A few observations from the road this week as well as SPN earnings this morning:
- Evidence of Activity Increases. There is hope (or a least a slight glimmer when you squint really hard). Our meetings, both in person and in various update calls, confirm some signs of near-term activity improvement. This by itself isn’t a big surprise as Q1 E&P earnings calls alluded to a 2H’20 improvement, but we were happy to hear of some potential jobs going on the board in June. Specifically, we learned of three private E&P’s looking for completion crews in June/July. This follows an anecdote we learned last week from a private frac company who had inbounds from a customer for some vertical completions. We believe those jobs are being completed this week. Meanwhile, a well service rig contractor reports a slight uptick in rigs deployed within the past few days. Yes, we may be grasping at straws, but we will take whatever good news we can. We should note that not all of our OFS friends see their respective customers coming back in June/July. Most see this as an August/September rebound. What ALL confirm is an active effort by customers to seek new price quotes as they run economics for the eventual activity rebound.
- Sand Company Observations: We conveyed our completion anecdotes to a sand contact. It confirms it too is seeing similar signs having received five inbound calls from E&P’s who self-source – all of whom suggest $35 oil is the price point by which they will resume activity. Thus far, however, the jobs are not on the board, but the customer tone is shifting.
- Public E&P Observations. In the midst of our excitement, we caught up with a public E&P to see how the recent rally in oil prices may be influencing its views on activity. This company rained down on our parade as it will not deviate from its most recently revised budget. Yes, the oil price rallied much faster than it anticipated and yes, the company’s 2020 revised budget contemplated a rebound in 2H’20 activity, but it will not necessarily expedite the remaining spend, nor will it spend in excess of this budget. The good news though is the oil price trajectory would most likely lead this company to increase activity again in 2021. At the same time, FCF will be allocated in a disciplined manner – debt reduction, potential changes in dividend/buyback as well as capex. Remember, many public E&P’s slashed capital returns to shareholders and those eventually need to be put back in place. Further, investors are increasingly enamored with clean balance sheets so companies will take steps to enhance their capital structures.
- Private E&P Views. Not all companies are created equal so no one company’s views on the market should never be applied as a generalization for the entire market. That said, we had the chance to visit with one player who targets conventional work. This company will soon begin bringing back wells which had previously been shut-in, but it does not see any rig additions until $40 oil. Its discussions with banks have been positive with only a modest reduction in its borrowing base. To be fair, the company is purportedly in good shape, perhaps explaining the banks friendly disposition.
- Our Prediction: We are encouraged by anecdotes of customers increasing activity, but we are still early. We would expect private players to react more quickly, in part because public companies can’t change their cautious tone which was recently conveyed on Q1 earnings calls. It would be bad for them to announce major budget cuts to then turn on a dime and start spending money too quickly. That’s the history of this business which is why institutional investors view energy equities as toxic investments. We continue to believe we could see 50+ frac crews return to service before YE assuming, of course, WTI prices remains near $30/bbl. We feel more confident about our prediction given WTI is trading this morning at $34/bbl while the 2021 strip is now high $30’s….let’s hope this trend persists.
- Questions to Consider: On the one hand, we pray for higher activity as the OFS sector desperately needs to generate better returns and we want to see our friends go back to work. On the other hand, we wonder what will happen to the oil macro narrative if activity resumes faster than expected? Will anecdotes of wells being brought back on line pressure oil prices such that we have a head fake? At this point, the activity upticks are largely private E&P’s so perhaps the market won’t care or even pay attention. It will be interesting to see what the big players say, but it will be more interesting to see what they actually do. On this point, we’ll be in Midland next week to gauge leading edge sentiment there. We also question the OFS industry’s approach to equipment reactivation. We suspect many companies will offer favorable pricing in order to win work, but what they should do is raise price and withhold capacity. Perhaps this is wishful thinking, but running equipment at near-breakeven pricing isn’t very smart, particularly for capital intensive businesses. It’s time for industry leaders to act the part.
- Superior Energy Q1 Earnings. SPN reported its Q1 earnings this morning. In keeping with other OFS peers, SPN is embarking on efforts to streamline its cost structure as it announced $115M in savings via wage reductions, furloughs and reductions in force. In addition, the company is reducing 2020 capex to under $50M, a y/y decline of roughly 65%. More importantly, the company announced that its proposed combination with Forbes Energy Services will not come to pass due to capital markets’ disruptions and the COVID crisis. The company still, however, believes in the merits of separating the company’s business lines. For the well service sector, the inability to effect the Forbes/SPN transaction is a bit of a bummer as we were seeing nice progress on the industry’s efforts to consolidate. We would expect more M&A to unfold as this sector really has no chance of material improvement without radically higher pricing, a process which can only occur with less cooks in the kitchen. Think of it this way, today you can get a workover rig with a 4 man crew in the Permian for just under $200 per hour. That’s nearly a $700,000 piece of equipment new and a service which has a relatively high degree of potential safety risk, yet customers still want a $5-10 per hour price cut. Really?