1.31.21 – DEP Industry Observations: OFS Anecdotes, Rig Count Rises Again, Q4 Earnings, THRIVE Update.

A long note so grab your preferred beverage and read on.

Federal Lands Anecdotes:  Not trying to get political in our weekly epistle, but a well service contact reports rigs being released this week from work on Federal lands.  These were production rigs, not completion rigs, but frankly the suspension of permits shouldn’t matter for either of those, at least not yet.  So why did this happen?  Not sure, but here’s a thought.  Remember Top Gun when Maverick employed hand signals to communicate with the Russian MiG pilot during their inverted 4G dive?  What if the E&P who released the rigs decided to communicate in a similar fashion to the Governor of New Mexico?  One way to have a more immediate impact on oil and natural gas production tax revenues might just be to shut-in production proactively.  Separately, land drilling contacts tell us at least one E&P is preparing to move rigs from New Mexico acreage back to company owned acreage in Texas, perhaps an effort to avoid potential future hassles with an energy unfriendly state.  We don’t really know why.  We also assume these field observations are correct, but if true, as we like to say – actions have consequences.

Sand Observations: Recent pricing anecdotes are encouraging but hardly great.  One regional contact reports Q4 pricing averaged ~$14/ton, but leading edge has bled higher to $19-$21/ton depending on grade.  Trucking services are tightening with driver loyalty fading as drivers are quick to jump ship for higher wages.  Demand feels better, but confidence levels are low.  Financial distress within sand is a well-established fact, but so too is deferred maintenance.  In fact, one sand logistics company reports multiple maintenance related issues with select in-basin mines developed within the past few weeks, impacting several mines ability to deliver on sand commitments (perhaps the cause of the recent price creep).  Yet, according to one contact, current leading-edge pricing is not sufficient to justify major repairs / reactivations.  Here’s an observation from one contact. A regional mine could double its capacity by reactivating an idle line but doing so would require the hiring of 50+ people.  That’s a big step to take, particularly if you are unsure about the duration of productive capacity.  If multiple parties decide to take this approach and boost production, history tells us sand prices will fall right back to break-even levels barring a surge in demand.  To that point, there are no real signs industry activity is poised to inflect materially higher, therefore, the wise move would be to do nothing and let prices bleed higher.  But wise is not typically the right descriptive word for oil service as market share growth historically trumps returns.  That said, one contact sees the time necessary to reactivate as ~12 weeks, thus suggesting recent price upticks may have some stickiness this quarter.  With regards to Q4 volumes, we anticipate decent percentage increases with one player indicating q/q volumes in Q4 were up north of 40% q/q.  This makes sense given the rise in frac crews plus volume gains are coming off a low base.

Pressure Pumping Observations: Inflationary input costs are requiring pass through’s to E&P end-users.  Several frac contacts have witnessed increases in chemical costs, trucking rates and fluid ends.  Some contend the rise in chemical costs, as much as +15-20%, may be attributed to select large chemical companies attempting to bypass service companies and sell direct to E&P’s.  With respect to trucking costs, multiple contacts – both sand and frac – now see a tightness in drivers.  Just reviewing Linkedin this weekend, we noticed one logistics provider now offering $1,000 sign-on bonuses.  This is a good way to attract drivers from competitors, but it is also a good way to drive up labor rates.  As for fluid ends, during the dark days of Q2/Q3, fluid end OEMs were dumping inventory to generate cash.  Those inventories, we presume, are dwindling thus pricing for fluid ends is now on the rise – at least for one active frac participant.

We also dug deeper into Tier 4 DGB / dual fuel considerations.  One player reports the cost for a fleet transition to Tier 4 dual fuel will run close to $5M.  Interest in this technology by E&P company varies.  In one case a customer is paying a ~10% premium to the pumping rate in order to secure the dual fuel solution.  In another case, a public company’s E&P’s field team inquired about Tier 4 dual fuel availability/conversion but upon hearing the premium rate, the c-suite of the E&P purportedly pushed back as well cost and completion efficiency still trump ESG.   We think this is the reality of ESG.  Some buy-in completely while others prefer to talk the talk but haven’t quite committed to walk the walk.

New Electric Designs:  Freemyer Industrial announced on Friday the creation of a new division within the company called REDEEM GREEN.  The announcement indicates Freemyer has developed an affordable EFRAC system.  We will look for more equipment specificity in the coming weeks, but the announcement is important as it is further validation that industry leaders recognize the growing ESG mandates and will design equipment to reduce GHG emissions.  One item of interest with Freemyer’s announcement is the intent to manufacture Green equipment beyond just the frac spread as the company has designs for the cementing, workover and drilling markets.

Land Rig Observations:  Modest optimism still percolating as updates with six private land drillers points to continued rig inquiries as well as expectations for a higher rig count.  Our contacts collectively expect a minimum increase of 4 rigs over the next 2 months and potentially as many as 14 rigs between now and early Q1.  The low end represents about a 7% increase over their collective working rig counts today while the high end would represent a ~26% improvement.  Let’s be conservative and go with the ~7% increase.  In that scenario and assuming one would allow us to extrapolate this to the entire U.S. rig count, the result would imply the BKR rig count exits Q1 at ~391 rigs.  For those more generous and glass half-full, the high end would suggest the rig count moves closer to ~450 rigs during Q2.  As there is some risk to double counting E&P inquiries with the high-end scenario, we contend a reasonable exit rate for Q1 should be around 400 rigs.

Pricing anecdotes are largely consistent with feedback gleaned in December.  Leading edge dayrates remain in the mid-teen’s.  This round of updates yielded feedback of upgraded SCR rigs garnering rates in the $14k vicinity.  Rigs outfitted with an extra engine/mud pump typically receive an extra $1k/day.  One contact did note a top tier rig going back to work with a rate in the high-teen’s.  None of our contacts see dayrates breaking $20,000/day in 2021.  Demand simply isn’t strong enough while too much supply exists.

In the category of FWIW, one large E&P has an RFP out for rigs in the Permian.  The company is seeking bids with multiple durations: (1) pad to pad; (2) six months; (3) one-year and (4) two-years.  Drilling contacts generally prefer not to win a two-year contract now given low dayrates.  Most remain optimistic the current recovery will bleed into 2022 and pricing will migrate higher.  Therefore, several want to keep rigs running on short-term projects so that hot rigs can reprice higher should conditions improve.

BKR U.S. Land Rig Count:  Up another 6 rigs this past week to 365 rigs.  Quick breakdown of current rig count by basin relative to the August 2020 low.

Source: BKR

E&P Capex Observations:  A few budget announcements which further validate rising spending relative to Q3/Q4 levels.  This, by the way, should not come as a surprise.  We’ve been preaching this for weeks, but the anecdotes are worth following.

• HES announced its 2021 budget.  For our purposes, we’ll focus just on its Bakken spend.  For 2021, HES will spend $450M in the Bakken.  In Q3’20, HES spent $86M in the Bakken, or $344M annualized.  Therefore, the 2021 budget relative to the annualized Q3 spend represents a 30% improvement.  The company increased its drilling rig count to two rigs from one rig.

• Enerplus Corporation announced its 2021 plans in concert with its announced acquisition of Bruin E&P HoldCo.   Enerplus, on a stand-alone basis, expects to spend $300M in 2021.  During Q4, the company spent $52M or $208M annualized.  In other words, the 2021 spend relative to the most recent run rate represents a 44% improvement.  Enerplus will pay $465M for the Bruin business.

• CNX Resources will spend $430M-$470M in 2021.  This compares to $487M in 2020, although Q4 spend came in at $92M or $368M annualized.  The increase relative to the Q4 run rate is roughly $82M at the mid-point, or +22%.  The company, we believe, will run an average of one drilling rig and one frac crew during 2021.  Priorities for CNX remain FCF which will be directed largely towards debt reduction.  During 2020, for example, CNX reduced net debt by over $300M although in Q4 CNX also repurchased ~$43M of its common stock.

• Murphy announced its 2021 capex budget which will total $675-$725M.  This compares to 2020 capex of $760M.  Within the company’s Eagle Ford operations, MUR spent $197M in 2020 which included the completion of 25 operated wells.  Our sense is Q4 Eagle Ford capex was minimal as MUR’s Q3 results implied that all of the 25 operated wells were completed during the first nine months and the company’s DUC balance was essentially the same at the end of Q3/Q4.   For 2021, the Eagle Ford will receive $170M of capex. The company’s IR slide deck highlights the bulk of the Eagle Ford completion activity will occur in Q1 with a tad less in Q2.  It would appear there will be no Eagle Ford wells brought on-line in 2H’21.  Finally, Murphy’s long-term plan calls to total company capex of $600M/year as FCF remains a priority for the company.

• Bonanza Creek.  Provided an operational update as well as some 2021 metrics.  Notably, the company will spend $35-$40M in Q1’21, up from $3.2M spent in Q4’20.  Our read of the press release suggests completion activity will be 1H weighted as BCEI plans to complete 30 wells from January through late Q2.

THRIVE Energy Conference Update:  Conference planning and registrations are both progressing well.  Today, there are over 360 confirmed conference registrations. There are another 383 folks who accepted the THRIVE LinkedIn conference invite, many of whom have yet to complete the formal registration process.  If that’s you, please register or you won’t get in.  Sponsoring companies now exceed 45, a number we expect will grow slightly in the coming two weeks.

A common question remains our COVID protocols.  Many inquire whether some companies have declined citing COVID as the reason.  With respect to the latter, the truthful answer is yes.  There are several companies who tell us current corporate policies prohibit their participation in the event.  We understand this position.  We also appreciate their candor.  That said, we have individuals representing nearly 200 companies now registered for the conference.  We expect this number will grow.

As we assess corporate behavior from the DEP cheap seats, we see companies beginning the pandemic thawing process.  As recently as four weeks ago, a few contacts told us their participation was unlikely, but now these contacts are signing up – some as sponsors.  We take this change as an easing of restrictions.  To be fair, however, there are a bunch of companies who are MIA and appear to be avoiding DEP entirely.  Perhaps this is because we are perceived as annoying.  Or maybe they simply don’t like us.  Perhaps it could be due to COVID travel restrictions.  We don’t know, but it’s probably some combination of all the above.  Nevertheless, the feeling we sense is the beginning of an industry pivot/desire to return to some normalcy.

As for our COVID protocols, here they are:

• We will require attendees to fill out a COVID questionnaire.
• There will be temperature checks at the door.
• We will require face masks.
• We will only allow a small group into the actual live conference in order to maximize social distancing.
• We will have TV’s throughout the stadium broadcasting the panels so folks can sit in the stands and watch the panels.
• We have ~25 luxury suites which we can be sponsored such that your team can watch the panels in a smaller setting.
• We instructed Minute Maid Park to keep the roof open, thus an outdoor event.  Bring a coat.
• We will serve tequila (Flecha Azul).
• We will have hand sanitizer stations throughout the stadium.
• We will limit THRIVE to no more than 1,000 attendees, which is roughly 2.5% of stadium capacity (not everyone will show up each day, thus effective capacity is less)
• We can’t eliminate all potential COVID risks, but we will do the best we can to spread folks out safely.  Don’t sue us if you get sick.
• Lastly, we watch closely the Texas Medical Center COVID reporting data.  While we are not out of the woods, we are encouraged to see positivity rates falling the past two weeks as the rate stood at 11.2% on Friday, down from ~15% nearly a month ago.  It is also good to see vaccinations on the rise as the TMC has performed 292,000 first doses so far.  This number is rising at about 10,000 per day.
• Look for another invite email blast this week.  We’ll send this out once a week for another two weeks and then we close registration on February 18^th.

RPC Inc. Earnings:  Constructive, but realistic call from RPC.  Quick Q4 highlights.  Revenue improved 27% sequentially with adjusted EBITDA moving into positive territory.  Q4 adjusted EBITDA totaled $8M, up from negative $12M in Q3.  Cash declined q/q but remains at a healthy $84M while RPC has no debt.  Conservatism continues to rule the day.  The 2021 capex budget will be flat y/y at $55M, essentially all maintenance.  The company averaged five fleets during both Q3/Q4 and remains at five fleets today.  Management noted higher pricing/returns necessary to reactivate more capacity.  Smart.   Q1 revenue growth guided up in the high single digits.  Management acknowledged some efforts by peers to test pricing, but RPC hasn’t seen any yet.  The company is converting some equipment to dual fuel and expects to exit Q1 with 50 dual fuel pumps.   The company sold its Wisconsin sand mine.  We will inquire about terms of sale and seek to learn more about the buyer.

Core Laboratories Earnings:  FCF generation and balance sheet augmentation remain near-term priorities for CLB.  During 2020, CLB generated free cash flow of $46M, allowing the company to improve its net debt position by $49M.  Like other OFS enterprises, CLB witnessed strong q/q improvement with its North American operations, largely product sales within Production Enhancement.  The company’s U.S. land energetic product sales witnessed a 65% q/q improvement.  International, meanwhile, is expected to see a seasonal decline in Q1, but improve thereafter.  Recall, CLB generates ~70% of its revenue from international markets.  One thing which stands out to us in the CLB results/commentary is the company’s projects which are focused on CO2 injection projects for both carbon capture and sequestration.  It’s not clear what these carbon capture projects generate from a P&L standpoint, but with more and more companies positioning to be net carbon neutral, it would seem CLB’s solutions could see rising demand.  We’ll dig into this more post earnings.

Valero Energy Earnings: VLO  hosted Q4 earnings call last week and we put together a few bullets from the call.  VLO believes the demand recovery will happen faster with worldwide vaccines, which is similar to our view.   I thought VLO’s commentary on the call about diesel demand holding up better during the pandemic is not only consistent with what the DOEs are showing, but a sign the stimulus continues to support the economy.   While VLO believes EV’s have a place in the market, their comments around the number of EV’s sold globally is eye opening and will likely continue to be a controversial topic in the years ahead.

Phillips 66 Earnings: PSX hosted Q4 earnings call last week and we put together a few bullets from the call.  What is PSX doing to navigate the current environment?  Near term: building renewables fuel pathway with major SFO facility conversion to be completed by 2024 and Humber in UK.   Renewables should generate $1B in EBITDA.  Medium term: working on batteries as supplier of specialty graphite and hope to help improve battery performance.  Long Term: hydrogen, but moving into transportation fuels in big way is probably decades out.  Refining utilization recovery all starts with vaccines and people getting back to normal driving.  PSX is constructive chemicals as demand is strong in China/Europe and NAM.   Chemical demand did not wane as much as consumables did not crater.  PSX FY21 Capex guide is $1.7B, which is below recent years.  PSX enjoys a diversified portfolio which is important in the current environment.

General Electric: Earnings guide of 15-25c and FCF in the range of $2.5B to $4.5B in 2021. The wide range on FCF is primarily a result of the uncertainty around Aviation.   Expect a continued reduction of BKR dividends, which represented more than $250MM of cash flow in 2020. Aviation clearly a big drag at GE and will be closely watched in 21’ . GE expects commercial aviation departures in Q1’21 will be similar to 4Q’20, but sees improvement in 2H’21.  Aftermarket in aviation will lag departure trends across regions and fleets.  Fewer aircraft retired in 2020 than 2019, but GE thinks retirements will be higher in 2021.  GE had some major project launches in 2020 with Haliade-X wind turbine and the GE9X, both are believed to be leaders in power output and efficiency.