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Daily Intelligence Briefing

Thursday, May 30, 2024

Identifying Change-Driven Investment Themes

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.

Consolidation Wave Continues to Merge Shale Assets, Yet US Production Remains Near Pre-COVID Plateau

Summary: The latest US energy sector megadeal will make ConocoPhillips the single largest producer in South Texas’s Eagle Ford shale basin and expand its presence in two other major shale patches. More importantly, it will improve the Conoco’s economies of scale, cutting costs by hundreds of millions of dollars, and helping it fund an aggressive dividend boost and buyback scheme.


Though some have suggested the ongoing wave of consolidation in oil and gas, particularly within US shale, is part of a bid for oil majors to increase output, there has been little movement in the country’s field production of crude oil for a period of almost eight months now despite persistently elevated crude prices throughout that period. Capex budget growth has slowed significantly, and it seems likely that big oil may be more concerned with capturing assets to increase pricing power than output, thereby maintaining their margins.


Related ETFs: Energy Select Sector SPDR Fund (XLE), Invesco DB Oil Fund (DBO), United States Gasoline Fund, LP (UGA)

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Continuing an unprecedented wave of energy sector consolidation, ConocoPhillips yesterday announced its acquisition of Marathon Petroleum in an all-stock deal worth $22.5 billion of enterprise value. US oil and gas deals hit a record $51 billion in the first quarter, a continuation of last year’s fierce merger pace centered in the top US shale field, according to data provider Enverus. Per Wood Mackenzie, the total value of deals focused on the US Permian shale basin alone surpassed $100 billion in 2023. ConocoPhillips will expand its presence there by 400 locations, but the real benefit of the Marathon tie-up will be concentrated in the Bakken and Eagle Ford shale basins. Conoco will now be the largest single producer in the latter region. Moreover, the two companies’ shale assets are largely adjacent to one another, allowing ConocoPhillips to leverage capital synergies that will cut -$500 million from the firm’s costs within a year of the deal closing. Marathon’s resources will add over two billion barrels of resources to Conoco’s portfolio, with an average cost of less than $30 per barrel to supply.


While many have suggested that oil majors are scooping up huge swathes of US shale assets in an effort to boost production, it seems more likely that ConocoPhillips and others are looking more closely at moving the needle on expanding their margins than upping extraction. Overall US production has not moved much at all since last October. In fact, for all that had been made of US oil output’s rise record highs earlier this year, that was mostly reflective of a recovery to pre-COVID levels of production. In other words, it has effectively taken the US four years just to regain what was lost after a sudden collapse in energy prices hollowed out the US oil and gas industry with more than 100 bankruptcies in 2020 alone. Field production of US crude did climb to an all-time high of 13.3 million barrels per day (bpd) earlier this year, but has since pulled back to 13.1 million bpd, identical to weekly production figures reached in March 2020, stagnating there for eleven consecutive weeks. This is hardly reflective of activity that would push oil majors toward bringing new production online in the near term.


The US Energy Information Administration (EIA) has projected a material slowdown in the recent production growth throughout the 2024. Though US output grew by 1 million bpd in 2023, only 270,000 bpd is expected to be added to the country’s output throughout this year. Only 43% of energy executives surveyed in the Dallas Fed’s Q4 2023 Energy Survey said they would be boosting capital expenditures in 2024, whereas the majority stated their firms would be holding capex steady or decreasing their spend compared to 2023 levels. Evercore ISI previously forecast drillers to increase capital spending by just 2% in 2024, compared with a 19% hike in 2023 year.


Brent crude futures were trading near $83.00 per barrel on Thursday morning, well-below the $88.00 average price that has been forecast by the US Energy Information Administration (EIA) for 2024 in its most recent Short-Term Energy Outlook (STEO). Further projections from the STEO see commercial crude oil inventories falling near the bottom of the five-year range in July and August 2024 – an indicator that the US’s summer driving season may initiate a strong drain on gasoline held in reserve. The White House apparently agrees with this sentiment, preparing the release of the entire Northeast Gasoline Supply Reserve (NGSR) ahead of the travel-intensive July 4th holiday. Nearly one million barrels of gasoline are held in the NGSR, established a decade ago, but these have been mandated to be sold as part of the US government’s fiscal 2024 budget.


The timing of the sale, however, is at the discretion of President Joe Biden’s administration, which has been dogged by elevated oil futures pricing and the resulting impact on gasoline prices throughout the past couple of years. Though regular conventional gasoline in the US was retailing at virtually the same level it was a year ago in the week to May 27, that price is up by nearly 16% in the year-to-date period. Across all formulations, gasoline prices have risen at their fastest YoY pace in 8 months in May. Commercial gasoline inventories have fallen by about -25.3 million barrels in the eighteen weeks going back to the start of February. This is a particularly urgent issue for the President these days, as Biden is knee-deep in the midst of a re-election bid, facing off against former President Donald Trump.


Though it may have been preferable to preserve the release of these barrels until closer to election day on November 5, an attempt to put a lid on prices now could be easier than trying to drag them back down later in the year. In a recent analysis, MRP noted that the monthly average Brent crude oil price between the start of 2017 and end of 2020 (roughly tracking Trump’s tenure as President) was $57.86, compared to an average of $84.65 across more than three years since – a nearly 50% increase. Trump has attacked the Biden White House’s environmentalist bend while courting potential fossil fuel industry donors and even taking on a “drill, baby, drill” mantra as part of a promise to lower energy prices.


Consolidation of the world’s crude oil output capacity, particularly that of the US’s shale resources, around among a smaller number of large firms could end up keeping prices elevated for a longer period of time – especially if those firms are concerned with keeping their lucrative oil and gas businesses running for a long time. The shale boom of the mid 2010s was spurred by a tsunami of smaller producers pouring into the fracking business to scale up production, but many of them were run out of business by years of losses and the crushing impact of COVID-19’s oil price collapse.


As MRP has previously noted, the goals of large fossil fuel producers appear to have shifted significantly over the past couple of years. According to reporting from Barron’s, compensation packages at energy majors have cut incentives for energy executives to prioritize production and boosted their pay for pumping cash instead. In 2019, production goals made up about 15% of executive compensation incentives, according to Morgan Stanley analyst Devin McDermott. By 2022, production made up just 6% of the packages. Meanwhile, the percentage for hitting free cash flow goals rose to 18% in 2022 from about 7% in 2019. That inversion is a break from historical trends and coincides with heavily criticized spending on buybacks, dividends, and other shareholder payouts over the last year.


MRP added LONG US Energy to our list of Active Themes on December 20, 2023. Since then, the Energy Select Sector SPDR Fund (XLE) has returned 7%, thus far underperforming an S&P 500 gain of 12% over the same period.


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