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Q4 2023 Research Theme: Beyond The Macro, A Lookback At 2023

The macro backdrop, discussed in prior notes, remains unchanged, underpinned by the imperative to ensure energy security while addressing continued global oil demand growth.

While global oil demand growth estimates for 2024 range from 1.2 mmbopd (IEA) to 2.2 mmbopd (OPEC) currently - the largest such variance observed since 2008, heightened geopolitical risks, disruptions to supply routes and low global oil inventories ensure that oil supply security remains as critical as ever.

In terms of upstream investment, growth momentum continues to favour international markets, led by the Middle East, Asia and Brazil. A strong FID pipeline for both shallow and deepwater projects, estimated at US$100 billion for both 2024 and 2025, will continue to drive up international demand for offshore rigs and subsea services.

The pullback in North American drilling activity, observed since mid-2023, is expected to persist through 2024 - a collective focus on capital discipline outweighing that of growth.

However, just sustaining US oil output at the record levels observed last year will demand further adoption of innovative OFS technology as operators seek to extend well productivity and recovery factors while reducing drilling and completion costs.

Rig Count: Continued International Growth, Sustained US Slowdown

Source: Baker Hughes

Looking beyond this macro backdrop, there were several notable developments during 2023 that we thought are worthy of some discussion:

Global Upstream M&A Skyrocketed to Near-Record Levels in 2023

In 2023, global upstream M&A market deal value skyrocketed to $234 billion, the largest annual M&A spend in more than a decade, according to Evaluate Energy data.

This surge in M&A activity was of course dominated by two mega-mergers - ExxonMobil/ Pioneer and Chevron/Hess - valued at $125 billion in aggregate. However, these two deals merely highlight the scale of consolidation already underway across the US oil & gas sector. Indeed, this consolidation wave is somewhat comparable to that of the late 1990s and early 2000s - the era that gave rise to the supermajors.

It should be noted that, of the top ten upstream deals of 2023, all but two were centred on US-based assets, primarily within the Permian Basin.

Global Upstream M&A Deal Value, 2008 - 2023

Such buoyant upstream M&A activity has continued into 2024, with six US E&P deals that surpass US$50 billion in aggregate already announced during January and February.

The Permian Basin remains a focal point for current M&A activity, reflecting the basin's relative abundance of high-quality drilling inventory, export infrastructure and potential for resource expansion.

After at least a decade of reduced exploration budgets and with the major US shale plays now largely defined, companies are increasingly focused on building drilling inventory and replacing declining reserves through strategic acquisitions.

What’s Good For The Goose Is Good For The Gander - OFS Consolidation Will Follow

The consolidation wave that has engulfed the upstream oil and gas sector of late, particularly US E&Ps, will likely migrate to the oilfield service sector in 2024.

In the short run, consolidation in the E&P space can prove negative for OFS companies as their customers’ capital projects are paused and/or operating budgets optimised.

Longer term, if unchecked, the loss of relative market power could also cap OFS margins.

Given the scale and particular focus of US-led upstream M&A on the Permian basin, US-focused OFS players therefore need to consolidate.

One recent example of such consolidation would be the all-share merger of Patterson-UTI and NexTier Solutions completed in September 2023, the result being that Patterson-UTI is now the second-largest OFS provider in the USA by revenue, behind Halliburton.

On a global scale, the OFS sector continues to benefit from a ‘broad, durable, resilient multi-year investment cycle’, as once more reiterated by SLB’s CEO, and is, in aggregate, generating levels of free cash flow not seen since 2015.

As interest rates settle, or even fall, elevated cash flow may well encourage oilfield service companies to explore strategic acquisition opportunities, since organic capacity expansion may prove too slow to fully capture and leverage the current investment cycle.

Pragmatism Returns - The ESG Pendulum Is Swinging Back, Aided By Activist Investors!

Responding to growing stakeholder pressure over the past few years, European oil majors pledged to reduce their Scope 1 and 2 emissions, albeit typically on an intensity-based rather than absolute basis. Their preferred route to lower emission intensity was diversification - increased investment in renewables - typically wind and solar projects.

By contrast, US oil majors, led by ExxonMobil, remained largely unapologetic for their core oil & gas businesses, promising instead that decarbonisation via carbon capture, hydrogen and biofuels would deliver lower overall CO2 emissions.

In February 2020, BP’s new CEO set out a uniquely ambitious strategy: BP would become a net-zero energy company by 2050 on an absolute basis across not only its Scope 1 and 2 emissions but also its Scope 3 emissions, namely the CO2 emissions caused by end users’ combustion of its oil & gas products.

In May 2021, despite having already pledged to deliver material cuts to the carbon intensity of its products, activists won a landmark judgement against Shell. A Dutch court ordered the company to drastically deepen such pledged cuts, specifically mandating Shell to reduce its absolute levels of carbon emissions, an outcome that the company will soon appeal in court.

Concurrently, with an equity stake of just US$50 million and a mission to confront climate change, a small hedge fund, Engine No. 1, shocked the oil & gas industry by unseating and replacing three of ExxonMobil’s twelve board members with their own nominees.

How times change!

Fast-forward to 2023 and a new energy realpolitik, high inflation and high interest rates.

Russia’s invasion of Ukraine has reminded politicians that energy security is paramount.

Prior to Russia’s invasion of Ukraine, European energy security was largely subjugated by an EU-led barrage of legislation to decarbonise power grids, ban the future sale of fossil-fuelled cars and hit net-zero by 2050. Notably, citizens were largely in the dark regarding the likely cost and impact of such policies and legislation on their lives.

In 2023, the reality of the EU’s environment policies began to bite. Dutch farmers protested en masse against government diktats to reduce livestock herds and thus nitrogen pollution. In Germany, wind turbines were dismantled to allow enlargement of a coal mine while French President Macron lobbied the EU to stop any further environmental legislation.

Likewise, 2023 saw US investment funds increasingly eschew any prior environmental concerns for the attractive returns available in the oil & gas sector, although a growing anti-ESG movement and the threat of withdrawals by fossil-fuel states such as Texas and West Virginia no doubt played a part in this volte face. BlackRock, State Street and Capital Group - all prominent members of the Net Zero Asset Managers initiative - have all substantially increased their exposure to the oil & gas sector.

In the US, Republicans and Democrats continue to battle over environmental policies, but all US politicians recognise that low gasoline prices are viewed by many as a birthright.

In 2023, oil companies began moderating some of their prior environmental initiatives:

  • The new CEO of Shell announced that the company would pivot back toward oil and gas, saying ‘we will invest in the models that work - those with the highest returns that play to our strengths’.

  • BP stated that it would no longer meet a prior pledge to reduce oil and gas production by 40% by 2030 against a 2020 baseline, arguing that near-term demand for oil and gas was higher than previously forecast and that additional fossil-fuel profits would ‘support investment’ in the energy transition.

  • ExxonMobil also withdrew its funding of its long-publicised efforts to use algae to create low-carbon fuels.

Diversification vs. Decarbonisation: The Market Has Spoken

The market has spoken - a large valuation gap has opened up between European and US oil majors, largely due to their divergent strategies to combat and reduce emissions: diversification versus decarbonisation.

Oil investors clearly flocked to the clear-cut, higher-return strategies of the US oil majors, shunning the dilutive returns offered by the European oil majors’ renewable investments.

In parallel, European oil majors were too wedded to their legacy oil and gas investments for their renewable investments to attract sufficient fresh demand from low-carbon investors.

The recent strategy shifts by European oil majors are a clear recognition that the alternate decarbonisation strategies of US oil majors are winning out in the market.

And what about those activists?

Many expected that Engine No. 1’s surprise mid-2021 seizure of three board seats at ExxonMobil would mark the beginning of the end for the company’s fossil-fuel growth.

Well, that’s not how it turned out: all three Engine No. 1 nominees voted in favour of ExxonMobil’s late-2023 acquisition of Pioneer Natural Resources!

At the time, Engine No. 1 stated: ‘We need oil and gas in the short-term and the Permian is the best and most affordable short-term asset’. Engine No. 1 now eschews aggressive shareholder activism and holds a 3% stake in Brazilian mining group Vale.

Likewise, as of late 2023, BP came under pressure from an activist shareholder, Bluebell Capital Partners, to bolster investments in oil and gas and cut investments in clean energy. Bluebell wants BP to stay away from businesses where they have ‘no right to win’ and where investment returns are low, such as solar and offshore wind.

The ESG pendulum is swinging back to a sensible, pragmatic position - aided by activists!


Sadly, it has taken a war for governments, regulators and investors alike to recognise that the need to ensure energy security - in particular, unimpeded access to oil & gas - trumps the legislative dash toward renewables. Energy security is paramount, and pragmatism is now tempering both the energy transition debate and investment in the oil & gas sector - oil & gas are no longer dirty words. The energy transition is well underway but innovative upstream and downstream technologies will ensure that the versatile, energetic carbon molecule will continue to play its part.

Resurgent upstream M&A activity and investment, particular in international markets, bode well for a ‘multi-year growth cycle’ across the OFS sector. In turn, upstream consolidation and burgeoning cash flows will likely prompt a cycle of strategic M&A across the OFS sector.

PillarFour is well placed to capitalise on current market opportunities given its long-held investment focus on oilfield services - in particular low capital intensity, scalable, proprietary technologies that deliver an improved value proposition for customers alongside lower carbon intensity.

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PillarFour Capital - Q4 2023 Investment Research
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