03.27.2023 DEP Industry Observations: Upcoming Events; Proximity Mine Additions; Rig Count +3 w/w

Macro/Headlines/Events

BKR U.S. Onshore Rig Count  +3 rigs w/w to 739 rigs.

WSJ-How Options-Hedging Turbocharged Oil Volatility- Link

WSJ- The House GOP Moves on Energy   Link

FT- Italy’s shift away from Russian gas clashes with its climate targets- Link

Bloomberg-  Energy Transfer to Buy Lotus Midstream for $1.45B.

DEP Update:  Two DEP events this week.  First, a reception on Tuesday in Midland and second, a small group dinner in Shreveport on Tuesday as well.  We return to OKC/Tulsa the week of April 3^rd and will begin assembling a meeting schedule this week.  Other events:

• April 10^th golf outing in Houston (still a few spots)
• April 19^th Midland reception
• April 20^th – BBQ for kids at the Bynum School
• May 1^st or 2^nd – OTC BBQ at Sean Mitchell’s house
• May 9^th cooking at the Merit Advisors Barrel’s and Clay outing (details coming next weekend).
• June 12-13^th – London Energy Day with historic pub crawl (moving forward with this)
• June 27-29 – Telluride Executive Series
• July 6^th – OKC Steak & Baseball
• August 29-31 – The Executive Series at Pebble Beach
• September 28^th – Permian Basin BBQ Cook-Off

In Memoriam – Dave Demshur.  We were very sad to learn that David Demshur passed away earlier this week.  For those who may not have known Dave, he was the former CEO of Core Laboratories.  Personally, I was a very big fan of Dave, not just because he grew up near Pittsburgh and, like yours truly, was a devoted Steelers fan, but because he was also a really great guy.  Let me explain.  Part of the game with sell-side research is to not just analyze companies, but to also deliver corporate access to institutional investors.  As a newbie to the business many, many years ago, I lacked street credibility relative to the many other name brand research analysts covering the OFS sector at that time.  Yet, despite my relative inexperience, Dave always made time for me.  In fact, whenever I hosted any event, Dave participated.  And in the rare instance, he couldn’t make it, he made sure members of his executive team would be there.  More importantly, he also picked up the phone when I called and didn’t pass my dumb questions off to others.  In other words, Dave made time for the little guy and did so with class and grace.  Further, as DEP readers know, we were all at some point the little guy/gal. Consequently, garnering special attention from someone more senior, like Dave, had a lasting and positive impact on me.  And one of his best and regular market thoughts is as applicable today as ever.  That is “the decline curve never sleeps and always wins”.  Indeed.

Research

Proximity Mine Expansion – OnCore Secures Another Win:  Further validation the proximity sand mine business model is gaining traction as OnCore announced plans to build its 6^th mobile mine unit.  This unit will be deployed with Pioneer Natural Resources, and it represents the 2^nd OnCore unit dedicated to PXD.  Customers of the other OnCore units are also name brand companies and we believe these units go out on a contractual basis.  The pitch on proximity mines is relatively simple: reduced costs due to shorter driving distances.  But the concept also offers ESG benefits including reduced diesel consumption, less road traffic and reduced emissions.  Each mine, we believe, has name plate capacity around 750,000 tons/year.  It is our understanding an additional 7^th unit is likely, although we don’t know the customer. We further suspect a couple more OnCore mines could be forthcoming before the end of this year.  BTW, OnCore is owned by Hi-Crush, Inc.

Random Observations/News:

• An equipment builder shared with us this week that it received an order to build a new frac fleet for an existing frac company.  They couldn’t say who placed the order, but in the coming weeks we’ll drive the facility and look for logos.  A second frac builder reports inquiries remain active while reliable industry contacts claim an OFS player presently not in frac is assessing the merits of jumping in.

• Following our note last week, we had mixed feedback from industry readers.  Some share our views regarding expectations of looming OFS pricing pressure while others are quick to point out the market remains nuanced, arguing not all services will fare the same in a flat-to-slightly down market.  Fair point.  So, let us once again say that we believe equipment on dedicated and contracted agreements should do better on a relative basis.  Equipment in the spot market and/or not differentiated will see more pressure.  Neither observation is rocket-science, but we want to again clarify our views.  Moreover, certain OFS segments have oligopolistic characteristics.  Therefore, if the leaders of those segments remain true to their words about defending price at the sake of market share, then any slowdown may yield less financial impact than we would normally assume.  Time will tell, however, if large players will walk the walk.

• The BKR U.S. Land Rig Count added three rigs w/w and is up nine rigs over the past two weeks.  Go figure.  DEP lowers its rig forecast, conducts a survey of E&P contacts which highlights an expected rig contraction and then the rig count rises the next two weeks.

• Inflation Observation:  Spent time in Vegas this past week.  Breakfast, which was comprised of avocado toast, OJ and coffee cost $39 without tip.  Fish & Chips at STK came in at $58, without beverage or tip. Rental car for three days (had to drive to Phoenix) was just under $1,000.  We did, however, hit the trifecta, unfortunately not at the track.  Rather, we lost on the tables; we lost at the sports book; and we lost on the slots.  Really hoping we get back to $80 oil and $4 gas.

• Select Energy Services announced an increased stock repurchase authorization.  The new $50M authorization supplements the prior $25M authorization which has $8M remaining.  Select’s market capitalization is roughly $800M, so the remaining authorization represents roughly 7% of shares at the current stock price.

E&P Observations (authored by Geoff Jay):  We talked with a number of producers this week, and the sentiment around activity and inflation has changed dramatically from a month ago.  Almost everyone sees activity slowing in the face of lower oil and—especially—natural-gas prices.  As one executive told me, “Private guys in the Haynesville must just be incinerating cash right now.”   Feels pretty strong, but we’ll be in the Haynesville on Tuesday/Wednesday and will cross-check this opinion while in the neighborhood.

Private E&P activity is on a lot of minds.  The CEO of a very large private-equity firm believes that US shale activity could fall by 20% if current pricing holds, with privates cutting back more given their weaker balance sheets.  That’s a stronger pullback than our survey would suggest, but it’s still early.  Meanwhile, an E&P contact suggested that tightening RBLs post the SVB collapse could make that problem even worse.  “I think RBLs are going to be like casing was—expensive and not always available.  Everyone will be going through re-determinations in the next few months, and I don’t think we’ll see a lot of flexibility.  Borrowing bases will come down, and there won’t be any waivers.”

There’s a lot of speculation about equipment leaving the Haynesville for the Permian, but so far, no one we spoke to this week has seen a lot of it yet.  However, my DEP OFS counterpart believes at least three frac fleets have moved, something we’ll confirm this week.  To be fair, it takes time to drop which is an observation from E&P one contact.  Another company said they have seen a non-Super-spec rig make the move.  Nevertheless, we get the sense that a number of people will use any increased availability as leverage against contractors doing pad-to-pad work.  We got a consistent message that investors are encouraging less spending and lower activity in this uncertain, low-price environment.  “A lot of what we have flexibility on will impact 2024.  Our shareholders are telling us not to hold production flat if it doesn’t make sense on a returns basis.”

In the meantime, costs are improving at the margin—especially for diesel.  According to one cost, this decline “is a big deal” as diesel in 2022 was a bigger line item for the contact than rigs.  There is some OCTG improvement, but we got mixed messages on casing.  Spot sand prices, according to our contacts, have been incredibly stubborn, thanks to ongoing maintenance at several mines.

Pro Frac Services Q4 Earnings:  ACDC is the final company to report Q4 earnings which it did this past week.

• Revs = $794M with adjusted EBITDA = $269M.
• Annualized adjusted EBITDA/fleet = $29.9M vs. $34M in Q3
• 2022 capex = $356M with 2023 capex expected to be similar to 2022.
• Total gross debt at YE’22 = $959M but is closer to $1.3B post the acquisition of Performance Proppants.
• 2023 consensus EBITDA is modeled at $1.54B with FCF of $699M.  If this proves directionally correct, it suggests the balance sheet should improve materially this year (assuming no further acquisitions).
• Q4 EBITDA/fleet metrics declined q/q, partially a reflection of fleet mix with the contribution of USWS and lower efficiencies.
• Q1 guidance, however, calls for profit levels at or exceeding Q3 levels on an average of 41 fleets.
• The company also shows an illustrative 2023 forecast which includes fleet expansion of 12 fleets, six of which come from the recent Rev and Producers deals, two from USWS with the balance being 4 new electric newbuilds.
• The illustrative forecast (in the IR slide deck) suggests a run-rate adjusted EBITDA of $1.74B which compares to Q4’22 annualized of $1.08B.  The growth is the combo of acquisitions recently closed and new electric fleets.
• ACDC did note some market dislocations as competitor fleets have moved into the Permian.  We believe as many as three from the Haynesville
• Company also called out some inefficiencies during Q4 which impacted results.
• For readers of our notes, we have highlighted growing market pressures for many weeks while the theme of OFS inefficiencies featured strongly at the Thrive conference, so not a big surprise.
• Running 8 electric fleets today with four more to be built this year.
• Maintenance capex characterized as $3-$3.5M per fleet.

Refining Observations:  Gasoline and distillate demand appear to be recovering from the doldrums, and refining margins remain well above last year and well above average.  Gasoline cracks have been especially strong.  VMT for January of this year seems to validate better roadway demand, increasing more than 5% from last year and coming in less than 1% below January 2019 levels.  There were many who thought that an SPR refill could provide a headwind to refining margins this year, but Energy Secretary Granholm said this week that the planned sale of 26 MM Bbls from April 1 to June 20^th, plus maintenance at two of its sites, would make it difficult to buy back oil this year.

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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