— Demand concerns no longer make sense as a negative in the energy investment process
— The game has changed
— In the new world of hydrocarbons it’s all about capital discipline and supply management.
— The Exxon (XON) / Pioneer (PXD) deal and Chevron (CHV) / Hess (HES) deals are emblematic of this shift.
According to this article from a well-known financial media source it was the reason for Wednesday’s sharp drop in crude … “Oil slumps nearly 3% to a three month low as demand concerns mount.”( you will need s CNBC subscription to view)
Why all the negativity? The article throws out several reasons including: China’s slowing October exports (interestingly the imports that everyone is so concerned about were stronger than expected in October), falling retail sales in the Euro-zone and a surprise 12 million barrel increase in US crude inventories in the latest American Petroleum Institute weekly report. Add to the the huge over-reaction (a $5 pop in the price of crude) to the start of the Gaza War and you have the traders in the commodity pits around the word reeling. Let me throw in for good measure the continuing worry about the possibility of a recession in the US due to the persistent high rates we are experiencing. The offset to these worries continues to be supply curtailment and underinvestment.
“Output from the 10 OPEC members that are subject to OPEC+ supply cut agreements rose by 150,000 bpd, the survey found. Saudi Arabia and other Gulf members maintained strong compliance with agreed cutbacks and extra voluntary reductions.
Saudi Arabia kept October and September (2023) output close to 9 million bpd, the survey found. The country in September extended a voluntary 1 million bpd output cut until the end of the year to provide extra support for the market.” (Reuters)
What oil traders naturally dismiss is the continuing restriction of supplies by sovereign producers as it does not effect short-term price action. Unfortunately energy stocks trade on the short-term fluctuations in oil prices rather than secular themes. Ergo the stocks have been crushed lately.
The Game Has Changed
Corporate energy producers are behaving the same way … restricting production, taking dollars formerly marked for investment and returning them to shareholders in the form of higher dividends, debt reduction or stock buy-backs. It use to be all about climbing up the down escalator, growing production to replace the depleting precious reserves taken out of the ground. It is not happening now, and even in the face of the green revolution, may over the longer-term put us in a shortage position. I stress longer-term because the day-to-day action in the commodity market is noise, trading on news items that do not contemplate long-term fundamentals.
Let me use the third quarter results from APA Corp (APA -$36.71), formerly known as Apache Corp, to point out the mismatch in stock price action and fundamentals. As a prelude I will point out that as benchmark for crude prices, West Texas intermediate crude (WTI) had an average price during 2022 of $94.90. So far in 2023 it has averaged 78.18. Here is the highlight reel from APA’s 3Q 2023 report:
Reported production of 412,000 barrels of oil equivalent (BOE) per day; adjusted production, excluding Egypt noncontrolling interest and tax barrels, was 340,000 BOE per day;
Year-over-year U.S. oil volumes increased 16% driven by operating efficiencies and strong well performance in the Permian Basin; (not new wells coming on line)
Confirmed an estimated recoverable resource of 700 million barrels of oil at Sapakara and Krabdagu discoveries on Block 58, offshore Suriname;
Generated net cash from operating activities of $764 million and free cash flow of $307 million during the quarter (APA’s Market cap is $11.26 billion); and
In the first three quarters of 2023, APA returned 65% of free cash flow to shareholders through dividends and buybacks, including the repurchase of 5.5 million shares at an avg. price of $37.91.
The stock was high at $41 last Friday, this amid the constant noise about demand concerns, which does nothing to address the issue of supply constraint, not replacing depleting reserves with new drilling. Yes, on the nine month comparison the earnings were down substantially ($3.50 vs. $9.51) but the in the first half of 2022 WTI spent a significant time above $100 a barrel. BTW, the stock only traded up to $50.58 on that $9.51 earnings number Yet this year the company could earn as much as $5.00 per share, garnering additional free cash flow which, instead of it investing in new production, will find its way to the benefit of shareholders via debt reductions, dividends and buybacks. Importantly this is money that in the past would go to the development of new Hydrocarbon resources.
In the new world of oil it is all about capital discipline
Reserves are cheaper to get by buying existing portfolios or companies a la Chevron and Exxon. Again this type of investment does nothing to replace depleting supplies. It’s about slow-walking development projects. That is the gambit of APA’s 50/50 partner in Suriname, French energy giant Total (TTE–$60.78). They are talking about not taking production out of their Suriname field until 2026. This is a big disappointment to us APA holders (yes, buyer beware, I own the name and have been a recent buyer). This all works to create shortages down the road especially if we underestimate the demand for crude.
The Exxon (XON) / Pioneer (PXD) and Chevron (CHV)/ Hess (HES), Canaries in the coal mine
I’ve heard criticisms on both deals that there will not be enough in the way of synergies to make the them good deals. The critics forget one great and sinister synergy, the ability to remove capital, cut capex and warehouse the properties for later use, thus making that capital available for investment outside the hydrocarbon energy field or returning it to the shareholders a la APA corp. Neither of these tactics does anything to replace reserves and the natural production declines that all oil wells encounter. Again, this could eventually lead us down a road to tighter supplies and much higher prices. It is reminiscent of the oligopoly known as airline industry … merging then reducing flights and raising prices. It should serve as a warning to those who may have written off this industry because of short-term demand concerns or an overly optimistic view of green energy replacing the hydrocarbon.
What do you think?
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