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Q3 2023 Research Theme: Market Update

Brent Crude oil has tumbled in recent weeks, briefly breaching $80/barrel in recent days, a popular interpretation being that concerns over demand, particularly that of China, now outweigh initial fears that the Israel/ Hamas conflict might widen and prompt action by other Middle East producers, akin to the post-Yom Kippur oil embargo of 1973.

Of course it’s never that simple - price discovery within oil spot and future markets crystallises a vast array of often conflicting data via myriad commercial and financial trades: the IEA forecasts peak oil demand by 2030; October’s US crude oil production set a new record of 13.2 mmbbls per day; record crude oil exports will follow, according to tanker-tracking data compiled by Bloomberg; global oil inventories stand at their lowest level in six years, according to Kpler; net long CFTC crude oil contract positions have declined by 25% from a late September peak; Saudi Arabia and Russia have reaffirmed their commitment to supply curbs of more than 1 mmbbls per day until year-end; Iraq has voiced its support for continued OPEC+ supply cuts; OPEC+ will meet November 26th; and so on….

Amid continued oil price volatility and this miasma of supply and demand data, forecasts, scenarios and the like, October saw two of the largest oil supermajors firmly ‘place their chips’ on continued long-term oil demand growth.

Big Oil M&A Is Back: Confident Of Long-Term Demand For Oil and Gas

Brits have a saying – 'You wait all day for a bus, then three come along at once!'

We may not have three ‘buses’ (as we go to press) but the two that recently showed up – ExxonMobil/Pioneer Natural Resources (PNR) and Chevron/Hess – are the biggest we’ve seen in a good while, at US$60 billion and US$53 billion respectively!

Indeed, the proposed takeover of PNR is Exxon’s largest deal since its merger with Mobil back in 1999, while the proposed Hess deal is the biggest in Chevron’s history.

With overall US upstream M&A totaling US$46bn year-to-date and US$58bn for 2022 per Enverus data, these two super-major megadeals surpass the entire US upstream M&A spend for the last two years.

'Walk The Talk' - Exxon & Chevron Double Down On Oil

The prime asset focus of each deal certainly differs – ExxonMobil consolidates shale acreage within the Permian Basin while Chevron acquires a material interest in a world-class, deepwater oil development offshore Guyana.

However, these two deals are underpinned by a common strategic rationale - an outspoken, bullish view on long-term oil demand and thus similar ambitions to secure economically robust, long-life reserves sufficient to meet future demand and offset the natural depletion of their respective legacy assets.

... And Put Their Money (Stock) Where Their Mouths Are

These two deals represent an audacious ‘bet’ on robust long-term global oil demand, confounding forecasts by the IEA and others of peak fossil-fuel demand before 2030.

ExxonMobil anticipates continued growth in global energy demand to 2050 with more than 50% of such energy demand still met by oil and gas. This outlook, although aligned with US EIA forecasts, stands in stark contrast to IPCC and IEA scenarios.

Likewise, Chevron CEO Mike Wirth’s response to the IEA’s recent forecast that ‘global demand for both oil and gas would peak before 2030’ was blunt: “I don’t think they’re remotely right … [they] can build scenarios but we live in the real world and have to allocate capital to meet real world demands.”

Proximity & Scale Offer Synergies, But Pioneer's Tier 1 Inventory Was Key

At first glance, the ExxonMobil / PNR deal is all about scale and synergies within the Permian Basin. The close, often contiguous, proximity of PNR’s acreage to that of ExxonMobil will no doubt unlock all manner of scale and logistic-related capital and operating synergies alongside the sharing of best practices and technologies.

But, in our view, the key to this deal may lie in ExxonMobil CEO Darren Woods’ initial comments on the merger call:

“Pioneer ... [holds] the largest undeveloped, Tier-one inventory in the Midland basin.”

To paraphrase Mark Twain: “Buy Tier 1 acreage, they’re not making it anymore”

As per our last note, access to high-quality Tier 1 acreage at scale is increasingly scarce across many US shale basins. Despite continued advances in completion techniques, lower-quality acreage inevitably yields lower unit well productivity (boe/day per lateral foot) - even the prolific Permian Basin succumbed last year.

Pioneer’s substantial Tier 1 drilling inventory will extend ExxonMobil’s low-cost unconventional production base for many years to come; further cost benefits that result from synergies are, in our view, the proverbial ‘icing on the cake’.

Hess Deal Adds Low-Cost Barrels, Scale & Longevity to Chevron's Deepwater Portfolio

No longer the leading oil major in the Permian Basin since the ExxonMobil/Pioneer deal, the Hess deal brings Chevron a material 30% interest in the ExxonMobil-operated Stabroek Block offshore Guyana, a world-class deepwater oil development with attractive fiscal terms that yields low-cost barrels and low emissions intensity.

US Supermajors 'Leaned Into; Oil & Gas, Euro Oil Majors 'Leaned Out' Into Renewables ...

These deals exemplify the divergent strategies of US oil majors and their European counterparts in recent years.

Despite the fervour to boost ESG credentials, both ExxonMobil and Chevron remain committed to oil & gas investment and have long shunned any significant investment in wind and solar projects, preferring instead to invest in low-carbon solutions such as hydrogen, biofuels and CCUS that better utilise core skills, assets and technologies.

To quote Chevron’s CEO: “We prefer molecules to electrons.”

By contrast, Europe’s oil majors have spent several years ‘leaning out’ - upstream growth no longer the sole focus, growing investments in renewables - as they sought to placate investors, financiers and campaigners. By way of example, asset sales and lower upstream reinvestment have caused net oil & gas production for both BP and Shell to slump by 22% since 2019 - no small achievement for one oil major, let alone two!

... But Now They're 'Leaning Into' Oil & Gas Once More ...

However, 2023 has marked an inflection point - as many of those oil companies that diversified into renewables are once more renewing their focus on their legacy oil and gas businesses.

Energy security may be the buzzword used to justify the volte-face being performed by those mainly European oil majors, but the harsh truth is that few if any of their existing renewables investments generate satisfactory equity returns, and many such future investments are no longer financially viable. For example, spiralling capital costs and debt interest are sounding the death knell for many offshore wind projects, once viewed as attractive investments:

  • BP has booked a $540 million impairment on its investment in three windfarm projects offshore New York state;

  • Equinor Renewables, BP’s partner in these offshore windfarms, has operating losses of over $400 million; and

  • Vattenfall ceased work on a large offshore UK windfarm, deemed unprofitable due to a 40% cost increase.

Shell’s new chief executive has vowed to shift Shell’s focus back to major high-impact oil projects, such as the ongoing appraisal of its three deepwater discoveries offshore Namibia, and expansion of its gas businesses, while reducing the headcount within its low-carbon division by as much as 25%.

Praised as a ‘first-mover’ oil major regarding emissions, BP has now walked back its original 2030 target reduction for Scope 3 emissions from 35-40% to 20-30% - effectively a proxy for restoring growth to its upstream portfolio.

... And Driving A Resurgence Of Deepwater Exploration & Development

Scale and technology enable deepwater oil discoveries to be swiftly monetized (ExxonMobil’s Liza field came onstream just 4 years post-discovery) and produced for many years, with relatively low unit costs - 50% of deepwater resources are estimated to be economic below $40 Brent - and low carbon intensity.

Given such advantages and a backdrop of recent high-impact discoveries, it is hardly surprising that that oil majors, including those ‘returning to the fold’, are driving a resurgence of deepwater exploration and development activity.

Implicit within this renaissance of deepwater exploration and development, given the prospective multi-decade production horizon of discoveries, is a renewed level of confidence in continued global oil demand growth.

Turning to the OFS sector, a host of empirical data - revenue growth, margin expansion, project FIDs, orderbooks, day rates and the like - all point to an extended growth cycle.

OFS Sector Is Enjoying A 'Broad, Durable, Resilient Multi-Year Growth Cycle'

Not our words, but those of SLB’s CEO in a clear message to the market during their recent Q3 earnings call. He repeated the phrase on four separate occasions during the call, just in case anybody missed it the first time round!

Our caution regarding any CEO ‘talking their book’ is tempered by SLB’s global client relationships and suite of services that span the entire upstream investment lifecycle (i.e. they should be well placed to know what’s going on globally, client-by-client, project-by-project).

Although rebranded to highlight energy innovation and decarbonization, SLB’s core OFS businesses still very much remain the ‘engine-room’ for profits and free cash flow, delivering US$2.1bn of EBITDA and US$1bn of FCF for Q323, up two-fold and six-fold respectively since the post-Covid uptick in upstream investment of Q121.

And SLB is far from alone in benefiting from the dramatic upswing in upstream investment since 2021 by NOCs, oil majors and independent E&P companies alike.

Overall ‘Big Three’ quarterly OFS revenues have grown by 54% since Q121 while, in tandem, average ‘Big Three’ EBITDA margins have expanded from 15% to 20%.

'Big Three' OFS Revenue Growth & EBIDTA Margin Expansion, Q121 to date

Sources: Company reports, PillarFour analysis; Note: HAL - adjusted op income margin, not adjusted EBITDA margin

With almost three years of growing revenues, rebounding profits and cashflow ‘in the bag’, what evidence supports further ‘broad, durable, resilient’ growth for the OFS sector?

Upstream Momentum Directed Toward Long-Lived International & Offshore Projects

As per our last note, operators’ upstream investment momentum remains firmly directed toward international and offshore exploration and development. By virtue of resource scale and complexity, such projects are long-lived and will require a host of OFS products and services to optimize performance across their multi-decade lifecycle.

Annualized international / offshore revenue growth for the ‘Big Four’ (we added WFT given its international / offshore exposure) OFS companies has averaged 20% over the last four quarters. By contrast, their annualized North American revenue growth has slowed dramatically over the last four quarters to a near halt.

‘Big Four’ - Annualized Revenue Growth, International/Offshore vs. N America

Source: Company reports: ‘Big Four’: SLB, BKR, HAL, WFT, PillarFour analysis

Offshore ‘Bull’ Signals: Growing Subsea Spending, FID Commitments

The visibility and growth of subsea capex, opex and project FID commitments out to 2024 is testament to the continued growth of investment in upstream offshore oil & gas projects, providing visibility of prospective ‘durable, resilient multi-year’ revenue growth across the OFS sector.

Subsea Spending, Project FID Commitment - 2019 - 2024E

Source: Rystad Energy, Subsea 7, Diamond Offshore, Wood Mackenzie

Tight Offshore Rig Market Prompts Operators To Offer Top Dollar, Longer Contract Awards

With growing demand for offshore drilling assets since 2021, so average day-rates across all rig types - jackups, semisubs and drillships - have soared as global utilisation rates have surged beyond 90%.

Recent semisub and drillship contracts have achieved dayrates of $495,000/day and $480,000/day respectively.

6th-generation harsh-environment deepwater semisubs are now fully booked out - with little availability until late 2024, while the marketed utilisation rate for high-specification deepwater drillships is close behind at 97%.

According to Wood Mackenzie, the majority of future offshore rig demand will lie within the ‘Golden Triangle’ of Latin America, North America, and West Africa, these regions driving 75% of global floating rig demand through 2027.

As available drilling rigs become increasingly scarce, so operators are not only having to offer ‘top dollar’ dayrates but also extend the duration of new contract awards.

Average global drillship and semisub contract durations currently stand at 19 and 13 months respectively, up 115% and 73% respectively since 2021. But 5-year contract fixtures (excl. options) have recently been signed - and there are already 10-year tenders out in the market for two drillships! One caveat though - as witnessed during the Covid pandemic, operators can terminate contracts early, or not exercise extension options. Contracts are only as good as their small print.


Headline-catching Big Oil mergers, resurgent upstream investment and, most importantly, robust financial, activity and backlog data - all reinforce the ‘multi-year growth cycle’ for the OFS sector characterised by SLB’s CEO - validating PillarFour’s long-held investment focus on oilfield services - in particular low capital intensity, scalable, proprietary technologies that deliver an improved value proposition alongside lower carbon intensity.

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PillarFour Capital - Q3 2023 Investment Reseach
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