Things I Learned This Week While Packing Up

It is earnings season again. They seem to run together these days, especially with Q4 results dragging out for so long. Oil flirted at $63 but couldn’t hold. Most prognosticators expect better pricing but the futures strip has oil at $54.50 this time next year so that market is not convinced. Many in the industry hope/expect a spike in oil prices will save them/bail them out or just provide some wind at their back. We asked at a PBPA luncheon last month how many people in the audience had sold equity at the top of the previous spike. No hands went up. We asked about the prior one, two or three spikes. Still no hands. A spike in oil prices gives short-term investors the ability to grab a profit. I’m not sure the industry is really rooting for hedge funds to make a killing. It is usually at the industry’s expense. There is a 200 year old saying that continues to prove true in the oil business. “What goes up, must come down” ends with the notice that “it is likely so to happen”. T. Sedgwick, 1826.

What we need is stability. We always want stability at a high price. I want world peace and the winning Powerball number, as long as we are “wanting”. Unfortunately, the market looks for its own equilibrium without our “wants” being considered. The prudent man recognizes this and runs his business to be marginally profitable in downturns and very profitable in upturns. I was always amazed at managements who suffered negative returns in down markets and expected the upturns to offset it. That is literally a zero sum game. Over time you would not generate a positive return at all. Not a productive goal.

I still find it odd that there is so little focus on generated positive returns versus the cost of capital. If you own a business and your net income is negative, the value of your equity declines. Math, not opinion. Notice there is no mention of cash flow in that statement. Cash flow is critical to keeping the doors open. But if we just want to keep doors open and never see our equity, our net worth increase, you are basically running a socialist company. You are keeping people employed but there is no increase in value at best and at worst, you are a liquidating business. We have enough issues in this business. The goal cannot be a slow gradual erosion of net worth, hoping for a winning lottery ticket. I have heard companies mention their very strong cash flow generation but when asked what return on invested capital that cash flow represents, it is crickets. No answer. I remember one CEO speaking at an equity conference boasting about the fact that his debt was all non-recourse. Non-recourse debt is a good thing but equity investors don’t’ see that as a reason to be excited. Not having terminal cancer is a good thing but it isn’t the same as being fit and healthy.

More and more companies and managements are understanding this. The escalation of technology has caused many to be very wary of capex spending sprees. In other industries it is called discipline. We are a needed, high risk, high technology industry. We need to make sure that the adjective “profitable” finds its way into the lexicon. The E&P industry is pursuing it through consolidation. It is much easier than OFS since the objectives and assets are much more homogeneous. But it will be required of OFS before it’s over. No time like the present to start.

 On a personal note, we have to be out of our house in a little over 3 weeks. We are moving in the Village Apartments in Dallas as an interim solution since the rental market is as hot as the house buying market. Those of you from Dallas are likely rolling on the floor laughing about now. Others won’t really get it but back in the day (30-40 years ago), every 20-something in Dallas lived there for a while. My little brother said he was surprised they had a geriatric section. Scratch his Christmas present. We will spend the summer reliving our youth. 1,345 square feet and the average age of the other tenants is likely mid-20’s. Kaari still looks young. I will leave it at that. Wish me luck.

 Not Over But Hitting Turbulence. SPAC Hot Streak Put on Ice by Regulatory Warnings. Investors are cooling to one of the hottest bets on Wall Street as new regulatory scrutiny of special-purpose acquisition companies cuts the flood of new issues to a trickle while share prices tumble. SPACs have raised about $100 billion so far this year, more than last year’s record of $83.4 billion, which itself was more than the amount raised in the nearly 30-year history of these blank-check companies.  Until last month, roughly five new SPACs hit the stock market every business day in 2021. In the past three weeks, 12 new SPACs have started trading. But the fear is that it is getting toppy. In one of the largest “de-SPACs”, is a $39.6 billion deal to list Grab Holdings, a ride-hailing, food-delivery and digital-wallet group that operates across much of Southeast Asia, and is by far the biggest involving a blank-check company and means Grab’s valuation has more than doubled in just 18 months. While stocks and cryptocurrencies are at or near records. SPACs are among the market’s worst performers lately. Over the past two weeks, the Securities and Exchange Commission, which was largely silent about SPACs through most of last year, questioned the optimistic revenue projections used by startups that are merging with SPACs.

It Ain’t Over Yet. Having visited India a number of times in the past, I have wondered for the last year why, when there is a “shanty town” of corregated tin and makeshift huts with more than 10 million people living there, there hasn’t been more of a Covid outbreak. It turns out it was just delayed. Now India is setting daily case records with 273,000 Sunday, up from 163,000 a week ago. Hong Kong suspended inbound flights from India and other nations while a Reuters poll of Japan executives has almost all expecting a 4th wave of infections that could peak in May. Reports show that 50% of US adults have gotten at least one vaccination so far.

Yikes! Gas Is the New Coal With Risk of $100 Billion in Stranded Assets. Natural gas is falling out of favor with emissions-wary investors and utilities at a quicker pace than coal did, catching some power generators unaware and potentially leaving them stuck with billions of dollars of assets they can’t sell.   Banks that strengthened their financing restrictions on thermal coal under pressure from shareholders wanting to avoid the fuel, and now the expectation is that gas is next. Executives at some western European companies say they’re already struggling to sell gas-fired facilities.– Bloomberg.

Interesting Snippet. Renewable energy jobs are growing in the U.S., but last year roughly three-quarters of them were construction-related, according to consulting firm Wood Mackenzie. Even after last year’s oil-field job losses, U.S. oil and gas production employment is likely to outnumber renewable energy jobs for roughly another decade, according to the firm’s analysis. The U.S. oil-and-gas industry has been one of the hardest hit in the pandemic, shedding nearly 75,000 jobs last year, or roughly 19% of positions, according to Bureau of Labor Statistics data on oil-and-gas extraction and associated services. Employment in U.S. oil and gas production has likely peaked, according to Wood Mackenzie. The firm expects industry jobs to increase some 18% from 2021 through 2027, to around 424,000 positions, before slowly declining as technology improves.– WSJ

Another Snippet. BP, the British oil giant plans to spend about $1.3 billion to build a massive network of pipes and other infrastructure to collect and capture natural gas produced as a byproduct from oil wells in the Permian Basin of Texas and New Mexico. It plans to announce Monday that it will eliminate routine flaring of natural gas in the oil field by 2025. - WSJ.

Snippet Day. Nearly half of all oil pipelines from the Permian basin are expected to be empty by the end of the year, analysts and executives said. Pipeline companies went on a construction spree throughout 2018 and 2019 to handle blistering growth in U.S. crude production to a record 13M bpd. By 4Q21, total utilization of the largest oil pipelines from the Permian is expected to drop to 57%, consultancy Wood Mackenzie said. The nadir during the last market bust in 2016 was roughly 70%. - Reuters

Geez. The New York State Common Retirement Fund, the third largest public pension plan in the country, will restrict investments in oil sands companies that have not demonstrated that they are prepared for the transition to a low-carbon economy,  The Fund will not directly purchase or directly hold debt or equity securities, or invest through an actively managed account or vehicle, in these companies. The fund will next evaluate shale oil and gas companies. The cancellation of the XL pipeline was appeasement to the progressive base, and especially the environmentalists who want to see oilsands production shut down completely. How little they know.

Getting Better All The Time.  The offshore rig market has been in decline for some time, about six years, and many thought that 2020 would be the year that the offshore market would finally turn around. But it wasn’t. Data from Bassoe Rig Analytics confirms that form January 2020 to February 2021 total backlog plummeted by 286 years or 33%, with jackups down 37%, semis down 26% and drillships down 11%. Looking ahead, Bassoe expects demand to increase from 398 units in February 2021 to 446 units by the end of 2021 and is headed to the 80% utilization over the next three years.

ESG in Action. NEXT was up +4.7% on Monday as it launched its Project Canary today, the formation of a joint pilot project for monitoring, reporting, and independent third-party measurement and certification of the greenhouse gas (GHG) intensity of liquefied natural gas (LNG) to be sold from NextDecade's Rio Grande LNG export facility in the Port of Brownsville, Texas.

Not Quite Enough. “HAL exceeded 1Q21 expectations for both revenue ($3.5 billion. vs. $3.3 bil/$3.4 bil. for us/Street) and EPS ($0.19 vs.$0.16/$0.17 for us/ Street), and subsequently guided 2Q21 revenue/operating income above prior consensus. Yet the stock finished down nearly 4% on earnings day, reflecting what we believe could have been lofty FY21 margin expectations for C&P (outlook unchanged at mid-teens for the year) on improving North America fundamentals. Looking ahead, as North America rebounds and international activity inflects, we see HAL as well-positioned to capitalize on the macro recovery. As such, we reiterate our OW rating… ” – Tommy Moll, Stephens. The drop on the day of earnings took ~$750 million off HAL’s market capitalization, greater than the market cap of 34 public OFS companies. Baker Hughes beat earnings as well but only lost about $400 million in market cap. Interesting market.

Headlines:

·       “Saudi’s Aramco is the third-most profitable company in the world after Apple and Microsoft.”

·       “In a sign of possible attrition, there were no billion-dollar bankruptcies filed in the first quarter by oil and gas producers in North America, which hasn't happened since third-quarter 2018, according to Texas-based law firm Haynes and Boone.”

·       “This business is broken. The industry is going through a multiyear process of wringing capital out of the sector, not bringing new capital in” – Adam Waterous Energy Fund

·       We now forecast '21 Lower 48 Drilling & Completion spending +5% YoY (vs -3% previously), and a +19% increase in '22. – Leading Analyst

·       It’s weird being the same age as old people. – Wise Sage

·       A sharp jump in the price of commodities in China has raised fears of inflation. The government has indicated a willingness to intervene swiftly in the market in order to tame output prices.

·       World’s Largest Gas-Producing Nations: Natural Gas Will Keep the Lights on for the Next Generation

·       Global energy demand to peak in 2026 - Rystaad

Performance. Only 9 of 65 OFS stocks on our screen are up over the last month. 38 out of the 65 stocks are up over the last three months. The OSX is down 12% over the last month and up 12% over the last three months. Crude is up 2% over the last month and up 18% over three months.  That is called a non-correlated reversal, or a near-term correction in the stocks which are lagging the commodity price. I will let everyone figure out for themselves what happens next!

Encouraging. Jeff Miller, Chairman, President and CEO: "Q1 marked an activity inflection for the international markets, while North America continued to stage a healthy recovery. I expect international activity growth to accelerate, and the early positive momentum in North America gives me confidence in the activity cadence for the rest of the year."

As If Capital Wasn’t Already an Issue. The Biden administration is working to end funding for “carbon-intensive” fossil fuel projects overseas, potentially cancelling billions of dollars in support for oil and gas projects around the world. In one in a series of executive orders aimed at tackling the climate crisis in the US and abroad, Biden committed his government “to identify steps through which the United States can promote ending international financing of carbon-intensive fossil fuel-based energy while simultaneously advancing sustainable development and a green recovery”. The order stated the secretary of state together with the treasury and energy secretaries would work with the US Export–Import Bank and the head of the Development Finance Corporation to achieve this. Biden also directed federal agencies to eliminate fossil fuel subsidies. – Climate Home News

Cutting Off One’s Nose. Gov. Gavin Newsom is reportedly planning to announce a ban on new fracking permits as soon Thursday or Friday. Politico reports the announcement comes the week after state lawmakers voted down a bill banning fracking. Sources told the news outlet Newsom would ban new fracking projects by 2024, and plan could rely on his emergency power or state regulators. - Politico During his first year in office, Newsom issued roughly 220 fracking permits, according to his administration, though he had said he wanted to ban fracking during his election campaign. Last year there was a 9-month moratorium on fracking but it has since resumed. Chevron and Aera, a JV between Exxon and Shell, are the most impacted. Several cities in California have banned the use of natural gas for cooking and heating in new construction. So now the utilities burn the natural gas to generate the electricity needed for cooking and heat at a multiple of the cost of direct use of natural gas. So much for common sense.

California’s Idea of Clean Energy

One Opinion. The rapid adoption of electric vehicles (EV) around the world will probably cause global oil demand to peak two years earlier than previously expected, Norway's biggest independent energy consultancy Rystad said today. World demand is now seen peaking at 101.6M bpd in 2026, down from a forecast made in November of a peak in 2028 at 102.2M bpd, Rystad Energy said. Little known fact – if you buy a Tesla in Dallas, you are forcing more coal to be burned. In California, it is much more convenient. You just plug it into the wall. No pollution. I am explaining the reality to all the people moving to Texas from California. If only it worked that way.

Optimism Reigns. “On their earnings call this week, Halliburton stated that rebalancing underway in the frac market right now is setting up a price recovery for pressure pumping in 2022. Forecasts compiled by our affiliate Lium Research predict total US frac HHP utilization peaking at 60% through 2022. While pumpers may be able to pass through some modest price increases on fleet reactivations, this is not a utilization level conducive to widespread inflation in pressure pumping prices.” - InfillThinking

Clear Head in the House. US House panel passed a bill opening OPEC up to lawsuits. Following legislation formed by a US House panel group, Secretary Barkindo, the current Secretary General of OPEC, urged members to reinforce diplomatic bilateral contacts with government officials in the US and explain the disadvantages if the legislation becomes law. He added that "these disadvantages might include: weakening the immunity principle at a global level, putting at risk US interests overseas, and the protection for their personnel and assets."

E&P Outlook. Stephen’s E&P analyst Gail Nicholson, published a Q1 Preview of 42 pages.  “1Q21 earnings kicks off next week, and for the most part we are not expecting anything extraordinary as a large number of companies have preannounced a combination of volumes, capex and/or realized pricing. Sentiment is a bit lackluster as relatively known 1Q21 prints, minimal catalysts, limited buyers, and continued questions regarding demand has paused the rally we have been experiencing since October ’20. A 2H21 demand recovery is still likely and incremental oil price appreciation should drive our coverage universe higher. At strip, the group currently trades at 5x/4.4x ’21/’22 EV/EBITDA multiples and reflects ~$48 oil.” Thirteen of the sixteen stocks covered are expected to have positive EPS in 2021 and all are expected to have positive EPS for 2022 according to Factset. The chart below shows Gail’s expectation of FCF yields for the sub-sectors. Discipline works.

Ambulance Chasing? A U.S. House panel today passed a bill to open the OPEC oil production group and countries that work with it to lawsuits for collusion in boosting petroleum prices, but it was uncertain whether the legislation would be considered by the full chamber. The so-called NOPEC bill, introduced by Representative Steve Chabot, a Republican, passed on a voice vote in the House Judiciary Committee. Similar bills to crack down on the Organization of the Petroleum Exporting Countries when oil prices are on the rise have appeared in Congress without success for more than 20 years. Reuters.

And the “Experts” Say…  Swedish climate activist Greta Thunberg testified before a U.S. congressional hearing on fossil fuel subsidies this week. The 18 year old denounced the “madness” of government subsidies for fossil fuel use. She says current pledges by different countries to halve their greenhouse gas emissions over the next decade are still not enough. The committee’s progressive chairman is pressuring President Joe Biden to end those subsidies. Rep. Ro Khanna (D-Calif.), listed some tax breaks he wants repealed, including one called intangible drilling costs, which allows producers to deduct most costs from drilling new wells.

Haynes & Boone plays a lot and well in the energy space. They completed a survey earlier this month on E&P company redeterminations. Some of the results below.

And How Much is Hedged???

But Where Does the Money Come FROM???? (Also H&B)

And Where Does the Money GO???

I Spaced It Out. 60 years ago last week, Yuri Gagarin became the first human to enter outer space. He was just 27 years old. 567 people have gone to outer space since. Three astronauts came back to Earth last week on a Russian craft, after a 6 month stint on the space station, leaving 7 people still working there. Amazing.

Cause for Concern. US oil drillers ‘dying on the vine’ as PE flight prompts funding drought.” A vital source of funding for the U.S. oil sector is drying up as private investors retreat, prompting stricken operators to make “last gasp” efforts to boost production and cash flow to lure in buyers. The exodus mirrors shale’s experience in public markets, where even before last year’s crash investors had soured on an industry notorious for poor returns and weak environmental, social and governance performance. “Private equity has been decimated in this downturn,” said Wil VanLoh, head of Quantum Energy Partners, one of the largest PE investors in the shale patch. “The total quantum of money available out there to private companies has shrunk and is going to stay much, much smaller.” Now scores of oil producers are “dying on the vine,” said Ben Dell, managing partner at rival Kimmeridge, as they are left without the regular cash infusions to bankroll the capital spending needed to keep on drilling. – Financial Times

The Wind Blows. The wind farms we see around Texas and other areas are large but it seems we haven’t fully appreciated what “large” really is. The current windmills out there can generate 1.5Kw of power. Offshore wind turbines are much bigger, averaging 8.2Kw. No GE has developed the Haliade-X turbine, which will be 853 feet tall.  That is the same height as the Transamerica Pyramid tower in San Francisco, 150 feet taller than the Lloyd Noble drilling rig and ranks as one of the 25 tallest structures in the world. Vestas and Siemens are building turbines of similar size. The blades will be 350 feet long. These turbines will generate 15Kw of power. It ids a brave new world. 

Playing Catch Up. The clean energy economy is being made in China. Washington Democrats are launching a late-stage rush to lure it back home. The Biden administration and Congressional Democrats plan to pump taxpayer money into the battery sector — investing in research, backing risky start-ups and developing tax incentives and grant programs to bring not just battery production but also the entire supply chain into the U.S. It’s an attempt at a rapid turnaround after the U.S. largely lost the battle for solar production in the 2010s, when China dumped billions of dollars into its own panel production. The U.S. now trails its economic rival in manufacturing batteries that will drive a coming wave of electric vehicles and make solar and wind more reliable, and the advantage is triggering comparisons to the Middle East’s ability to dominate oil markets decades ago. – Politico

OMG. The Cambridge Sustainability Commission on Scaling Behaviour Change recently published a new report revealing that the UK’s richest 1% produce 11x times the combined carbon emissions of the world’s poorest 50. The richest 10% of the world’s population produced 52% of all consumption-based greenhouse gas emissions. The study concluded that people, particularly society’s richest, need to change their lifestyles. Eliminating energy and resource intensive lifestyles of the richest would by far rapidly reduce emissions. A UK Labour MP Claudia Webbe said that “Earth is overpopulated; there are too many rich people. To solve the climate crisis; the rich must be abolished.” So to be a well off white male in the oil & gas business has to be one of the most vilified people in the world to people like Claudia. We are doomed.