A day late, but hopefully not a dollar short. Apologies for a delayed note, but the DEP team took Easter weekend off to go see the kids and parents with travels this past week taking us first to Midland for three days followed by a three day trip to the University of Virginia. Not quite sure which venue we prefer as our heart bleeds energy, but the college scene certainly brought back fond memories. As for energy-related observations, this note touches on last week’s PXD/Double Eagle transaction while we also share observations from our Midland trip.
More E&P M&A. Another subtle reminder regarding the need for the oil service sector to find a way to consolidate as Pioneer Natural Resources once again stepped into the foray of consolidation via its $6.4B purchase of DoublePoint Energy (i.e. Double Eagle). First, hat’s off to the Double Eagle team, a group who has been exceedingly helpful to DEP, not just as a customer, but also via availability for update meetings during our trips to Midland and Fort Worth. We wish the team well and hope they crush it again with whatever they choose to do next.
The significance of the Double Eagle transaction seems obvious to us. It continues a trend of M&A within the E&P sector as large players such as PXD seek more scale in order to allow operational optimization while at the same time, the transaction yields significant cost savings. In the case of the PXD/Double Eagle deal, advertised savings are $175M per year which includes operational efficiencies, G&A savings and interest expense reduction.
For oil service companies, the onslaught of E&P consolidation should be a concern, particularly as public players buy private players. Vendor lists will be squeezed with legacy relationships with the acquiree likely disappearing. Moreover, in the case of the PXD/Double Eagle transaction, PXD will slow the rate of growth at Double Eagle, reducing its rig count from 7 rigs to 5 rigs. This move is necessary as large E&P’s seek to assuage investor fears by managing production and exhibiting capital discipline. Keep in mind, the fastest growing companies coming out of the Q2’20 trough have been private players, thus the oil service sector needs their zeal (and survival). On this point, when we look at Permian operators today, we still count ~52 private players who collectively run over 70 rigs. Yes, few enjoy the same scale as Double Eagle, but when these companies go from zero to one rig or from one rig to two rigs, that’s a big rate of change improvement and the collective spending power of these companies is a necessary first step for the OFS sector to return to profitability. Should these companies go away and the buyer subsequently reduce spend (i.e. PXD), this would create an unexpected headwind. Further, the inevitability of additional E&P M&A seems probable and is out of the control of the OFS C-suite, just as E&P capex budgets are. Therefore, getting ahead of potential lost customers should be front and center at forward-looking OFS enterprises. One way to do this is to pursue a similar consolidation strategy where asset re-deployment is contained, thereby allowing a better service pricing environment. Again, just as E&P’s seek to contain production growth, OFS companies would be wise to contain asset reactivations.
By the way, while the big news last week was the PXD deal, there were two small deals which were announced/closed. First, Earthstone Energy announced two deals which collectively totaled $127M as it will acquire the assets of Tracker Resource Development as well as interests in other properties. Recall, Earthstone recently purchased the Independence Resources Management assets five months ago for $188M. Second, Surge Energy closed its $420M purchase of producing wells/interests from Grenadier Energy Partners. These small deals sometimes get overlooked when headlines such as COP/CXO, FANG/QEP, CVX/NBL, PXD/PE, etc. seem to pop up about every other week, but these deals have implications as well.
Recap from the Permian. Another successful trip to Midland as our Tuesday reception attracted nearly 75 attendees, the largest showing over the past twelve months. Based on wine consumption, we assume our guests enjoyed the evening soiree. But while we enjoyed catching up with a gaggle of our industry friends, the real purpose of this trip was to learn about new product innovations. Two reasons for this. First, we do not foresee any radical activity changes in the coming months. E&P budgets have been set so uncovering new inflection points right now seems unlikely. In fact, our Midland friends generally concur stability is the order of the day as few see any surge in the Permian frac crew count, which we believe continues to hover in the 90-vicinity. Drilling activity likely bleeds higher with perhaps the most pronounced activity gains occurring in the well service space. In fact, our well service friends are now reporting successful efforts to raise rates with more potentially coming later this year. A return to production work, growth in drillouts as well as higher P&A activity are creating a nice tailwind.
So, with relative stability expected, we would rather use our time to learn about new OFS products, particularly those which could further the ESG narrative. On this point, numerous initiatives across the industry are underway, something we hope to write about more frequently in upcoming notes. Importantly, these ESG initiatives extend well beyond just electric frac technology which has, to date, received the bulk of industry attention.
This week we focused on new monoline and new drilling fluid technologies. We summarize our observations below, but before doing so, however, we want to first state these and future product discussions are not meant to serve as a commercial for those we met even though we know that will be the first impression to some. Rather, these companies graciously allowed us to learn more about their respective initiatives without hiding behind the veil of secrecy. Second, while we appreciate the hospitality of our industry friends, we cannot and will not claim that these products are better than solutions offered by their respective peers. Why? We aren’t qualified to do that and we don’t personally use any of these products. It’s the job of these companies to prove out their product to customers. Nevertheless, we know ESG is a prominent concern for many E&P’s, thus our desire to point out potential solutions which may further one’s ESG goals.
Large Bore Technology. Our Permian tour included a site visit to Liberty’s frac yard where we visited with the large bore operations team as well as their key large bore provider, UTEX Industries. On site we discussed and viewed the UTEX large bore solution. By way of background, we first toured the UTEX Mansfield plant in 2019 where we reviewed the company’s first-generation solution. At that time, our Q&A centered less on ESG as the ESG train hadn’t quite left the station. Now, however, we wanted to see where UTEX was vis-à-vis product development as the company has two years of field trials underneath it. And, before we dive into the UTEX system, we will note several other companies offer large bore solutions, including Forum, Caterpillar/Kemper, SPM Oil & Gas, FMC Technologies, NOV, BEST Flowline Equipment, Trigger Energy, Texas Monoline, among others. There are other companies who simply rent the large bore equipment.
So why switch to large bore systems? First, move times between pads are dramatically reduced, a benefit cited by all manufacturers. In the case of the UTEX/LBRT operations, time to make component connections are reduced to minutes vs. hours. A key reason for this is UTEX’ patent pending Quick Connect technology. While LBRT/UTEX did not specifically quantify actual time savings (presumably for competitive reasons), representations of these reductions, in our assessment, seem material. Consequently, for a frac company who employs these systems for dedicated crews (whether it be a UTEX solution or a peer offering), additional uptime would, in theory, allow more time to frac, thus a positive revenue implication for the pressure pumper. For E&P’s, the efficiency allows the frac provider to move between locations more quickly, thus it speeds up the time to bring wells online. The efficiency gains, as described, were validated by other frac market participants, however, efficiencies don’t address our quest for ESG benefits. On this point, large bore technology such as the UTEX system require less connections which helps minimize potential leaks. In other words, with fewer component parts, there are reduced points of failure. Fewer connections further reduce the number of hammer-swings on rig-up and rig-down, a potential safety benefit. Moreover, the UTEX system employs assisted lifting of major components, a safety benefit. Finally, the belief is the large bore system has a longer life, but given how new the system is, it’s hard to make an official proclamation on this potential virtue, but if true could save money over the long-term.
Frac company feedback is noteworthy. We chatted with multiple contacts about their respective use of large bore systems. We didn’t ask for preferred vendors as that’s not the objective of this note. Rather, we wanted to channel check the purported benefits. On this point, feedback is largely consistent with the advertised benefits messaged from the large bore OEMs. The systems are more efficient, safer and cleaner, but here’s the catch. Frac company investment in large bore technology is limited due to cash flow constraints and excess capacity of existing equipment. While systems are not grossly expense (perhaps ~$1.5M depending on set-up), it has been difficult to date to justify the spend as the technology largely came to market during the past two years, a period when industry returns were depressed. Second, most frac companies have existing inventory of traditional missile systems which still work. Thus, some claim their best return on capital is to use existing equipment inventory, replacing with newer technology once the equipment fails. In doing so, the potential ESG benefits are not being conveyed to the E&P end-user.
So how does the large bore rollout develop? First, industry profitability needs to improve with legacy equipment attrition to materialize. Second, higher pricing or sponsorship of large bore investment would help. Interestingly, in a few isolated cases, frac companies report E&P customers will pay for the large bore system. These E&P’s are name-brand, high-quality players. Separately, some frac companies will simply rent large bore equipment on an “as needed basis” – this helps defer a capital cost, but does elevate the day-to-day operating costs which might hurt in an RFP situation. Last observation – most frac companies with whom we chatted have far less than 50% of their active fleets outfitted with large bore systems, thus this is an area of eventual improvement, particularly given the frac players’ consistent positive feedback and preference for large bore systems.
Drilling Fluids. An interesting new twist on drilling fluids. Drilling fluids, as most readers probably know, are either oil-based (perhaps ~90%) while others are water-based (~10%). The oil-based muds, as described, have a diesel component, which on the surface would seem to conflict with the ESG narrative. Yet, the benefit of oil-based muds is years of proven success – better lubricity vs. water-based muds. But a new green drilling fluid is now being marketed by Wildcat Oil Tools. The company’s Clear FluidTM solution is a polymerized carbohydrate blend which is non-toxic and edible (although we didn’t attempt to try it). Basically, the product is an agricultural-derived solution which purportedly offers the same lubricity characteristics as oil-based muds, but with no harmful ingredients. Further, the company claims the product is priced favorably with oil-based muds and has less costs with disposal. Some E&P’s have shown signs of interest, but many still want to see hard data on others’ wells before committing to use it on their own. Makes sense, but assuming this product works, it would seem a natural substitution to traditional products.
Final disclosure. Yes, all of the companies listed above are clients of DEP. But frankly, most respected OFS and Cap Equipment players are now paying DEP clients (thank you). That, however, is not intended to influence who we see. If you are not a DEP client (or a DEP client) and you have a solution which would help drive the ESG narrative, let us know. We would like to use the coming months to go out and see new solutions which could lift up the industry. Our objective is to highlight, not recommend, new solutions. It is your responsibility to prove it out to customers and deliver on the advertised benefits.
U.S. Rig Count. Further gains again this week as the U.S. land rig count (per BKR) rose 11 rigs to 416 rigs. For Q1, the BKR land rig count gained ~81 rigs and improved 27% q/q. We continue to see the rig count rising to the ~500 level by year-end 2021 and potentially jumping to ~600 rigs during Q1’22 should the CY’22 strip stay in the $55/bbl range.
Upcoming Events. We had some last minute cancellations for Wednesday’s golf outing. If you would like to play, let me know. Event is this Wednesday (April 7th) at Kingwood Country Club. On Sunday, we fly to the Bakken where we will look at new sand logistics technology. If you have an innovative design and have something in the Bakken/PRB and would be willing to let us stop by, let us know.
New Permian Frac Company. Local contact reports a new company will enter the basin with two frac spreads. This equipment was purchased several months ago (at least) from a vertically integrated E&P. At that time, we were under the impression (and reported) the equipment would go to the Eagle Ford, but it would appear it is now destined for the Permian. Not precisely sure when the equipment will go to work, but contacts claim it could be soon. Stay tuned.
As always, no stock recommendations or investment advice intended from this note….good luck out there….JD