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Daily Intelligence Briefing

Wednesday, October 20, 2021

Identifying Change-Driven Investment Themes – Five sections, explained here.

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.

I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

A Quiet Expansion of US Oil & Gas Activity is Boosting Oilfield Services and Exploration Firms

Summary: Many publicly traded energy firms are holding back on upping their fossil fuel output amid heavy ESG-focused scrutiny from shareholders, but privately held drillers are sucking up market share, feasting on surging energy prices, and driving a recovery in US shale output.

Though most investors cannot access equity in those private firms, shares of companies working in oilfield services, as well as exploration and production, are rising steadily alongside rig counts that remain well below pre-pandemic levels.

Related ETFs: VanEck Vectors Oil Services ETF (OIH), SPDR S&P Oil & Gas Exploration & Production ETF (XOP)

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Fossil Fuel Financing and Capex Down, But Not Out

Renewable energy investments have undoubtedly accelerated over the past few years, but fossil fuels remain a necessity, still making up the vast majority of the global energy mix. Even if energy supplies generated from oil and gas has fallen out of favor with more ESG-focused investors, many leading institutions remain committed to financing fossil fuel projects.

In a report highlighted by the New York Times, the Private Equity Stakeholder Project examined the energy investments made by the top 10 private equity firms since 2010, including giants Blackstone, KKR and Carlyle. The report found that about 80% of their current holdings remain in oil, gas and coal.

That is significant, considering privately held operators may now be more important than ever before. While publicly traded oil producers like Exxon and Chevron are shouldering increasing ESG pressure from shareholders, privately-held firms now control 59% of the nearly 600 active US oil and gas rigs, compared with 42% of the 1,150 rigs in January 2019, according to Tudor, Pickering, Holt & Co.

US crude oil output is projected to increase by about 800,000 barrels per day (bpd) over the course of 2022. Of that gain, privately held producers will account for more than half, compared with about 20% in a typical year, according to Raoul LeBlanc, an analyst at IHS Markit. Additionally, LeBlanc told the Financial Times that spending on drilling and bringing new wells into production in shale patches onshore will rise from about $65 billion in 2021 to more than $80 billion next year.

For example, onshore US rig data from Lium LLC and analysis by Bloomberg show little-known Mewbourne Oil Co. now running 17 drill rigs in the US, more than Exxon Mobil and Chevron combined. They expect to continue propping up more wells next year.

Ken Waits, CEO of Mewbourne, told the Wall Street Journal that the number of rigs actively drilling in the Permian will probably only keep grinding slowly upward. The region’s oil and gas rig count this year has risen to 266, compared with 418 before the pandemic and its peak of 568 in October 2014.

Oil & Gas Services, Exploration Firms Tapped for Expansion

Though many of the drillers boosting their output next year will not be tradable in public markets, the companies that facilitate their expansion are. With energy supplies in increasingly short supply, wiped out by a quicker than expected recovery in oil and gas demand, downstream investment in oil services, exploration, and production will be especially critical in the year ahead.

Already, WTI crude oil prices oil prices have rocketed north of $83 per barrel – a level unseen since 2014. The US’s overall rig count has more than doubled from the depths reached in Autumn 2020, according to Baker Hughes’ rotary rig count. However, the 543 rigs active today comprise just about 50% of the pre-pandemic peak of almost 1,100.

With demand set to hold strong, the re-opening of rigs and completion of wells – a boon for oil and gas services firms – is likely to continue apace for months to come.

The International Energy Agency (IEA) recently noted in its monthly oil market report that OPEC+ spare capacity could fall to below 4 million barrels per day (bpd) in the fourth quarter of 2022 from 9 million bpd in the first quarter of 2021. “Shrinking global spare capacity underscores the need for increased investments to meet demand further down the road,” the agency said.

Per the WSJ, capital investments in US oil patches this year are projected to touch their lowest levels since 2004. Oil companies cut spending to an estimated $55.8 billion this year, compared with $108 billion in 2019. Next year, oil companies are set to boost domestic spending 15% to 20%, but the expenditure will still remain well-below levels seen prior to 2020.

Halliburton, a top energy services firm, just reported third quarter adjusted profit of 28 cents per share, beating forecasts for 27 cents per share, on sales of $3.9 billion in. That revenue was slightly below expectations and significantly lower than the $5.6 billion worth of sales the company collected in the same quarter two years ago.

Among the report’s highlights, noted by Barron’s, was free cash flow coming in 56% higher than expected, as well as CEO Jeff Miller’s commentary. Miller stated that he sees “a multiyear upcycle unfolding… Structural global commodity tightness drives increased demand for our services, both internationally and in North America.”

Though supply bottlenecks and other generators of inflation have driven up the cost of doing business in US shale patches, the Financial Times writes that oilfield service companies have warned for months that they will shift the rising cost burden of supplies and wages on to producers. Halliburton’s Miller has explicitly stated that there’s been “inflation in many parts of our business… but we’ve been able to pass that along”.

For Investors

A sustained rise in crude prices is likely to drive a parallel rise in the US rig count, driven primarily by privately held producers. Even if Chevron and Exxon now face a corporate reckoning by their shareholders and board of directors, oil & gas services, as well as exploration and production firms, will be set to benefit from ongoing expansion in US shale basins.

Investors can gain exposure to each of those industries via the VanEck Vectors Oil Services ETF (OIH) and SPDR S&P Oil & Gas Exploration & Production ETF (XOP).


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