Introduction

Last week we enjoyed a day trip to North Texas and then took a day off to cook BBQ for local Houston politicians (Crenshaw and Hunt). The good news is the food turned out ok, but the bad news is two days out of the office means a weekend of reading earnings transcripts. We highlight several Q3 releases/conference calls below as well as provide some high level observations.

Right now, the macro backdrop is the most concerning as the rise in COVID cases, European lockdowns, surging Libyan production have pushed oil prices lower with WTI trading at ~$34/bbl this evening (down 5%). Moreover, the election is now two days away (thankfully). Package all this together, it makes anyone’s crystal ball cloudy for 2021 and that theme was obvious from Q3 calls. What is clear, however, is the industry’s commitment to generating FCF and pursuing ESG, the latter point featured prominently on virtually every single call. What was also clear is an industry that seemingly recognizes the need to live within its means as speculative capex is essentially non-existent.

Looking forward, the DEP team will be in Houston this week conducting meetings with local contacts, but we head north to Williston next Monday for a week long Bakken/PRB/DJ Basin tour. Let us know if you will be in the area or if you are open to allowing me to visit your operation. Also, DEP and our friends at CP Energy Sand Commander will co-host a reception in Williston next Monday evening. Details to follow. Following our arctic tour, we return to the Permian again for a four day tour the week of 11/16. In concert with this trip, we’ll host a small industry reception on Tuesday the 17th. Seating is limited, so let us know if you are around (preference given to DEP subscribers). Finally, we will be blasting out sponsorship / exhibition details for our February conference at Minute Maid Park later this week. No plans at DEP to go Virtual

General Observations 

With Q3 earnings season almost over, a few things stand out. First, even with the healthy rise in completion activity (+~80 frac crews from the Q2 trough) and the early stages of a rig count recovery (+51 rigs from the August trough), the OFS sector remains exceedingly challenged. Case in point, this week we learned of two small private well service companies who finally elected to shutdown due to continued oppressive operating conditions. One is located in North Texas and the other in Oklahoma. According to contacts, with PPP money having run out and well service rates depressed, the owners decided to go ahead and exit. Of note, these companies have operated for 30+ years. In one case, the rigs are now marketed for sale and will most likely be bought and return to service under new ownership. Not a surprise as that’s what we’ve seen in other instances as well as in other sectors such as frac. As for the public OFS companies, several reported Q3 results last week including LBRT, RES, SOI and SCLA – all good companies and industry friends.

One takeaway is the large q/q jump in revenue for a few players, yet in several cases, another quarter of negative/depressed EBITDA. Take LBRT and RES, for instance. LBRT witnessed an impressive 67% q/q jump in revenue, but Q3 EBITDA came in at negative $3M. Meanwhile, RES reported q/q revenue growth of 31%, while its quarterly EBITDA came in at negative $12M. Thankfully, both RES and LBRT enjoy fortress balance sheets, thereby allowing them to weather the current storm. The same can’t be said for some of their peers. SOI, meanwhile, reported best-in-class revenue improvement with Q3 top line up 120% sequentially with positive adjusted EBITDA $3.1M, up from the negative territory reported in Q2. This is a commendable performance given the current market difficulties and like its frac peers RES and LBRT, Solaris also enjoys a strong balance sheet, a key reason the company still pays a dividend today.

Now the preceding elevator analysis is not meant to be a stock opinion. Rather, we are simply pointing out the healthy revenue generation with limited profitability pull-through. This speaks to the need for the industry to garner higher pricing or witness a material step-change improvement in activity. Neither seem likely in the near-term, but both are needed as negative EBITDA in a capital intensive business simply can’t continue. To be fair, SOI is not a capital intensive business, but its frac friends are.

With energy stocks under assault last week, we caught up with an institutional investor friend who has spent much of his career trading energy stocks, particularly OFS names. Our friend candidly explained that Q3 financial results are a key reason why his willingness to own OFS stocks is greatly diminished. Specifically, for this investor, it is increasingly difficult to own a sector (in his words) where profitability is elusive and visibility is limited. This challenge extends to even the best-in-class OFS stocks such as those referenced above. To prove his point, the contact cited the ~15% drop in LBRT stock after it reported earnings (which included a sharp q/q top line improvement and a commendable Q4 outlook). To be fair, last week saw a big decline in oil prices, a backdrop which will weigh on virtually any energy stock, particularly SMID-Cap OFS. But the concern about lack of profits is real and it keeps an established OFS investor on the sidelines.

Investor Observation #2:

In keeping with the preceding investor commentary, another energy buyside firm whom we have known for many years announced it will cease investing in traditional energy stocks. This contact began his career trading energy and at one point we believe his energy portfolio exceeded $1.5B. Earlier this year, the company ceased trading OFS names and now it has stopped trading E&P names. Instead, the company’s energy team has transitioned to Industrials and Clean Energy. This is simply an example of a trend which has been underway for the past couple years as investors continue to flee energy. In doing so, actions have consequences. With respect to the impact on the energy sector, a shrinking investor base means less available capital and/or a higher cost of capital. Neither are good. For financial geeks such as ourselves as well as for other financial services professionals (i.e. the sell-side), this move is terrible as the continued evaporation in energy investment means less research and trading dollars. With this potential outcome, one wonders if more sell-side firms will eventually leave the energy space (there have already been a few). One also wonders if/when some public companies lose all analyst coverage. Time will tell. What we do expect is lower analyst compensation which may lead to the juniorization of the energy sell-side and/or lower quality research. Moreover, we wouldn’t be surprised to see some firms combine the E&P/OFS senior analyst role in order to save money. With consolidation in the sector likely to persist, the number of “investable” names will further diminish while companies deemed “uninvestable” due to low trading volumes, low market cap and/or balance sheet leverage may have no consequential analyst coverage at all. Consequently, this will give rise to more DEP-type research models. Self-serving plug: This is why DEP is working so aggressively to create multiple high-quality industry events in order to fill what we see will be a looming void in quality energy specific sell-side events. It is also why we frequently ask for your support.

Conference Call Observation

ESG, ESG and ESG. Virtually all E&P’s and most service companies are hammering home their respective commitments to ESG, highlighting efforts to reduce emissions while also focusing on the “S” and “G” equations with discussions on safety performance, diversity and inclusion. In some cases, companies point to recently published sustainability reports, which, in full disclosure, we have not read yet. And while we embrace the concepts of ESG, we also believe there is an element of hypocrisy embedded in the rating systems, but we’ll save that preaching for another time. What is important, however, is the need for everyone to “play the game”. Take for instance the rising call on dual fuel technology. Both LBRT and RES noted investments in dual-fuel capability, but RES noted E&P customers are unwilling to pay for the upgrades. According to industry contacts (and something we’ve written about before) E&P customers are increasingly requesting dual-fuel as part of the RFP process. Companies wishing to win the work must therefore make an investment in the capability. Probably a bad analogy, but this feels somewhat like a pay to play process. If one elects not to upgrade, potential work may not be forthcoming. One the one hand, dual-fuel upgrades help win work but without incremental pricing, this becomes a bone of contention for us as the move feels like a market share grab vs. a sound investment decision. If industry profits were robust, the upgrades could easily be justified, but when EBITDA is essentially negative, capital upgrades give us a queasy stomach. The rejoinder to our view, of course, is the lack of investment could mean you don’t work. If you don’t work, you don’t have a business and that’s a damning outcome too. What is clear to us is the E&P industry is taking ESG seriously and vendors to the E&P sector should pay attention as we are entering a phase where ESG-friendly vendors may have a better shot of winning work vs. those who opt to do things the ways things have always been done.

BKR US Land Rig Count 

Up 9 rigs to 282 rigs on Friday with all of the gains forthcoming in the Permian. We expect the rig count will continue to creep higher, assuming the current sell-off in oil prices is temporal. That is if oil moves to ~$40+, we see gains, but if we are sustained in the $35-$40 range, who knows. If we revert sub-$35, Ebenezer Scrooge will roam Houston this Christmas.

Q3 Earnings Highlights

A small sample of recent Q3 earnings calls/press releases. We’ll put out a few additional summaries mid-week as we are working to get caught up.

RPC, Inc.:

  • Revenue up 31% q/q to $117M.
  • EBITDA was negative $12M vs. negative $18M in Q2
  • 2020 capex budgeted at $60-$70M – includes some dual fuel upgrades
  • Ran ~5 fleets in Q3
  • Fleet capacity remains 728,000HP.
  • Cash = $146M with no debt.
  • Q4 top line will be better than Q3, perhaps ~10%
  • Does not see normal seasonal/holiday slowdown this quarter
  • Objective is to be FCF positive in 2021
  • Noted customers want, but won’t pay for dual-fuel.
  • In some cases, E&P’s use a small portion of dual-fuel units, but the rest will be conventional
  • Believes the E&P consolidation backdrop may delay service pricing recovery.
Liberty Oilfield Services:
  • Revenue up 67% q/q to $147M
  • Adjusted EBITDA was negative $3M in Q3 vs. negative $13M in Q2.
  • Averaged 9.4 fleets in Q3, up from 4.6 fleets in Q2
  • Sees Q4 fleet count 20+% q/q.
  • Cash = $85M with total debt = $106M.
  • Acquisition of SLB’s OneStim should close in late Q4.
  • No formal guidance but gross profit per fleet should be up q/q.
Solaris Oilfield Services:
  • Q3 revenue = $21M, up 120% q/q.
  • Adjusted EBITDA = $3M vs. negative $0.4M in Q2
  • 34 mobile proppant systems active in Q3, a 70% improvement vs. Q2.
  • Sees Q4 activity flat-to-up modestly (assuming normal holiday seasonality).
  • Cash = $61M with no long term debt.
  • 2020 capex budget = $5M.
  • Continues to pay a quarterly dividend and has returned a total of $68M to shareholders.
U.S. Silica:
  • Q3 revenue = $177M vs. $173M in Q2.
  • Oil & Gas Segment:
  • Revenue = $66M vs. $73M in Q2
  • 1.282 million tons sold vs. 1.112 million tons sold in Q2
  • Contribution margin = $24.55/ton.
  • Contribution margin totaled $32M, up from $26M in Q2.
  • The Q3 results benefited from an $18M benefit from the remeasurement of rail leases.
  • Clean contribution margin up 40% q/q with clean contribution margin/ton up 21% q/q.
  • SandBox loads increased 74% q/q.
  • Cash = $135M and total debt = $1.25B.
  • Cash prioritization is key. SLCA noted it reduced active capacity and capex by 75%.
  • SLCA sees Q4 Oil and Gas volumes up 20-30% in Q4.
  • Noted October is off to a strong start.
  • 2020 capex budget $30-$40M.
  • Key question will be the speed at which industry idle mines come back on line in Q1. This could limit the recovery in sand prices.
Range Resources:
  • YTD capex at $298M with $63M cash spent in Q3; 2020 budget = $415M or less (implies ~28% remains).
  • Original 2020 capex budget set at $520M in March, but was subsequently reduced to $430M. Now guided to $415M or less.
  • The company turned-in-line 19 wells in Q3 with ~7 wells remaining in the 2020 program.
  • Company stated plans to add one rig and one frac crew in late Q4.
  • The company ran one frac crew in Q3.
  • Several laterals drilled in Q3 had lengths over 17,000 feet.
  • YTD drilling results have lateral lengths up over 24% y/y.
  • All of the Q3 wells drilled were drilled via remote directional operations (reduced people on-site, improved safety, etc.)
Antero Resources:
  • YTD capex at $694M with $161M cash spent in Q3; 2020 budget = $750M.
  • Q4 spend will decline as AR reduces drilling and completion activity.
  • 2021 maintenance capex budget is $580M, suggesting flat-to-down vs. Q3.
  • Company noted a 2021 budget is not yet Board approved, but this is likely the plan.
  • Therefore, it will not increase activity should commodity prices rise.
  • Antero is focused on FCF for debt reduction.
  • Currently running one rig and one frac crew.
  • Completed 96 of the expected 105 wells in 2020.
  • Average Q3 lateral length was 15,900 feet.
Chevron Observations:
  • Anticipates 2021 capex of $14.0B which is below the $14.8B combined spend of CVX/NBL.
  • The 2021 budget includes about $11B for upstream capex.
  • Q3 U.S. upstream capex = $904M vs. $1.0B in Q2 and $2.0B in Q1.
  • Total company capex YTD = $10.3B with $2.6B in Q3.
  • Details on the 2021 budget will be released in December, but call us crazy, we would think the CVX/NBL combined U.S. upstream spending is at least flat (if not up) vs. Q3 annualized spend assuming a return to ~$40 oil.
  • Noted sizeable commitments to renewables with $200M committed to R&D ventures.
  • Noted the sale of the NBL plane. If we recall correctly, the OXY/APC deal yielded the sale of 3 planes.
  • CVX selling Marcellus assets to EQT….not sure what CVX spent on capex this year for that acreage.
Matador Resources Observations:
  • YTD capex at $468M with $123M spent in Q3. 2020 budget = ~$560M ($92M budgeted for Q4).
  • Rig count at 3 rigs and expect to stay here for some time.
QEP Resources:
  • YTD capex at $285M with $38M spent in Q3.
  • 2020 Capex budget lowered to $340M vs. a prior range of $340M-$380M.
  • Implies Q4 capex = ~$55M, up q/q.
  • Running two rigs in the Permian and no operated activity in the Williston.
  • Drilled 9 Permian wells in Q3 with an average lateral length of 12,548 feet.
  • Resumed Permian completion activity in October and is running one crew.
  • Completing an average of 3,867 lateral feet per day.
  • Claims 90% pump time efficiency.
  • 2021 capex budget decreasing to $300M vs. $340M in 2020.
  • Of note, 65% of the 2021 budget will be spent in 1H’21.
  • Most of the capex will go to the Permian where QEP will run a two-rig program all year.
SM Energy Observations:
  • YTD capex at $420M with $110M spent in Q3. 2020 budget = ~$605-$610M which implies ~30% remains).
  • Announced plans to spend ~10% more in 2021 vs. 2020.
  • Expects a DUC draw down in 2021 from heightened levels at YE’20.
  • Dropped a rig in Q4, but added a frac crew.
  • Will evaluate using dual-fuel technology on its rigs and frac crews (starts Q4 into 1H’21).
  • Noted, but did not describe plans to test a higher cost completion design.
  • Permian Operational highlights include: (1) average lateral lengths of 11,500 feet in 2020, up from 9,300 feet in 2017; (2) ~49% reduction in sand costs since the beginning of 2019; (3) completing 2,028 feet/day, a +165% improvement since 2017 and (4) average lateral feet drilled/day at 772 feet, a 51% improvement since 2017.
  • The implied lateral feet/day suggests SM drills an average lateral in ~15 days.
  • Running three rigs and two frac crews in the Permian (completed 22 net wells in Q3; 50 YTD thus ~20 expected in Q4).
  • Running one rig and one frac crew in South Texas.
Southwestern Energy Observations:
  • YTD capex at $705M with $223M spent in Q3. 2020 budget = ~$860M to $915M.
  • Company averaged 3 rigs and 3 crews in Q3.
  • Drilled 16 wells and completed 25 wells in Q3.
  • Efficiency Highlight: Company-owned frac crew tested an ‘ultra-efficient” stimulation which simultaneously executed two independent zipper fracs on the same pad with one crew. This approach set company records, including completing 22 stages in one day and averaging 15 stages/day for the full pad. Savings using this approach quantified at $400,000. We believe this was a 7-well pad.
  • 2021 formal guidance will be released early next year, but management has no plans to invest above maintenance capital next year as it will seek to hold production levels flat exit-to-exit from Q4’20 to Q4’21. Should seasonal nat gas prices improve, SWN claims it will not increase activity.
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