Things I Learned This Week in Baffin Bay

October 27, 2023

What did I learn while fishing with five friends down on Baffin Bay? If the wind is blowing from the wrong direction, you don’t catch any fish. Thank goodness for red wine and Scotch, allowing us to solve all the world’s problems. Cigars helped as well. My biggest problem? Not enough quail hunts lined up! If you need a speaker…

A Tsunami, Not a Wave. Exxon buys Pioneer. Now, Chevron is buying Hess. It was rumored this week that Devon was looking at Marathon. Who is next? Conoco, Diamondback, Marathon and Continental are all looking at CrownRock, a company with 86,000 acres in the Midland Basin, said to be worth $10-$15 billion. This comes after the $59.5 billion Exxon paid for Pioneer and the $53 billion that Chevron is paying for Hess. The next shoe to drop? CrownRock’s banking team is collecting initial offers starting next week.

Oil at $85. Remember when oil was $94 per barrel and headed to $100 per barrel? That was four weeks ago, and now oil is at $85. And there are lots of good reasons. There always are. We have long said that, at $5 per barrel we have no oil left, and at $250 a barrel you have all the oil you could ever want. Somewhere in there is equilibrium. Our forecasted oil prices are pegged at $84, but that is based on all sorts of math and I am either too smart or too dumb to predict oil prices. But, for a current dollar long-term normalized price, our math shows $84. And it will be volatile, which means sometimes it will be $10 below that or $10 ahead of that. It makes for difficult planning and very nice profitability. It forces a conservative mindset and limits our historical overreaction. We don’t want oil at $120, unless you are just looking to sell everything you own in energy into that price.

Another Oil View. “The fallacy of oil price forecasting exposed yet again.” Evercore’s oil analyst issued a report that looks at the current risk premium on oil prices and puts the current premium at $5-$10 per barrel. Weakness from the seasonal roll in refining margins is offset by issues in the Middle East, which have the risk of spreading and are contributing the most to that premium. “While U.S. demand data has shifted sideways to down, key underpinnings of the market remain in place. Upward demand revisions (China) and evidence of slowing U.S. supply growth.” The report suggests the price can maintain the upper bound of the $70-$90/bbl range. Smart guys.

Hit and Miss. Exxon and Chevron both missed earnings numbers this week, even as they announced mega-deals. OFS companies reported inline or slightly ahead of expectations, but were cautious on the outlook, focusing comments on the positives of the Middle East and offshore. Saudi put 53 jackups to work in the past year. Deepwater is in year 2 of recovery after 6-7 years in the wilderness and has momentum. The U.S. will get very little growth capital with a focus on maximizing profitability in a slow or no growth environment.

Described Well. While perusing an industry journal, I came across the following pitch. It was for a white paper, not a solicitation for investment. It describes where the industry is and where it is going, from a technical and financial perspective. Being a geoscientist through the development of software programs and platforms such as Landmark Graphics and Petrel, I have always appreciated the combination of technology and finance. Accountants don’t start high-tech companies and often the engineer who developed the technology is not ideal for continued management. As the two narrow in discretion and granularity, the industry improves.

Near-Field Exploration and Development: A Holistic Look at Leveraging Digital Technologies to Increase Productivity and Profitability.
Near-field or infrastructure-led exploration is growing in popularity, with lower discovery costs and a higher likelihood of a faster time to market. This requires optimization across the upstream value chain and further automation to reduce dependencies on scarce skilled resources. Digitalization is a strategic and necessary focus that can provide a competitive advantage for upstream companies. This paper presents an end-to-end digital solution approach that can reduce project costs and timetables, accelerate time to revenue, optimize production, leverage existing assets and infrastructure and reduce the carbon intensity of products.

Snippets.

The EU is said to be falling behind on its provision of one million artillery shells by March.
Shell is cutting at least 15% of the workforce at its low-carbon solutions division and scaling back its hydrogen business as part of the CEO’s drive to boost profits.
Saudi Prince says Exxon, Chevron megadeals show oil is here to stay.
The CFA Level III exam pass rate slipped to 47%, below the decade average but above historic lows set two years ago.
Exxon Mobil raises its dividend by 4.4%

Def-Con What? Russian President Vladimir Putin said there’s a risk that an escalating conflict could “spill far beyond the borders of the Middle East.” This comes after Russian nuclear drills by air, land and sea were held. They are intended to address a “massive nuclear strike by strategic forces in response to an enemy’s nuclear attack”, the Russian Defense Minister said to Putin. Russia said they were regular strategic drills and, of course, NATO had just finished its annual nuclear exercises.

Already There? Two U.S. fighter jets struck weapons and ammunition facilities in Syria in retaliation for the attacks on U.S. forces by Iranian-backed militia. President Joe Biden ordered strikes on facilities used by Iran's Revolutionary Guard Corps and groups that it supports.

EIA Weekly Report.

Crude Implications: Bearish – build above expectations. WTI backwardation between 1M-12M @ $7/bbl, $2/bbl narrower w/w. Money managers increased ICE Brent and NYMEX WTI net long positions by ~6% 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 1.2mm BOPD y/y.
Refinery Runs: 15.2mm BOPD, down 0.2mm BOPD w/w and down 0.2mm BOPD y/y. Utilization at 85.6% as turnarounds have commenced.
Crude Imports (net): 1.2mm BOPD, up 0.5mm BOPD w/w and up 0.1mm BOPD y/y. Brent-WTI spread at $4/bbl, $1/bbl wider w/w.
Gasoline: Bearish – build vs. expected draw. Demand down 0.9% w/w and down 0.7% y/y.
Distillate: Neutral – draw above expectations. Demand down 7.9% w/w and up 4.9% y/y.

Did We Mention the Philippines? Biden has been unequivocal in his stance, saying the U.S. has an “ironclad” defense commitment to the Philippines. “Any attack on the Filipino aircraft, vessels or armed forces will invoke our Mutual Defense Treaty.” China and the Philippines have fought, figuratively, for years over a disputed area in the Second Thomas Shoal in the South China Sea. It seems to be coming to a head with Chinese ships firing on Philippine ships, reinforcing their outpost. Both countries have since accused one another of infringing on their respective territorial sovereignty. Neither side is backing down. And we have a defense pact that says we must come to their aid. Conflagration?

Non-U.S. EV Challenges. “Europe’s carmakers find themselves teetering on the brink in the face of competitive predatory pricing practices and a market that is now being overwhelmed by a flood of Chinese-made EVs.” We have written extensively on the many reasons that we will not all be driving electric vehicles quite as soon as the politicians imagine. Even they can’t change the laws of physics, though they have done a good job of changing many other things that don’t make sense. The CFO of Mercedes Benz was bemoaning the “brutal EV pricing” and the “pretty brutal space.” The company reported a decline in both revenues and profit, citing challenges from electric vehicle competition to supply chains. The company said it faced a “subdued market environment marked by intense price competition.” So, now we are seeing companies cut prices on EVs to prevent them piling up in yards. China has made a big push selling their cars in Europe, well below those of European manufacturers, which isn’t a surprise since the pictures of the thousands and thousands of newly manufactured EVs parked in lots forced Chinese manufactures to sell vehicles somewhere, and below cost usually works. Parting shot by the CFO? “I can hardly imagine the current status quo is fully sustainable for everybody.”

Early & Successful Transition. Seaway 7 has always been known as a heavy lift vessel company, moving rigs and platforms around the world and installing very complex offshore production facilities. It just won a $300 million contract from Equinor, focused on the business Seaway started in 2009, well ahead of any “transition” discussions. It took over 30 years of offshore expertise and started a “renewables” business that has installed over 800 wind turbine generator foundations, 30 substations and 2500 km of inner array cables. The $300 million contract is for engineering, procurement, construction and installation of 100 66kV inter-array cables, measuring approximately 200 km in length.

Another Beat and Raise. That is how one analyst describes Weatherford’s results for the quarter. I go back a very long way with Weatherford. It has been an interesting ride, and I have always had confidence in the ability of their business to generate meaningful returns. Current management is doing an excellent job and, instead of explaining what is different about this version of Weatherford, a suggestion I made, they have focused on simply producing a string of amazing results. It is one of the best performing OFS stocks over the past year. The analyst at Evercore describes the quarter well and, since I now longer write individual stock research, I look for analysts who I think do a good job.

“Weatherford continues to benefit from a favorable geographical mix, strategically positioned in the rapidly growing regions of the Middle East, Latin America, and Asia. The company's production-oriented business in North America also acts as a buffer against slower activity growth in the region. Recent commercial wins and partnerships in both the oilfield services and clean energy sectors have bolstered our confidence in Weatherford's long-term prospects and its potential to deliver strong earnings and drive margin expansion. With a solid capital allocation strategy, an emphasis on profitability and free cash flow generation, improved balance sheet strength, and a capital-light approach, Weatherford is well-positioned to capitalize on the ongoing long-duration upcycle.”

Going Away. We have written about the problems of the Chinese property development companies, most of whom have gone bankrupt. Developer Country Garden Holdings is the biggest in the Chinese industry and four times the size of Evergrande, the last large developer to fail. This was the last large solvent developer. We have all seen the pictures of empty major cities in China and now that has all come to a head. What does it mean to us? U.S. banks such as Citi hold the U.S. dollar denominated debt, which means they could end up owning the properties and, since that isn’t their business, they will sell them, exacerbating a major property revaluation in China and other parts of the world. Country Garden would be one of the biggest restructurings in China’s history.

Going Fast. A Dom Pérignon reception, a $5,000-per-person dinner, and a Sports Illustrated pop-up club are just a few of the events on offer during the Formula One Las Vegas Grand Prix next month.

Consumer Bailout? I don’t think so. College loans now have to be paid, the average car costs $47,000, credit card debt is more than student loans and now, the headline reads “Car Owners Fall Behind on Payments at Highest Rate on Record.” Historically, this is the highest interest rate environment in the last 30 years, with car loans moving up just like all interest rates. The percentage of subprime auto borrowers at least 60 days past due on their loans rose to 6.11% in September, the highest in data going back to 1994, according to Fitch Ratings. A recession has been predicted now for over a year. My biggest fear was this would turn into a debt recession rather than an equity recession and, unfortunately, we are looking increasingly right.

Headlines.

Consolidation in the oil market is key to success.
Big Tech earnings keep disappointing, wiping $200 billion off stocks.
Europe’s natural gas storage facilities are 98.69% full, a record.
BofA warns of more downside for U.S. stocks.
Ford Lost $62,016 For Every EV It Sold In 3Q.

Take the World by Storm. Swift Inc. is essentially a multinational conglomerate with significant economic power. Taylor Swift’s 53 U.S. concerts this year are estimated to have added $4.3 billion to GDP. She is also now a billionaire.

Currency of War. The role of cryptocurrency in financing terrorists in the wake of the Oct. 7 attack by Hamas on Israel has gained the sector a great deal of attention, that is not all positive. In a speech in London, U.S. Deputy Treasury Secretary Adeyemo warned crypto firms against allowing their platforms to be used to finance or support terrorist organizations, as geopolitical tensions heat up across the globe. Considering that cryptocurrency has long been the preferred and non-traceable source of exchange for drugs and arms deals, the fact that Hamas was “aided” by the ability to use this method should come as no surprise. And since it isn’t regulated (and shouldn’t be, in my opinion, as it provides legitimacy), comments such as Secretary Adeyemo’s have little impact. Cryptocurrencies have also gone on a rip in recent weeks, with Bitcoin up 30% to as high as $35,000.

Quiet Appeasement. Try and shut down the U.S. oil business in the face of record production and demand would seem odd to some, but the Biden administration is here to solve the problem. In exchange for promising to hold fair elections, the U.S. has suspended sanctions that allows Venezuela’s oil industry to sell their products into the U.S. and get much higher prices. And surely, we all trust the government and its leaders to abide by their promise. Or else? 221,000 Venezuelans crossed the border into the U.S. last year. Fleeing Nirvana?

Risky Work. Both SLB and Halliburton do a great deal of business in Mexico and, of course, the primary client in Mexico is Pemex. Talk about working for nothing. SLB says it is owed ~$1.2 billion in unpaid bills for work in Mexico, 20% more than three months earlier. Halliburton said their primary customer in Mexico accounted for ~10% of all its unpaid bills at the end of Q3, up from 9% at the end of Q2. The amounts owed don’t seem to be in dispute, just not paid. $2 billion. Wow. That is a lot of free work. Both companies issued filings stating the above, and Pemex was not named in either. Pemex is one of the world's most indebted oil companies, totaling more than $106 billion as of September.

Bad Day at Blackrock. Wednesday this week.

Expro Group Holdings N.V. (XPRO) -17%.
Oceaneering International (OII) -9%.
ChampionX (CHX) -7%.
Nabors Industries (NBR) -7%.
RPC (RES) -7%.

Equality. Microsoft, Palantir Technologies and Abercrombie & Fitch are among a small, but increasing, number of U.S. businesses offering menopause benefits, with women most likely to be affected now representing 20% of the female workforce. Employers are stepping in as menopause-related loss of productivity and medical expenses are costing the U.S. economy $26.6 billion a year.

No Caption Needed.

Walking It Back. Victoria’s Secret figured it out. Even larger women don’t seem to appreciate advertising by their peers. The company has quietly canceled its planned Lizzo lingerie line, which was intended to cater to larger women, and will return to a more attractive marketing presentation of its product. The Angels are back! "We probably should've given this more thought before we started," said Lillian Ellison, a marketing executive for the company. "Surprisingly, our customer base, and society as a whole, prefers to look at people and objects that are attractive to look at. You learn something new every day in the marketing business, I tell you!" Victoria's Secret has now chosen to move away from plus-sized and transgender models. "I wish someone would have told us that tailoring our marketing to feature a minuscule percentage of the population wasn't a good idea," Ellison said. Executives were struggling to figure out what to do with all of the fabric purchased to produce the line, with the leading suggestion to sell it to a company that makes those gigantic flags that are unfurled to cover entire football fields.

Mixed Reviews. Oxy is leading the global charge to expand the use of technologies that suck carbon dioxide out of the atmosphere and bury it underground. Its billion-dollar Stratos complex in Texas is attracting attention from businesses and governments. Yet, a Bloomberg Green investigation found that an earlier mega-plant, named Century and built in 2010, never operated at more than a third of its capacity and was quietly ditched last year. I have not been a big fan of Oxy’s direct capture business considering that the full cycle economics debate is a challenging one.

Worse Than We Thought. “New York Times decided this week to run a guest essay with the unintentionally hilarious headline, ‘Exxon Mobil’s Pioneer Acquisition is a Direct Threat to Democracy.’ The Times is, after all, the media bible of America’s political left, so what else should we expect? The Times doesn’t like ExxonMobil – has never liked ExxonMobil – and so was no doubt thrilled to run a piece containing such a specious claim.” – David Blackmon is one of my favorites.

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.