04.24.2023 DEP Industry Observations: New DEP Hire; Permian Trip Recap; BKR Rig Count +5 w/w

Macro/Headlines/Events:

Baker Hughes U.S. onshore rig count +5 last week from 727 to 732.

WSJ- America’s Oil Patch Loses Its Luster- Link

WSJ- Billionaires are betting on fusion technology as a source of almost limitless energy  Link

FT- US renewables industry joins Big Oil to fight delays to project permits Link

WSJ- China Strikes Energy Deals as Its Clout Grows in Middle East- Link

DEP Update:  Just returned from four days driving around the Permian Basin.  No funky rashes or viruses from our hotel stay this trip, but we still managed to spend an average of ~$300/night for a room with towels that our dogs would be offended to use.  As for work, this coming week, we divide and conquer.  Part of the team heads to the World Oilman’s Poker Tournament in Vegas while others will focus on Q1 earnings; make two corporate presentations and do a day trip to Dallas to look for a venue for our E&P Supply Chain Forum.  Next week is our OTC BBQ on May 1^st and then cooking for the Merit Advisors Barrels and Clays the following week.

New DEP Teammate:  We are pleased to announce the addition of Jacinto Hernandez to the DEP team.  Mr. Hernandez will lead DEP’s executive advisory practice, which will assist CEOs, boards, and leadership teams with strategy, investor communications, corporate alignment and capital allocation. Jacinto is uniquely positioned to lead this practice, marrying the perspective of an investor and a board member.  During his 22-year career at Capital Group, he closely evaluated almost every public energy offering in the US, while also assisting with the voting of hundreds of proxies.  In addition to his role at DEP, Mr. Hernandez also serves on the Board of Directors of Aris Water Solutions and Altria Group.  In May he will step down from the board of Pioneer Natural Resources, where he currently also serves as a director.  He is a graduate of Stanford University.  DEP Editorial Comment: For those who don’t know Jacinto, he is regarded as one of the most influential and early investors in shale oil and gas.  As a former sell-side analyst who would often pitch ideas to him, I was often schooled through his sage advice while his direct and often critical feedback helped make better those who worked with him.  Moreover, his participation in capital markets transactions was often viewed as a sign of approval from those involved in a deal.  By having Jacinto on the DEP team, we intend to provide expert project-based corporate communication and investor relations advisory services to clients.

Permian BBQ Cook-Off – College Team Announcements: Just like the Army Rangers, congrats to the Montana Tech alumni base for leading the way as they were the first to step up to support/sponsor a team for the Permian BBQ Cook-Off (9/28).  Montana Tech will join seniors of the SAE chapter at the University of Virginia who will descend to Midland to cook as well.  Meanwhile, crickets from alumni at the Texas schools.  Reason for bringing college students to Midland – the industry needs more, smart young people – hopefully some companies will make time to host teach-in’s.  And, for those who wish to get involved with the BBQ, we’ll have event details blasted out sometime in the next 7-10 days.

Energy Earnings Calls this Week

Research

Permian Trip: Well Service Observations:  Toured two workover rig builders’ shops this trip.  Feedback consistent.  Very few new rigs are being built and a handful of those being built are going to existing well service companies.  DEP best guess for total industry-wide orders in 2023 is about ~30 rigs – we’ll attempt to clean up after we survey more builders.  Orders include some from one new start-up.  The low new build tallies are likely a function of anemic returns and lack of capital.  What is happening, however, is a modest step up in rig maintenance as companies are finally increasing capex on Cat 4 inspections.  To be fair, this process kicked off last year and it is a much needed one as the U.S. well service fleet is old and, in our opinion, many companies have not invested properly.  Let’s use the Category 4 inspection as an example.  This review typically costs $40,000 – $50,000 assuming no major issues are found.  According to builders, the inspection more often than not leads to invoices in the vicinity of $100,000.  Why? Rigs are old and out of shape.  Time to complete the inspection often takes upwards of six weeks, so that’s lost revenue to the service company as many companies don’t have proper swing rig capacity, according to the builders.  If one assumes a production rig generates $900,000 of average revenue per rig per year (50 weeks/year at 55 hours/week at $350/hour and 85% utilization) and one simplistically assumes a ~30-35% rig-level EBITDA margin, the implied EBITDA per rig is about $300,000 (RNGR is the only public U.S. well service company – its Well Service Segment EBITDA margins were 21% in Q4 and 2022).  We’ll be generous and assume no interest burden for the company, no corporate G&A allocation and no cash taxes – again, a generous view.  We also exclude any add-on charges.  The implication is a rig going through the Category 4 process will generate minimal cash that year for the well service company.   A side note, which we hope we aren’t misinterpreting – years ago, the well service industry had a policy where derrick inspections should occur every 10 years.  That process got extended to 13 years.  Some would argue the extension simply reflects the ups/downs of the business, so a rig isn’t necessarily always working every day of every year.  We would suggest the change was to save money.  The point is for E&P end-users, maintenance in the industry was deferred because so many companies were broke.  Yes, well service pricing is up, but that money is getting put back into the equipment as well as into the people. Final note.  Visibility for our fabricating friends is up as demand is good.  At one yard, there were over 20 rigs waiting for service.  Growing workloads, however, mean wait times to get equipment in and serviced are elongating.  Further, at one facility, we couldn’t help but notice several really old mechanics.  Not trying to offend old people, but this is emblematic of the aging workforce, particularly in the well service sector.  With labor markets tight, we wonder how easily it will be to replace really good talent who fade away due to retirement.

Permian Recap – Field Sentiment & Random Observations:  Mixed.  A theme we have highlighted for weeks as some companies contend no price concessions; others acknowledge dropping rates while others point fingers at competition and call them out for dropping price.  It’s a little bit of Who’s On First.  That said, visibility is characterized as good, and optimism abounds.  Makes sense with oil back above $80/bbl.  What we found refreshing are additional indications of private E&P players seeking to reemerge post-sale.  One unnamed private contact is now opening office space and will soon seek funding for a new venture.  Objective is to buy Tier-2 type acreage from larger players and then prove it out.  In addition, we note an announcement by FireBird Energy that it has secured $500M equity commitment from Quantum Energy Partners.  Recall, the original FireBird sold to FANG last year.  We visited with two private E&P’s.  Both have added and/or are adding rigs.  Dayrates reported in the low-to-mid $30k range.   Discussions about the Permian Basin’s need for power featured prominently in one meeting while everyone wanted to speculate on E&P M&A and the corresponding implications.

PureFrac Expansion:  A LinkedIn post on Friday indicates the company is buying an additional 62,500 horsepower from ORTEQ Energy Technologies.  This, we believe, will be the 5^th fleet for PureFrac.  The company is upgrading its recently purchased fourth fleet to Tier 4 dual fuel.  We would assume both fleets will be available to Pure Frac in Q3.

A Big Thank You:  Oilfield folks are great, particularly Clint Walker from Cudd Energy Services.  This past week we made a rookie mistake.  Trailering our smoker from the Key Energy yard in Odessa to the Bynum School, the smoker came unhitched right as we were merging onto I-20 Business (we failed to secure the smoker to the hitch).  Thankfully, we were able to drag it to the side of the road where we proceeded to have a panic attack and an unexpected bowel movement.  Given we are weak and unable to lift a smoker by ourselves, it was time to phone a friend and seek assistance.  Thankfully, Clint, unlike many DEP clients, did not use his caller id to screen our call.  Rather, he immediately picked up, likely laughed at me on mute, but then promptly drove from Midland to Odessa to save a struggling research analyst from a potentially epic disaster.  For coming to our rescue, he gets free KD’s BBQ anytime DEP comes to Midland.  BTW – the smoker has now been donated to the Bynum School so that the kids can learn to cook.  Shout out to our friends at Baseline Energy Services who have offered to help teach them.

Q1 Earnings: We’ll recap thoughts from Big 3 OFS earnings next week.  Only Liberty Energy this weekend:

LBRT:

• Revs = $1.26B, +3% q/q
• Adjusted EBITDA = $330M vs. $295M last Q
• Adjusted EBITDA margin = 26%
• Q2 expected to see modest sequential growth.
• No disclosure on fleet counts, although we assume low 40’s which includes four fleets in Canada.
• LBRT will move some fleets in 2H’23 from gas to oily areas.
• The first digiFrac fleet was deployed in Q1 with the second going out in Q2.
• We believe these units are going as supplemental horsepower to existing fleets, thus there is not an all DigiFrac fleet in the market.
• LBRT has returned $218M to shareholders since July 2022.
• Roughly 7% of shares outstanding have been retired.
• $300M remains on the current authorization.
• Capex guided to 40-50% of EBITDA in 2023 and ~30% of EBITDA in 2024.  Consensus estimates pegs this at $618M in 2023 and $439M in 2024.
• Elevated 2023 capex reflects, in our view, an assertive newbuild effort for digiFrac and digiPrime fleets.

E&P Observations: E&P earnings begin in earnest this week (see table below), with results from 9 E&Ps and 2 majors.  We’re looking for incremental commentary about the effects of oil-price volatility and natural gas’ collapse on activity, budgets, equipment availability, and inflation.

Upstream Earnings Calls This Week (All Times EDT)

Firebird Energy II, formed after Firebird Energy I sold to FANG in December, announced that Quantum Energy Partners committed >$500mm of equity to the firm.  Firebird II will focus on the Permian, primarily in the Midland Basin.

DVN invested $10mm in Fervo Energy, a geothermal-technology company.  The partnership will apply horizontal-drilling learnings from shale to geothermal wells, in a bid to open up new geographies, as well as increase reliability.

Refining Observations: Lousy apparent demand for products met a big uptick in utilization this week (91% vs ~89% last week) and sent crack spreads lower.  Gulf Coast 3:2:1 ended the week at $21/Bbl, vs a QTD average of >$26.  Gasoline and jet-fuel demand so far in this admittedly nascent quarter are running more than 1% lower than last year.  Distillate demand for the first two weeks is down nearly 7% from last year.  The saving grace, of course, is that inventories remain extremely low by historical standards and are likely to stay that way if we don’t fall into a deep and protracted recession.

Hot on the heels of the XOM/Toyota low-carbon-fuels partnership announced last week, CVX announced a road trip using Toyota vehicles to showcase its new 50% renewable gasoline, which uses a “variety of feedstocks” and is 40% less carbon intensive than traditional gasoline.  Chevron and Toyota also announced a partnership to build a large-scale, commercially viable hydrogen business.  Given the limitations and expense of widespread EV conversion, we welcome these efforts.

Product Inventory, Demand, and Margin Charts

(Shaded areas show the 5-year range 2017-2021)

Source for Inventory and Demand Charts:  Energy Information Administration, Bloomberg, LP

Source for Margin Charts:  Bloomberg, LP

John M. Daniel

Managing Partner, Founder

Daniel Energy Partners, LLC

832-247-8215

jd@danielep.com

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