DEP Upcoming Events: We return to the Permian tomorrow for a three-day tour. This trip will include a thank you reception for DEP subscribers and supporters – we have a few open seats, so let us know if you are in town. On December 9th, DEP will host its annual BBQ Christmas Social in Houston and then we’ll head to Fort Worth for our semi-annual golf outing on December 15th (still several spots open). From there, we’ll drive north to Oklahoma for a three-day father/son Christmas Break oilfield tour. This trip may include the full brood of kids as twin sister is in trouble for two motor vehicle violations/tickets yesterday. One must work to repay dad for these tickets.
DEP Thank You. As a small firm, we take all assistance and donations. This weekend we were blessed to receive some office furniture, a donation from Ranger Energy Services. We thank the Ranger team for helping us out as we prepare to open the first DEP office next month. Separately, for those who have not yet signed up for a DEP subscription, we would be grateful for your support as well. Lots of good events being planned for DEP patrons next year.
Bakken/PRB Tour. We just returned from a three-day Bakken/PRB tour which included visits through Williston and Gillette. Mood in the region is a bit better than what we experienced during our last trip in June. Different this time was a greater COVID-related concern as surging cases in the region have resulted in multiple COVID-related work disruptions. All of these COVID incidents have occurred within the past 1-2 weeks. For example, one completions-oriented contact pointed to a recent frac job which was suspended by the large Independent due to a localized COVID break-out. In another case, a well service company reports roughly ~25% of its rigs in the region were shut down recently due to COVID. Not all of the companies with whom we visited have experienced job shutdowns yet, but regional caseloads are rising.
One comment we found interesting is an apparent effort by some employees to use COVID as an excuse to get out of work. According to one company, it reports rotational employees who arrive into the Bakken who then claim to have been near/exposed to a COVID victim. Per this company, CDC guidelines call for such an individual to go into quarantine. If this occurs, the employee is apparently entitled to his/her pay. This then leads to another question – what do you do with the employee? Do you keep this person in the region and put them into a hotel? This adds even more cost, something an OFS company with weak margins can ill-afford. On the other hand, do you send a potentially high-risk person back home and if so, how do they get there? For some companies, this isn’t an issue as they have man-camps where employees can isolate, but for those who don’t, the COVID situation, including how to deal with employees, creates an interesting dilemma.
But while the COVID flare up could lead to more job disruptions and perhaps be a talking point on Q4 earnings calls, the overall mood is a tad more upbeat as utilization is picking up. One well service company reports its Bakken fleet utilization will soon be at ~70% while another well service company’s working fleet has more than doubled since the April/May trough. In fact, numerous workover rigs (such as the one below) could be seen working on the drive around Williston, down through Watford City and onto Dickinson.
Near-Term Activity Outlook. Consistent refrain from locals. October was good while November and December should be flat-to-up. There is less concern about a sharp holiday slowdown this year, in part due to near-term government stimulus which is expected to support activity (see below). Beyond Q4, there is a general view about a potential lull in January/February activity given a rush to get DUC’s completed in 2H’20 and the lack of any sharp uptick in localized drilling activity (Wyoming rig count at 3 rigs per BKR vs. Q1’20 average of ~22 rigs while North Dakota rig count at 11 rigs vs. Q1’20 average of ~50 rigs). In fact, we visited with a local land drilling contact who sees regional drilling activity holding relatively stable over the next few months as some E&P customers claim a desire to see ~$45+ oil before commencing new drilling operations. Also, local contacts claim January/February are generally slow for seasonal reasons as operations tend to be less efficient due to weather-related factors and this tends to drive up well costs.
Near Term Pricing Strategy. In each of our meetings, we inquired about current pricing trends. For our completions-oriented contacts, pricing is generally characterized as weak, but stable. One contact reports a ~43% decline in pricing since the end of 2019. For our well service friends, pricing is weak and in some cases, still bleeding lower. The big frustration remains the fragmented U.S. market with no company seemingly willing to show price discipline. As for when companies intend to raise rates, we had one company opine that a potential “relief” increase could be forthcoming in late Q1, but overall most contacts see no pricing opportunities. These field opinions matter as more often than not these individuals are closest to the customer, thus they have a good sense when it is the right time to press pricing.
Government Stimulus Helping Activity. In both Wyoming and North Dakota, there are two programs geared towards supporting upstream activity. In North Dakota, there is ~$16M of CARES Act funding which will be granted to E&P’s who complete wells. Our understanding is the grant is for $200,000 per well, up to 80 wells. Local contacts report requests for nearly 92 wells have been received thus far. The funding will offset well completion costs and we believe must be used by YE’20. In Wyoming, the Governor announced last week that the state will use $15M of CARES Act funds to create the Energy Rebound Program. This plan makes operators eligible for up to $500,000 for the following purposes: (1) completing DUCs; (2) re-fracs and/or (3) P&A work. Every little bit helps.
OFS Capex Outlook. We updated our capex table for a select group of ~24 OFS companies. The table below tracks historical capex as well as an estimate for this year and the Q3 annualized capex spend. No surprise, OFS companies slammed the brakes on equipment upgrades/expansion this year as 2020 OFS capex is likely down ~50% y/y. If one wanted to take a more extreme view, the Q3 annualized spend is tracking ~30% below our 2020 estimated capex, but is closer to ~65% below what was spent in 2019. To be fair, we see OFS capex bleeding higher (relative to Q3) now that field activity is rising. Furthermore, there are select companies such as NEX and RES who tweaked 2020 spending plans higher as these companies pursue fleet upgrades and/or select fleet expansion endeavors. The increases announced in Q3, however, are minimal.
In a research piece published months ago, we noted the sad reality that actions have consequences. This, we submit, will become more evident should an activity upswing materialize with consequence. The OFS industry’s lack of proper reinvestment could restrain its ability to quickly meet demand and/or will weigh on margins as a recovery unfolds. For example, as we move into Q4/Q1, look for more references to “reactivation” costs. Case in point, LBRT incurred ~$6M of fleet reactivation costs in Q3. We’re sure others did as well, but not all of these companies called out the expense.
When reviewing the chart below, we should point out the obvious which is in an environment of minimal activity, one’s capital spend should naturally go down as less equipment running means less need for equipment repairs. But, when one considers the EBITDA breakeven profitability metrics for a basket of OFS companies, it’s also worth considering some of them may not have the wherewithal to properly reinvest in their fleets, a key reason we incessantly bark about the need for higher OFS pricing. Call it an ESG thing as we think providing (and paying for) safe equipment makes for good governance as well as classifies a socially responsible thing to do.
Source: Company releases, SEC Filings, DEP estimates
BKR U.S. Land Rig Count. Up again. This past week the U.S. land rig count increased 11 rigs to 297 rigs. The rig count is up ~66 rigs from the trough or +29%. Presently, the rig count is tracking up ~19% q/q. Our Q4 forecast for an average of ~277 rigs is going to prove too light (thankfully). For Q1, we estimate an average of 330 rigs.
THRIVE Energy Conference. We have rebranded our inaugural Houston Energy Conference & Expo as the THRIVE Energy Conference. This invite-only trade show / conference will be held at Minute Maid Park on February 25-26, 2021. This past week we sent out the sponsorship and exhibit brochures. If you did not receive these marketing materials and would like to receive them, please shoot me an email. We aim to make this the best boutique trade show for the upstream energy community. In early December, we will circulate the conference agenda, but already we are pleased to have received strong support from many industry leaders who will make themselves available to present at our event.
Q3 Earnings Takeaways:
OXY: Company noted it would pick up 4 rigs in the Permian during Q4, taking the company’s total rig count to 7 rigs. The Q3 earnings presentation also cited a Q4 capex plan of $500M to $700M with total 2020 capex likely to range in the $2.4B to $2.6B range. Recall from last week’s DEP note, we expressed some optimism as we looked at 2H’20 annualized spend relative to select companies’ announced preliminary 2021 plan and/or their sustaining capex estimate. In both cases, the simple math suggested a decent uptick in spending relative to the current spend rate. OXY fits this example well as the annualized Q4 spend is ~$2.0B to $2.8B. The company announced a 2021 sustaining capex of ~$2.9B. If one simply takes the mid-point of Q4 annualized (i.e. $2.4B) then the 2021 sustaining capex spend of $2.9B represents a ~15% improvement. Also, we note that OXY’s 2020 capex for midstream, marketing and corporate is roughly $200M. We wonder how much of this spend will be required in 2021 if the objective is to maintain flat production vis-à-vis the Q4’20 run rate.
SND: Had a chance to look at a sell-side note on SND. One thing which jumped out to us was the analyst’s description of the U.S. shale market as structurally impaired, a key reason for the firm’s low rating on SND shares. Now, as all loyal DEP readers know, this is not investment research and the following is not an investment opinion, but what we find interesting is one can make a “structurally impaired” claim, but not give credit to a company which is trying to address the industry’s structural challenges. In the case of SND, it took advantage of the depressed market to acquire the assets of a competitor. Notably, during Q3 Smart Sand made an opportunistic purchase of Eagle Materials sand assets. This purchase was made at a tremendous discount relative to the actual construction costs of the acquired properties. Time will tell how this deal will play out, but the purchase did give SND access to the BNSF, another pipeline by which it can deploy its sand production. Even more important, in our view, is the transaction eliminated a competitor. On this point, the abundance of competition within virtually every OFS service line, coupled with depressed E&P capital spending, are the key reasons why the OFS sector remains such a tough place to operate. That said, industry leaders sometimes need to make defensive deals and we commend SND for showing that initiative. In fact, a quick way for the industry to change investor perception regarding its apparent “structurally impaired” status is to consolidate. Not consolidating might lead to bankruptcies and/or restructurings, but as we have seen, most bankruptcies simply yield the exact same company that happens to have less debt. Alternatively, letting companies go under and then auctioning off capacity might just end up creating even more competition. We’ll see this week if that’s the case as a bunch of BJS equipment goes to auction in Odessa on Tuesday/Wednesday. Notwithstanding the sell-side note which struck a nerve, we should point out SND’s Q4 guidance which calls for q/q volume increases of 10-20%. That rate of growth is directionally consistent with guidance from other OFS enterprises as well as the rig count trajectory noted above.