Q4 Earnings Season kicks off this week with HAL leading the way on Tuesday. These are themes we’ll be looking for over the next few weeks: (1) E&P commentary with respect to free cash flow allocation – we don’t envision publics talking up further activity gains near-term, although some likely do so quietly; (2) Oil Service – go-forward strategy with respect to further equipment reactivations vs. pricing discipline; opportunities to fine-tune one’s business via select asset sales; prospects for M&A ; and (3) opportunities/appetite to tap the capital markets. Other items: ESG/electrification opportunities; prospects for further efficiency gains; hedging philosophies.
Permian Takeaways: Nearly all meetings were with E&P contacts. This included phone calls during our ~1,000 mile drive as well as exchanges over the weekend. The feedback leans neutral-to-positive, but the persistent capital discipline narrative continues to bore us. So here’s the big picture takeaway and this takeaway is not without debate. For public contacts, we were reminded that the budget is the budget. Cash flow generated above the budget will go towards debt reduction or will be returned to shareholders. Again, that doesn’t yield much excitement. As for several of our PE-backed E&P friends, a couple points stood out. First, many were the first to resume activity in 2H’20 so they will now hold steady. Second, in some cases last year, companies were required to hedge production for this year (hedged 2021 in the ~$40’s) so they are not presently enjoying WTI’s run into the low $50’s. Those with hedges in the $40’s could see limited activity gains until such time the hedges expire later this year. They are also a bit more sensitive to potential OFS price increases.
So here’s where we get excited. We visited with several private E&P’s who are stepping up activity, in some cases in a sizable way. One E&P who shut down drilling activity will soon increase its rig count to one and perhaps to two rigs. Wellhead returns are characterized as ~90% vs. ~50-60% pre-COVID. The huge improvement comes primarily from lower completion costs. Next month, another private E&P will pick up two rigs purportedly being sub-leased by a large public E&P while a third private added a rig just this past week. Finally, we know of another E&P who is likely to add an additional four rigs. So while there is chatter about capital discipline/activity restraint, this is not a uniform view.
College Break Father/Son Permian Tour
If we assume the 2021 budget is the budget theme plays true, what lies beyond in 2022 if we live in an all-else being equal world. In other words, assume WTI stays in the low $50’s band and there is no material rise in OFS costs, what happens? We posed this question to multiple contacts. The answer varies, but several contacts allude to a ~20% activity increase to potentially a ~50% increase, where activity is defined as rig count. Clearly, there is a lot of time between now and 2022 and who knows how long the Saudi rational guardianship will persist, but hope springs eternal. Now, on that point, one private E&P claims it will witness a 50% y/y jump in oil production in 2021, in part because its business came to a complete stop in early 2020. Thankfully this is a small player as too many of these anecdotes would be a negative for the improving oil macro picture.
Electric Frac in the News. Lots of positive news coming from the electric frac world. First, U.S. Well Services announced contracts with Range Resources and EQT. The contract for Range will support one fleet while two fleets will be contracted with EQT. Terms of the contracts were not disclosed, but we should point out the EQT contract increases its use of USWS’ technology as the company will expand from one to two fleets. We think EQT is a smart company (not investment advice) so we pay attention to what they do (as well as what they say). The electric news extends beyond USWS as HAL announced its first successful grid-powered fracturing operation. What’s not clear is whether or not the full fleet was powered by grid-power or just a portion of the pumps on location. That’s neither here, nor there as the message is clear – the largest U.S. frac player is making progress with its electric roll-out and it’s probably a safe bet this will continue. You don’t issue a press release if this is a one-off success that’s not expected to continue.
Engine Emissions Profiles Matter. We recently visited with the Cap’n Crunch of our E&P contacts. This is an operations-oriented friend whom we’ve known for many years. During our update, he inquired about the viability of Tier 2 engines, asking whether or not anyone would use them going forward. Now, within our frac company contact network, all are well-schooled on the Tier 2 vs. Tier 4 differences. However, as we visit with E&P friends, their understanding, generally speaking, is not quite as comprehensive. That, however, is changing as the ESG movement gains steam. What caught us by surprise was the matter-of-factness inquiry on his part about the go-forward demand for Tier 2 fleets (presumably by E&P’s). The quick answer is yes. Tier 2 fleets will still have some underlying demand, but we suspect this demand will come from privately-held enterprises who don’t face investor ESG pressures. But industry players should pay attention to this question as it comes from a best-of-breed player who offers dedicated work. As interest in Tier 4, particularly Tier 4 dual fuel grows, this is a potential tight spot vis-à-vis idle capacity and it will, in our view, lead to the bifurcation of the U.S. pressure pumping industry. The comment also suggests frac companies would be wise to invest in new engine technology, particularly if customer selection matters.
OFS Pricing. Some nuggets from our Permian journey. A large E&P player concedes it is working with service providers now on price recovery. Our contact acknowledged there is great value in service companies who can consistently pump 21-22 hours/day, thus it makes little sense to risk that frac provider’s viability. Another E&P contact understands oil service pricing is poised to rise, but has not yet blessed increases to date. Meanwhile, a coiled tubing contact is moving forward with high single-digit increases now. Sub-$30k/day rates for large diameter CT units are not sustainable. Another E&P contact has already witnessed its completion costs rise from Q2’20, but at this point, the company does not see completion costs returning to the pre-COVID prices (at least not this year). Dayrates on its rig remain sub-$16,000, but with Permian rig activity rising, a return to high teen’s seems probable later this year. Basically, the theme from our E&P contacts is clarity with regard to the need for service companies to see some price recovery, but it’s also clear the E&P’s realize sufficient capacity still exists should they wish to pursue a low-bid strategy.
U.S. Land Rig Count. The BKR U.S. land rig count jumped another 13 rigs and now stands at 354 rigs. The largest gain occurred in the Permian which increased 10 rigs to 189 rigs (+66 rigs from the trough). Our Q1’21 forecast called for an average of ~359 rigs. With more than two months to go this quarter and oil prices above $50/bbl, it feels good to know we are likely too conservative. We’ll true up our forecast sometime next month, but safe to say, our comment last week about activity potentially being up ~25% from current levels seems like a reasonable guess at this point. Note, our starting point for this prophesy is 341 rigs which means the target is ~425 rigs.
Permian Frac Crew Count. Locals report ~81 active fleets today in the Permian. The fleets are spread across an estimated 46 E&P companies and 18 frac companies. Per BKR, the Permian rig count stands at 189 rigs, thus a rig/crew ratio of 2.33x. We note our industry friend’s tally highlights roughly 23 E&P’s drilling with at least one rig, but not running any crews. Conversely, the data shows eleven E&P’s running crews, but no rigs.
THRIVE Energy Conference Update. We would like to thank all who provided positive feedback/messages regarding our upcoming THRIVE Energy Conference. Both the working agenda and the conference registration went live earlier this week and thus far, we have ~140 industry executives who have formally registered while just over ~250 participants have accepted the conference invite via LinkedIn. If the latter is you, please fill out the formal registration link. From our standpoint, the feedback is good as we are approaching 400 attendees – don’t worry, we’ll make sure there is plenty of social distancing and we’ll eventually cap attendance.
Separately, we are also encouraged by our growing list of sponsors. You are a huge help, so thank you. Additionally, demand for panel participation is similarly high. Consequently, we will add ~2-3 panels to Friday’s line up, so be on the lookout for the revised agenda sometime later this week. The excitement creates good news/bad news. The good news is the obvious excitement within the industry to get back together again. The bad news is we are severely limited on our welcome reception tickets; therefore, the allocation of these spots from this point forward will have to go to key DEP clients and leading event sponsors. We say this not to look like we are pressing for fees, rather we don’t want to upset those who can’t join as there simply aren’t enough invites to pass around. Just want to let you know where things stand today vs. getting disappointed down the road. If it weren’t for COVID headcount limits, our invite list would be much more robust and we could be more welcoming. With respect to the actual Expo, there is still plenty of availability to attend as we will likely cap that portion of the event to ~1,000 or so folks in order to maximize social distancing.
For those who have not registered for the event, please access the link below.
Next week we will attach an updated agenda along with the committed/registered companies. Hope everyone has a great week. Time to watch the Saints game.