A weekly look at what occurred in the oil markets of the U.S. and the world this past week and what’s ahead, with special acknowledgement for the headline this week to The Pretenders.
An unusual research note published this week by the energy investment banking firm of Tudor Holt Pickering captures the essence of why predictions that the market is headed toward $100 per barrel oil may get another dose of shale-related reality – the producers just don’t want to stop growing.
This is not the first time Tudor Holt has been a bit of an iconoclast, but it’s one of the more unique. Under the heading of “Don’t Raise Your Budget,” the company pleaded with upstream oil and gas producers to rein it in a bit.
“We’re struggling to comprehend why, when buy side, sell side, talking heads and taxi drivers are saying not to, companies press on with budget increases and accelerated growth plans,” the brief but succinct report said when it was released in the middle of the week. “The market could not be any more clear on this topic and to quote Indiana Jones, ‘Only the penitent man shall pass.'”
The Tudor Holt plea, if that’s what you can call it, comes back to an issue that has bedeviled the U.S. upstream since the start of the shale revolution – a lot of companies survive, they keep increasing their output, but they don’t thrive in a particularly traditional definition for how that goes on at an upstream oil company. On paper, they are profitable, but their free cash flow numbers are low to non-existent, and in some cases they’ve been that way for years.
Tudor was reacting to some companies, in the midst of announcing weak earnings, also announcing that they were raising their capital expenditures (cap ex) budget. Consol Energy (NYSE: CEIX) was one of them, though on its earnings call CEO Nicholas Deluliis proclaimed that there would be substantial free cash flow from operations in 2020 in part as a result of its capex plans.
“We don’t see a lot of grey areas here – stick to the plan, moderate growth, generate free cash flow, and the market should reward you,” Tudor Holt wrote in its note to investors. “Otherwise? It’s a foregone conclusion: The equity will get crushed. It’s going to be a long two weeks (let alone the next year) if exploration and production (E&P) names make growth and outspend the theme for 2019.” The two weeks could be seen as a reference to the ongoing earnings season.
As far as the prediction of crushed equity, Consol in particular did see its shares drop to $8.95 from $10.06 on Tuesday, the day it announced its earnings and capital spending plan.
And in the type of language you normally don’t see from equity analysts, the company declared: “Please, for the love of God, don’t do it.”
Paige Marcus of the equity research firm CFRA, reacting to the Consol earnings, said something similar about the decision to increase capital spending: “We think this will result in an overspend of operating cash flow during the year in pursuit of growth, contrary to what shareholders want from exploration and production companies.”
It used to be that growth was seen as an unalloyed good for oil and gas E&P companies. Now, not so much. From the perspective of a trucking industry that is a major consumer of their product, the decision by a lot of E&P companies to ignore conventional wisdom is a good thing; it puts more product on the market.
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The plans by U.S. producers – some of them at least – to continue spending and growing is the kind of thing that OPEC is fighting against. Although the group has exceeded the cuts in output it approved in December, and supply and demand are seen as mostly in balance, it remains concerned that the U.S. rise in output will continue and that inventories globally are still on the high side.
But the specter of the never-ending rise in U.S. production took a bit of a hit this last week. Each week the Energy Information Administration (EIA) each week puts out a supply/demand/inventory survey that everyone knows is preliminary but people trade on it anyway. In recent weeks, it has been showing U.S. crude production at 12.2 million barrels per day (b/d) for most of April before that climbed to 12.3 million b/d in the most recent report. Back in February, the weekly report went 11.9/11.9/12/12.1.
But the monthly EIA report for February was just released and it told a different story The monthly report has the advantage of time and more data. It showed that U.S. output was 11.683 million b/d in February, far less than the weekly estimates. That number was down from the 11.87 million b/d in January. The fact is that the EIA has yet to report a full-month average for U.S. production in excess of 12 million b/d despite weeks of short-term estimates that put it above that level. The type of spending that Tudor Holt is likely to get it there eventually but the February numbers certainly should give some pause.
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What has been surprising is that the market still seems to have had little reaction to what could be a major story – the contamination of Russian crude and the halt in pipeline shipments from the country to it customers on the Druzhba pipeline.
The halt began around Easter when it was determined in Belarus – first stop on Druzhba – that oil on the pipeline was contaminated with chlorine. The precise amount of supply lost was not confirmed but the pipeline’s capacity is about 1 million b/d. Countries on the Druzhba line, which include Poland and the Czech Republic, reacted by releasing some of their state oil reserves.
On Thursday, Belarus reported that “clean” oil was again flowing through the pipeline. But a lot of contaminated oil still needs to be removed from the line and it is expected to be months before full operations resume. Yet this news had no apparent significant impact on markets while a Trump tweet or statement to reporters about a phone call to OPEC about gasoline prices that may not even have taken place can send prices plummeting.