Things I Learned This Week About the Middle East

October 13, 2023

The Worst Kept Secret. Exxon is buying Pioneer in a $60 billion acquisition that many think is the foreshadowing of more major/E&P hookups. XOM will pay 2.3234 shares for every PXD share in a 100% equity deal that implies per share value of PXD at $254. It was so heavily rumored a week ago that it was considered by the media a “done deal.” And they were right, even if it did take a couple of days.

Bottom Line. Last week we wrote again about the emerging deal in the Middle East where Saudi Arabia recognizes Israel and the U.S. signs a defense pact with the Saudis. We questioned the reasons behind Saudi’s high level of interest and urgency for the deal. The Biden administration, if I were a conspiracy theorist, would likely try to get Saudi to put their full production back on the market, drive down oil prices, and cause gasoline prices to fall as we go into election season. That was a sideline but now it is all moot. “Hamas Just Torched Biden’s Deal to Remake the Middle East” reads the Sunday headlines. Iran had a great deal of interest in seeing the deal fail since it would have shifted power in the Middle East away from themselves. Now we know. It was at the cost of thousands of lives and kills any idea of a separate Palistinean state. Big gamble, few winners.

The Shape of Things to Come????

Great Economics. Over the past five years, the top four turbine producers outside of China have lost almost $7 billion USD, and over $5 billion USD in 2022 alone. Last year the CEO of turbine-maker Vestas said that the company lost 8% on every turbine sold.

TFOA. The Texas Family Office Association had their annual Symposium this week at TCU’s Neeley School of Business. Ken Hersh, Bill Montgomery of Quantum, Robert Goff of Crescent and several others (including me who was flattered to be on the same program) gave their views on energy, civility, the large number of energy opportunities today and the benefits of persistence and determination. If any of you have not read the book, The Big Rich, you should. It was required reading for my associates. It shows that brilliance is well and good, but persistence and determination are what has made the oil industry what it is today.

Misguided. Pro-Palestinian activists chanted "gas the Jews" at a rally in Sydney, Australia, after Hamas terrorists killed hundreds of innocent civilians, including 14 Americans, and captured over 100 hostages and brought them into Gaza. More than 1,000 demonstrators protested at the Sydney Opera House against the building being lit up with the color of the Israeli flag. According to the Guardian, "Large crowds had gathered on Sunday night in south-west Sydney, where Hamas’s attacks on Israel were celebrated as acts of ‘courage’ and ‘resistance.’" If the same percentage of Americans lost their lives at the same level as Israel did in the opening day, it would be the equivalent of 42,000 people, 14x those lost in 9/11. 260 attendees at a Music Festival in Israel were killed. Over 40 babies were found killed, many decapitated. This is not what was considered a “war” where combatants battle. This was the intentional murder of civilians.

What Matter Most. Those who follow my work know that I have been focused on ROIC for years. Our initiation 10 years ago at Credit Suisse used a valuation metric derived from the ROIC. The problem is that for about 14 years, the industry’s ROIC was in decline, a point that was made on several conference calls. When your ROIC goes down, your equity value declines. The decline in equity value resulted in energy dropping from almost 20% of the S&P to a low of 1.7% two years ago. Now that ROIC appears to have reversed, and the E&P industry is now focused on ROIC discipline, we would expect the below correlation to continue, and the Energy weighting should increase.

How Much?? E&P valuations have come into the spotlight following the Exxon/Pioneer combination. Below is a chart that shows the valuations per flowing barrels of the three big oil basins. Interesting at least.

Factoid. Nearly 60% of global end-use products have no alternative to hydrocarbons. Natural gas, propane, ethane, and butane demand is expected to grow approximately 5% annually over the next decade. With ~1.2 billion people entering the middle class by 2030 and nearly 3 billion in energy poverty, demand for all energy sources will continue to grow.

Oil Opinions. Three agencies, the EIA, IEA and OPEC reported very different outlooks for global oil supply/demand this week. Two government bodies and one cartel who produces about 30% of global oil supply. Pick your poison.

IEA trims 2024 oil demand growth forecast to 880,000 BOPD
OPEC sticks to 2024 growth forecast of 2.25 million BOPD
IEA cites signs of demand destruction from higher prices

Quit Farming!!! “Agriculture contributes about 33% of all the emissions of the world. And we can’t get to net zero — we don’t get this job done — unless agriculture is front and center as part of the solution. You just can’t continue to warm the planet, while also expecting to feed it. It doesn’t work.” - John Kerry

Headlines.

U.S. crude oil output hits new highs of 13.2mm BOPD.
API: Analysis finds that proposed Gulf of Mexico restrictions diminish energy security.
AI may be a “game changer,” helping cut operational costs by between $200 billion and $300 billion.
Harvard Student Leaves Lecture on Microaggressions to Attend ‘Kill The Jews’ Rally (Babylon Bee Satire).

Weak Tail? IMF says 'weak tail' of banks could struggle in an economic downturn. “Around 5% of global banks are vulnerable to stress if central bank interest rates remain higher for longer, despite the easing of turmoil in the sector in recent months,” the International Monetary Fund (IMF) said on Tuesday.

Energy Credit. A few stats I thought were interesting. The high yield market has long been dominated by the energy sector. Sometimes debt players love us, sometimes we can’t borrow enough for a coke. But when oil goes above $90, they come out in droves. There has been approximately $26 billion in high yield debt issued this year versus $8 billion last year. Even B rated debt demand is huge. Vital’s debt raise was 3-4x over-subscribed. Banks are setting increasing levels of asset write-downs and those mark to market losses take capital away from lending and we have enough issues as it is. Regional banking’s concentration in real estate and $1.25 trillion refinance needs by the end of 2025 are causing regulators to clamp down. You reduce the loan book and be more demanding to existing customers. But if you only spend 70% of cash flow on drilling, there is really no need for debt other than financing M&A and some small cash management. We are less dependent on debt than ever before, and returns are still headed up. The E&P sector is where most lenders are focused, with lots of money, but from fewer players. Access to capital is better now than a year ago.

Still Going Broke. Bankruptcies are rising at the fastest rate since the pandemic, but still some corporations are taking on more debt. It’s possibly a sign that the Fed’s work may not be done, and restructuring experts and debt investors warn there’s more pain to come.

My First Mortgage. U.S. Treasury yields are hitting 16-year highs as investors bet that high interest rates will slow growth and dampen the appetite for riskier assets. Friday’s job numbers suggest that this trend could continue. That’s bad news for investors as well as anyone who considers home mortgage rates to be scandalous these days. I paid 12% for my first mortgage which was amazing because the prime lending rate, now approaching 5%, was over 20% at that time. 16 years is a long time but not forever.

We Are Gaining Ground. The mood among investors in energy is different than just two years ago. The tipping point was Russia/Ukraine. Energy security became paramount. There were no champions of oil before, but more are emerging. After years of losing and declining share prices, it’s different this time?!?! There is less capital available in the business but that brings opportunity with fewer buyers, more negotiating leverage and fewer auctions. It’s a compelling time if you have capital when no one else does. If you have the right team, platform and money, you win. Being shunned gets opportunity.

Surveys. I have the greatest respect for the Dallas Fed and have a good friend who works there. Their survey is as good as it gets. Period. The issue is with “as good as it gets”. I have hosted an Annual Xmas Soirée Luncheon for the last 13 years and as part of the entertainment, we write down our predictions for both oil and natural gas prices at the luncheon next year on separate $20 bills. These are CEOs and CFOs primarily of OFS, Drilling, E&P and Manufacturing companies. Their records (as well as mine) are abysmal to say the least. And remember, expectations of future oil prices, and therefore drilling activity, drove at least some influence of capital spending. We all sucked. It didn’t matter if it was oil or gas. Sometimes ridiculously optimistic and sometimes amazingly doom and gloom. Many times, the one who won was just the closest, not close. So, regarding the parts of the Fed survey that deal specifically with commodity prices, be careful. A survey of people who are consistently wrong has no better chance to be right next time. The survey shows WTI to average $88 per barrel by the end of 2023, with a range of $70 to $120 per barrel. In the same survey for the second quarter, the year-end WTI price expectation was $77 per barrel, with a range of $60 to $100 per barrel. This really proves a point. No one comes close but when the range is $70 to $120, that proves it. These aren’t random outliers. So, we ratcheted up the range, which is big enough to drive a truck through. It’s a survey. We are hoping and guessing, and we really have no clue at all.

No Big Deal. Just $9 Billion. TotalEnergies and APA Corp. are launching development studies related to their Suriname Offshore Block 58 where they plan to start detailed engineering studies by the end of 2023 and announce a $9 billion final investment decision (FID) by year-end 2024. They spent $1.4 billion just looking for it. Total said the project could be developed at a production cost of less than $20 barrel. Suriname loves the deal since the country could earn between $16 billion and $26 billion.

Notice how all the numbers are positive?!?! But the charge-off continues.

Snowflakes? “These are not issues that we can wait and resolve later. As a society, we must act now.” Dr. Dennis P. Stolleis, a senior director for the American Psychiatric Association, commented on a new report that revealed climate change can have "lifelong impacts" on young people's mental health. The study suggests extreme weather events and poor air quality can increase the risks of anxiety, depression, bipolar disorder, aggression, cognitive impairment and more.

Red Carpet. The Gulf Energy Information Excellence Awards: The winner of the 2023 "Mid/Small-cap Energy Firm of the Year" award goes to Nabors’ Canrig. Congratulations!

Medical-Device Stocks. They were hit hard by the rising popularity of a new class of weight loss drugs and are poised to extend a drop into year end. That’s according to JPMorgan analyst Robbie Marcus, who says the sector will see more declines as big-money investors steer clear. “If these levels of fear and doubt remain the primary emotional response, then MedTech could suffer,” he said.

Big Brother. Walmart can see you getting a weight loss drug, track what food you buy and calculate your calorie consumption, tracking the details and nuances many of us never considered. Invasion of privacy? There is no privacy anymore. Just algorithms that control our lives. Calories count whether you like Oreos or snickerdoodles.

Shout Out. I have always had a great deal of respect and admiration for Oceaneering. From finding the Titanic to life support systems in space to the design of amusement parks, OII has it all. And now they get a little more. Oceaneering's wholly owned subsidiary Marine Production Systems Do Brasil Ltda. has secured a five-year contract from Petrobras for the operation of three existing drill pipe riser systems to support intervention and completion operations in Brazil. Petrobras also has the option to add a fourth drill pipe riser system by notifying Oceaneering prior to mid-December 2023. The contract’s value could be worth up to $75 million in revenue during the five-year period.

Inverse Relationship. It’s pretty fascinating to see all of the renewable heavy U.S. independent power producer stocks down 30-40% YTD (NextEra, Clearway, AES, Brookfield, and others). Why now? Most of these companies sell their power through fixed-price PPAs. These PPAs are essentially like long-term bonds because they provide these companies with fixed returns. As with any bonds, prices go down when interest rates go up. Recently, real interest rates went up massively. Hence, stock prices of renewable companies tanked. It isn’t because of issues with their businesses.

More Gas! For years, Saudi Arabia has been working to develop its natural gas reserves, an effort that has taken years to get going. The idea was that if enough natural gas could be found to offset the use of oil, it would free up almost 250,000 BOPD of oil for foreign sales. While the effort continues, Saudi is dipping its toe in the LNG market, being lauded as proof that natural gas and LNG long-term demand has legs. Saudi Aramco agreed to buy a stake in MidOcean Energy, marking its first investment in LNG. MidOcean is in the process of acquiring interests in four Australian LNG projects and is also part of a consortium to buy Sydney-based Origin Energy Ltd. More activity is expected as Saudi hired a team of LNG traders in Singapore and was in talks with producers before the Covid pandemic upended negotiations. Aramco has plans to spend $110 billion developing the Jafurah gas field that will help double output by 2030 and make the kingdom a gas exporter for the first time. It’s also weighing exporting that gas as LNG. Saudi is not alone. Total announced plans for billions in investments through 2028 to expand its LNG portfolio, while Shell Plc and Chevron Corp. are also building up their gas businesses.

More LNG/Gas. In the first half of 2023, U.S. LNG exports averaged 11.6 Bcf/d, making the United States the world’s top LNG exporting country. U.S. LNG exports in 1H23 increased 4% compared with the same period in 2022, despite declining in May and June. In addition to LNG, we move gas to other countries through pipelines. Natural gas pipeline exports to Canada and Mexico increased 4% compared with 1H22, averaging 8.8 Bcf/d. Net natural gas exports by pipeline, particularly to Mexico, contributed to record-high natural gas exports. U.S. natural gas exports by pipeline to Mexico reached a monthly high of 6.8 Bcf/d in June and accounted for about 66% of total U.S. pipeline exports from January through June.

Pope Francis Weigh In. “Climate Change is the biggest chorus I have seen, and everyone has an opinion.” Including the head of the Catholic Church… https://www.vatican.va/content/francesco/en/apost_exhortations/documents/20231004-laudate-deum.html

Talk About Real Inflation. Disneyland prices for the lowest-tier single-day ticket is $104. On the most popular days, though, Disneyland is raising prices by more than 80% to $194.

Workers Rule. Across the U.S. oil and gas industry, 838 jobs were added in September, according to preliminary data from the Bureau of Labor Statistics and analysis by the Energy Workforce & Technology Council. The energy market has added jobs in seven out of the past 10 months. Data also indicates that the historical oil and gas market continues to recover post-pandemic, with U.S. jobs totaling 650,777. “The energy workforce is amongst the most resilient industries in the nation. No matter the challenge, we have continuously risen to the occasion, using innovation and technology to drive our industry forward. As the need for skilled labor increases, the energy workforce remains a lucrative sector for those wishing to make an impact on powering the world of today and tomorrow.” Molly Determan, President, Energy Workforce & Technology Council.

Easing Limits. Remember when China had a very strict “one child” rule? Not any more. The number of births in China tumbled 10% last year to hit their lowest level on record - a drop that comes despite government efforts to support parents as Beijing's alarm grows over its aging population.

Still Hurting. Britain's economy partially recovered in August after a drop in July, but the bigger picture remained one of sluggish growth after last year's surge in inflation and 14 back-to-back interest rate hikes by the Bank of England.

Guatemala. El Aguacate, with a population of about 500 and barely accessible by road, sits within Central America’s Dry Corridor, a region that has suffered a series of debilitating droughts and storms over the past decade. Such weather extremes are linked to climate change and hit subsistence farmers hard in the Dry Corridor, an already-difficult region for agriculture, according to the U.N.’s Intergovernmental Panel on Climate Change (IPCC). Insecurity and violence are commonly cited as root causes of emigration. Climate change, however, is a growing factor for people who decide to leave, the U.S. State Department said in response to questions from Reuters. The number of Guatemalans arriving at the U.S. border soared fivefold from 2020 to 2022; more than 200,000 arrived in 2022, close to record levels, according to U.S. data. Guatemala has a relatively warm and tropical climate, with daytime temperatures usually between 70°F and 90°F all year round. March and April are the hottest months, with the rainy season from May to October breaking the often-overbearing humidity with afternoon showers and occasional thunderstorms. So, a tropical rain forest has seen a two year drought. CLIMATE CHANGE!!!!

Opportunities in My Inbox.

Unveiling Secure Controllers for Efficient and Automated Operations
Offshore Wind Executive Summit
Navigating Natural Gas Markets: Winter’s Scary Surprise, a Summer of Discontent and the Long-Term LNG Puzzle

Don’t Drive. The October edition of the Oil Market Report from the International Energy Agency revealed preliminary data for September, indicating signs of falling demand, notably in the U.S., where gasoline consumption reached its lowest level in two decades.

A Good Deal. I recently saw a research report from an analyst I have a great deal of respect for. One piece I saw this week made me think. The company name isn’t important, but it isn’t in the oil and gas space and is a renewable service company. “Management remains focused on achieving its stated goal of adjusted EBITDA profitability in the fourth quarter of next year. The company has several levers to improve gross margins including a corporate reorganization that will reduce operating expenses by an estimated $30 million on an annualized basis. After this latest ATM raise, we do not expect the company will need to use it again. (The company) was being proactive with this capital raise as its current cash burn would have likely led to a small amount of cash on the balance sheet. Therefore, these transactions strengthen its balance sheet and the march towards positive adjusted EBITDA can continue. The lead investor in its $300M convertible notes issued in April 2022 agreed to extend the maturity of the notes to April 1, 2028, increase the cash coupon from 3.5% to 7% per year, increase the payment in kind coupon from 5% to 8.5%, and to adjust the conversion price from $24.03 to $12 per share.” Wow.

Under Businesses You Didn’t Think About. Scope3, a firm that aims to help marketers and publishers understand and reduce emissions associated with their digital ads, raised $20 million in new funding at a valuation of $100 million, developing a platform that ad-industry players can use to view sustainability information and emissions data for websites, mobile apps and tech providers in order to reduce emissions. There are obviously many business opportunities out there that really haven’t been pursued yet.

Inventories. We recently published a chart showing oil inventories versus the oil price. There was basically no correlation at all. Yes, Cushing inventories are low. That is one spot and while it may set the price, investors and traders well understand the difference between a short-term price arbitrage and a shortage of crude. So this week, crude oil inventories jumped by 10 million barrels over the seven days ending on October 6. The increase was the largest in 34 weeks since early February 2023. It was concentrated at locations on the Gulf of Mexico (+9 million barrels), the region most open to international seaborne crude flows. There were no significant changes at Cushing (-0.3 million barrels) or in the rest of the Midwest (+0.9 million barrels). Cushing inventories have been low but stable for the last three weeks.

EIA Weekly Oil Report.

Crude Implications: Bearish – build above expectations. WTI backwardation between 1M-12M @ $8/bbl, $1/bbl lower w/w. SPR unchanged. Money managers’ net long positions in ICE Brent and NYMEX WTI lower by 6% w/w.
U.S. Crude Production: Indicated at 13.2mm BOPD, up 0.3mm BOPD w/w, and up 1.3mm BOPD y/y.
Refinery Runs: 15.2mm BOPD, down 0.4mm BOPD w/w and down 0.5mm BOPD y/y. Utilization at 85.7% due to turnaround.
Crude Imports (net): 3.3mm BOPD, up 2.0mm BOPD w/w and up 0.1mm BOPD y/y. Brent-WTI spread at $2/bbl, flat w/w.
Gasoline: Neutral – draw above expectations. Demand up 7.1% w/w and up 3.7% y/y.
Distillate: Bearish – draw above expectations. Demand down 3.8% w/w and down 16% y/y.

Yoyo. We have written about the collapse of the Chinese property market. Several companies have gone bankrupt, and several are on the verge. One looked to be in default two weeks ago, then caught up with payments last week and there’s now warning of its ability to make payments on its offshore debt going forward. Yo-yo. The issue, of course, is the direction of this is clearly not positive and teetering on the edge of bankruptcy after a few decades of doing well. That drop is usually not small and short. The devaluation of global assets as inflation cools and the money supply shrinks is being seen, and in what has been the fastest growing economy for the last several decades. All good things come to an end. China will continue to be a major economic force in the world and will be a market pursued by many. The concerns about Taiwan exist and clearly China has taken the lead in securing access to rare earth minerals across Africa. That is hard to compare. But slowing growth is never good for an economy and doesn’t look to be good for China going forward. The IMF cut its growth forecasts for China this week and said, “overall global growth remained low and uneven despite what it called the ‘remarkable strength’ of the U.S. economy”.

The Great ReThink. Many companies and governments are reevaluating climate policies as they face voters exhausted by inflation, with the UK delaying a ban on petrol car sales last month. Majors BP and Shell have shifted their focus back to their traditional oil and gas businesses after experimenting with a faster switch to renewable energy. There are many instances of this happening, and it is hard to keep track.

I’ll Take the Over. The IEA predicts that demand for fossil fuels will plateau by the end of this decade, as countries switch to renewable energy sources and electric vehicles. Investment in new oil projects must cease now if governments want to meet net zero emissions targets and limit temperature increases to 1.5C.

Two Sides of the Coin.

OPEC Secretary General Haitham Al Ghais cited pushback against net zero policies and said climate action should not come at the cost of global energy security. “Recent developments have led the OPEC team to reassess just what each energy can deliver, with a focus on pragmatic and realistic options and solutions.” “Calls to stop investments in new oil projects are misguided and could lead to energy and economic chaos," he added, putting the required oil sector investment at $14 trillion through 2045, up from $12.1 trillion estimated last year. OPEC expects world oil demand to reach 116 million barrels per day by 2045, around 6 million BOPD higher than expected in last year's report, with growth led by China, India, other Asian nations, Africa and the Middle East.
IEA Executive Director Fatih Birol said last week that global coal, oil and natural gas consumption may peak before 2030. The IEA advises industrialized countries and in 2021 said investors should halt new oil investments if the world wants to reach net zero emissions by mid-century.

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.