The past five years have been terrible for OFS and exceptionally painful for investors that have been persistently long the sector. The macro backdrop for OFS has become increasingly tenuous, such that more factors need to cooperate to sustain a modest upcycle. Whereas E&Ps previously would reliably outspend budgets by +20%, they are now more inclined to abruptly stopping work programs prior to year-end. In the current paradigm, we acknowledge that minor differences in macro views or time horizons can nullify broader stock calls, and are conscientious that a rising proportion of OFS observers are now market neutral. With this in mind, we are introducing a periodical tailored towards shorter timeframes and more actionable calls that may not necessarily mesh with our longer-term theses. In this report, we detail our thoughts for why we believe SLB is primed to outperform HAL into 3Q earnings, and also rehash our thesis for why we prefer HAL to SLB longer-term.
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Yesterday’s (09/17/19) messaging from officials close to the supply disruption in Saudi would suggest a more expedited resolution than had previously been captured in the energy market “spike” earlier in the week. Wolfe Energy team reaction contemplated the go-forward risk premium that should be captured in crude prices, and it appears that oil has settled about $3-4/bbl higher than it was before the disruption – Sam Margolin further noted that heightened US exports could keep the Brent-WTI diff in check, and we are curious to see how a potential spot-shift in supply could impact US inventories. Trading-wise, oil beta OFS/E&P names generally outperformed in an otherwise volatile two days of trading, and higher short interest (specifically) saw the biggest bid. The key take from the OFS perspective (color from Silverstein’s E&P Armageddon webcast) is that upstream operations were minimally disrupted in country (and all employees safe and accounted for), but we see logistical/administrative frictions during & following the outage as potentially negative for both project start-ups (as previously called out by HAL, and following a particularly slow August month) and also collections/AR in 3Q.
We are rolling out the first edition of the Cat Walk Chronicle, our monthly (global) rig count tracker, during an otherwise uncertain period for the WR Land Drilling Group. This report leverages RigData/other sources to present regional, contractor, and E&P-specific rig count trends, and specifically focuses on super spec utilization and customer alignment across the top USL rig providers. In the context of accelerated USL rig declines in recent months, this report aims to tabulate & identify data-based rig inflections ahead of company commentary (given the availability of weekly info). We welcome feedback and bespoke data queries.
As of this writing, WTI is over $59/bbl and Brent is over $65/bbl on news of the drone attacks on Saudi Aramco’s production facilities, taking off over 5mmbpd of global supply for an unknown period.
We are on the road this week in London, where sentiment hasn’t markedly improved toward OFS/energy, but where the US oil growth slowdown narrative is gaining appreciable traction (as an aside, last week’s joint OFS/E&P/IOC energy note above is the most widely-read report in recent memory). Critically, the discussion here across the pond has not only focused on the E&P spending/production growth rollover (good for oil), but has also surrounded underlying well productivity frictions (good for oil & OFS) from our refreshed OFS production model (link). One investor noted that 600kbpd, exit-exit US oil growth in FY20 would be bearish vs. internal expectations, despite the growth figure severely undercutting recent forecast agency assumptions. We initially touched upon this theme back in January, and Sam Margolin just published some tactical inventory thoughts around refinery downtime as a near-term headwind to EIA reports. Nevertheless, Wolfe Energy remains cohesively bullish on the 2020 crude outlook (backstopped by IMO 2020), and on Oct 3rd will host a conference panel on US shale productivity trends, featuring LBRT, CLB, APY, Rystad, and QEP. Come see us in NYC, Oct 3rd!
Strong strategic messaging from SLB, with positive implications across the OFS sector. Deservedly, Olivier Le Peuch’s address was the key positive highlight from recent conference presentations this week, with potentially positive implications for an otherwise embattled global OFS sector. Fleshing out the capital light shift was understandably well received, but the candor with which Olivier cited a go-forward deemphasis of UP areas within this capital light footprint (SPM, certain NAM, LSTK-type projects) was especially powerful. In our view, the lofty expectation of double-digit NAM margins, and recapturing peak int’l margins (link), is highly constructive for OFS broadly considering SLB’s influence on sector-wide earnings power across the globe.
August marked more of the same 2019 blues for the E&Ps, with our benchmark Index falling a steep 17.3% last month. Driving the poor performance were global economic fears, WTI/Brent prices moving lower by 6%/9%, and operational missteps during 2Q earnings that caused outsized moves in multiple equities. Given the magnitude of the selloff with crude oil prices still near $55/bbl, investors remain cautiously optimistic, with a small majority expecting the sector to both end higher by YE19 and outperform the S&P 500 (see our 8/26 Survey note). We see the same potential, but the execution bar remains high and the follow through on FCF generation remains key. EOG and FANG remain top picks.
Increasingly favorable US oil drivers beneath suffocating macro pessimism, reiterate $80 Brent in FY20. Yesterday, the entire Wolfe Energy team collaborated on a US oil growth from 3 methodologies note, which framed an 800kbpd exit-exit growth scenario for US oil in FY19 (underpinned by continued E&P capex deceleration). Team OFS contributed our WR Production model (frac productivity), with Silverstein refreshing a bottom-up E&P approach and Margolin layering on a stress case with maximum IOC contribution. In addition, Margolin analyzed key IMO 2020 demand indicators related to a lofty 4MMbpd of disadvantaged heavy crude inputs, much of which needs to be switched for lighter/sweeter grades to work down HSFO output. This is a positive, but differentiated call – reiterate $80 Brent in FY20.
Across three energy sub-sectors, we encounter almost no investors that are bullish crude oil prices for 2020. Sliding GDP forecasts, currency headwinds, trade war impacts, and non-OPEC supply fears have increasingly stressed expectations. However, the two components that led us to be constructive on crude heading into the year – decelerating US production growth and IMO 2020-driven low sulfur demand pull – remain intact. We examine both in this note.
Energy survey – Some contrarian green shoots amidst deepening market pessimism. Josh Silverstein & team led the effort on the 2Q Energy Survey, which polled 85 clients on sector and commodity views. As expected, OFS remains the doghouse relative to more favored IOC/Midstream subsectors, with over 50% of respondents predicting services as the worst performing group through FY19. Interestingly, this view coincides with a benign outlook for YE19 oil prices (even better outlook for gas), and with a near 50% majority that believes S&P Energy will outperform the broader market – perhaps dismissive of OFS as the traditionally high-beta energy play, although more defensive groups could be favored in the context of oil price leverage, capex reduction, and acceleration of shareholder returns.
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