September 27, 2024
Things I Learned This Week at Breakfast
Breakfast Club. Some friends in Dallas had breakfast this week with several people in the business. The top energy lawyer in town, the head of a petroleum engineering company, a couple of family offices, a few well known private equity firms and me. There were some interesting observations. First, conventional drilling and production is popular. Initial costs are lower and so are overall well costs. It turns out that throwing a good amount of unconventional technology into those older wells can work very well. Second, there is a lot of money chasing deals. The public E&P companies have paid off much of their debt and have money to play with. Most of the completed energy deals have been for stock, but cash is king when it comes to E&P divestitures. Diversified public debt companies and funds are providing a great deal of the capital since banks have moved away. One recent deal had 85 NDAs signed and 30 bids. Another very interesting thing was the focus on non-operated investments. Non-ops were the anathema of oil investing for decades. Knowing the operating partner has some advantages. All of this had kept non-op interest low, until NOG came along and proved it works. Now others are jumping on board. Midstream infrastructure, which includes water, may be the next deal flurry on the IPO calendar. Very interesting breakfast. Thanks, Thad and Holt.
Snippets.
Suggestion: “If you are considering a Hydrogen/Ammonia IPO… maybe put that on hold for now.” - Timm Schneider of The Schneider Capital Group.
The Baker Hughes U.S. land rig count has decreased 6 of the last 8 weeks.
According to Rystad, the latest oil rig total is 454, which is 3% lower than a year earlier, while those for gas stood at 69, 27% lower than last year.
Experts Say. Rystad Energy tracks the historical breakeven price estimates for all unsanctioned projects, aiming to analyze the profitability of new oil schemes. “Our latest research, updating previous analysis (from 2018, 2020, 2021, 2022 and 2023), has revealed that the average non-OPEC breakeven price for not yet producing fields has risen to around $47 per barrel of Brent Crude, up by almost 5% over the past year due partly to inflationary pressures. Despite this cost increase, the breakeven price remains considerably lower than the current oil price.”
A Pitch for An Industry Webinar. “There is a sense of bearishness in the oil and gas industry due to continued weakness in the commodities market fundamentals. Operators and service companies are navigating these uncertain times by being cautious in their approach to drilling activity levels and production targets amongst other things. As budgets are being set for 2025, commodity price forecasts, well productivity, gas drilling recovery timelines, service price deflation and activity levels under varying commodity prices are topics on everyone’s minds.” I am reminded of the ad I hear on the radio for California Psychists. “Get certainty in your life.” If only it were that easy.
Research Opinion. From Roger Read, at Wells Fargo. “Wells Fargo downgrades NOV, the oil and gas drilling services provider, to Underweight from Equal Weight with a $16 price target, cut from $20. He upgraded Baker Hughes to Overweight from Equal Weight with a $42 price target, bumped up from $40. Read’s view is based on two factors: Current market conditions are not likely to cause a meaningful upswing in orders for NOV, and oilfield equipment companies will likely lag peers with an overall backdrop of declining capex intensity and modest D&C activity recovery. E&P companies continue to favor efficiency gains, cost-cutting and right-sizing instead of growth at all costs. Read expects NOV's traditional onshore and offshore drilling rig customers to restrain their capital spending for the next several years, especially for deepwater drilling rigs. Read raises Baker Hughes to reflect the company's diversified business model and improvements to date in terms of margin and cash flow performance. NOV’s ROIC is 12.9% compared to Baker’s ROIC is 10%.
Hydrogen. Huge amounts of money, thanks to the Inflation Reduction Act, is flowing into making and using hydrogen as a cleaner fuel source. According to Deloitte, the hydrogen market is expected to grow from $642 billion in 2030, to $1.4 trillion by 2050. While all of that sounds great, there are a couple of issues. One is that the current market is only $170 billion, so all we need is 7 years of 20% growth through 2030. Ambitious. Especially since the EPA did not include hydrogen in its Power Plant Emissions rule because the technology to achieve the anticipated use is not yet available. Distributed power and utility projects are expected to drive that demand but leaving it out of the EPA rule will make that exceedingly difficult.
IOU. The U.S. is the biggest debtor nation. Our current debt is $35 trillion. That is more debt than the next four countries combined: China, Japan, France and Italy. It is increasing at $1 trillion every quarter. This is very serious.
The Brand-New Frontier. Exxon has put together the most impressive and significant success rate and discovery pace in memory thanks to Guyana. Now, drilling is moving ahead in Suriname, Guyana’s neighbor. Why quit there? It appears that Peru is next on the list after a ten-year hiatus from activity. A new seismic survey has been completed in the Trujillo Basin and a new hydrocarbon system is the objective. We have found several new hydrocarbon systems over the past several years, from Columbia to Ghana. Based on the idea of Pangaea, the west coast of Africa and the east coast of South America were together for an eternity until they separated. So, it stands to reason that oil and gas systems are in both. Now Peru. Drilling in the country stalled over the last two years, but now it is in the industry’s sights.
German Woes. We drive our German cars and think how good those Germans must have it. Germany is hitting the skids, though the argument is being made that it hit the rocks a couple of years ago and started taking on water and is now floundering. We have written about the surplus of Chinese EVs and the attempts of the Chinese government to keep manufacturing at its historical levels. But, demand in China for EVs is stalling, as it is in the states. China’s answer? Start sending and selling more of those EVs to Europeans and Americans. The EU has established a very high import tariff and Mr. Trump has said he would as well. The slowdown of new buyers in China, and the push to sell their cars, has resulted in Volkswagen laying off 30,000 employees in Germany. Northvolt, a Swedish battery company, has seen rapid increases in costs and a slowing of demand, resulting in 1,600 jobs being cut. Auto supplier ZF Group, supplying advanced mobility products and systems for passenger cars, commercial vehicles and industrial technology, is cutting 11,000 – 14,000 jobs over the next four years. Additionally, the German rail company, Deutsche Bahn, is cutting almost 10% of its people, totaling about 30,000 jobs. The German credit agency, Creditreform, reported that ~11,000 companies filed for bankruptcy in the first half of 2024, a nearly 30% increase from the previous year.
PPHB – U.S. Energy Market Update Highlights.
Commodity Prices: WTI crude oil is currently $69.69 per barrel (down ~2.1% week-over-week) and natural gas is $2.82 per MMBtu (up ~8.5% week-over-week).
Crude Oil Production: U.S. crude oil production is currently ~13.2 MM BOPD (up ~2.3% year-over-year).
Crude Oil Inventories: U.S. crude oil inventories decreased by 4.5 million barrels week-over-week vs. an estimated decrease of ~1.3 million barrels.
Frac Spread Count: There are currently 236 frac spreads operating in the U.S. (an increase of 6 spreads week-over-week).
Onshore Drilling Rig Count: There are currently 567 drilling rigs operating in the U.S. (a decrease of 1 rig week-over-week).
It's Everywhere!! Germany has been in stagflation for the last several years. The phenomenon is attributed to high energy prices, overregulation, inadequate infrastructure, a shortage of skilled labor, insufficient raw material supplies and supply chain disruptions. The German Institute for Economic Research says German companies need to evolve. The President of the Institute also said that the German economy is both export and industry dependent, and in the face of the energy transition, "companies have missed out on the transformation," and that many, such as VW, have “fallen behind.” "It's not just the automotive sector, it's machinery, it's pharmaceuticals, the chemical sector, this is quite a problem many have," he said in a recent interview. Thousands more jobs are expected to be cut across many different sectors, and avoiding a recession will be a challenge.
Reparations?? or I'm Watching High School. Heisman Trophy winner, Reggie Bush, has filed a lawsuit against USC, the PAC-12 conference, and the NCAA. He is seeking compensation for their use of his name, image and likeness while he was a star collegiate running back decades ago and years after he left the Trojans. “Reggie Bush received all the accolades a college football athlete could receive during his three years playing football at USC.” said Bush’s attorney. According to the attorneys, Bush received the accolades, but the NCAA, USC and the PAC-12 conference received all the money. Imagine how much money George Brett would have made if he played just 4 or 5 years later. It happens. There are no “claw backs” from years ago. The lawsuit is a little embarrassing to me. Revisionist history? Or just bad luck and timing?
Money in Texas. Dallas is the 22nd wealthiest city in the world and sixth in the U.S. based on the number of millionaire residents according to a London-based report. Houston was 17th. Texas is now ranked second the country for attracting young rich people according to a study by SmartAsset and data from the IRS.
Three Mile Island. Who would’ve thought. If you ever wondered about all the fuss regarding powering AI chips, the following provides a really good example. Microsoft has signed a 20-year power offtake agreement with Constellation Energy to restart the undamaged nuclear reactor at Three Mile Island to help power its AI needs. Recent reports about the significant increase in emissions from technology companies has put their net-zero promises into question. So, they are scrambling to find a reliable and clean electric megawatt. The problem with solar and wind, of course, is the reliability issues. And nuclear has some of the lowest emissions of all. I often ask people; How many people died at Three Mile Island? The answer is none, but it has been stuck in everybody’s head for decades that it was a nuclear disaster of epic proportions. Restarting a nuclear reactor to bolster a tech company’s artificial intelligence capabilities demonstrates how critical the need for electricity generation is. It’s as simple as that. With Three Mile Island, it’s one concentrated source. With wind and the solar, we also have to consider the infrastructure for power delivery into the grid. Stranded gas projects in places like West Texas started attracting the attention of bitcoin miners after they got kicked out of China three years ago. The decline in bitcoin prices over the last couple of years has taken it off the front pages, but now, bitcoin is back, and data centers are hot. We would expect to see stranded gas development increase across the state. I remember being told if you keep something long enough, it’ll come back into fashion. I’m still waiting on the Nehru jacket, but the revival of Three Mile Island is not what I expected to see. Regardless, I’m glad it’s happening.
Melt-Down. On March 28, 1979, the reactor known as “Three Mile Unit 2” suffered a core meltdown due to a strange combination of mechanical failures and human error. This resulted in the reactor being severely damaged and radioactive water and iodine being released due to a failure of the pressurized water coolant system. No one died. The facility was not completely shut down following the break, with one reactor set to continue operating until 2029. The restart will be the first ever for an American reactor after it has been shut down “for good.”
Short Squeeze? Citi research analysts highlighted five energy stocks that have the highest short crowding score within the sector. Analysts define “crowding” as “something that often happens in the latter stages of the life cycle of a stock, where the market has a consistent view on the stock – a risk factor.”
Energy.
Helmerich & Payne Inc. (HP) – short crowding composite rank: 100%
Core Laboratories Inc. (CLB) – short crowding composite rank: 99.9%
Oceaneering International Inc. (OII) – short crowding composite rank: 99.7%
APA Corp. (APA) – short crowding composite rank: 99%
Vital Energy Inc. (VTLE) – short crowding composite rank: 98.8%
One Little Omission. If you leave out one little detail, it all changes. You have an “aha!” moment. The headline read “More electrification of offshore upstream facilities could have major impact on emissions.” Electrifying rigs and other equipment using either natural gas or produced gas, has been a big deal for a while. However, fully powering a drilling and completion operation with electricity sounds great until there are issues. Fully electrified rigs and other facilities operating across the Norwegian Continental Shelf are emitting 1.2 kg of CO2 per boe produced, 86% lower than the typical 8.4 kg of CO2. Norway can cut emissions from operations by 70% by 2040. Why don’t we adopt this globally? Why shouldn’t we all accelerate the electrification effort on all rigs? Nirvana! But what the article didn’t mention was that 98% of Norway’s electricity comes from its 4,000 dams. That’s right. The country we all associate with significant oil production, is an Aquarian’s dream. Clean, basically constant, inexpensive source of electricity. Lay a cable to the rig and plug everything in. Norway is 7th in the total amount of electricity generated, preceded by China, Brazil, the U.S., Canada, Russia and India. Other countries have greater issues converting their offshore facilities for the same purpose, including much larger distances from the mainland, insufficient power grid infrastructure and limited renewable power capacity. Other countries with very high percentage of energy coming from renewables: Albania, Bhutan, Nepal, Paraguay, Iceland, Ethiopia, and the Democratic Republic of Congo. See a trend?
Top 20 Most Dangerous Cities in America.
The Right to Defend. First and foremost, the conflict between Hamas and Israel is very destructive. All wars are. Hamas was elected in 2007 in a democratic election as Israel exited Gaza, and they have run the area ever since. Their original charter had only one goal. That goal was to remove all the Jews from the earth and destroy Israel. Early in October of last year, Hamas fighters drove, flew and glided into Israel and slaughtered 1,200 people. 300 or so were soldiers. The rest were civilians. The Hamas fighters have posted cell phone videos of the killings and atrocities they committed. It isn’t speculation. On a percentage of population basis, that would be the same as seeing 42,000 Americans killed in a day. 9/11 was less than 4,000. What would we do? But it isn’t up to us, it is up to the leaders of the aggrieved party, Israel.
A Safe War? So far, about 45,000 civilians have died. That makes this one of the safest wars for civilians ever. Safest??? Okay, most efficient. The U.S. post-9/11 wars in Iraq, Afghanistan, Yemen, Syria, and Pakistan were all very similar to the war that Israel is pursuing in Gaza. Urban warfare. During that period, civilians have made up about 90% of deaths. The soldiers killed were only 10% of the casualties. Soldiers have been almost 40% of the people killed in Gaza. As a civilian in Gaza, your chances of living are nearly 4 times greater than that of a civilian in Iraq, Afghanistan, Yemen, Syria or Pakistan. We have never had the media we have today, where anyone with a cell phone is the media. The granularity and the effective clickbait give more details to consider, all biased and promotional. The rest of the world? According to one study: 432,093 civilians have died violent deaths as a direct result of the U.S. post-9/11 wars. An estimated 3.6 – 3.8 million people have died directly in post-9/11 war zones, bringing the total death toll to at least 4.5 – 4.7 million. What country has the highest death toll? Ethiopia in 2022, where it racked up 40% of all war deaths that year, followed by Afghanistan in 2021.
Another consideration. The U.S. post-9/11 wars have forcibly displaced at least 38 million people in and from Afghanistan, Iraq, Pakistan, Yemen, Somalia, the Philippines, Libya and Syria. This number exceeds the total displaced by every war since 1900, except World War II.
Texas Football. Our local high school named their stadium after their head coach this weekend. Randy Allen has coached the team for 26 years, except for those three months where he retired and came back. Highland Park was defeated by Cherry Creek High School in Colorado this weekend. They lost at home. It was the 3rd home loss in 26 years under the Coach and he had a record 84 straight home wins. His record is 296-36. He was Matthew Stafford’s coach.
Yikes. “UK must accept hard times or risk ruin” and “Britain faces economic ruin unless public finances are stabilized,” Rachel Reeves warned at the Labour conference in Liverpool. Her speech said, “growth is the challenge, and investment is the solution” She also offered new hints about the Budget next month, which Sir Keir has warned will be “painful”.
It’s Not Just Us.
Ecuador orders power cuts on insufficient hydro output (Reuters).
Argentina will cut power in summer peak periods (Bloomberg).
Bangladesh fails to pay for power imports from India (Reuters).
Indicative. I own PTEN. I have great respect for the management, the company assets, and the consolidation they have done. But the market is the market, and right now, the oil and gas markets are weak. Capital One is now estimating 6% below the consensus for this year, with only a few months left, and down 12% for next year. And this is one of the best drillers, best pressure pumpers and a decent drill bit business. They expected to be at a 14% free cash flow yield this year, but now that is likely to come down. Forecasts are for LNG-related natural gas demand to double over the next five years and that is with decent visibility. So, natural gas activity is waiting, down 27%, and hoping the bottom has been made. It is never just one company. We would expect, now that Q2 earnings and filings are complete, for the entire OFS universe to see a reset of 2024-25 expectations.
From Capital One. “Historically, energy stocks tend to perform better as signs of economic growth and improving demand growth emerge. A better entry point could be after the first slew of Fed rate cuts, which could give China a green light for direct consumer stimulus.” We have had a 50-basis point rate cut and China has already started its direct consumer stimulus, working to increase homeownership and continued spending to buoy the economy. Now to see if it will work.
The Follow-On Effects of the Fed.
People’s Bank of China Gov., Pan Gongsheng, announced on Tuesday that Beijing would reduce the interest rates on existing individual mortgages by an average of 0.5 percentage points, and lower down-payment ratios for second home purchases to 15% from 25%.
The Hang Seng Mainland Properties Index surged as much as 5% when Hong Kong markets opened shortly after the announcement was made.
Hong Kong-listed shares of real estate developers like China Resources Land, Longfor Group Holdings and China Overseas Land & Investment were some of the biggest movers, gaining as much as 2.84%, 3.31% and 4.22%, respectively.
Gimme the Money. Oil Change International published a research report that shows that rich countries could generate $5 trillion a year from a combination of wealth/corporate taxes, and a crackdown on fossil fuels. A wealth tax on billionaires could generate $483 billion globally, while a financial transaction tax could raise $327 billion. Taxes on sales of big technology, arms and luxury fashion would be another $112 billion. Also, redistributing 20% of public military spending would be worth $454 billion if implemented around the world. Stopping fossil fuel subsidies would free up $270 billion of public money in the rich world, and about $846 billion globally. Taxes on fossil fuel extraction would be worth $160 billion in the rich world, and $618 billion globally.
That Isn’t All. The California Attorney General is filing a lawsuit against Exxon, accusing the company of misleading consumers about the recyclability of plastic products and the role it plays in polluting the state. After concluding a nearly two-year investigation, the AG says that the company was deliberately misleading the public about the limitations of recycling. Exxon is accused of continuing to deceive the public through advertising that insinuates that recycling can fix the plastic pollution crisis after claiming for years that all plastic is recyclable. So, Exxon said plastic was a recyclable product but because it didn’t specify that only some plastic is recyclable, they get sued for billions of dollars. If no one bought the products, this wouldn’t happen, and shouldn’t you penalize the people who are keeping Exxon in business even after seeing this lawsuit? The ultimate example of irrational virtue signaling.
Not All of Our Predictions Work. If all, or even some, of your employees work remotely, they are not involved in the day-to-day creation and support of the corporate culture. And as an analyst for ~30 years, I can say that culture matters. A lot. As one wrote “it’s crucial for collaboration, mentoring and keeping culture alive.” It is. But I also have a slide in my deck that says moderation in all things. And I felt it important enough to warrant an entire slide. It reminds me of the fight between electric vehicles and internal combustion engines. Everyone now realizes the answer is probably somewhere in the middle… Probably hybrids. The hybrid model is likely to win in the end. A large percentage of people claimed to be more productive and more engaged working remotely, which usually means from home. I don’t take this hook line and sinker because if I was having a good time and I got asked, “would you like to keep having a good time?”, I’d say what I needed to say to keep having a good time. Working from home five days a week isn’t any better than being forced to be in the office five days a week. There is culture in companies. But just like relationships that don’t require 24/7 maintenance, culture is likely the same. Because of the way the pendulum swings we will see more and more firms bring back employees for more days in the office. The cities and the taxing authorities who lose significant revenues as people work at different venues are pressuring companies to change their policies. Again, they are looking at their best option just like we always look for our best option, but the best reality is usually in the middle. So, there will be a wave of quotas pushing employees to return to the office, but it isn’t likely to be 100% of anything. Balance always occurs in the end. Finding that balance can take time, effort and lost opportunity. And in this world, no one has given time. Two days a week remote. That’s my bet.
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.
