September 15, 2023
Things I Learned This Week in Pennsylvania
September 15, 2023
Small Mouth Bass Are Fun to Catch. I have never been on a fishing trip that focused solely on small mouth bass. My friend was taking me to his club (a very good and generous friend. Thanks JW). It was my best trout experience in a decade. The first day, I only caught 35. The next day, we focused on big fish only so the count dropped to 15. The last day was back to rainbow trout and the last three fish caught were on dry flies. Those of you who fly fish understand how cool that is. And speaking of cool, it was 66 degrees for the first couple of days, turning into a scorching 75 on the last day. Coming home was tough.
Be Careful What You Wish For. Well, August CPI showed a jump that moves the annualized inflation rate back above 8%, which includes fuel and food, two fairly basic needs, at least in my family. That was in August. Check today’s date and realize that oil prices are up 17% in the last three weeks. So, the September annualized inflation rate will most likely go even higher, unless some component of the market is seeing a price slide, which (except for EVs in China) seems unlikely. So? Some of this increases the likelihood of further action by the Federal Reserve to “re-tame” inflation. And when the Fed raises rates, the goal is to slow the economy, and a slowing economy is not good for oil prices. Oil had moved due to a variety of factors including millions of barrels being taken out of the market by OPEC+, which can come back in the market immediately if a certain Saudi were to wake up one morning and change his mind. Another was that with the Fed “done” tightening, conventional wisdom until the August inflation numbers came out was that the effort to slow the economy would abate and growth would drive oil higher. Now one key basic premise, demand, remains in question. And this is without mentioning that China, the growth engine of the WORLD for the last few decades, is slowing down. And their SPR is now full.
The Market. Several countries in the EU are headed for recession if they are not already in one, and few appreciate what the region would have looked like economically if they had drawn the stray for the cold winter. And I appreciate the fact that the U.S. is the best economy in the world today, and even with current politics, this is the most riskless country in which we operate. But demand growth has been focused on the increased consumption in underdeveloped countries (Mexico, China and India were the most mentioned) as they catch up with our standard of living. Remember the slide - “if the consumption per person in China were only X% of the U.S., we would need X million more barrels of oil produced per day”. Unfortunately, the amount of oil needed to produce $1,000 of GDP has dropped about 60% since I first saw that slide.
Price? The point of all this is that few trust the oil price. I am celebrating that oil is at $90 again, for the first time since, well, last year. Since then, it hit $67 twice, once in March and then again in June. I hoped that $90 last November would stick. And remember, we had every expectation it would. All the fundamentals pointed to it. Then those hopes dashed, with oil going into the $60’s, but 2023 has to be better. OPEC+ had to cut production to pull it back up. But as recently as July, oil prices were in the $60’s. Not everyone’s prediction.
Close? Maybe we have just been early. Boone Pickens told me once that “being 15 years early is almost the same as being wrong”. We were early by a year and having analyzed these trends for a few decades and having annual commodity price bets on the future, I can honestly say we suck on timing. “Oil will hit $75!” Okay, when? 2 months from now? 6 months? 12 months? We understand our capabilities of supply but the vast number of variables that dictate demand makes predicting oil prices too complex for even the largest super computers.
Steady Boy! The point of all this is to tread carefully. Oil fell from $90 to $67, and we weren’t really sure why. Oil from $67 to $90, and while we have conjecture, we really aren’t sure why. That won’t change. Everyone believed oil prices would be higher in the second half of this year. They’ve been right so far. But for how long with these other issues looming?? We have little idea. The discipline of the E&P business today stops us from acting like it will be $90 or higher for the rest of our lives, ideas that caused us to boom dramatically, then bust spectacularly. And remember, there is a big difference these days between gassy and oily E&Ps. Years ago, the commodities traded on 6 to 1 BTU parity which means if oil sold for $6/bbl, natural gas sold for $1/mcf. At $12, gas would be $2. At today’s $90, natural gas should be $15/mcf. It’s $2. That relationship broke down years ago but 6-1 going to 45-1 is dramatic. They are completely uncoupled. And as such, gassy E&Ps are not having nearly as much fun with some borrowing money again but this time it is to pay the dividend, not drill more holes. Also, everyone that produces oil also produces gas.
Stay the Course. Since we didn’t go nuts last year at $90, the odds we stay as disciplined this time around are high. Remember, the stability of oil prices is as important as the price level, if not more so. My oil prediction? It will remain volatile but over time, while the frequency of price changes may accelerate, the amplitude should be reduced over time. That provides a more stable price backdrop. The best of all worlds: sustained high oil prices but not high enough to impact demand. It could very well be in our future. But we have to maintain discipline along the way.
Yikes. “I will say this again… It is no longer safe to raise your children in California. Children are not old enough to drive, drink, vote, smoke or get a tattoo, but the Democrats in California think children (who are naive and easily manipulated) are old enough to make decisions that permanently remove sexual organs, take castration drugs and risk becoming infertile FOR LIFE! This is pure evil, and the American people will not let this stand.” This is from comedian Rob Schneider responding to California governor Gavin Newsom who said, "no state in America supports local control and parental engagement like the state of California," and yet he may soon sign legislation that would allow the government to take children away from parents who oppose their gender transition.
Wait Your Turn. The Secretary of Energy tried to take a four-day road trip in an electric vehicle in an attempt to get more Americans to use EVs. The problem was identified last month when the CEO of Ford drove an EV F-150 across the country. “We have more work to do.” There aren’t enough fast chargers for EVs. So, when the Secretary’s support staff parked their regular vehicles in front of the fast-changing stations at one point, other customers were left waiting. One couple who had been in line and had a child in the car even called the police. But there is currently no law stopping an ICE from parking in front of a charging station. The entire trip by the Secretary generated more negative comments than positive ones, and demonstrated that the recharging infrastructure is woefully behind the ability to efficiently charge an EV fleet, and that government employees can act with complete impunity when it best serves their interests, even if the interests are completely self-servicing.
Better Here. We complain about our gasoline prices, our water bills and how much we are getting screwed and manipulated by others. If you think this is bad, check out Northern European natural gas prices. And they should get worse since it turns out that the wind is not blowing up there right now. This is what is keeping Germany in recession and pushing the UK ever closer. Remember that most of the current LNG production is sold under long-term contracts and used for the project financing of the multi-billion-dollar construction costs with very little “spot” LNG really available. So, there is no immediate solution to supplying Europe with the LNG both Biden and Trudeau promised. That means little relief. This past winter, Europe dodged a HUGE bullet by having the warmest winter in ages. This winter should prove interesting and serve to keep European financial health in a very precarious position.
Consolidation Continues – Pieces Add Up. Vital Energy has gone on a buying spree, spending almost $12 billion acquiring Henry Energy and Resources, Tall City and Maple Energy. It will dramatically increase Vital’s size, setting it up to be one of the next multi-billion-dollar acquisitions in the future. The acquisitions are slightly higher than the market cap of Vital, demonstrating the ambition of the company. Earlier this year, the company bought the Delaware assets of Forge Energy II for $378 million. The latest three acquisitions add nearly 53,000 net acres in the Permian and proved reserves of approximately 248 MMboe (44% oil). The acquisitions were made from private equity players Riverstone, Warburg Pincus, Post Oak and others. The acquisitions add 115 net drilling locations with an average WTI breakeven price of approximately $50/bbl and will bring 2024 production to approximately 112,000 boe/d, with crude oil averaging 55,000 bbl/d, and will give Vital about 250,000 net acres in the Permian.
Tidal Power. No, not Turtle Power. No ninjas here. Harnessing tidal movements for the production of energy has been worked on for years. The first one I got peripherally involved in was about 16 years ago and is still not up and running. In fact, after all this time, there are no commercial tidal energy products in the U.S., though tests and demonstration projects continue. The Cook Inlet in Alaska and a few places in Maine are about the only candidates since a tidal range of at least 10 feet is required for economic operations. The impact on plants and marine animals has not yet been determined but wind farm installations are causing the death of whales off the East Coast of the country and are still being supported by the government. South Korea has the largest tidal power system and the second largest facility is offshore La Rance, France. Tidal turbines are placed on the ocean floor and have turbines that spin and generate power.
The demonstration projects in the U.S. are currently focused on:
Roosevelt Island Tidal Energy Project Pilot in the East River, NYC
Western Passage Tidal Energy Project in Maine
Cobscook Bay Tidal Energy Project in Maine
Blow Hard. "The components needed for our projects to progress simply do not exist in the U.S. at this time, and we see no signs that the supply chain will be ready in time to meet our procurement schedule," said David Marks, a spokesperson for Norway-based Equinor. Common problem, right? Except he was talking about the offshore wind business. It turns out that offshore wind went uneconomic again (without subsidies, it always was) due to this thing called inflation. This isn’t the only project, and we aren’t the only country. We have written about this before and the topic continues to come up more often. So, companies like Equinor, formerly Statoil, the Norwegian national oil company, are making new demands of the Biden administration, asking for more help and money. The current and earlier expected subsidies just aren’t enough. (Have we mentioned the 61 whales identified as being killed due to offshore East coast U.S. wind projects?). Another offshore wind company, Orsted, is threatening to “walk away” from its offshore wind plans, after booking an $8 billion loss on its U.S. offshore plans. There are too many stories for one issue but expect this to continue to be a factor in the coming elections.
Relative Value. Crude oil was a bigger contributor to inflation in the 1970s, when it was used much more intensively per unit of economic output. Back then, the U.S. economy consumed more than a barrel of crude per $1,000 of gross domestic product. By 2015, that had dropped to about 0.4 barrels per $1,000 of GDP.
The SPR. While much is made of it, notice the lack of any real drawdown over the last few decades.
Peak Oil. King Hubbert was amazingly accurate in predicting peak conventional oil production in the U.S. and Canada decades in advance. Now the IEA is taking their shot. We have more confidence in King. The IEA is updating its prediction of when demand for fossil fuels will peak in its World Energy Outlook due next month but the head of the IEA said, “peak fossil fuel demand will happen in this decade”, and by that, he did not just mean oil and gas but all fossil fuels. He said they would then be in permanent decline. He may be right. China, India, Pakistan, Germany and others may have finished building out their additional coal-fired capacity by then, and while gasoline might be in the decline, natural gas, for either electricity or hydrogen, should continue to be strong. Heck, Germany could still be burning wood in the name of sustainability. But at what level of consumption?
Weekly EIA Petroleum Stats: Evercore.
Crude Implications: Bearish – build vs expected draw. WTI backwardation between 1M-12M @ $9/bbl, wider by $0.5/bbl w/w. SPR higher by 0.3mm BBLs. Money managers’ net long positions in ICE Brent and NYMEX WTI are sharply higher by 22% w/w, and only 3% below year-to-date high. Open interest is higher and close to highs as the market gains visibility and confidence in continued inventory draws until the end of 2023.
U.S. Crude Production: indicated at 12.9mm BOPD, up 0.1mm BOPD w/w, and up 0.8mm BOPD y/y.
Refinery Runs: 16.8m BOPD, up 0.2mm BOPD w/w and up 0.8mm BOPD y/y. Utilization at 93.7%. The peak of seasonal demand is behind us but hurricane disruption and turnaround season are ahead, reducing runs.
Crude Imports (net): 4.5mm BOPD, up 2.7mm BOPD w/w and up 2.2mm BOPD y/y. Brent-WTI spread at $3.3/bbl, flat w/w.
Too Funny. Comedian Terance Williams did a great job of explaining his failure of identification.
Misbehavior. Bernard Looney stepped down as CEO of BP just four years after taking the helm. In our opinion, he has done an excellent job as CEO, dealing with the net zero issues of an oil company but continuing to be an oil company. But it wasn’t policies that spelled his downfall. It was a “small number” of historical relationships with colleagues prior to assuming the CEO role. A year ago, when similar allegations surfaced, and while no breach of the company’s code of conduct occurred, Looney acknowledged his past relationships. This time it appears that there were more that weren’t originally disclosed. I guess he didn’t quite remember all of them so after an undisclosed one cropped up, the board had little choice. Takeaways: first, behave and second, come clean when caught.
The Headline Read. The ‘White Gold Rush:’ Extracting Lithium from Alberta’s Wastewater. Lithium, the modern gold rush. Leaching lithium out of brine, whether in wastewater pits or brand-new wheel, the search for riches in lithium is in full force. Friends are starting companies with “brand new” technologies. Improved methods for improved recovery abound. The price of lithium soared in mid-2021 to late 2022 by 5x. It has dropped by more than half since then but is still double the long-term price. Electric vehicles and all forms of batteries use lithium as a critical component. Oil companies are aggressively getting into the game since they are knee deep in produced water that contains lithium, even if only in very small amounts. So, the next time a friend says “lithium, it’s the future”, the response should be “no duh”. Be very careful.
Too Funny. If You are in Texas. Democrat mayors are complaining about the large influx of migrants. New York, Chicago, Baltimore and others are saying they don’t have room for all these people, and they are having to invent means of housing them. Shock!!! Communities are faced with radical changes, as migrants take up space, crowd hotels, and encamp parks. A new report reveals Biden’s policy is driving voters to this Trump-era program. From The Post Millennial: According to the poll, which surveyed 800 people between September 5 and 8, 41% of residents across New York state said they support the construction of a wall down the entire length of the border with Mexico. A similar percentage of the population agreed that migrants “take more in resources than they return in economic activity.”
Indicator? Okay, no Russian gas for Europe. But spared by a warm winter and increased supply, the record high natural gas prices have retreated dramatically. Remember one year ago, August 2022, when U.S. natural gas averaged over $9/mcf. Europe has seen a more than 80% drop since then and consumption is down by 10% - 15%, primarily attributed to reduced use by energy-intensive manufacturing, as expected, but with no recovery expected through this year. Even with lower prices, some of this “demand” loss may be permanent. In fact, in several countries, the momentum is still to the downside with Germany, Italy and the Netherlands seeing the decline in use exacerbating through the year. Germany was the “worst” offender, with demand down 17% since the start of the Ukraine war. That shouldn’t have happened but the price shock of last year has impacted the capital planning of companies that require long-term price and supply contracts, and the near-term ability to guarantee supply was saved only by weather. What do they do? Rationalize regional manufacturing which often leads to a loss of some capacity to the benefit of other locations. These energy intensive industries include steelmaking, smelting, cement, ceramics, glassmaking, fertilizers, petrochemicals and horticulture.
Barrel Hub. We have mentioned before a company called Barrel Hub that helps oil and gas companies understand pricing in their commodities which gives dramatically more transparency to pricing and allows producers to maximize their sales. Hub is continuing its recent expansion with two new hires. Sarah Ledford has joined the team as CFO, and John Fox has come aboard to head up sales. A very interesting project and product, in which I have no financial interests at all. I just like to see things in our industry improving the efficiency of what we do.
Our Contribution. Bringing the world out of poverty.
Cornering the Market. Business combinations continue, in different ways. Diamondback, an E&P company, and Five Point Energy, a midstream private equity firm, said they formed a new joint venture, Deep Blue Midland Basin, to create the largest independent water infrastructure platform in the Midland Basin. It was an interesting monetization for FANG. We have said for the last year that the next wave of IPOs in our business will be water-related businesses, they will just be listed as “Industrials” not “energy”. Who cares? They are still our businesses. Aris, a public company, was one of very few OFS IPOs in the last several years, another being ProFrac. But everyone is chasing scale first. Okay, maybe tied to commitment. We are seeing water treatment contracts of longer duration than imagined with this one at 15 years. For an industry where nearly everything is well to well or day to day, that is amazing. And then commitments. Build with project financing, have an almost guaranteed revenue base, all with the confidence of knowing that water production in the Permian Basin and others for the next several years regardless of oil price or rig counts.
Details. FANG will get $500 million with a possible earn-out and own 30% of the JV. The 15-year contract covers a 12-county area for produced water, expected to be 75k BPD next year. Assets in the JV include exclusivity on virtually all of FANG’s acreage, 800 miles of pipe, SWDs with a total of 2mm BPD of disposal capacity, 65mm barrels of water storage and will recycle about 500k BPD for reuse. As to scale, Five Point has other partnerships with Matador, Concho (Conoco now), and Devon. Keep an eye on this sector. It is going to be significantly more than saltwater disposal wells.
Snippets.
A Bigger Bloc: The BRICS group will admit Saudi Arabia, Iran, Ethiopia, Egypt, Argentina and the United Arab Emirates to accelerate its push to reshuffle a world order it sees as outdated.
More Mortar Required: Pledges by BRICS leaders to defend non-Western countries' interests are part of a gradual shift in emphasis by the group from economics to geopolitics, but expansion likely will bring more disagreements.
Kyle Bass predicts banks may lose $250 billion on office holdings.
California fast food workers set to win $20 minimum wage with automatic increases every year! They will also have representatives on a new Fast Food Council that sets industry-wide wages and conditions.
Events:
IADC HSE & Sustainability Conference – Amsterdam
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.
