This weekend our epistle largely focuses on DEP’s recent NYC/Boston marketing trip. We’ll return to more industry observations next weekend. As for upcoming events/travel, the DEP Christmas party is on Tuesday in Houston. If you join us, please consider taking Uber. The week of December 13th, we’ll be back in the Permian to cook BBQ for the kids/staff at the Bynum School on December 14th. Bringing my bride on this trip, so come out so she thinks I have friends. Lastly, the week of December 20th we hope to hit ETX for the annual father/son oilfield Christmas Tour.
Investor Marketing Takeaways: This past week we spent five days visiting institutional investors in New York City and Boston. Notwithstanding Omicron and anemic energy weightings, the schedule was relatively strong, although not quite the go-go days of 2008-2014. That said, interest levels appear to be growing, although we didn’t sense a rush to own OFS just yet. Rather, investors remain comfortable with their E&P positions. Also, the client mix included both equity, credit and private equity investors as well as an equal balance between long-only and hedge funds.
The following are several of the key themes/questions.
- OFS vs. E&P: No discernible change in sentiment vis-à-vis E&P and OFS. Investors still want free cash flow and positive returns. Unfortunately, most OFS names don’t pass that test. Further, the shear lack of OFS names with sufficient trading liquidity/market capitalization further alienates some clients. However, investors are beginning to pay attention to leading edge pricing anecdotes, although all ask what the true net pricing is (we don’t know quite yet). Some wonder how the leading-edge anecdotes compare relative to consensus expectations. There is a view by some that with diminished sell-side OFS coverage, including the juniorization of the research community as well as a growing chorus of analysts who split time between various segments, the focus on individual company models might not be as good as years ago. Therefore, does the blend of lack of experience and/or lack of focus create the right backdrop for an emerging beat-and-raise market. And if so, is that the catalyst needed to elevate OFS names? Some think so, but others remain in the camp the OFS sector needs to generate sustainable FCF. Notably, one smart long-only client sees leading edge positive OFS data points today as exceedingly bullish while other smart clients are more comfortable sticking with E&P given their high FCF yields.
- OFS Capital Discipline: Notwithstanding the growing list of positive pricing anecdotes, as well as the emergence of OFS M&A activity, a recurring question/concern is the perceived lack of FCF within many OFS enterprises. Investors all foresee a continued activity ramp. Factor in higher pricing and the combination clearly leads to higher ’22 EBITDA. However, will continued equipment reactivation costs, higher maintenance capex and potentially incremental growth capex rob shareholders of FCF? That’s a big question with investors in multiple meetings pointing to recent surprise capex announcement by one OFS player which translated into weak relative stock price performance. Others are weary of potential frac newbuild efforts and the impact to the frac sector just as pricing is beginning to inflect higher. Lastly, while new OFS start-up anecdotes are minimal thus far, the few examples which exist give some investors reason to pause as these new companies appear to validate the low barrier to entry perception associated with most OFS segments.
- 2023 E&P Capital Spending. One theme which came up in many meetings is the what if scenario should all OPEC barrels return to the market in 2022 and there is then a call on U.S. Shale in 2023. In such a scenario, should U.S. E&P companies flex the capex muscle and hit the drill-bit? Or, should discipline remain the order of the day? Buyside clients have clearly embraced improving dividend payouts, but some openly wonder how the broader investment community will react to growing capex budgets. A bit of a hypothetical discussion as DEP doesn’t model E&P’s but it would seem to us there could be a best of both worlds in this scenario as higher capex would, in theory, eventually lead to greater cash flow should commodity prices remain elevated. To state the obvious, no one really knows precisely what will happen in 2023, but we sense investors would embrace a modicum of growth. For OFS, that’s a good thing as it means activity could ramp further in 2023.
- Private Equity: Visited with smart PE folks who have long history in traditional upstream energy. Like so many others, this team is making the switch to Energy Transition names. Still involved with legacy positions, however, but not actively looking to invest in OFS today. Contacts still see a long tail for traditional energy, but the concern surrounds a couple key points: (1) terminal value of a new investment and (2) lack of interest by investors to invest in a traditional upstream fund.
Sand Market Thoughts: Continued signs of tightening in the sand market. This week we received unsolicited inquiries/observations on the sand market from both E&P and frac company contacts. The nature of these inquiries led us to make some calls to sand friends. First, we have additional anecdotes of in-basin sand prices moving higher. One Eagle Ford sand contact confirms sand is being contracted in the $30+/ton realm while Permian sand contacts report contracted sales in the $20-$22/ton range. One regional player’s CEO shared his recent internal mandate to salespeople which is to drive prices higher with hopes of up to another +20% increase during 2022. The CEO believes it’s time for his business to make money and that all benefits/profits of an improving oil macro shouldn’t just be to the benefit of the E&P customer. Moreover, the contact contends some lost market share at the expense of higher profits is the right decision. Folks can agree to disagree with this strategy while time will tell if this actually occurs, but the bigger theme is a message which is consistent to the refrain we’ve been reporting for months. Specifically, there is a desire by many company execs to address the current disparity between customer and service provider. Separately, we had a frac company in the Northeast share frustrations over sand availability, thus one would assume regional prices there could be going higher (we don’t have specific price anecdotes yet).
The issue, according to some mines, is two-fold. First, maintenance practices at mines in recent quarters have not been ideal due to sustained weak profitability. Second, the shift to simulfrac is creating an added stress on both the sand mine as well as the logistics provider. These stresses can lead to shortages according to sand contacts. As for the longevity of the price gains, mixed views from sand contacts. Some contend improving financial results will lead to increased capacity/throughput while others see a tight market in both the short-and-medium term. What likely happens, however, is a shift by E&P players to reduce sand costs, thus we would not be surprised to see more E&P companies shift to wet sand and/or evaluate mini-mines.
OFS M&A: Transaction in the OFS capital equipment space announced this week as Lee Specialties will combine with Nexus Energy Technologies, becoming NXL Technologies. The transaction brings together expertise in the wireline market and the coiled tubing pressure control market. Moreover, the new enterprise will have greater scale and presumably should be able to achieve some degree of cost synergies. No transaction terms were provided.
BKR U.S. Land Rig Count: +2 rigs to 554 rigs – all gains in the Permian.