Sebastian S. Elzein

In a previous post, we highlighted common themes from OFS companies’ Q2 earnings calls, which included the role of OFS in energy security, OFS operators’ focus on margins rather than market share, and industry optimism.  In last week’s post, we noted common themes from E&P companies, including a continued focus on share buybacks, moderate production growth, and the effects of inflation.  This week we focus on the key takeaways from the OFS operators’ Q3 2022 earnings calls.Expanding Role of International Business SegmentsA common theme among OFS operators included the prevalence of quarterly growth in international segments and expectations of continued optimism among international segments.  Executives noted that this growth is primarily driven by the need for updated oilfield equipment and technology outside the U.S.  Their optimism is further enhanced by the surging U.S. dollar’s effect on overseas freight costs and labor.  As broad-based activity increases tighten equipment availability, this will further drive price increases within global business segments.“Over the last few months, we booked orders for equipment into the Middle East and Africa.  We’ll continue to selectively target international markets as we progress plans for more meaningful growth abroad.  On the supply chain front, transit times and overseas freight costs are improving…while a strengthening dollar further supports improving margins.”  – Scott Bender, CEO, Cactus Inc.“Our third quarter performance demonstrates the strength of our strategy to deliver profitable international growth through improved pricing… International revenue in the third quarter for the C&P [Completion and Production] and D&E [Drilling and Evaluation] divisions grew year-over-year from a percentage standpoint in the high teens and mid-20s, respectively, which outpaced international rig count growth and reflects our competitiveness in all markets.  Our year-over-year growth and the margin expansion demonstrated by both divisions give me confidence in the earnings power of our international business.” – Jeff Miller, Chairman & CEO, Halliburton Company“I think international markets, in particular, have a long way to go in stepping up their technology that they apply in… in their drilling operations.” – Clay Williams, Chairman, President & CEO, NOV Inc. The Suspected Result of Near-Term Market Tightness — Long-term Sustainable Growth for Oilfield Service CompaniesOFS operators attributed expectations of steady and sustainable growth in their business to near-term tightness in the hydrocarbon commodity market.  Without an immediate fix to the current supply and demand imbalances, equilibrium in the global oil and gas commodity marketplace will require years of investment to level.  The imbalance may be further prolonged by E&P companies focusing on returning cash to shareholders.“While broader market volatility is clear, what we see in our business is strong and growing demand for equipment and services.  There is no immediate solution to balance the world’s demand for secure and reliable oil and gas against its limited supply.  I believe that only multiple years of increased investment in existing and new sources of production will solve the short supply… [E&P operators’] commitments to investor returns require a measured approach to growth and investment.  Service companies follow the same discipline, delivering on their commitments to investor returns and taking a measured approach to growth and investment.  What I think is underappreciated is how this results in more sustainable growth and returns over a longer period of time.” – Jeff Miller, Chairman & CEO, Halliburton Company“There’s very little used equipment that really can be refurbished economically, and what we’ve seen over the past year is more and more pressure pumpers in North America are pivoting towards buying new and the longevity and sort of the overall value offered by going to new versus used, I think, is a lot stronger.” – Clay Williams, Chairman, President & CEO, NOV Inc.“And there’s some drill out rigs that, again, what a couple of our customers have said is that they wanted to --they were out of budget, they were out of wells to complete.  They wanted to stop that in kind of mid-Q4 and then pick them back up in Q1.  Now we’ve had demand that’s kind of been building up behind, and so most of those rigs have already been redeployed… We’re now in a situation where even though there was some budget exhaustion, those rigs are now being put to work.  And we know we have demand coming on the backside and 2023.” – Melissa Cougle, CFO, Ranger Energy Services Inc.E&P Production Growth Plans Concentrated Amid Strict BudgetsAs highlighted in a theme from last week’s post, domestic E&P production is expected to rise, albeit modestly.  This growth is concentrated among certain large contracts; though the top lines may indicate relatively gradual and steady growth across the board, production growth is more concentrated among certain E&P operator plans.  More generally, a limitation on broader growth for oilfield services companies in the near term is attributable to the E&P’s limited budgets.  Considering the fragmentation in domestic production plans, some OFS companies have sought growth through acquisitions.“In terms of concentration, I’m going to guess that two-thirds — maybe a half to two-thirds — have to do with additions from our existing customers, which would be the publics and the other would be new logos.  So, I guess the short answer is, [plans for production growth are] certainly concentrated with the large publicly traded E&Ps, at least ours.” – Scott Bender, CEO, Cactus Inc.“For the fourth quarter, we expect growing opportunities associated with our Completion & Production Solutions segment’s backlog to be mostly offset by certain projects that were pulled forward into the third quarter and supply chains that remain elongated, resulting in revenues that should be relatively flat.” – Jose Bayardo, SVP & CFO, NOV Inc.“It is clear that our acquisitions executed last year are now delivering strong returns, demonstrating the value of our consolidation strategy for Ranger and for the sector more broadly.  The Ranger management team and board believe that consolidation remains an essential and ongoing process for the company within both existing and adjacent product lines.  And we continue to be actively engaged on this front.” – Stuart Bodden, CEO, Ranger Energy Services Inc. Mercer Capital has its finger on the pulse of the OFS operator space.  As the oil and gas industry evolves through these pivotal times, we take a holistic perspective to bring you thoughtful analysis and commentary regarding the full hydrocarbon stream, including the ancillary service companies that help start and keep the stream flowing.  For more targeted energy sector analysis to meet your valuation needs, please contact the Mercer Capital Oil & Gas Team for further assistance.

In the post Upstream Reviews of Q1 2022 Earnings Calls, the common themes among the earning calls of both E&P operators and mineral aggregators included the role of U.S. production in the European market, industry confidence in continued favorable pricing, and the trend of increasing completions.This week, we focus on the key takeaways from the Q2 2022 Upstream earnings calls including strong balance sheets, the increasing role of share buybacks, and supply and demand in the global oil & gas commodities market.Strong Balance Sheets and Cash Positions to Weather Price Volatility and Gain Upside ExposureExecutives zeroed in on the importance of a strong balance sheet amid the continuing volatility of oil and gas commodity prices. Upstream players can utilize robust cash positions to weather different price cycles and increase operational flexibility. Additionally, upstream Q2 earnings calls underlined the greater exposure to the high cycles by minimizing firm debt burden.“My perspective [is] as long as our return objectives are being met, modestly building some cash on the balance sheet is a positive thing. We're obviously in a highly volatile commodity price environment [and] I'd like to have a minimum of $500 million on the balance sheet just to handle intra-month working capital swings. We do have a couple of debt maturities coming up… We intend to retire that debt with cash on hand, so preparing for that time when prices are strong, is a good thing. And then also, it provides us the flexibility… on accretive bolt-on acquisitions that can improve our portfolio… given the macro uncertainties [ and] the volatility. So having a very robust company with strong liquidity, I think is a plus… Our return to shareholder commitment is top priority, but also keeping a bulletproof balance sheet and ample liquidity is right alongside that in our conservative financial model.”– Dane Whitehead, EVP & CFO, Marathon Oil Corp.“We want the absolute debt levels to be at $2 billion or even lower than that. We'd like to approach $1.5 billion over the next kind of medium term… The one times and the $2 billion or less of debt allows us to have a balance sheet that positions us to [future] swings in commodity prices. So, for us it's not as much a mid-cycle price. It allows us to go low and it allows us to go high. And we have a balance sheet that we feel gets us through the different commodity price environments.”– Kevin Haggard, SVP & CFO, Callon Petroleum Co.“The way we think about it is the best hedge is to have a strong balance sheet coupled with the strategy that can pretty much work in [a] multitude of prices and operational environments. So, this allows us to execute through these different commodity cycles. At current prices, our balance sheet is improving rapidly, so I think that's positioned us well to achieve our long-term debt target.”– Tom Mireles, EVP & CFO, Murphy Oil Corp.Increasing Role of Share Buybacks in Capital AllocationE&P operators and mineral aggregators have seen exceptional profitability since the start of the upcycle in 2021; companies started paying down their debt and distributing to shareholders. With the continuance of stable cash flows, the role of share buybacks has increased as a source of returns in lieu of bolt-on acquisitions or other investment opportunities.“So yes, like we’ve mentioned a bunch of different times. I mean, evaluating M&A, we are going to be selective and picky. I mean, we do look at this from an internal kind of risk-adjusted rate of return standpoint -- and as we’ve said before… it has to compete with our other capital allocation opportunities. And right now, at this current time, the best risk-adjusted meaningful for way to grow our free cash flow per share is buying ourselves… We’re always in the know of what’s going on in the M&A space, but with the low-risk opportunity to grow free cash flow per share, so visibly in front of us [by] buying ourselves, it’s hard to compete with that.”– Don Rush, Chief Strategy Officer, CNX Resources Corp.“We certainly think that there's a lot of value in our existing stock price, and we think that, that oil and public equity stocks [are] really undervalued right now… We spent about $500 million in the last 2 to 3 months repurchasing shares, and the Board just essentially doubled our authorization up to $4 billion. So, the base dividend still remains sacred, sustainable and growing followed by this environment share repurchases… [We will] make up the difference... returning at least 75% of free cash flow.”– Travis Stice, CEO & Chairman, Diamondback Energy Inc.“We're always assessing and evaluating bolt-on opportunities in basins where we have a competitive advantage and can generate value for our shareholders… We have a tremendous amount of confidence in our organic case, which delivers market-leading free cash flow and return of capital. And that is [how] we're going to assess all opportunities. So, the bar is quite high, and whatever we do, it's going to have to be accretive to that organic case… So, the same discipline that we show in our business is the same discipline we'll show in assessing inorganic opportunities. But to be clear, we like the assets in our core portfolio, and we're always looking to further improve our core positions.”– Lee Tillman, Chairman, President & CEO, Marathon Oil Corp.Beliefs of a Prolonged Imbalance of Supply and Demand in the Global Oil & Gas Commodities MarketExecutives of E&P companies and mineral aggregators underscored the economic effects of current global events as it pertains to the industry. Global demand for such commodities continues to grow despite the obstacles on the supply side. The current stream of Russian natural gas to Europe is not deemed to be reliable, OPEC+ is either unable or unwilling to meaningfully increase oil production, and U.S. E&P operators can only marginally ramp up production in the near-term. Meanwhile, demand shows no sign of dissipating as China re-opens from Covid-19 lockdowns and European officials attempt to secure enough natural gas in preparation for the winter so as to avoid rationing.“You think about US E&Ps, [and] the inability to really ramp up production because of the supply chain or the return of capital pieces… You think about the current potential issues in Russia and the potential embargo that's going to happen here at the end of December, the need to refill the SPR [Strategic Petroleum Reserve], because we've drawn down on those volumes significantly, and then really kind of the lack of OPEC’s ability to ramp up production here… [it] is really indicative to me of fundamental positives as we think about the second half and into 2023. So, I think you're going to see an improvement in energy markets going forward, and hopefully that yield compresses as well.”– Rob Roosa, Founder & CEO, Brigham Minerals Inc.“As China reopens further [the] utilization rate is expected to climb to the upper 80% range. This higher utilization rate, combined with an estimated 500,000 barrels per day of new PDH capacity coming online in China and over 100,000 barrels per day of new capacity in Europe and North America over the next 18 months, is expected to lead to a tightening propane market as we enter winter, with over 50% of our NGL volumes being exported.”– Dave Cannelongo, SVP of Liquids Marketing & Transportation, Antero Resources Corp.“I'm still very optimistic that the oil price is going to continue to march forward with probably more upside than downside. Demand is coming back. Around the world, people are flying more. China's going to come back and as you know there's not much supply [in] the OPEC agreement… OPEC+ announced a minuscule increase today… They just don't have the supply, [there is] very little left in UAE and Saudi.”– Scott Sheffield, CEO & Director, Pioneer Natural Resources Co. Mercer Capital has its finger on the pulse of the minerals market. As the oil and gas industry evolves through these pivotal times, we take a holistic perspective to bring you thoughtful analysis and commentary regarding the full hydrocarbon stream, including the E&P operators and mineral aggregators comprising the upstream space. For more targeted energy sector analysis to meet your valuation needs, please contact the Mercer Capital Oil & Gas Team for further assistance.

In a prior post — Themes from Q4 2021 Earnings Calls, Part 3: OFS — we noted common themes from OFS companies’ Q4 earnings calls, including macro headwinds, industry consolidation through M&A activity, and ESG activity.In Themes from Q1 2022 Earnings Calls, Part 1: Upstream, we explored key topics among the upstream segment of the oil & gas industry through the earnings calls of E&P operators and mineral aggregators.  These themes included:The future role of U.S. production in the European market as European nations plan to phase out Russian oil & gas;Confidence of continued favorable pricing exhibited through shorter-term deals and unhedged positions;Increasing completion rates in Q1, with expectations of further growth in completions beyond Q1. This week we focus on the key takeaways from the OFS Q1 2022 earnings calls.Short-Cycle Projects to Bolster Near-Term Production Are Those Most Sought AfterOFS companies have highlighted that — as E&P companies remain focused on returning near-term profits to shareholders — their investment efforts are sighted on capitalizing on short-cycle developments, rather than longer-term developments.  Amid ESG headwinds and supply chain disruptions, OFS companies have been more commonly tasked with supporting active rigs, supplying marginal equipment, and other services necessary for E&P companies to capitalize on this commodity upcycle.“In addition, I expect an important change in our customers behavior and priorities will provide structural support to oil prices throughout this upcycle. I believe supply dynamics have fundamentally changed due to investor return requirements, public ESG commitments and regulatory pressure, which make it more difficult for operators to commit to long-cycle hydrocarbon investments and instead drive investment flexibility through short-cycle barrels.” – Jeff Miller, Chairman, President & CEO, Halliburton“The shorter cycle [is] catching up, improving the situation around our very, very constrained supply chain challenges [and] meeting sort of the near-term demand of supporting rigs, frac fleets and stimulation equipment…both land and offshore, I think that's kind of the biggest near-term needle mover for NOV.” – Clay Williams, Chairman, President & CEO, NOV“There have been episodic supply chain disruptions with our customers, where we've been on location waiting for another service company to arrive or complete a job, and that's becoming, unfortunately, more frequent. I think that you're seeing a lot of marginal equipment being deployed and you're going to see a lot more marginal equipment being deployed as we pass through the 700 level in the U.S. rig count on the way to maybe just under 800 by year-end.” – Scott Bender, President, CEO & Director, Cactus  Shifting Priority to Margin ExpansionThough the demand for oilfield services has particularly revolved around short-cycle projects to support production, executives note that total demand for these products and services has still increased across the board.  Amid a plague of supply constraints and a tight market for their products and services, OFS companies have shifted their focus towards increasing margins, rather than gaining market share.  Despite a surge in demand, margins face pushback as inflation and rising wages erode the pricing power of OFS companies.“It's probably fair to say that we're entering into a period of potential meaningful margin expansion. And I think that volume expansion in terms of shipments is going to be constrained. And unlike some of our peers, we have the capacity to manage increased volumes. So we could potentially benefit from [this].” – Scott Bender, President, CEO & Director, Cactus“We are seeing increasing demand across all services. And I'd say, particularly on the well servicing side just because for a lot of operators, some of their cheapest incremental barrels are workover barrels. So we are seeing that demand. As Brandon indicated, we're now running 157 rigs and we would expect through the year that, that number starts to kind of trend up.We are being pretty diligent in maintaining margins, but we do think we can deploy additional rigs and maintain margins.” – Stuart Bodden, President & CEO, Ranger Energy ServicesPrivate Companies Have an Increasing Role Within the Customer BaseA recurring theme, as mentioned in previous blog posts, is how private companies have been more active than public companies in ramping up production.  As this relates to OFS, Q1 earnings calls have acknowledged that relationships with private operators are of greater importance than in the past.  This shift comes in light of capital restraint from public operators.  While perspectives differ about the future activity plans of the public E&P companies, OFS company executives commonly recognized increased activity from private operators, due to growth, consolidation, and greater capital freedom.“Our penetration of privates is undeniable. It's going to increase this year because I think the privates are becoming much more sophisticated. They're consolidating. And as they become more sophisticated and larger, then our product becomes far more attractive to them. They're not nearly restrained from a capital perspective. And we're doing our level best to call on those customers with whom it makes economic sense for us to pursue that business.” – Scott Bender, President, CEO & Director, Cactus “Today, as I look at a combination of customer activity and inflation, my outlook has improved, and I now expect North America spending to increase by over 35% this year. With respect to activity, over 60% of the US land rig count sits with private companies and they keep growing, while public E&Ps remain committed to their activity plans. Activity and demand for our services are increasing, both internationally and in North America.” – Jeff Miller, Chairman, President & CEO, Halliburton “As far as mix, I'd say it's twofold. We referred on the call that we are working for larger group of operators and I'd say the preponderance of that increase is probably in the private side ... so I think we will see growth in both sides, but two different dynamics driving this.” – Kyle Ramachandran, CFO & President, Solaris Oilfield Infrastructure Mercer Capital has its finger on the pulse of the minerals market.  As the oil and gas industry evolves through these pivotal times, we take a holistic perspective to bring you thoughtful analysis and commentary regarding the full hydrocarbon stream, including the mineral aggregators with working and royalty interests in the underlying production.  For more targeted energy sector analysis to meet your valuation needs, please contact the Mercer Capital Oil & Gas Team for further assistance.

The upstream oil and gas sector is highly capital intensive; production requires expensive equipment and constant maintenance. Despite higher oil and gas prices, E&P operators have refrained from increasing capital investment and instead, are delivering cash to shareholders. This post explores recent capex trends in the oil & gas industry and the outlook for 2022 through 28 selected public companies.Historical and Projected Capital ExpendituresCapital expenditures, as measured by spending on property, plant, and equipment (PPE) has varied widely during the last five years.  After the recent high in capital investment in 2019 of $138 billion, guideline group capex dropped 33.5% in 2020 to $91 billion.  After minor growth from 2020 to 2021 on the order of 1.8%, capital expenditures are expected to ramp up investment to about $109 billion in 2022, representing a growth of 17.5% but still below pre-pandemic levels. Leading this growth, Exxon (XOM) is expected to increase capital expenditures by 44.0% to $17.4 billion in 2022, up from $12.1 billion in 2021.  Chevron follows Exxon with an estimated $11 billion in capital spending for 2022, up 37.5% from 2021’s level of $8 billion. All in all, global integrated companies and E&P companies are expected to experience capex growth on the order of 26.3%, up from $71 billion in 2021 to $89 billion in 2022. The global guideline companies account for the lion’s share of total forecasted growth in capital spending, as summarized in the chart below. Appalachia Is Regional Leader in 2022 Capex Growth EstimatesThrough the lens of our company groups by region, the Appalachian Basin is expected to see the largest upswing in capital expenditures. This is by no means an exhaustive indication of growth by region, but it is indicative of the industry environment in Appalachia — capital expenditures are expected to total $5.4 billion in 2022 from the five major operators active in the area, up from $3.9 billion in 2021. As shown below, 2022 is set to be the first year of significant capital investment growth since 2018. Companies in the Eagle Ford are expected to increase capital spending modestly by about 12.6% to $5.1 billion, up from $4.5 billion in 2021. On the other hand, companies in the Bakken and Permian have lowered their capital plans after relatively high spending in 2021, representing a decrease of 52.8% and 15.0%, respectively. Cost Inflation Baked into 2022 Capex BudgetsWhile the expected rise in 2022 capital investment levels from 2021 is encouraging for the global supply of oil & gas, spectators need to acknowledge the effects of cost inflation in the estimates.  According to the Bureau of Labor Statistics ' March Consumer Price Report, inflation has reached a four-decade high in March 2022 as the Consumer Price Index (“CPI”) rose 8.5% over the last 12 months.  Cost inflation, by definition, will detract from operators’ “bang-for-the-buck,” and it is no secret that this is baked into 2022 capex estimates.“In this upcycle, investors have made it clear they wanted to see discipline from all players. So far, E&Ps for the most [part] are exhibiting capital discipline. A significant part of E&P capital spending growth this year (2022 versus 2021) will be consumed by cost inflation as the cost for all inputs continues to increase…” – Dallas Fed Respondent, Q1 Dallas Fed Energy SurveyMoreover, estimates are directly tied to operators’ budgets and management forecasts — which also commonly attribute rising capital expenditures levels within their budget to, among other things, inflation — a theme we covered in a previous blog post.  This helps bridge the divide between rising capital investment budgets and the common industry theme of “capital discipline”.ConclusionCapital expenditures fluctuate as operators react to global marketplace demand for Oil & Gas commodities.  After a recent low in 2020, capital investment is expected to pick up — rising by about 17.5% in 2022, after relatively stagnant growth in 2021.  Rising capital expenditures are generally a precursor to increased production, which will likely help to alleviate the current imbalance of supply and demand of oil & gas in the global marketplace at some point.  However, capital expenditures for 2022 are expected to trail pre-pandemic levels still, and rising inflation is eroding the value generated by those investment dollars.We have assisted many clients with various valuation needs in the upstream oil and gas space for both conventional and unconventional plays in North America, and around the world.  Contact a Mercer Capital professional to discuss. your needs in confidence and learn more about how we can help you succeed.Appendix A – Selected Public Company Capital ExpendituresClick here to expand the chart above