- Actions Have Consequences: Magnitude of cuts will impact industry’s ability to ramp when recovery unfolds.
- Working frac fleets trending towards our estimate of 50-75 fleets; land rig count will likely trough above our forecast.
- Oil Service Q2 outlooks point to ~70% q/q activity declines.
- E&P earnings highlight production shut-in’s and additional capex budget cuts.
- Baker Hughes rig count at 408 rigs, down 57 rigs w/w and tracking down 48% q/q.
- We depart early tomorrow morning for Midland. We have some open slots Monday afternoon if anyone has time. Just shoot me a text at 832-247-8215.
- Hitting SE New Mexico and surrounding area Tuesday morning late and then up to Amarillo on Tuesday night.
- Pampa, Canadian, Perryton, Woodward, Hennessey and Cushing on Wednesday.
- OKC area on Thursday with a possible jaunt up to Tulsa.
- Duncan, Sulphur, Gainesville and Fort Worth on Friday. Return to Houston on Saturday.
- Driving 1,800 miles – doing our best to help bring down gasoline inventories.
Actions Have Consequences: Here’s a long-winded opinion. Grab a coffee or alternatively, wait and read when you get into bed – it might just put you to sleep.
What we are witnessing with the rapid collapse of the domestic upstream industry is nothing short of shocking. The OFS market, which had cut away the fat in 2015/2016, quickly cut away muscle during the past few weeks. In some cases, companies are now amputating limbs. With industry activity poised to decline 70-80% q/q in Q2, the quick reaction was to slash headcount, lower wages, cut benefits and reduce capex. Within milliseconds, industry leaders at the geographically diverse companies quickly realized the need to shut-down operations, which includes closing facilities.
In the moment, closing a facility may be the right call. It doesn’t make sense to eat fixed costs when there is neither revenue to support the operation nor visibility when that revenue will return. Downturns such as this also allow companies the opportunity to finally right-size operations which, in decent markets, might have otherwise been tough to do. In a somewhat twisted sense, the downturn allows companies a free pass to take charges and impairments with little push back from investors.
Q1 results as well as Q1 conference call commentary illustrate this point. First, very few investors questioned the operational actions of companies. Rather, everyone is fixated on the path forward. Notably, when is the bottom? When is the recovery? And, what is the slope of the recovery? With respect to facility rationalization, virtually all companies are right-sizing as RNGR, PTEN and HP all cited facility closures. Others such as SLCA have idled mines, some of which, we submit, may not come back while SOI wrote-off its Kingfisher terminal (recall this had been built with a 7 year contract). Sadly, these closures equal job losses, but companies are fighting for survival. We get it.
Right sizing one’s operational footprint isn’t the only thing happening. Oil service capex is being slashed as companies have dropped below maintenance level spend. In downturns, particularly severe ones, we contend most companies will cannibalize assets rather than expend cash. Over the years, we have taken photos to prove our point and we suspect we’ll see this again first-hand when we go to the Permian and Mid-Con this week. Remember, cash is king and every conference call / press release cites each companies actions to cut cost and slow the cash burn. So what does this mean?
Well, we point to a comment by LBRT management on its call. And, by the way, we respect the company’s candor. Specifically, in response to a question about maintenance capex, the company responded, “so, if an engine blows up, we can put that pump on the bench and we can use one of the ones that wasn’t being utilized before.” This strategy makes sense as it illustrates the flex in the system. Why go buy an engine or repair the broken engine now if you have a perfectly capable unit parked against the fence. But, while this makes short-term sense, a prolonged downturn means much of the workable idle capacity may be cannibalized.
For well capitalized companies, needed repairs can be made, but for highly levered franchises, need cash flow for capex might not be available. In other words, the harsh slowdown and ensuing fight for survival will mean the human equation gets evaporated as people leave the industry; equipment will be in really bad shape thus the true “marketed” fleet will likely be overstated; and finally, as companies exit unprofitable regions, the number of service providers remaining in said region will shrink as well.
Ultimately, this scenario is bad for the E&P customer. Why? Because activity will rebound. Reduced completion activity, massive shut-in’s, and a coordinated effort by OPEC+ to cut production are a key solution to solving the supply situation. Meanwhile, demand will recover as economies are slowly starting to re-open. The demand uplift will take time, but think of this backdrop: (1) news of anti-viral meds working helps consumer confidence; (2) each day that passes gets us one day closer to a vaccine which, in turn, raises confidence; (3) COVID death rates don’t seem as high as we originally thought; and (4) there is some debate as to the real death rate (i.e. did the person really die of COVID?). We won’t get into the politics of the COVID crisis, but if the data ultimately shows the virus isn’t as bad as feared, and if people believe they can get treatment when/if they get sick, we submit people will choose to go on living life as opposed to being forced to stay at home. We are seeing this now. Just look at increasing reports of the populous rising up in protest against local/state governments. Some would say these restrictions are infringing on citizens civil liberties. What say you? Lastly, people vote with their wallets and the masses are increasingly out of work. One would think this leads some politicians to lean towards less restrictions. Lastly, when faced with losing everything and potential poverty versus getting sick, we believe most people will take their chances with the virus. We know we would. So, that’s our long-winded rationale which explains why we believe energy demand will return. True, this isn’t an overly scientific analysis, but it’s our opinion and since it’s Saturday night and we have nothing else to do, we felt a calling to convey it. As an FYI, we were at the office on Friday, the first day Texas lifted restrictions. We were pleased to find ourselves in traffic on Beltway 8 as we headed home that afternoon.
Back to our Actions Have Consequences opening statement. This is where we get excited as we see a defensible scenario where demand for OFS activity will rise as E&P’s adjust activity to an improving commodity price market. Case in point, during Q1 earning season, we heard CNX Resources reference potentially picking up a spot frac crew later this year if nat gas prices improve while QEP resources budget shows improving Q4 capex vis-à-vis its expected Q2/Q3 spend. We don’t think their views are any different from other E&P’s. We also point out Precision Drilling commentary which noted some inquiries for rigs later this year in nat gas regions. These are early anecdotes, but they suggest E&P spending will recover in 2021 (albeit we’re not off to the races). The forward curve would argue the recovery should be modest, but the curve is not always right. Importantly, we are in the camp of accelerating activity in 2022 assuming, of course, OPEC+ behaves.
And, if industry activity levels remain depressed for multiple quarters, which seems likely, then our thesis on OFS underinvestment will persist. And, in this same scenario, we will continue to see oil service companies exiting underperforming regions, thus less bidders in certain markets when bidding actually comes back. Moreover, throw in two new dynamics called consolidation and bankruptcies and the collective machination of all these events will be a structurally redefined L48 oil service market. When this happens, E&P’s foot will come off oil service jugular and oil service pricing will have the wherewithal to snap back assertively.
Actions Have Consequences – Part 2. Less long-winded than Part 1, but a practical case study to consider. We estimate there are seven frac companies with capacity still in the Bakken. We would submit maybe three of these companies are running fleets in Q2. One player – Oasis – just shut down its frac operation and those assets are now for sale. If one ascribes to the view that Bakken activity lags other low-cost oily markets, then the eventual recovery may take several quarters. Will those companies with no fleets running really keep the lights on? If so, for how long? Let’s now fast-forward to the scenario where oil prices revert higher and E&P’s need equipment. Will there still be seven Bakken frac companies? What if it’s just three? I think we all know that answer. Frac pricing rallies and rallies hard. Xerox this statement to other hobby basins. In the Mid-Con, we estimate there are nine providers, but roughly half of those operators keep two or less fleets in the region. Is that sufficient scale? Not at current pricing and probably not at 2019 pricing. And, we would submit only two to three of these players are running equipment in the region. Could more facility rationalization could occur in this region? Probably. End result: should market conditions improve, we wonder if sufficient oil service capacity will be able to meet a potential call on demand? For a period of time, probably not.
Oil Service Observations
Pressure Pumping Earnings: Granularity from FTSI and LBRT makes clear to all that E&P’s are essentially in shutdown mode. FTSI, which averaged 16 fleets operating in Q1, expects to average 3-4 fleets in Q2, of which these fleets are expected to generate utilization of 50-60%. In other words, effectively two fleets operating. LBRT meanwhile reduced its staffed fleets from 24 to 12, but management acknowledged its’ working fleet count is in the single digits. We suspect around five. Moreover, the company noted it will likely see utilization slip in May/June. These 70-80% q/q declines, we submit, support our view which is the U.S. working frac fleet bottoms in the vicinity of 50-75 fleets. We hope we are wrong, but leading edge data continues to suggest the SLB activity guidance on its Q1 call is a tad off. Also, we highlight FTSI’s Q2 EBITDA guidance which calls for EBITDA in the negative $13-$15M range. They won’t be alone and the implication is clear – this isn’t sustainable.
Land Driller Commentary: Is a new dawn emerging for land drilling? HP noted it will transition away from providing dayrate commentary to the investment community after this fiscal year (which ends on September 30th). The company, we believe, sees the old dayrate model as antiquated given high quality drillers deliver more value than a dayrate concept confers. This change is driven by HP’s push for more performance based contracts, a concept it alluded to earlier this year. Last quarter, the company reported ~15% of its rig fleet were under this structure, which management sees as a win-win. Simplistically, should HP perform well, it gets a higher rate. The opposite would also hold true. On the call this week, we don’t believe a specific number was quoted; however, management did note it’s a greater percentage given the drop off in its active fleet. The concept involves incorporating HP FlexRig technology along with the utilization of software from the HP Technologies segment. Ideally, the combination leads to an overall lower well cost while also enhancing wellbore placement and quality. For modeling nerds such as ourselves, we will miss the old style disclosure, but we get HP’s point. You want customers to focus on overall value and not just price. Interestingly, however, we sensed some push back to this pricing concept on the Precision call. Management seemed to imply the performance based contracts just give E&P’s more levers to pull in order to get rates lower. We’ll dig into this so if any E&P friends read this note, give us a call so we can hear your views. In terms of activity outlook, HP averaged nearly 190 rigs operating in calendar Q1. It exited March at ~150 rigs and expects to exit June below 70 rigs. We believe included in the 70 count are 10 idle, but contracted rigs. For Precision, it averaged 55 rigs in Q1, but it now has 35 rigs operating. The company sees its U.S. activity bottoming in the low 30’s. If this holds, Precision would likely have the smallest relative decline amongst its public peers. Translation, Precision may have gained market share – something we’ll calculate once all the land drillers report.
Land Rig Outlook: Sometimes it’s good to be wrong. Earlier this month, we stated a view the U.S. land rig count could bottom in the 150-200 range. Based on commentary over the past two weeks, it appears our forecast could be too penal. Specifically, Precision Drilling sees Q2 as the bottom in U.S. activity. It believes its rig count will bottom in the low 30’s. HP noted it will exit Q2 at 70 rigs, of which we believe 10 are idle, but contracted. We’ll call this 60 rigs drilling. PTEN meanwhile stated it could exit Q2 with ~50 rigs working. If Q2 is indeed the bottom and their respective exit rates are correct, this totals ~140 rigs. We suspect that once NBR, UNT, PES, ESI and ICD report, we’ll see the collective count above our range. That’s a good thing and we will be happy to be wrong.
Well Service Commentary: Only one player tied to well servicing has reported and that’s Ranger Energy Services. The company operates one of the newest well service fleets, but even that equipment profile isn’t sparing the company from the current carnage. The company reported a modest 3% q/q decline in rig hours in Q1, but the real hit occurred in April as management noted its April rig hours were down ~53% relative to the Q1 monthly average. This decline, frankly, is not surprising as signs of carnage emerged earlier this month when major E&P’s began releasing workover rigs in size. Also, well service pricing, we believe, is under pressure as some companies we believe are using the receipt of federal PPP revenue to subsidize rig rates, thus some quotes for rig services are disturbingly low. Frankly, any E&P which takes the bid on such pricing needs to reassess their true commitment to ESG as there is no way these companies are adequately making sustainable investment in their equipment or personnel.
Sand / Sand Logistics Commentary: SOI was one of the first companies to publicly call out the impending market crash when management announced on April 7th its view that Q2 activity could be down greater than 50%. Therefore, when the company updated this view this week and stated activity could be down 75-85%, folks should pay attention. This is a smart management team. Moreover, SOI is one of the OFS gems as it generates positive free cash flow and responsibly gives that cash flow back to shareholders. Therefore, when management notes its Q2 EBITDA could potentially be negative, we again take note of just how bad the current market is. As for SLCA, the company is taking action by idling facilities and reducing capacity. Its name plate capacity in Oil and Gas will move to 6M tons from 24M tons. Sand pricing likely moves lower as industry players try to dump inventory for cash (our view).
E&P Observations: Shut in’s and reduced capex were key themes. Both Chevron and Concho are reducing their capex budgets again. Meanwhile, SM announced a 20% cut to its budget. This upcoming week will feature a bunch of E&P announcements. We, however, will be on the road all week, so we’ll recap the most important data points when we return as well as update our E&P capex table then. That said, look for some of our friendly competition who will likely have real-time shut-in tally announcements. This is the discipline the industry needs to see and frankly, we need the shut-in’s to last more than just one or two months.
Weekly Rig Count. Just took our weekly Xanax as we digest another rig count collapse.
As always – no investment advice or stock opinions here in this note. Just our two cents on the business and industry commentary. Apologies in advance if we have typos. We did proof read this time.
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