09/16/2019
|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.
**Nothing on the Hammerstone Platform is a recommendation that you purchase, sell or hold any security or other investment, or that you pursue any investment style or strategy**
This email and any files transmitted with it are confidential and intended solely for the use of the individual or entity to which they are addressed. If you have received this email in error please notify the system manager. Please note that any views or opinions presented in this email are solely those of the author and do not necessarily represent those of the Company. Finally, the recipient should check this email and any attachments for the presence of viruses. The Company accepts no liability for any damage caused by any virus transmitted by this email
Independent Third Party Research Report Disclosures: Hammerstone Inc periodically receives Reports from third party vendors and contacts that provide various types of news sources, that may include, but is not limited to, news headlines, analysis of certain factors that may drive the market, and Independent Third-Party Research Reports. Hammerstone represents that it has no affiliation or contractual relationship with the third party service vendor or any subscriber or contact, thereof. Further, Hammerstone represents that it makes no content determinations and has no input into the outcome of any Independent Third Party Research Report that it receives from the third party service vendor, or contacts and distributes to its clients. The information contained herein has been obtained from sources which we believe to be reliable, but we do not guarantee its accuracy, adequacy or completeness. Hammerstone is not responsible for any errors or omissions or the results obtained from our clients’ use of such information. These reports are intended only to help a requestor and may not be retransmitted without the sender’s permission. Hammerstone does not own any class of equity securities of any subject company referenced in any Independent Third Party Research Report that it may distribute; Hammerstone does not offer investment banking services; Hammerstone does not offer research services; Hammerstone does not make a market in any securities