part of the country. On both coasts, populations are centered mostly around dense urban areas which are well served. Hard to live in the sticks.
Lots of Money!! There were just a couple of conditions being set by the federal government. States have to submit a plan to the commerce department on how they'll use the money and what they're going to charge. The government is requiring providers to subsidize service for low-income customers. Building it out wasn't enough? And now we have to guarantee them low rates. Grant recipients have to pay union scale wages, and not oppose union organizing. It also stipulates that “hiring must focus on under-represented groups, including aging individuals, prisoners, racial, religious, and ethnic minorities, indigenous, and Native Americans and LGBQT persons and persons otherwise adversely affected by persistent, poverty or inequality.” Notice, that was a quote. States also have to identify future climate risks from the money they get from the government and how their proposed plan will avoid and/or mitigate climate risks. All proposals must advance some progressive goals. A Minnesota trade association noted that none of its members plan to bid for federal grants because of the rate rules, which is basically outright regulation. And there are other burdens “to put these obligations on small rural providers is a hell of a roadblock. Most of our members are small and can't afford to offer a low-cost option.” It's turning out that the largest providers of these services are standing to benefit the most. But there are some rural communities that are doing well. The Breakers Mansion in Newport and affluent areas of Westerly, where Taylor Swift lives, are places where Rhode Island is going to spend some the government’s money. Cox Communications has sued claiming it is all a duplicate effort. The FCC says that 99.97% of U.S. households already have access to high-speed Internet. $42.5 billion dollars. How much of it will end up in pockets other than those of the taxpayers?
Capital, Capital. Who Has the Capital? This isn't new news. We've been talking about it for a year at least and so have others. But you know when it appears in the media it is starting to hit its stride. “Family Offices Worldwide are Queuing to Invest in E&Ps and U.S. family offices have stepped in quickly to fill the void left by other investors while family desks abroad have been slow to move but they’re watching closely.” Don't forget about the diversified credit funds that are out there taking the place of banks and traditional lenders. These groups don't operate with DEI or EG mandates, they just focus on returns. As a result, they like the oil and gas industry and we like them.
Oil Prices Surge on What?? “Oil Bets Most Bullish in Two Years as Mideast Tension Flares!!” and “Bearish traders whipsawed by China stimulus, Iran-Israel” and “WTI call skew highest since Russia’s invasion of Ukraine.” The bounce wasn't all fundamental. I like $75+ oil prices as much as anyone and whether the Middle East conflicts get worse or not, the U.S. is likely to start to enforce sanctions, which have gotten a blind eye from the administration as increased oil production puts billions in Iran’s pocket to cause trouble. It was a short squeeze. Investment portfolios were at near-record bearish positions, the 4th lowest in 13 years, and the hedge funds and other money managers had very few long positions. So, when Iran struck Israel, it wasn’t all fundamentals. Just the market at work.
Oh Germany! German manufacturing orders in August were down 5.8% from July, weaker than the 2% drop predicted by some economists. The government gets its corporate tax revenue first on its profits before the shareholders. So the more you pay in taxes, the less money you have, and the value of what you have left goes down. That's not an opinion that's a mathematical and accounting fact. Being a big fan of RIC, I know well that if my net income tax expense goes up, my ROC goes down. Why does that matter? It is estimated that more than 100 million Americans own stock directly or through pension and other retirement funds. That means that the value of the assets of 100 million Americans will go down as well. Their income will decrease every time the government raises taxes. All facts. Why does it matter? If you look at some tax proposals by current politicians in the race there is the discussion of raising the corporate rate to 28%. And the capital gains tax to 32%. That means that the government takes 50% of the pretax income of every dollar you make dropping the value of the assets you have left by 50%. We hear numbers thrown around and we become indifferent to them, but there are times when the numbers really stand out. This was one.
Oh Canada! Total Energy sells Canadian acreage for $1.8 billion last year. Devon sold theirs for $2.8 billion. Repsol sold their position in Canada last year as well. Exxon sold their Monterey and Duvernay positions in 2022 for $1.5 billion. Shell sold their Duvernay position in 2021. Baytex and Murphy are gone. Is something wrong with Canada? So now, Chevron, a big player, is selling its heavy oil and Duvernay positions for $6.5 billion. People have been saying that Canadian E&P is cheap and undervalued. There seems to be no shortage of comps. The Duvernay is one of Canada's top shale plays and has seen eight deals worth $2.9 billion in the last three years - Wood Mackenzie said in January. For every buyer, there is a seller, it is just getting to be a much more localized industry. The assets Chevron is selling contributed 84,000 barrels of oil equivalent (“boe”) in 2023.
You’ve Been Penetrated! Israel broke into the communication system of the control tower of Beirut and warned that it would not allow the landing of a transport plane of the company "Qasem Air" (flight No. QFZ9964) which was making its way to land. Qeshm is a beautiful island in the south of Iran. And it worked. Lebanon's Ministry of Transport instructed Beirut Airport to tell the Iranian civilian plane not to enter Lebanese airspace after the Israeli threat to target it. Their technological capability is amazing.
Scale Still Matters. Ben Dell, co-founder and managing partner at Kimmeridge, said "The pandemic accelerated oil and gas' maturation past its growth-at-all-costs mindset. However, while the industry has evolved, resource quality and capital efficiency have declined. The reality is that being larger in-basin is more efficient, and enhancing efficiency is crucial to offsetting the impacts of a dwindling resource base – one need look no further than Kimmeridge's own portfolio to see the benefits of consolidation in action. We believe the industry is far from the ideal level of consolidation, and the right number of E&Ps is much lower than the number we have today. Ultimately, the industry will be led by basin champions, and smaller operators will be left out in the cold."
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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.
