Hammerstone’s Energy Report

By admin | 09/16/2019

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Monday, September 16, 2019

News of Note
– As trading gets back underway, the market is urgently trying to figure out the supply impacts of Saturday’s attacks on oil infrastructure in Saudi Arabia that knocked out about half the output of the world’s biggest exporter.
– Goldman Sees Brent Topping $75/Bbl If Outage Lasts Over 6 Weeks
– E&Ps in focus amid the surge in crude prices (WTI and Brent) which have given back some earlier gains as Saudi Arabia has pledged to restore a large amount of its offline production
– CDEV: Centennial Resource Upgraded to Buy at SunTrust; PT $8
– HAL: Halliburton Downgraded to Equal-weight at Barclays; PT $23
– JAG: Jagged Peak Upgraded to Overweight at KeyBanc; PT Set to $10
– PCG: PG&E Upgraded to Neutral at Citi; PT Set to $12
– SLB: Schlumberger Upgraded to Overweight at Barclays; PT $50
– SM: SM Energy Upgraded to Overweight at KeyBanc; PT Set to $14
– Oil posted its biggest ever intraday jump, briefly surging above $71/bbl after a strike on a Saudi Arabian oil facility removed about 5% of global supplies and raised the specter of more destabilization in the region. In an extraordinary start to trading on Monday, London’s Brent futures leaped almost $12 in the seconds after the open, the most in dollar terms since their launch in 1988. Prices have since pulled back about half of that initial gain of almost 20%, but with Saudi Aramco officials saying they’re less hopeful of a rapid output recovery, crude is still heading for the biggest advance in almost three years.
– U.S. President Donald Trump authorized the release of oil from the nation’s emergency reserves after a series of drone attacks in Saudi Arabia knocked out half of the kingdom’s crude output, or about 5% of world supplies. In tweets, the president said the amount of oil released would be determined “sufficient to keep the markets well-supplied.” In a later tweet, he declared: “PLENTY OF OIL!”
– Saudi Officials Consider Delaying Aramco IPO After Oil Facility Attacks – DJ

Overnight Crude

Overnight Natural Gas

Bloomberg
                ‘Most Ever’ Tells You Everything You Need to Know: Taking Stock
                (Bloomberg) — Brent crude surged the most ever intraday in Monday’s session, a signal that can’t be ignored in a week that was previously pre-determined for Federal Reserve narrative dominance.
                The attacks on Saudi Arabian facilities threatened 5% of the world’s production. Despite the fact that Saudi Arabia is still working furiously to restore operations and OPEC thus far has withheld emergency action to support supply, the attack exposed an underbelly of risk that may not dissipate anytime soon.
                Devilish and nefarious incentives have aligned through this crisis. Iran-backed Yemeni rebels are understood to have carried out the attacks — impacts that only serve to boost oil prices — something that has knock-on effects supportive of a flailing and oversupplied market. This in turn supports Iran and its exports, while simultaneously crippling its Middle Eastern neighbor’s infrastructure and lifeblood. Those “benefts”, if you’d like to call them that, find their ways through to leveraged equities and integrated oil names.
                U.S. E&Ps last week were already on the receiving end of the “great rotation” as some of the deepest value names across U.S. equities. S&P 500 energy sector was the second-best performer even before this latest surge in oil and natural gas prices due to unfold today. NBL, XEC, VLO, SLB and APA led with gains near or exceeding 9% last week, while just 3 of the 28 members recorded losses. Bloomberg Intelligence analysts Vincent Piazza and Mike McGlone wrote earlier that U.S. E&Ps should see a boost in near-term sentiment as volatility benchmarks remain elevated. Stronger cash flows should result, they wrote, as the risk premium will likely be sustained given the sophistication of the attacks.
                Keybanc analysts also point to some of the heaviest shorted names in energy as likely “benefiting” the most from the spike, and identify CDEV, JAG, SM, WLL and XOG as high on that list. Others with lower levels of hedged volumes should also benefit from the elevated prices, and include CLR, CXO, EOG, FANG and MUR, to name a few.
                Before one rushes to buy anything and all associated with black gold, keep in mind there are very real assets in play. Citi analysts write that, in the energy patch, companies like Nabors Industries (NBR), Schlumberger (SLB), Halliburton (HAL) and Valero (VAL) have “material operations” in Saudi Arabia that may be impacted from an activity standpoint.

Today’s Research

Bernstein
                Asia-Pacific Oil & Gas
                Quick Take: Saudi oil disruption. Initial thoughts
                A drone attack on Saturday has damaged the Abqaiq and Khurais oil facilities in Saudi Arabia which are the largest oil stabilization plants in the world (8.2MMbls/d of capacity). The attacks have caused a suspension of crude oil supplies of 5.7MMbls/d which is 58% of Saudi daily oil production and 5.5% of global oil supply.
                The duration for crude outage is unclear but may take weeks to restore full capacity. Saudi Aramco has announced that they will update the market in the next 48 hours. According to media reports, the Saudi officials said part of the shutdown was precautionary although it will take weeks to restore full production level. The Saudi stock exchange is down only 1% currently, which seems to suggest that the impact may be more benign than some think.
                Saudi Arabia has an oil inventory of 188MMbls according to latest Jodi data. This implies that Saudi has enough inventory to cover 33 days of production losses.
                Global spare capacity is 3.2MMbls/d of which 71% or 2.3MMbls/d is in Saudi Arabia. It is not clear how much of existing Saudi spare capacity can be utilised. Given the loss of 5.7MMbls/d, this pushes the oil market into a temporary supply deficit of 5MMBls/d (5% of demand) assuming Saudi spare capacity cannot be used. This deficit can be offset in the short term by spare capacity in the UAE and Kuwait (0.6MMbbls/d). Other temporary supply includes OECD strategic petroleum reserves (1548MMBls) and commercial oil inventories in OECD and non-OECD (5220MMbls).
                Saudi oil exports are mostly orientated to China. China is arguably the largest customer impacted by these events, accounting for 1.7MMbls/d or 24.5% of Saudi exports. China has been building up strategic reserves and currently has 1,095MMBls of commercial and strategic reserves, enough to cover 644 days of Saudi imports.
                While the attacks may result in only short term disruption to supply there are other factors to consider. Firstly, these attacks could be repeated. We understand that there have been on going attacks since May 2019, but these have been the first to result in material damage. Secondly if Iran is shown to be implicated, then it could de-rail a potential US-Iran repreachment. This means that Iranian sanctions are unlikely to be removed any time soon.
                Based on similar disruptions to oil supply we could see an oil price response of at least 5% if the outage is short term or greater than 20% if impact is protracted. There is no direct analogue to these drone strikes. The closest could be Venezuelan oil strikes which resulted in the loss of 5% of oil supply from the market over two months and a price increase of c.40% over this period. The Iraq invasion of Kuwait resulted in a loss of 0.5% of supply for six weeks and triggered a price response of c.60%.
                We expect a positive response from oil equities as a result of these attacks. The highest oil beta stocks in the region include CNOOC, Inpex, PTTEP and Santos. That said, we expect the impact on oil stocks to be less than the impact on short dated Brent prices, given that equities will tend to price off of the long end of the curve.

BTIG
                The Global Oil Markets Just Got More Complicated
                Impact of Attack on Saudi Oil Facilities
                Roughly half of Saudi Arabia’s crude oil production, or 5% of global supply, is estimated to be offline following the attacks on Saturday. We expect oil prices to trend higher, with near-term sources of additional supply largely capped. We see this as having a major blow on the global tanker industry, resulting in a demand loss of 2.5 VLCCs per day. However, we see the product tanker industry as a beneficiary, due to increased refined product price volatility around the world, creating increased arbitrage opportunities for product.
                Assessing Potential Impacts. Following the attacks on Saudi Arabia on Saturday, estimates point to roughly 50% of Saudi’s crude oil production which translates to roughly ~5% of global production being off-line. While near-term solutions include removing waivers on Iran (very complicated) and tapping into the US SPR (strategic petroleum reserve) are potential near-term band-aids, expectations are for global oil prices to move higher. The Saudis are already working to bring production on-line but the question remains how much will be off-line (force majeure is being discussed for some international shipments) and for how long.
                Making Up the Potential Shortfall? Over the last few years, North American shale oil production growth has been capped by oil prices and the shift by investors to focus on returns (makes sense to us). And while we do not expect that to change, higher oil prices should translate into higher returns and hence more production (think a pickup in completions). The one sticking point with a pickup in NAM production is oil company budget exhaustion; however, higher oil prices should allow for hedging and the locking in of profits. We note the damage and return of Saudi production need to be understood before oil companies can plan accordingly.
                Turned On Its Head. The oil tanker industry was just thrown a major curveball – which should see an initial loss of demand for roughly 2.5 VLCCs per day. The partial loss of Saudi production should drive major disruptions throughout the tanker industry into what is already the seasonally strong part of the year. We expect product tanker rates to benefit from this unprecedented disaster as refined product price volatility around the world increases creating arbitrage opportunities for cargoes. We expect product tanker ton-miles to increase near term. Also, we expect more Atlantic basin barrels to move to Asia as long as Saudi production is off-line. The loss of Saudi barrels should artificially reduce supply as ballast (no cargo) voyage legs to the Atlantic increases.

Citi
                Global Commodities Focus — A crude awakening. Attack on Saudi facilities may push crude by $10/bbl.
                No matter whether it takes Saudi Arabia 5 days or a lot longer to get oil back into production, there is but one rational takeaway from this weekend’s drone attacks on the Kingdom’s infrastructure – that infrastructure is highly vulnerable to attack, and the market has been persistently mispricing oil, which Citi reckons should have been a good $10 a barrel higher than it has been for months. Complacency might well take hold through a stock release, but drawing from the Country’s crude stockpile without trimming refinery runs would bring inventories down quickly to a stressful level, particularly in light of the risks coming from other potential disruptions. The double jolt to complacency is the attacks themselves and the US and Saudi conclusion that they were directed by Iran, with the Islamic Revolutionary Guard Corps having no interest in peace talks.

                Citi Upstream (E&P and OFS) — Which Stocks Will Display the Greatest Oil Beta?
                Sizing Up the Beta Response — Following the Saudi Arabia attacks, we expect most if not all of the Upstream Energy complex could see an uplift led by 1) SMID oil E&Ps that screen as heavily shorted; 2) heavily shorted land drillers, pumpers and sand/logistics companies; and 3) E&Ps with high sensitivity to oil or financial leverage. Offshore drillers could see a large short cover bounce but could fade before other sub-sectors. Where Could Beta be More Limited? — Natural gas names could bounce but would likely fade as more associated gas production would result from any oil drilling uplift. NBR, SLB, HAL and VAL have material operations in Saudi and could see activity slow given the magnitude of the outage. Key Metrics Assessed Within — Click through for charts on short interest ratios, market cap as a % of EV, oil betas and trailing performance across both the E&Ps and OFS names.

                Equity Strategy — Implications of the Saudi Production Outage
                The drone attacks on the Abqaiq and Khurais facilities over the weekend have left a crucial supply hole in global crude production and likely will drive oil prices higher by an estimated $5-$10/barrel or so most likely through year-end. The notion of a $5-$10 increase for WTI with maybe a simultaneous $0.10-$0.25 per gallon of gasoline jump would not be that disruptive to US GDP since each penny equates to about $1 billion of annual consumer spending. Oil prices do have an effect on inflation expectations and changes in TIPS breakevens have been important to the performance of cyclical stocks versus defensive ones. Energy stocks, in theory, should benefit from higher prices but the relative performance of the hydrocarbon sector has not been as tightly correlated with crude as seen in the past, possibly due to continued poor returns on equity.

                PG&E Corp (PCG) — Subro Settlement a Game Changer. Upgrading to Neutral; $12PT
                All Subrogation claims for 2017/2018 fires settled for $11B. The settlement includes Tubbs and is for 100% of the claims even though only 85% have agreed as of now. The remaining 15% are expected to agree with this settlement and now have limited leverage. Game Changer as it changes negotiation dynamics; PCG Likely Retains Exclusivity. If exclusivity is extended and TCC are the only holdout, there is a good chance that TCC settle at a reasonable number and not take the chance with a trial. A settlement also increases the likelihood of hitting the June 2020 exit. Only Remaining Class is the TCC;Bid/Ask in the $10/30B range. We expect a $12-15B settlement. The Subro Settlement surprised us. Updating PT to $12/share.

                MPLX LP (MPLX) — ~40% of EBITDA from G&P and Still a ‘Buy?’ Please Advise…
                Leading with the Conclusion — We are rolling out new estimates post the company’s merger with ANDX. While we remain at a ‘Buy’ tied to an acceptable ‘risk-reward’ profile, our Street-low $32 target price also conveys an implied acknowledgment that the investor base remains weary of G&P heavy businesses – or the ‘E&P of Midstream.’ Recall MPLX’s EBITDA is ~40% G&P (pro-forma for ANDX) and ~20% of EBITDA is tied to Northeast G&P. Comps haven’t been kind. We value MPLX’ s G&P EBITDA at 8x. See within for a detailed ‘true FCF’ (forget DCF) reconciliation. We believe MPLX offers an attractive yield / income proposition. We estimate the company will grow its distribution ~5% per annum from ~$2.69/unit to ~$3.49/unit in 2024 at an average coverage ratio of ~$1.3bn.

                A Much Needed Dose of Vitamin C2+ — Emerging from our Happy Place: The World of NGL Fundamentals
                With the majority of recent discussions solely tied to sentiment on the group, we took a welcome detour into the world of NGL/LPG fundamentals at a major industry conference in Houston earlier this week (our Happy Place). We emerge incrementally more constructive on Neutral-rated TRGP and Buy-rated EPD. We maintain Buy ratings on ET & OKE, though discussions around OKE’s lack of an export facility are starting to push to the fore. We emerge from the conference incrementally more negative AM (Buy; ‘High-risk’). Within, we also discuss the lack of bullish data points for medium-term propane & normal butane prices; the emergence of a non-Belvieu NGL super-complex along the Texas Gulf Coast; a transition to a new framework for thinking about the price of ethane; and the expected transition from term to spot economics for GC LPG export facilities.

                Midstream Implications Post Attack in Saudi — Own High Short Interest & Optical Crude Leverage
                (Short-Term) Midstream Stock Implications — Within, we provide an analysis combining 1) short interest for our coverage universe; as well as 2) recent correlation (six months trailing) to crude oil. We believe fundamentals will take a back-seat to shorter-term trading dynamics. We want to own high (trading) correlation to crude (at least optically) and high short-interest stocks. Our ‘Buy’ basket consists of 1) GEL (Buy); 2) ET (Buy), and 3) SEMG (Buy), while we identify Neutral-rated DCP as a stock likely to outperform based on this criteria. See within for additional stocks to own. The Commodity View — Ed Morse & Team believe a $10/bbl move higher for crude is likely (and is the case currently) and the key takeaway from the incident is that oil infrastructure abroad might be highly vulnerable to attack, and that the market has persistently mispriced this risk.

Credit Suisse
                Drone Strike on Critical Saudi Oil Infrastructure Knocks Out >5 MMBbld; Hikes Geopolitical Risk
                Largest attack on Saudi oil infrastructure temporarily knocks out 5.7 MMBbld of production. On Saturday, Iranian-backed Houthi rebels from Yemen attacked, with a wave of 10 drones, two critical pieces of Saudi crude oil infrastructure: the Abqaiq processing facility (7 MMBbld of capacity) and the 1.45 MMBbld Khurais field. Roughly 5.7 MMBbld of production has been shut-in. While an update on how long it will take to restore production will be provided on Tuesday, early third-party reports indicate it will be weeks, not days. Abqaiq processes crude from the 3.8 MMBbld Ghawar field, the world’s largest oilfield. Khurais is Saudi Arabia’s second largest field, with 1.45 MMBbld of production.
                Putting the attack in perspective. The 5 MMBbld of production initially offline as a result of the attack represents roughly half of Saudi Arabia’s production (9.8 MMBbld in August), 5% of global demand, and in excess of the latest estimated OPEC spare capacity of 3.1 MMBbld. Excluding Saudi Arabia, OPEC spare capacity is just 0.93 MMBbld. And beyond the physical impact of this attack, the fact that the Houthi rebels were able to do such damage to a critical Saudi oil facility 500 miles away from their stronghold highlights their military capability and the increased risk to Saudi infrastructure.
                We see two potential impacts to oil prices:
                – If production can be restored quickly, we’d expect oil prices to rally several dollars as the market prices-in increased geopolitical risk. Preliminary reports indicate production can be restored fairly quickly and Saudi Arabia can meet customer demand for several weeks from its large inventory of crude. We estimate Saudi Arabia has ~188 MMBbls of inventories, or just 33 days of supply (at ~5 MMBbld), if production at Abqaiq remained offline for long.
                – However, if Saudi Arabia requires an extended period of time to restore production, we would expect prices to spike in order to thwart demand, as spare capacity is insufficient to offset the sustained loss of ~5 MMBbld. Of OPEC’s spare capacity of 3.1 MMBbld, members other than Saudi Arabia and Iran have less than 1 MMBbld of spare capacity. With OECD inventories just 20 MMBbls above the 5-year average, an extended period of downtime would take inventories below recent historical averages.
                Oil markets will now be forced to factor geopolitical risk. And for a market so focused recently on slowing global demand and looming oversupply of ~0.5 MMBbld, this attack is a stark reminder of how limited global spare capacity is and the risks of higher prices from growing geopolitical tension in the Middle East. With the Saudi-Houthi conflict generally viewed as a proxy war between Saudi Arabia and Iran, this attack escalates geopolitical risk, which we expect to remain embedded in oil prices even if production is restored quickly, particularly as Iran has threatened safe passage through the Strait of Hormuz, where ~18 MMBbld traverses daily.

                Viper Energy Partners LP (VNOM)
                No Days Off In West Texas
                The acquisition machine rolls on… VNOM announces highly accretive all-equity acquisition from Santa Elena Minerals. After the close on Friday, VNOM announced the acquisition of 1,358 net royalty acres from EnCap-backed Santa Elena Minerals, LP in an all equity transaction valued at $150MM. The assets produced ~1.4 MBoed (~60-65% oil) in 2Q, ~7% of VNOM’s volumes. We estimate the deal would add ~$21MM to 2020 cash flow at current strip prices, implying an attractive acquisition yield of ~14%, 0.2% accretive to VNOM’s pre-deal yield of 8.6% in 2020 and is ~1.3% accretive to per share NAV. Importantly, the acreage spans two ranches primarily in Glasscock and Martin counties, 65% of which is operated by FANG, and VNOM only paid PDP value for non-FANG operated acreage. The assets also have a higher NRI of 5.6%, accretive to their corporate average, increasing exposure to FANG’s development. While this is VNOM’s first equity-funded deal of size, this is ideally suited for VNOM given core Permian acreage, and exposure to FANG… made more attractive by the acquisition valuation.

                Canada Integrated and E&P
                Sensitivity to Possible Oil Price Increase
                What happened? On Saturday, Iranian-backed Houthi rebels from Yemen attacked with a wave of 10 drones two critical pieces of Saudi crude oil infrastructure: the Abqaiq processing facility (7 MMBbld of capacity) and the 1.45 MMBbld Khurais field. Please see the detailed report published by CS US E&P and Integrated Oil team: “Oil Market Comment: Drone Strike on Critical Saudi Oil Infrastructure Knocks Out >5 MMBbld; Hikes Geopolitical Risk”. Roughly 5.7 MMBbld of production has been shut-in. While an update on how long it will take to restore production will be provided on Tuesday, early third-party reports indicate it will be weeks, not days. In its report published earlier today, our Oil and Gas team believes that even if the production can be restored quickly, oil prices could rally several dollars as the market prices-in increased geopolitical risk. In the event Saudi Arabia requires an extended period of time to restore production, Mr. Featherston expects prices to spike in order to thwart demand as spare capacity is insufficient to offset the sustained loss of ~5 MMBbld. While there are many unknowns at this point, in this report we are highlight Canadian companies in our coverage universe with the greatest leverage to crude oil prices.
                Canadian Integrated: Within our Canadian Integrated space, we believe CNQ and CVE will be the biggest beneficiaries of an oil price increase. We see CNQ’s 2020 FFO up 9% if Oil prices are up +$2.5/bbl, and up 16% if Oil rises by +$5.0 /bbl. We see CVE’s 2020 FFO up 8% if Oil prices are up +$2.5/bbl, and up 15% if Oil rises by +$5.0 /bbl. We would like to highlight that if Oil prices do go up by $5/bbl, SU and IMO will also see a double-digit increase in FFO in 2020 (Figure 1). While all names under coverage are expected to benefit, generally in a price spike environment, integrated names tend to lag higher beta names due to less commodity exposure. The reverse is true when commodity prices crash as integrated names act more defensively. We expect CNQ and CVE to be up the most on this news. The ~122mb/d of Oil production that CNQ acquired from DVN, for which it received a lot of unfair criticism, would suddenly look a lot more attractive.
                Canadian E&P. Within the E&P space MEG and BTE will be the biggest beneficiaries of potentially higher oil prices. MEG’s volume is 100% Oil (no gas or NGL), and we see MEG’s 2020 FFO up 13% if Oil prices are up +$2.5/bbl, and up 24% if Oil rises by +$5.0 /bbl. BTE, which is ~72% oil, is next in line to benefit from higher oil prices. We see BTE’s 2020 FFO up 8% if Oil prices are up +$2.5/bbl, and up 15% if Oil rises by +$5.0 /bbl. We also highlight that in 1H19, when commodity prices rebounded from 4Q18 lows, MEG and BTE generated sufficient cash to pay down debt by ~$285M and ~$235M, respectively. Both companies received very little credit for paying down debt aggressively. While all names under coverage are expected to benefit to some degree (Figure 2), we expect MEG be up most on this news.

                U.S. E&P Weekly
                Crude declines while US natural gas rises WoW. The week was filled with constructive macro headlines, but oil prices finished down 3.0% WoW to $54.85/Bbl on the small risk President Trump relaxes waivers on Iran & a wave of updated S/D forecasts that point to an oversupplied 2020 market. Macro news was supportive with US-China trade talks taking a more positive tone and the EU easing, bolstering demand outlooks. On the supply front, the new Saudi energy minister reiterated commitments to the OPEC+ cuts and led efforts for improved compliance at the JMCC meeting. However, oil succumbed to profit-taking after NSA Bolton (an Iran hawk) was fired & reports emerged that President Trump was considering waivers for Iran. While unlikely in our opinion, this risk was compounded by IEA & OPEC reports pointing to a ~0.5 MMBbld oversupplied market in 2020, creating a risk of lower prices to clear the market. Natural gas rose another 4.4% this week to $2.61/MMBtu on favorable weather forecast and a storage injection below consensus.
                Company news. CHK agreed to issue an aggregate of ~250.7MM common shares in exchange for retiring ~$588MM million of debt and preferred stock, implying CHK it is retiring debt at $0.80 on the dollar but at a cost of ~15% dilution to shareholders. Assuming current futures strip prices, our 2020E net debt/EBITDX improves from ~4.4x to ~4.1x, still too high with meaningful reduction unlikely to be attainable in the medium term. Paulson disclosed a 9.5% stake in CPE and announced their opposition against the CRZO merger while urging mgmt. to pursue a sale. We believe CPE paid a rich valuation for CRZO (see note), and Paulson’s opposition increases risks around the deal. ECA announced a number of changes to its executive leadership team, including the promotion of Michael McAllister (previously COO) to President succeeded by Greg Givens as COO. EQT announced a ~23% reduction (196 positions) to its workforce, which it expects to result in $50MM of annualized G&A cost savings. RRC trimmed its overall 3Q volume guidance by ~1% (to 2.22-2.23 Bcfed) to reflect modestly lower reported NGL production due to the downtime on Mariner East 1 pipeline in September, though it expects stronger NGL/natural gas differentials and higher underlying natural gas volumes will largely serve as an offset, resulting in minimal cash flow impact from the disruption.

                Duke Energy (DUK)
                Looking to Pick Up the Trail in October
                We brought Steve Young, CFO around for meetings in Europe last week. We remain Neutral rated at the current price given ~8.5% total return potential to our unchanged $98 TP, which could swing +/- $4 (~4%) depending on the outcome of legal issues for the Atlantic Coast Pipeline (ACP) project. Many investors were focused on ESG issues and decarbonization progress, and our sense is that there is an increasing willingness among some to consider future plans in addition to the current snapshot of carbon output. We also saw a focus on dividend stability and growth given >4% yield for the sector’s largest regulated utility play, the status of pending legislation that would reduce regulatory lag in North Carolina, and the fate of ACP. Hurricane Dorian had minimal impact on the company from an investor’s point of view. Our estimates are unchanged.

                Utilities & Renewable Roundup
                Things We Learned This Week
                Our take – Utilities: We are back from Europe this week, where we brought DUK management around to see a mix of mostly long-only investors interested in both ESG (focus on decarbonization plans) and yield in a strongly outperforming US Utilities sector, especially amid negative rates on the Continent. See our companion note this morning for more details. We note some reversal this past week as the group has underperformed the S&P 500 by 2%, which will leaves regulated utilities at a 17.6% premium to the S&P 2021 P/E, or roughly 10% too expensive based on both regression to 10-year yields that have sharply risen nearly 40 bps in the past week and forward beta-adjusted total return potential. Despite this and the past week’s mini-reversal, we see the likelihood of lower interest rates and bond yields into next year as supportive of a premium regulated valuation for the regulateds for the next few months. See our 9/6 Sector Valuation Update.
                Our take – Renewables: Inverter stocks have been under pressure likely due to concerns over competition, which we believe is premature. Expect to learn more on SEDG NDR and our meetings at SPI conference over the next two weeks. Q2 solar market data is in line with our expectations, with RUN and SEDG still leading vs peers in residential market. We calculate SDG&E’s higher monthly minimum bills could reduce residential solar NPV/watt by up to 22%, but still needs CPUC and public support. Democrat candidates have announced multiple prorenewable plans, but mostly in line with our prior expectations.

                IMO 2020 Watch
                MGO vs. VLSFO vs. HSFO – What to track so you can pick the ‘Real’ winner
                We believe it’s still too early to say if VLSFO will be able to make a material dent into incremental MGO demand as a preferred bunker fuel replacing HSFO. In this report we have put together a list of indicators that investors need to watch carefully into 2020 to see which fuel comes out on top. The MGO vs. VLSFO debate is inherently a distillate margin spike vs. heavy-light widening debate, where one is seen succeeding at the expense of the other.
                MGO vs. VLSFO debate. The good news is that the collapse in HSFO price is indicating that this would be a two-way fight between MGO and VLSFO and that implies that one way or the other the US refining industry is set to benefit from IMO 2020. While MGO (diesel) still remains the most popular choice to replace HSFO, we have seen VLSFO gaining traction with shippers due to price discount; as a result, it has become a hot topic in the investment community. While complex refiners can produce VLSFO with even high sulfur crude grades as they have residue desulfurization units (RDS), for the majority of global refiners (low complexity) the way to produce VLSFO is by lightening the feed slate and swapping heavy sour barrels for sweet crude. If VLSFO were to become a bigger part of the solution it would imply the increase in distillate margins would be less material than previously estimated, but it would also imply that heavy-light spreads will widen. The investment community does see IMO 2020 as a big earnings tailwind for refiners, but remains divided as to what would be a bigger driver of earnings, higher distillate margins or wider heavy-light spread. Consistency remains a key issue with VLSFO. We believe MGO has an edge going in 2020 but VLSFO can certainly make an impact in 2H 2020 as shippers get more comfortable with it.
                Stock thoughts. IMO trade got ahead of itself in 2018 as people got too bullish too soon. Most investors are currently on the sidelines tracking data points and trying to decide when and how to positon for the IMO 2020. Within our coverage VLO and PSX have the best overlap of high distillate yield and heavy sour usage to benefit either way (MGO or VLSFO). If heavy-light widens materially, PBF would be well positioned. SU emerges as the winner in Canada.

                Energy Infrastructure
                Cross-Border Connections: Serious about Storage and Talking about Terminals
                Acquisition Action: We see a renewed interest in storage assets following Pembina Pipeline Corporation’s (PPL) deal to acquire Kinder Morgan Canada (KML). Given the skew of natural gas storage assets owned by a number of utilities and tied to the rate bases of natural gas pipelines, our focus in this note is largely on crude oil and natural gas liquids terminals. We highlight Enbridge Inc. (ENB) and Plains All American (PAA) as the largest Cushing players – a vital hub that sets WTI pricing.
                Cross-Border Connection: For some, the KML deal helped raised the profile of storage in Western Canada’s two dominant areas: Edmonton and Hardisty (both Alberta for the less geographically inclined). This note gives a coherent listing of major terminals owners across North America. In our view, storage and terminal assets likely continue to generate interest from strategics and private equity, especially in a defensive environment. There is an inherently high degree of interest in storage assets given several factors, including: (a) low sustaining capex; (b) sizeable geographic moats from physical locations and pipeline connectivity; (c) ability to scale; (d) a high option value in a commodity contango environment; and, (e) network opportunities from value chain extensions. We highlight ENB, Enterprise Products Partners (EPD), Gibson Energy (GEI) and PAA with critical storage assets across major North American hubs.
                Seeking Smaller Storage: In our deep dive, we consider a number of the smaller storage players – From a market cap perspective, NS (not covered) and SEMG (not covered) standout in the US with sizable liquids storage relative to market cap. In Canada, we highlight GEI, Inter Pipeline (IPL) along with Keyera Corp (KEY).

                Canadian Energy Infrastructure
                Calling all Crude and Canadian Connectivity
                Canadian Considerations: For an overall consideration of crude markets and some of the specifics related to the current “Saudi situation”, in part, we rely upon the views of our Global Energy Team and crude commodity calls as expressed in their note. Very simply, a wave of drones knocked out some critical crude processing infrastructure and ~5.7m bpd of production has been shut-in. Early third-party expectations are for outages in weeks and not days for the restoration of production. Our team expects a rally in crude prices given increased geopolitical risks. The magnitude of the rally and the duration, we suggest consulting their work for greater granularity. Canada is relatively uniquely positioned as a large producer of crude with infrastructure integrated into the North American energy market. Beyond that reality, Canada has a petrodollar that tends to be highly correlated with movements in crude oil prices.
                Selected Stocks: We divide the stock impacts into three categories: (a) CAD positive; (b) infrastructure advantage; and, (c) outright energy. Under the first category of positive exposure to the CAD, we consider the largely domestic oriented businesses of Canadian Utilities (CU) and Hydro One (H) in the Utilities sector along with Energy infrastructure players like Keyera (KEY) and Pembina (PPL) all Outperform rated in our coverage. On the infrastructure advantaged, the major Canadian names like Enbridge Inc. (ENB) and TC Energy (TRP) are mired in various challenges around pipeline approvals to provide critical egress for Western Canadian producers. The combination of a Canadian election and high connectivity to the with rising geopolitical risks may be helpful for sentiment. In terms of outright energy exposure, for the infrastructure players, the dynamics are bit more complicated and key exposure includes: Gibson Energy (GEI), KEY and PPL – all as being mixed in nature. We exclude Kinder Morgan Canada (KML) given the pending takeover offer from PPL.

JPM
                Diamondback Energy (FANG)
                FANG Week Day 1: Financial Deep Dive: Stock Should Trade at a Premium, Not a Discount
                We are taking a multi-day deep dive into Permian Basin pure-play Diamondback Energy. In this report, we will look at the company primarily through a financial lens. From effectively all angles, we see Diamondback as a premier oil-levered name in our coverage list and view the company as a model for “the new E&P” that can attract new money into the space. While clearly, at this point, it would be nearly impossible for a company to fully emulate FANG’s strategy (much less its management team), there are some characteristics of the company that the industry needs to continue to move towards. In conjunction with this note, we are rolling our model through 2025. While there are undoubtedly some macro uncertainties over that time horizon, the clear takeaway is the company’s cash generation potential, which we model at nearly ~48% of the company’s market cap over through 2025. Shorter-term, we believe the Street is too low on 4Q:19 oil (JPMe +2% versus the Street), which could drive a better than expected exitrate/trajectory entering 2020. In addition to our E&P analysis, we include our midstream team’s updated view on Diamondback’s midstream entity, Rattler Midstream. The overall bottom line is that our analysis suggests FANG paces the group on nearly every important measure by which we benchmark E&P companies (capital efficiency, margins, FCF), yet the stock still trades at a discount to peers and the group on multiple metrics. We believe this is unjustified and that the stock should trade at a premium relative to the group and the Permian as a whole.

                Initial Thoughts on Sector Implications of Saudi Attacks
                Following the attack on Saudi’s key oil facilities over the weekend, we thought it would be helpful to discuss some of the potential impacts on the North American integrated & refining sectors. In summary, we think the impact of the unfortunate incident should be a near-term positive for Upstream (higher oil price effects) and mixed for Downstream (related higher feedstock cost effects). While it is still very early in assessing the impact of the attack, initial media reports suggest that Saudi’s production is currently down ~5.7mmbpd, of which ~1/3 is hoped to be restarted within days, while full restoration could take as much as six months (again, the situation is very fluid). By way of background, the Abqaiq facility that was attacked is Saudi’s main processing center for Arab Light and Arab Extra Light, handling ~1/2 of the company’s crude output last year. Along with the impact on crude oil, it is also thought that production of NGL’s could be impacted as well. Below we provide some further thoughts on the North American Integrated Oils and Refining sectors.
                North American Integrated Oils: Positive for all, particularly high torque names, but we remain most focused on longer term price impacts > initial spot price move. In terms of the potential impact on the majors, clearly this should be positive for all names, especially those with higher financial leverage, given that all of our companies have Upstream oil price exposure. This would include CNQ/CVE/MEG in Canada and COP/OXY in the US. Below we show our frequently published FCF yield sensitivities to every $5/bbl move in the Brent oil price. As of Sunday evening, spot Brent crude prices are up >$6/bbl (or >10%), while 2022 strip prices are up a more modest >$1/bbl (or >2%). On an absolute basis, the 2022 Brent price is currently in the high $50s, which compares with our long-term $60/bbl forecast. While equity prices could initially pop on the news, we think that the stocks will ultimately settle out based on the longer term price impacts.
                US Refiners: Our knee-jerk reaction says there puts and takes, though cracks and diffs responding positively so far. For the refining sector, our knee-jerk reaction to the news was that the removal of oil from the market could increase feedstock costs, while higher oil prices could weigh on both demand and shorter term capture rates (when oil prices go up, product price increases tend to lag crude price increases). That said, the product markets appear to be reacting positively for now, with 2020 strip crack spreads trading higher for both gasoline and diesel. On crude differentials, Brent/WTI is trading wider as well, which we anticipated would be the case, as the greater impact of the lost crude production is being felt on international crude markets (Brent) versus domestic markets (WTI). All in, as long as refined product production is not materially impacted by lack of crude availability, we think the product/differential impacts could prove mixed.

                Enphase Energy (ENPH)
                “Inverting” Into Profitable Growth Mode; Initiating Coverage at Overweight, PT $32
                We are initiating coverage of ENPH with an Overweight rating and December 2020 price target of $32. We are encouraged by ENPH’s fundamental outlook, driven by industry tailwinds (unit growth in solar, MLPE share gains against traditional string inverters, residential energy storage penetration), as well as company-specific tailwinds (new products, improving margins and cash flow, international expansion opportunities). Although the stock has significantly outperformed y/y and trades at a premium to industry-leader SolarEdge (SEDG/OW), we believe valuation remains attractive on a growth-adjusted basis and believe there could be upside to estimates with continued execution.
               

Jefferies
                Integrated Oil
                Crude Political Risk Skyrockets
                The attack on the Abqaiq processing facility in Saudi Arabia will necessitate a large political risk premium in oil prices. While oil market fundamentals are generally sluggish, the threat of a Saudi outage of +5 mbd becomes the overwhelming driver of price in the near term. We expect that Brent price could be up >$5/bbl until such time as the extent of damages is determined.
                Unprecedented threat to supply. The attack on the Saudi Arabian processing facility at Abqaiq raises significant threats to oil supply. Abqaiq is the largest oil processing facility in the world with 7 mbd of capacity. The facility handles production from the Abqaiq and Khurais fields and is also the eastern terminus of the East-West Pipeline in Saudi Arabia that ensures Saudi export capacity via the Red Sea in the event of interruptions in the Straits of Hormuz. Initial reports indicate that up to 5 mbd of Saudi production may be impacted by the attack; if this effect is for a few days it is not particularly impactful but if it is multiple weeks it will elicit a sustained a spike in oil prices.
                Regional peace the bigger threat. Initial reports indicate that the attack on Abqaiq was carried out by drones operated by the Houthi rebels in Yemen. This frankly seems a bit far fetched given the distance from Yemen to the Eastern Province of Saudi Arabia and the extent of the damage. The US State Department has already indicated that Iran was responsible for the attack, although Iran has denied this. However, cruise missiles seem a much likelier explanation for an attack of such magnitude. Iranian exports have officially dropped to minimal levels, although Iranian-owned tankers have been operating without transponders. If the Iranians have been driven to desperate measures from the loss of crude export revenues, an attack on Saudi capacity seems a likely response. The risk of wider conflict in the regions, including a Saudi or US response, will likely raise the political risk premium on crude prices by $5-10/bbl.
                In a worst case scenario that resulted in a shutdown of oil transport through the Straits of Hormuz, oil prices could push through $100/bbl. We think this outcome is highly unlikely however, not least because important Iranian allies like the Chinese would be hit hard.

                China Oil Demand: I Want Security, Yeah
                Geopolitical risk materialized with a vengeance as Saturday’s attacks on Saudi oil facilities shut down 5.7 mmbbl/d of production. Officials indicated that output would recover by Monday. Even if production is quickly restored, we believe markets may price in ~US$3-5/bbl of increased geopolitical risk in the medium term as nations shore up SPR and security at energy facilities. China’s efforts to increase domestic production now seems prescient, in our view

Keybanc
                As oil prices surge, KeyBanc’s Leo Mariani expects “high beta and heavily shorted” cos. including CDEV, JAG, SM, WLL, XOG will get the most short-term benefit
                Mariani also sees “E&Ps with higher oil cuts and lower hedged volumes in 2H” having “nice upside”: CLR, CXO, EOG, FANG, MUR, OXY, PE, PXD, WPX
                “The attack should prove disruptive as opposed to catastrophic,” Citi’s Tobias Levkovich wrote in a note, as the Saudis are already able to make up 40% of the lost production, and there’s potential for strategic reserve releases
               

Ladenburg
                Energy – Exploration & Production
                Drone Attack Shuts Down Roughly One-half of Saudi Oil Production
                Saudi Arabia shut down roughly one-half of its oil production after 10 drones attacked its Abqaiq plant (world’s largest oil processing facility with 7.0+ MMBbls/d of capacity) and Khurais oil field (Saudi’s second largest oil field with a capacity to pump ~1.5 MMBbls/d) on Saturday. The closure impacts 5.7 MMBbls/d of crude production, ~5.0% of total global daily oil production. Saudi Arabia produced ~9.8 MMBbls/d in August.
                Iran-backed Houthi rebels in Yemen, who have launched several drone attacks on Saudi targets, claimed responsibility for the attack, although U.S. Secretary of State Michael Pompeo blamed Iran directly. President Trump tweeted “There is reason to believe that we know the culprit, are locked and loaded depending on verification, but are waiting to hear from the Kingdom as to who they believe was the cause of this attack, and under what terms we would proceed!”.
                Saudi Arabia indicated that the fires at the processing facility are under control and it is expected to begin restoring part of the shut-ins immediately, although it is likely to take longer to fully restore all of the shut-in production. Saudi Arabia believes it should be able to keep customers supplied for several weeks by drawing on its global storage network. In addition, President Trump authorized the release of oil from the Strategic Petroleum Oil Reserve, if needed. The IEA indicated that it was monitoring the situation, but “the world was well-supplied with commercial stockpiles”. In its September Oil Markets Report, the IEA estimated that OECD commercial stocks in July were 2,931 MMBbls, 19.7 MMBbls above the five-year average.
                Regardless of the time required to fully restore production, we believe concerns over escalated tensions in the Middle East, along with the vulnerability of Middle East oil infrastructure, is likely to increase the geopolitical risk premium in oil prices for the foreseeable future.
               

Mizuho
                American Electric Power Company, Inc. (AEP)
                Take It to the Limit
                AEP has identified significant spending upside associated with its North Central Wind project but may face substantial regulatory challenges in obtaining approvals. Recent rate recommendations in Indiana and Texas signal growing push-back to higher utility bills. Weak cash flows arising from customer flow-back of deferred taxes will likely require incremental equity for any additions to the company’s capital spending program. We reiterate our Neutral rating and update our PT to $90 from $85.

Piper
                Energy Ruminations – Quick Thoughts on Saudi Attacks, Growing Insecurity of Forward Supply
                Saudi Arabia incurred, early Saturday morning, drone attacks on the Abqaiq processing center and the Khurais Field. Although Iranian-backed Houthi rebels have claimed responsibility for the assault, Secretary of State Mike Pompeo is now blaming Iran for the attack which purportedly encompassed launching ten drones into the heart of the Saudi oil industry (although now there are some reports that cruise missiles, as opposed to drones, were employed in the attack). As of the writing of this note, however, Mr. Pompeo has yet to provide evidence that Iran perpetrated the attack.
                Abqaiq is the world’s most important and largest crude processing facility, processing ~7 MBD from multiple important Saudi fields, while the Khurais Field produces 1.5 MBD and is Saudi’s third-largest producing oilfield. This marks at least the 6th assault on Saudi energy facilities since May. The latest attack has reportedly disrupted close to 60% of Saudi production or 5.7 MBD (according to OPEC Secondary Sources, latest estimated Saudi production was 9.8 MBD). While Saudi officials are reassuring the world that lost production can be restored by Monday, industry observers contend that the disruption could be longer lasting.
                All of us are operating in the fog of war and thus data transparency falls well short of crystalline, even by the abysmal standards of energy data. Pivotal considerations attendant to the pricing transmission for oil and energy stocks will eventually be a function of duration and magnitude of the supply disruption. This attack should have broader implications in redefining the geopolitical risk premium for oil. The popular mythology governing energy sentiment on the part of Wall Street and the financial media has been driven by the deadening indolence and complacency of resource abundance, with a perennial fixation on the Permian, and range-bound oil prices, seemingly forever. This is a reminder that there is a very big world outside of the Permian.

                E&P-  2020 Budgets and the Slow Grind Lower
                Over the past couple of weeks we have met with and/or spoken with a large portion of our coverage universe. And while much remains the same, one of the clear takeaways on the margin is that 2020 E&P budgets continue to be biased lower, below current Street expectations (SE 2020 capex estimates -4% vs. prior SE, -4% YoY and -5% vs. Street). While this is just one of many (baby) steps in a long process on the return to respectability, we view it as a clear positive, as it 1) supports capital discipline bona fides, 2) improves the FCF outlook, and 3) improves near/medium-term crude oil balances (even more so given the outages in Saudi). Biggest deltas: APA, DVN, FANG, NBL. Our top picks on a 12-month view are NBL, FANG. For higher beta on a likely near-term jump in crude: DVN, MRO
                2020 Budgets moving lower – Across 8 names in our coverage universe, we have reduced 2020 capex budgets by 4%, where we now see capex budgets -4% YoY, and 5% below current Street estimates. This is driven almost entirely by a reduction to activity outlooks (ie. not deflation), representing either a reduction to current activity levels (APA, DVN) or the likely decision not to add previously anticipated rigs (FANG, CXO, NBL). Should efficiency gains/cost deflation continue on current trends, there is likely further downside to our estimates. Not everybody is declining, however, with EOG and PXD both adding rigs into 2020, and our capex estimates up 8%/7% YoY, respectively.
                Even post-Saudi outage? – Yes, unless we see a structural shift materially higher and that looks to have duration well beyond upcoming budget season, we still expect activity to be biased flat to down. Given current multiples, management teams see no incentive to add additional activity.
                Production growth slowing… – Although growth remains an impressive 9% on average across this group in 2020, this is a modest reduction from our prior estimates (APA, DVN, OAS revised lower), but it is also meaningfully less than the growth rate across the same 8 companies in 2019. We view this as largely representative of the larger sector, both public E&Ps and privates (based on recent conversations). Per the most recent Simmons energy crude macro outlook, we estimated US growth in 2020 of ~1.0 MMb/d YoY, which we expect has meaningful downside based on recent conversations. Given the current outages in Saudi and the increase of both fundamental and perceived risk going forward, we expect that the ’20 crude outlook may look more constructive than our prior base case.
                …but FCF (and likely dividends) increasing – Despite the modest reductions to 2020 crude production, the reductions to capex have a meaningful and positive effect on 2020 FCF, which increases from $5.6 Bn to $6.1 Bn (+9%) across the 8 companies. Further, while the preferred method for returning cash to shareholders has been via buyback (at least on the margin for E&Ps), our conversations made it clear that dividend growth is shifting higher in priority – in line with investor preference. We expect increases in 2020 from NBL, DVN, EOG, FANG, PXD, with others likely as well.

                Viper Energy Partners LP (VNOM)
                Announces $150M Acquisition of Midland Basin Acreage
                Friday after the close VNOM announced it had acquired nearly 1,400 net royalty acres from Santa Elena Minerals for $150M or roughly 5.2M common units based on a weighted avg. price of $29.02 over the five trading days ending 9/5/19. The acquisition is moderately accretive to 2019E/2020E EBITDA, however, and more importantly, it further increases VNOM’s exposure to FANG-operated acreage providing further line of sight to future cash flow levels tied to a premier Permian operator in FANG (covered by Ryan Todd). All-in we view this as positive for VNOM and reiterate our Overweight rating.

PVM
                Daily Oil Fundamentals
                War in the Middle East
                It has always been on the cards and the warning signals came almost on a weekly basis in the form of drone strikes on a Saudi airport. The weekend’s attack on Saudi oil installations, however, must have taken everyone by surprise and disbelief. So what exactly has happened?
                Details are sketchy. The freshly appointed Saudi energy minister promised more information probably later today. Currently there are no reports of casualties. What we presently know is that Iran-friendly Houthi rebels claimed responsibility for an attack on two oil facilities carried out by ten drones on Saturday morning. The two facilities involved in the attack are the Abqaiq oil processing plant and the Khurais oil field. The former is about 60 km from the Aramco headquarters in Dhahran. It processes crude oil from the giant Ghawar oil field and also handles crude oil for oil exports to the Ras Tanura terminal – the biggest offshore oil facility in the world. Additionally, it sends oil across Saudi Arabia to export terminals at the Red Sea. The Khurais oil field is adjacent to the above-mentioned Ghawar field and went online 10 years ago. Its production stood around 1.5 mbpd.
                The attack cut the Kingdom’s oil production by more than half – latest reports put this figure at 5.7 mbpd. The weekend’s developments have understandably sent shivers down investors’ spines. Brent registered its biggest ever intra-day jump as it peaked at $71.95/bbl in the early hours of today’s trading, $11.73/bbl above Friday’s settlement level. Activity is concentrated on the front-end and the November/December spread has jumped well above $1/ bbl. The impact on WTI was not as profound as on Brent. The US marker peaked $8.90/bbl above last week’s closing price. Middle East stock markets are hit and the Saudi stock index started trading 2.3% lower although pared some of these losses later on. Gold is more than 1% up on the day at 8.30 a.m. London time.
                As reports about the impact filtering through a relative calm is being restored in the market. At the time of writing Brent is trading slightly above $65/bbl, nearly $7/ bbl below the day’s high. It is probably down to two things. Firstly, Saudi Arabia said that its oil exports will continue as normal this week using stocks in order to fulfil commitments. Secondly, The US President authorized the release of oil from the Strategic Petroleum Reserve if needed but the quantity is still to be determined in case of such a move.
                The short-term impact of the attack was there for everyone to see. Oil prices spiked as shorts covered their position but the panic rally was not maintained. Is it because the market does not believe in a prolonged supply disruption? Probably not, but the situation is still being evaluated. If you took a snapshot here you would end up with an extremely bullish supply/demand balance. Saudi Arabia has been forced to cut 5.7 mbpd of its production. Firstly, one of the very few countries with spare oil capacity is Saudi Arabia. The kingdom could ramp up its output by 2-2.5 mbpd in a relatively short period of time. It was exactly this extra supply cushion that has been wiped out over the weekend albeit possibly only for a limited period of time. The latest survey of secondary sources published in last week’s monthly OPEC report estimated that member countries pumped 29.74 mbpd in August. Take away the aforementioned 5.7 mbpd and you will end up with 24 mbpd. This is when the demand for OPEC oil is seen 30.61 mbpd for the current quarter and 30.03 mbpd for 4Q 2014.
                This is a frighteningly bullish estimate and yet the market seems relatively calm about it given the fall from the day’s highs. This is because the current thinking is that a.) the situation will be normalized quickly and b.) higher oil prices will have a negative impact on oil demand. One of the reasons why oil prices have not been able to rally lately is economic considerations that have a negative impact on global oil demand and oil demand growth
                The medium-term prospect, however, could easily turn out to be price supportive or at least could provide some kind of price floor. Although Yemeni Houthi rebels claimed responsibility for the attack the US administration clearly puts the blame on Iran. A US official says that there were 19 points of impact and evidence apparently showed that the launch area was west-northwest of the targets, which is Iran and south from Yemen. Iran immediately denied the allegations and called them pointless. Nevertheless President Trump said that the US is “locked and loaded depending on verification” that Iran was, in fact behind the attack. Some kind of retaliatory response is likely to be forthcoming.
                It is, however, not clear what kind of measure the US might take. It seems that there is no acceptable response in this case. On one hand the US cannot afford a military action as it could make the current conflict spiral out of control. On the other hand, the President cannot afford to look weak after his “maximum pressure” policy on Iran. It would send out a message that Iran and its allies in the region are free to strike without any retortion. It is a delicate situation the US finds itself in. The only conclusion that can be drawn at this stage is that the weekend’s attack on Saudi oil facilities makes any Iranian come back to the oil market much less plausible than a week ago

Raymond James
                Attack in Saudi Shuts 5% of Global Oil Supply…..This Is a BIG Deal!
                Approximately half of Saudi oil production – an estimated 5-6 million bpd (or 5% of global supply) – was offline as of Sunday, following Saturday’s drone attack against the Abqaiq facility and Khurais oilfield. In this brief, we will try to address the following key questions that investors will likely have this morning, including: 1) What is Abquiq/Khurais, and how important is it?, 2) How long is it likely to be down, and how much oil supply will it ultimately impact?, 3) What will this attack mean for oil prices?, and 4) What will this attack mean for U.S./Saudi relations with Iran?
                What is Abquiq/Khurais, and how important is it to world oil supplies?
                Abqaiq is Saudi’s largest oil processing plant. It processes a whopping 7 million barrels per day of sour, dirty crude into a usable, sweeter crude that can be loaded onto tankers and refined by simpler refineries around the world. It is, by far, the world’s largest oil processing plant, covering over 600 acres in size. Khurais is a major producing field that is not directly near Abqaiq but was slated for development of its lighter sweeter crude. It is also notable for its location adjacent to the supergiant Ghawar field and has substantial gas processing and separating facilities.
                Who did it, and how relevant is this disruption? Hint: this is a BIG deal!
                We are witnessing a historic event: the world’s largest oil supply disruption in decades. Responsibility for the attacks was claimed by Yemen’s Houthi rebels, in the context of the long-running war between them and the Saudi-led coalition; however, Secretary Pompeo has tweeted that evidence surrounded this complex attack points directly to Iran. Put simply, the U.S. government places blame on Iran, which is likely to escalate the risk of a more substantial conflict involving the U.S., Saudi, and Israel pitted against Iran. Regardless of the culprit, this attack provides a stark reminder that geopolitical risk to oil supply is very real. In recent months, oil prices have traded predominantly on demand-related fears surrounding the U.S.-China trade war, but as this attack illustrates, geopolitics can be much more consequential to the overall oil supply/ demand equation than the oil market has been pricing in. In addition to the fundamental implications for the oil market, this episode also demonstrates the vulnerability of Saudi Aramco’s assets at a time when the company is ramping up IPO efforts.
                Regardless of who is behind the attack, a supply disruption on this scale is an extraordinary event – no single disruption on this scale, either in barrel terms or percentage terms, has occurred in decades. Even the Arab Spring in 2011 and the Iraq War in 2003 did not cut off this much supply in one fell swoop. We would have to go back to the Gulf War in 1991 – which knocked out production from both Iraq and Kuwait – to see the last time that 5% of global supply went offline. For more recent perspective, 5 million bpd is more than the cumulative production drop in recent years resulting from Venezuela’s domestic crisis and U.S. sanctions against Iran, combined. It is also worth noting that Abqaiq had been the target of a (failed) al-Qaeda attack in 2006. It took thirteen years and a different set of players, but one of Saudi’s most well-protected strategic facilities has experienced a long-feared “worst-case” scenario.
                The elephant in the room: Will this be the “last straw” between the U.S. and Iran?
                It seems clear that this complex, well-orchestrated attack was unlikely to have been pulled off by the Houthi rebels on their own. While Iran will likely maintain plausible deniability, it is well-documented that Iran has been feeding drone technology to the Houthis fighting the Saudi-led coalition. The other thing that we have noticed about the increasing number of attacks from the Houthis is Saudi’s quick denial of any major disruptions. In this case, satellite and space station photos don’t lie. This attack burned up a bunch of things!
                One of the reasons why the Saudi government has an incentive to exaggerate its ability to resume production quickly may be due to the complex geopolitical triangle between Saudi, Iran, and the U.S. As noted earlier, the U.S. is blaming Iran (rather than the Houthis) for this attack, which Iran denies. Let’s suppose that the U.S. and Iran actually go into an escalated conflict. In such a scenario, Saudi oilfields would be among the most tempting targets for Iranian retaliation. If the U.S. government doubts Saudi’s ability to quickly repair damage and therefore stabilize the global oil market, fears of sky-high oil prices – in an election year, no less! – would presumably dissuade the White House from pursuing such a course. In the coming days and weeks, we will be closely watching the politics of all this. Either way, the poker stakes in this Middle East geopolitical game have increased dramatically over the past few days. Also, it is now very clear that Saudi oil production defenses are penetrable, and the risk premium to global oil supplies has entered a new era.

                Energy Stat: Latin American Oil Output and Activity May Tick Up in 2020 – But No Real Recovery Without Venezuela
                “It was the best of times, it was the worst of times”… we are pretty sure Dickens was not writing about Latin America’s oil industry – but the phrase is apt. In recent years, Latin America has been the site of the world’s most dreadful oil production collapse (Venezuela) but also the numberone deepwater success story (Guyana). These two extreme examples – and other case studies in between – exemplify the mixed messages coming out of this important oil-producing region. Today we will take a holistic look at the outlook for South American (plus Mexican) oil production growth in the coming years. In aggregate, the region’s oil production is tracking for a fourth consecutive hefty decline in 2019 but stands a reasonable chance of posting a small uptick in 2020 – the latter in large part due to Guyana and Brazil finally beginning to contribute. However, any meaningful long-term recovery towards the region’s 10+ million bpd run-rate of 2011-2015 will largely hinge on Venezuela returning. Bottom line: Despite the disaster in Venezuela, we are looking for a modest uptick in 2020 oil supplies and overall oilfield activity from “South of the Border” for the first time in five years.

                With Short Interests High, What Does Saudi Outage Mean for OFS?
                Following the attacks on Saudi Arabian oil processing facilities (link), we wanted to check in to our coverage universe from a short interest and E&P cash flow perspective. Given the chaos that ensued, we suspect the high uncertainty will naturally fuel short covering. As shown below, and given the malaise of the sector, it should come as no surprise that there is significant short interest across the space. As such we expect the price response amongst oilfield services names to be significant in the short term. Furthermore, the oilfield service space lacks market cap and thus any significant inflow of capital should result in significant equity price swings. From a days of coverage perspective (>$1B market cap), HLX, RES, and NOV all have oil leverage and the highest short interest in our coverage. As such, we would not be surprised to see significant price increases for these names and the group as a whole.
                From a cash flow perspective, this may act as a test of capital discipline in both the upstream and oilfield services space. Historically, significant oil price spikes have led to a significant activity response in the following months as operators naturally would look to take advantage of positive price signals. While any significant, sustained rally in oil prices would undoubtedly lead to an activity response, we would expect more hesitancy for operators to respond to near term oil price increases. In addition, given the lack of capital, we would expect service companies to be more cautious to reactivate equipment until operators give definitive indications or until contracts are signed. Nevertheless we note that a $5 change in oil prices results in a ~15% change to overall 2020 U.S. E&P cash flows.
                In the near term, we would not expect major changes to public operator activity. As our E&P team discussed previously, public independent E&Ps are ~50% hedged on oil prices for 2019. However, hedging is relatively minor for 2020 with public independent E&Ps ~27% hedged on oil volumes (link). At the fringe, this optionality may provide some stability to service pricing as optionality plays in service companies favor if elevated oil prices carry into budget season. It should be noted that private operators can certainly react faster to price signals and are likely the first to respond if oil prices remain elevated.

                Delek (DK)
                Notes From the Road: Key Takeaways From Management Meetings
                While it’s been a more volatile ride than we’d have liked, Delek remains our favorite SMID-cap refining stock. After spending time with management in the Midwest, our conviction in DK’s outlook and growth evolution has been reinforced (helped by solid investor interest). While the near-term conversation in energy-land will undoubtedly be dominated by this past weekend’s events in Saudi, we think the setup for refiners – and DK in particular – is positive heading into 2020. Investors remain focused on several topics, which we’ll highlight in more detail below: (1) DK’s midstream growth and outlook, (2) Permian diffs, (3) refining macro for 2H19+ (gasoline margins, IMO, etc.), (4) capital allocation (growth spending vs div./buybacks), and (5) 2020+ earnings power and overall strategy. We still believe the company trades at a discounted sum of the parts valuation and management is taking numerous value-enhancing initiatives to eliminate the discount. We reiterate our Strong Buy rating on shares of DK.

RBC
                International E&P – Highlighting oil price correlation
                This weekend’s attacks on Saudi Arabia’s Abqaiq processing facility and the Khurais oilfield have sidelined a reported 5.7mmb/d of output; Brent this morning initially surged to ~$72/bbl, before returning to $66/bbl, up 10% from Friday’s close.
                The oil price outlook remains dependent on the duration of the outage, the ability to meet export commitments through domestic drawdowns, demand elasticity at higher prices as well as government and agency policy. The IEA has suggested that drawing from strategic reserves is not imminent and that markets remain well supplied with ample commercial stocks; a view that has been echoed this morning by Russia, while POTUS has tweeted that he has authorized the release of oil from the US’s strategic reserve, if needed.
                Aramco officials have suggested that exports may restart within days, there is a high degree of ambiguity around timing, extent of damage, coordinated supply response measures and the impact on investor sentiment. At a minimum, the attack is a key reminder that the geopolitical risk premium, which has long been absent, should make a pronounced return back into the market.
                In Exhibit 1, we highlight the most oil price correlated and leveraged international E&P names – Premier Oil, Genel Energy, Tullow Oil, EnQuest, etc. Given the geographical focus on the Middle East we wonder whether the Kurdistan-focused names might lag their North Sea-focused peers. Moreover, the imminent start of Johan Sverdrup, combined with higher prices, would be a shot-in-the-arm for participants Lundin Petroleum and Aker BP.
                More generally, today’s surges might have been utilized as a liquidity event to better position portfolios for anticipated newsflow in Q4/19, and the outlook for 2020.

                RBC International E&P and OFS Daily
                Oil prices jumped ~$8/bbl on Monday morning after two major Saudi oil installations were hit by a drone strike on Saturday. Bloomberg reported the attacks, claimed by Yemen’s Houthi rebels, damaged strategic facilities forcing a shutdown of half of the kingdom’s crude production on Saturday; ~5.7 mb/ d of Saudi crude output were cut, representing over 5% of the world’s supply. Russia’s Energy Minister Alexander Novak said that he planned to have a phone call later today with his Saudi counterpart following the attacks. Novak said “If there is a need, in case of an emergency, we always can get together and discuss some other parameters. But it is too early to talk about it now” and added that there is enough oil in commercial stockpiles worldwide to cover the shortfall of supplies. Meanwhile, US Secretary of State Mike Pompeo directly blamed Iran for the attacks, Iran’s Foreign Ministry spokesman Abbas Mousavi denied the accusation. US President Donald Trump said on Sunday the United States was “locked and loaded” for a potential response to the attack on Saudi Arabia’s oil facilities.

                Saudi Arabia/Iran Crisis Guide Update: This is Your Wake Up Call… Commodity Strategy
                With 5 mmb/d of Saudi exports offline, today’s twin drone attacks mark the most dramatic escalation in the ongoing Iran standoff and have put the region more squarely on the path to a military conflict. Since the attack on the tankers off the coast of Fujairah in May, the oil market has largely shrugged off the wave of worrying security incidents in the Gulf region. As long as no physical supplies were disrupted, market participants could focus their fears on the potential for an ongoing trade war between the US and China to destroy oil demand. We contend that this morning’s drone attacks on Saudi Arabia’s all important Abqaiq processing facility (which has processing capacity of more than 7 mmb/d and the 1.5 mmb/d Khurais oil field represents a game changer in the escalating Iranian regional standoff. With 5 mmb/d of the Kingdom’s oil exports at least temporarily taken offline, it represents the most serious assault to date on the country’s energy infrastructure. Though Aramco officials have indicated that exports will resume in the next few days, there is nothing to suggest that this is a one-off event and that the Iranian-backed Houthi rebels will forgo further strikes on Saudi sites. For now, they seem neither deterred in their disruptive intentions nor degraded in their capabilities. In many respects, today’s security incident was anything but surprising as it merely marked the most dramatic in a series of recent attacks on Saudi energy infrastructure – starting with the drone strikes on the strategically important East- West Pipeline in May and continuing with last month’s attack on the 1 mm/d Shaybah field. Abqaiq is an especially critical site as it is the world’s largest oil processing facility and defense and intelligence officials have been concerned about its security ever since the foiled 2006 Al Qaeda truck bomb attack.

                Oil Strategy – Supply Crisis Playbook and Indicators to Watch
                Even if the Kingdom normalizes output in short order, the threat of massive unprecedented outages is no longer a hypothetical, a black swan or a fat tail. The price path in the coming days hinges on how much the physical market tightens. We highlight three indicators to watch: Shifting oil trade flow, crude quality differentials and demand elasticity.
                The weekend attacks on Saudi Arabia’s Abqaiq processing facility and the Khurais oilfield has sidelined a reported 5.7 mmb/d of output, which should shock prices higher once markets open on Monday. However, the forward-looking path and the ability to sustain at an elevated price remain dependent on the duration of the outage, the ability to meet export commitments through domestic drawdowns, demand elasticity at higher prices as well as government and agency policy. At a minimum, the attack is a key reminder that the geopolitical risk premium, which has long been absent, should make a pronounced return back into the market.
                The IEA has suggested that drawing from strategic reserves is not imminent and that markets remain well supplied with ample commercial stocks, but as suggested in our note from yesterday , this is not a one off event and there are no signs of de-escalation. JODI data suggests that Saudi Arabia has domestic crude inventories of 190 mmbbl (equivalent to less than four weeks of export cover). Of that, real time geospatial data indicate 92 mmbbl currently reside in above ground floating roof-tank storage. While the Kingdom could meet commitments by drawing down on commercial stocks, additional potential attacks on storage facilities would effectively sterilize the ability to meet customer needs for the country that many deem to be the world’s central bank of oil and houses the majority of current global spare capacity.

Seaport Global
                Oil thoughts and E&P crude exposure post the Saudi attack
                What’s the initial price action? As of 9 pm CT Sunday WTI is up 10.2% to $60.43 and Brent is +11.4% to $67.07.
                How much is offline and for how long? 5.7 MMbpd initially. Saudi has stated that 33% of this should be back online on Monday. After talking with multiple traders in Houston, we’re hearing the belief that 60% could be restored by Tuesday. To frame the 5.7 MMbpd, that accounts for 5.66% of the 100.7 MMbopd of worldwide production the IEA reported in August. It also accounts for 58% of Saudi’s 9.75 MMbpd of production in August. There is also the belief that Saudi is sitting on ample storage of crude at the moment post refraining from exporting crude in August to the tune of 0.700 MMbpd, which could reduce the disruption. As it pertains to OECD crude and product inventories, we sat at 2,931 MMbbl, which was comprised of 1,084 MMbbl of crude. Thus, having 5.7 MMbpd offline for one month would lower OECD crude inventories by a non-trivial ~15%.
                Who done it, Yemen rebels, Iran, or inside job? We’re somewhat amazed at the amount of theories currently being floated. Houthi rebels in Yemen were quick to take credit for what was initially thought to be a drone attack, but the WSJ is reporting that U.S. officials are indicating that the blasts were the results of cruise-missile strikes launched from Iraq or Iran. Furthermore, Secretary of State Mike Pompeo took to Twitter to point the finger directly at Iran and Sen. Lindsey Graham tweeted that the US should consider an attack on Iranian oil refineries. The stakes for oil certainly go up with Iranian involvement. There are also more than just a few conspiracy theorists claiming that this attack could have come from within Saudi itself. With crack margins for High Sulfur Fuel Oil poised to nosedive in Q4, this would be a swift way to take product off the market and to juice the geopolitical risk premium ahead of the Aramco IPO at the same time.
                Risk Premium to return? One of the most common conversations we had today on the topic was that the attack should put some sort of risk premium back into the price of oil, which many believe stood at $0/bbl on Friday afternoon. With that said, most people we’ve talked to thus far don’t believe this weekend’s events fundamentally change the long-term price of oil in a meaningful fashion.
                Got hedges? We’re hearing that US producers are currently lighting up commodity trading desks tonight in an effort to lock in higher prices.

                Diamondback Energy, Inc. (NASDAQ: FANG; $96.73; Buy; $130.00 PT) NDR notes: We all use the same Bloomberg’s, some just better than others
                When pressed by an account how FANG could consistently outperform its peers on the capital efficiency front despite having the same oilfield service vendors and the same pricing, management responded that all portfolio managers basically uses the same Bloomberg’s – some just have a better process, clearly defined incentives, and an enabling culture. Post our NDR last week through NYC, we don’t think FANG is at risk of slipping off the top of the capital efficiency charts anytime soon. Our note focuses on the incrementally positive data points pertaining to FANG’s trajectory headed into 2020, defining the well cost advantage, and thoughts on M&A/capital allocation. We also discuss our new NAV methodology and apply it to our FANG model – the net/net is that FANG still looks great when we use actual well results and $50/oil for our long-term price. We reiterate our Buy rating and shift our NAV-based price target to $130/share from $155/share.
               

UBS
                UBS Specialist Sales: Oil & Gas
                Scraping the Barrel
                Oil is up ~10% following attacks on Saudi oil production and processing infrastructure over the weekend that have resulted in the loss of 5.7mb/d of capacity, or approximately 5% of global oil production. While little is known at the moment about the extent of the damage or the expected duration of the outages, it is clear that a successful precision attack on producer as important as Saudi will add a risk premium to oil that will persist for quite some time. Jon and the team point out in yesterday’s note that there is ample oil in storage in Saudi and globally to take the edge off the disruption (Saudi’s 187mb of inventories cover ~28 days of exports, for example), but the perception of what constitutes an adequate level of global spare capacity is likely to shift at a time where the potential to meaningfully expand spare capacity is limited. Evidence of a more dovish approach to foreign policy from the US after the firing of John Bolton as National Security Adviser last week was beginning to point to downside risks in oil, but with the US pointing the finger at Iran for these attacks I have to imagine rumoured talks between Presidents Trump and Rouhani are off the table. Where oil goes in the near term will depend on the extent of the damage and the duration of the stoppage (more on which is expected from Saudi today/tomorrow), but risks are now skewed very much to the upside in my view as markets weigh a shift to risk perception that will persist far longer than the actual supply disruption. Integrated oil and E&P companies are performing well this morning, but is worth considering the negative impact on refiners of a higher oil price. Although most Saudi crude goes to Asia, global margins will be squeezed by higher oil prices and complex European refiners will be under particular pressure as light/heavy differentials tighten.

                NorAm E&Ps
                Did It All Just Change? What Themes Now? Also VNOM, SU, NBL & CHK at the Margin
                Themes, Themes, Themes… Did it All Just Change?
                The option value of crude oil prices has been declining for years as the combination of short cycle US shale oil capacity became better understood, and new technologies (i.e. solar, wind, and battery) targeting future energy demand moved to the forefront. However, the drone attacks over the weekend on the Abqaiq facility and the Khurais oil field in Saudi Arabia may have just changed that, until proven otherwise. Abqaiq is the largest and arguably most important oil processing facility (H2S removal) in the world, and Khurais is Saudi Arabia’s second largest oil field. Investors are presently awaiting word on outages and downtime, with more than half of Kingdom’s capacity, or roughly 5% of global supply, widely reported to being offline (a/o Sunday early evening). More importantly, though, the question will remain, ‘Can it happen again?’ Drone attacks impacting such important targets are something few imagined possible, especially given the Saudi defense budget. Our initial premise is the oil price initially spikes higher, only to retreat, but settling at a higher back of the curve level until risk of repeatability and/or retaliation can be adequately addressed. Macro demand concerns will emerge, though, once a better understanding of the latter is understood. Top Picks include FANG, PE, PXD, CNQ, SU, EOG & ECA.
                Last Week’s Themes…
                We’ve already had multiple generalists reach out. The oil markets open Sunday evening. We’ll also get a better feel for level of investor concerns this week as we host our Houston Energy Tour. From the corporates, we still expect a message grounded in discipline, avenues to return excess capital, and a focus on continued improvement in cycle times / costs. For midcap E&Ps, a plan to secure debt refinancing and retirement has to remain a priority. Investors also are focused on resource life, MOEs, 2019 proxies, and 2020 board access. In order of presentations, our tour includes presentations by BP, RDSA, FTI, ECA, EOG, NBL, EQNR NO, NBR, MGY, MEG CN, OAS, DO, NE, RIG, COP, OXY, HES, MRO, CVX, BSM, KRP, and MNRL. Please reach out if you’d like to follow up post our trip.
                At the Margin Moves… Waha, NGLs, Midland-WTI
                Although these spreads now take a back seat, Waha did close Friday at $1.62/Mcf. And while not compelling on an absolute basis, the change from negative has garnered some attention. In fact, spot Waha’s 2Q average was negative $0.02/Mcf (Figure 2). Putting aside oil, the other commodity that investors are keeping an eye on remains NGLs. 3Q19 average prices are down materially from both 2Q19 and year ago levels; ~16% and ~50%, respectively, at Mont Belvieu (Figure 3). But rather than Q-o-Q averages, investors are watching the recent pricing improvement

                Global Oil Fundamentals
                Saudi Arabia attacks: Oil market supply risk raised
                Attacks on key Saudi oil facilities take out >5% of global oil supply
                Attacks, reported to be by drones, carried out over the weekend on two key Saudi oil facilities, the Abqaiq crude processing plant and a processing plant at the Khurais field, have resulted in Saudi Arabia initially shutting 5.7mb/d of its oil production, over half its total output. The Abqaiq facility is the main center for handling Arab Light and Arab Extra Light crude mainly from the Ghawar, Berri and Shaybah fields and processed about half of Saudi Arabia’s crude last year. It supplies into the East-West pipeline and its status as the hub of Saudi oil industry is clear. It has heavy security and was the attacked by AQ in 2006. The 1.45mb/d Khurais field is the kingdom’s second-largest. ~2bcf/d of associated gas production (incl. 700kb/d of NGLs) has also been suspended.
                Duration of outage is key; global inventories sufficient in the short term The direct impact from the shutdown on physical oil markets will be determined by its duration, and the CEO of Saudi Aramco said on Saturday that an update will be provided in 48 hours. In the meantime the kingdom will continue to supply customers out of inventories. Saudi crude inventories of ~187mb cover about 28 days of exports. Total OECD inventories (incl. products) cover ~60 days total demand. Most members are above the IEA reserve requirement for 90 days of net imports (avg. 215 days).
                Event to prompt a return of political risk pricing If nothing else a reassessment of risk pricing will likely presumably come in the aftermath of this attack. To take out over 5% of global supply (in the country with the bulk of ‘spare capacity’) in a single strike – a volume exceeding cumulative non-OPEC supply growth over 2014-2018 – is highly worrying. The departure of National Security Advisor Bolton last week was interpreted by many as a reduction in political risk – this event may be significant magnitudes more consequential.
                Upward pressure on oil prices; sensitivity to supply side developments to rise We expect the resultant supply outage to drive up oil prices as markets reopen. While US-China trade and US oil supply growth have been the primary price drivers we see a return of the political risk premium as the market has been arguably complacent about risk events. Our upside price scenario sees risk of prices rising to $80/bbl+ for a significant OPEC outage but we want to understand the details before being able to determine if that is realistic.

                PG&E (PCG)
                What happened? On 9/13 PCG announced an agreement in principle with entities representing approximately 85% of insurance subrogation claims to an $11B settlement to resolve all claims related to the 2017 Northern California wildfires and the 2018 Camp Fire (including insurance subrogation claims related to the Tubbs fire).
                What are the implications? The company’s $18B claims figure in the draft plan of reorganization will likely increase given that it set aside $8.5B to resolve all insurance subrogation claims despite the fact that the settlement reduces uncertainty in the process. The settlement does not address claims from individuals for the wildfires for which the plan included $8.4B. We estimate an increase in gross claims under the plan of reorganization to $22.3B from $18.0B previously which implies a reduction in implied equity value to $13 from $22/share.

Wells Fargo
                Oil Macro: Initial Thoughts On The Attack On Saudi Arabia
                Key Takeaways. The most likely outcome will be higher oil prices to start the week on Monday, September 16, 2019, in our view. We also expect oil & gas stocks to rally alongside crude oil. This view is consistent with our note from September 5, 2019, Integrated Oils: Are Energy Stocks Cheap Enough To Buy Now? The unexpected loss of 5% of global oil supply over the weekend should result in at least an equivalent upward move in crude oil to start the week in our view. A secondary effect should be an expansion in the differential for light/sweet crudes like Brent and WTI relative to medium and heavy/sour crudes as the Abqaiq facility’s specific capability is desulphurization and the production of extra light and light oils. The magnitude and longevity of these moves will depend on how quickly the facility returns to operations, the nature of the attack and Saudi Arabia’s potential responses against Yemen/Houthi (who reportedly claimed responsibility) and/or their sponsor, Iran. All combine to increase the risks and insecurities of global oil supplies in our view.
                Summary. Early on the morning of Saturday, September 14, 2019, a drone/cruise missile attack on Saudi Arabia’s Abqaiq crude processing and stabilization facility. Following the attack, Saudi Aramco shut down the facility, which reduced its production/export capacity by about 50% or 5.0mmbpd. How extensive the damage and how long the facility will be out of service are unknowns.
                The Abqaiq Facility. Using Hydrocarbons Technology as our reference, this major crude processing and stabilization facility is Saudi Aramco’s largest. The facility has a capacity of 7.0 mmbpd and is the primary oil processing site for Arabian extra light and Arabian light crude oils. The Abqaiq facility comprises three primary processing units; one each for oil, NGLs and power. The oil processing is the most important with multiple spheroids and 18 stabilizer columns that remove Sulphur and light ends from the crude oil. Processing at the gas oil separation plant (GOSP) involves depressurization followed by the extraction of gas and water from the crude oil. The crude oil then goes through the stabilization unit where the sulfur and remaining gas are removed. The NGL facility contains eight trains with stripper and deethaniser columns. The power facility provides electricity, steam, treated water and air to the other two facilities. Electricity comes from six generators; three steam turbines and three gas turbines. Steam comes from 14 boilers. Treated water comes from 16 reverse osmosis units and is mostly used by the steam generators, but also provides drinking water in the plant and local communities. The instrument air facility is powered by two steam-driven and three motor-driven air compressors. Instrument air is utilized to operate control valves across the facility. Given the size of the facility, the number of units and the fact is was not operating at full utilization at the time of the attack, we expect there are substantial redundancies and workarounds that will allow a fairly quick resumption of activity.

                Midstream: Quantifying Capital Intensity
                Quantifying Capital Intensity – What Is True Sustaining Capex? While reported ”maintenance capex” identifies the capital required to maintain the physical integrity of the assets, our question is different. How much capital does a company need to spend each year to keep cash flows flat? (What we call sustaining capex.) We calculate sustaining capex by adding: (1) reported maintenance capex + (2) well connect capex required to maintain volumes (for G&P assets) + (3) capital required to offset EBITDA declines in the base business (for pipeline assets). Based on this methodology, we estimate that sustaining capex equates to a median of 20% of 2020E EBITDA for our midstream coverage universe (i.e. 21% and 19% for G&Ps and pipeline/diversified midstream, respectively). Within this report, we’ve implemented these findings into our models. Net-net, we are reducing our 2020 and 2021 DCF/unit estimates by (1.0)% and (2.2)%, respectively, and select price targets by a median of (2.3)%.
                Sustaining Capex As % Of EBITDA – Highest & Lowest. Among our large-cap universe, TRGP, PAA, KMI, and ET have the highest sustaining capex as a percentage of 2020E EBITDA while PSXP, EPD, ENB-CA and MPLX have the lowest. For the first group, sustaining capex is elevated based on our forecast for a high amount of pipeline contract expirations and well connect capital (for those with G&P assets). For the latter group, sustaining capex is low as these companies own mostly pipelines (versus the more capital intensive G&P business outside of the Northeast region) and/or have a business model with steady cash flows and minimal EBITDA degradation.
                Lower Sustaining Capex Generally Translates To Higher Growth. We estimate sustaining capex equates to a median of 38% of total capex (based on 2020E) for midstream. The lower a company’s sustaining capex as a percentage of total capex, the higher the EBITDA growth, all else being equal. For pipeline companies with sustaining capex that’s greater than 40% of total capex we project a median 3-year EBITDA CAGR of 4.6%. For pipelines companies with sustaining capex less than 30%, we project a median 3-year EBITDA CAGR of 7.6%. Large-cap companies that screen best (low sustaining capex as a % of total capex relative to EBITDA growth) include: OKE, ENB, PSXP and TRGP. Companies that screen worst include ET, MPLX and KMI.
                Putting It Together – Capital Intensity Winners & Losers. Screening for sustaining capex as a percentage of EBITDA and sustaining capex as a percentage of total capex versus EBITDA growth, ENB-CA, OKE and PSXP look best, while ET and KMI look worst (among the large-cap companies).
                Lowering Estimates And Price Targets. We’re lowering our 2020 and 2021 DCF/unit estimates by medians of (1.0)% and (2.2)%, respectively. Material changes (i.e. 5% or greater) include: CNXM, DCP, ET, NS, OMP, SMLP and TRGP. We’re also lowering our price targets by (2.3)%. Material changes (in order of magnitude) include: SMLP, DCP, WES, ET, AM, HESM, NS, TRGP, ENBL, CNXM and MPLX.

                PCG: Lowering EPS Estimates & Price Target
                Key Points. On 9/15, PCG announced an $11B settlement with parties that hold 85% of the insurance subrogation claims related to the ’17 Northern California wildfires and the ’18 Camp Fire. The settlement is pending bankruptcy court approval. We view the agreement favorably as the company continues to work with various constituents on a path to emerge out of Chapter 11 bankruptcy. As a result of the $11B settlement, PCG plans to amend the Plan of Reorganization (filed on 9/9) that proposed capping insurance company claims at $8.5B. Separately, the reorg plan also included a $1B payment for ”Public Entity Wildfire Claims” (settled) and proposed capping individual claims at 8.4B. In conjunction with the recent announcements, we scrubbed our model and made some changes. Given the increased uncertainty related to the Tubbs Fire (individual claims), we increase our total assumed wildfire liabilities to $20B from $15B – this reflects the move of the Tubbs claims to state court. In addition, our model includes the $5B payment into CA’s state wildfire fund. We lower our 20E & 21E EPS to $1.75/$2.75, $1.20/$2.20, due to the combination of higher assumed financing needs and a lower assumed share price for assumed equity needs ($17.5B). The EPS outlook remains highly sensitive to these variables. We lower our forward price target to $12/sh from $18/sh. Reiterate Market Perform.

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