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The LyondellBasell-A. Schulman Merger Illustrates America’s Shale-Gas-Driven Chemicals Boom

The announcement by LyondellBasell Industries that it is acquiring rival A. Schulman Inc. for $2.25 billion is another in a long line of positive indicators on how affordable prices for natural gas are helping to grow the U.S. economy.

LyondellBasell has focused its business on the manufacture of polymers targeting the automotive industry, and now believes the acquisition of A. Schulman will allow it to diversify its business into what it calls “high-growth end markets” like agriculture, electronics and appliances, and building and construction. As the U.S. economy continues to grow at a rapid pace, LyondellBasell hopes to take advantage as a supplier to these high-growth sectors.

Few sectors of the U.S. economy have been on a growth trajectory higher than that of the chemicals and plastics industry over the last half-decade. This is an industry that saw a very high degree of flight of capital investment overseas during the 1990s and 2000s, as tight supplies and high prices for natural gas — the industry’s major feed stock — made it far cheaper to invest in new plant and equipment in other countries. But with the discovery of massive natural gas shale plays like the Haynesville in Louisiana and the gigantic Marcellus in Pennsylvania/Ohio/West Virginia, the concerns about high prices or lack of adequate domestic supplies have dissipated.

In a December 2017 report titled “U.S. Chemical Investment Linked to Shale Gas: $185 Billion and Counting”, the American Chemistry Council (ACC) reports that, as of December, it has identified 317 new projects that will either expand existing chemical plants or build new ones in the United States. Of those, 48 percent have been completed or are currently under construction, 44 percent are in the planning phase, and the status for the remaining 8 percent is currently unknown.

One of the most compelling findings in the ACC report is that “Fully 63 percent of the announced investment is by firms based outside the U.S.” Thus, the sea change in U.S. natural gas supply and prices during this decade has completely transformed this major industry from one where U.S.-based companies were fleeing to invest billions in capital dollars overseas to one in which companies based overseas are competing with U.S.-based firms to invest in new plant and equipment in the United States.

 

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The Oil And Gas Situation: Volatility Returns, As The Market Overreacts

After a 7-month period of remarkably low volatility in the global crude oil markets, the last two weeks have seen a return of turbulence.   The sudden correction that has hit stock markets around the world has in turn diminished stability where crude is concerned.  A 10 percent drop in the Dow Jones Industrial average was met by a 10 percent drop in the price for WTI, as a strengthening dollar, a jump in the U.S. rig count and the preliminary announcement by the U.S. Energy Information Administration (EIA) that domestic production set a new record of 10.25 million barrels of oil per day during the final week in January led to a predictable reaction in the trader and investor communities.

Suddenly, those $55 hedge contracts some U.S. producers entered into during Q4 2017 aren’t looking so conservative after all , as it appears that the WTI price could approach that level by the end of February.  But the question that keeps nagging at my mind is, are we overreacting just a little bit here?  True, we’ve had a confluence of seemingly bearish signals in the last two weeks, but it’s hard to keep from wondering how much of it is actually more than offset by other, bullish signals, and how much of it might not even be real?

Let’s take the rig count as an example of a seemingly bearish signal that might not in fact even be real.  Last Friday, within a couple of hours after Baker Hughes release its weekly rig count indicating a very large, 29-rig increase in a single week, the WTI pricedropped by $2 per barrel, not a surprising reaction when the price had already been in a fall over the 10 previous trading days.

But normal as the price move may have been, was it really justified?  After all, that 29-rig jump, if it is indeed real, represents all but 17 of the total 46 rig increase in the Baker Hughes count for all of 2018 to this point.  The current Baker Hughes count of 975 is also just 17 rigs higher than the count sat on July 28 of last year.

By way of comparison, as of February 10, 2017, the Baker Hughes count had risen by 66 total rigs from the first of the year, and was 217 rigs higher than its level at the end of July 2016.  So put in context, that 29 rig jump last week represents a barely increased level of active rigs in the U.S. over the preceding half year.

At the same time, the DrillingInfo daily rig count, which uses a different methodology than the Baker Hughes count, showed no similar big jump in its tally over last week.  In fact, as of February 12, the DrillingInfo count was just 11 rigs higher than where it sat on December 19, almost two months before.

 

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Pioneer’s Decision Cements The Permian Basin’s Status As ‘Saudi Texas’

The report in The Dallas Morning News on Wednesday morning that Pioneer Natural Resources has decided to divest all other assets in order to focus exclusively on the Permian Basin confirms what many have already known: The Permian truly is America’s “Super Basin,” or as others prefer to call it, Saudi Texas.

After all, it isn’t as if the assets Pioneer will divest are just your basic oilfield garbage: They include roughly 70,000 acres of prime acreage in the Eagle Ford Shale region, in which Pioneer was an early and very successful player. They also include some prolific natural gas acreage in deep South Texas and in the Raton Basin along the border between Colorado and New Mexico.

Pioneer is a company that has had a strong record of success wherever it has produced; thus, it’s decision to focus exclusively on the Permian is strong testimony to both the magnitude of the resource available in that region, and the prime economics offered by prolific oil and natural gas formations stacked one atop another throughout a vast region that is larger than the state of South Carolina.

The timing of Pioneer’s announcement is interesting, coming as it does on the same day that Halcon Resources announced a $381 million acquisition of 22,000+ acres in the Delaware Basin part of the Permian, just a few weeks after Oasis Petroleum had announced its own 20,000+ acre entry into the region, and barely a week after ExxonMobil announced its plans to triple its production from the Permian over the next five years. The pace of deal-making and capital investment related to the Permian region had slowed noticeably during the second half of 2017, as management teams focused more capital dollars on programs designed to maximize investor returns, but it now appears to be heating up once again early in the new year.

Meanwhile, I’m not the only one making comparisons between the Permian Basin and Saudi Arabia. In remarks delivered at a recent conference, Nansen Saleri, former head of reservoir management at Saudi Aramco, drew his own analogy between the two oil producing provinces. According to Saleri, who is now CEO at Quantum Reservoir Impact, oil producers in the Permian Basin combined currently have between 500,000 and 1 million barrels a day of idle oil production capacity. By comparison, Saudi Arabia’s current spare capacity is about 1.5 million barrels a day, according to data compiled by Bloomberg.

 

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The Oil Industry Is Missing An Opportunity Related To The Trump Tax Cuts

It has been quite a phenomenon over the last six weeks, since President Donald Trump signed the Tax Cuts and Jobs Act of 2017 (TCJA) into law:  Company after company announcing one-time special bonuses, employee pay raises or expanded employee benefits as a result of the tax savings that will accrue to them under the new law.

The organization Americans For Tax Reform (ATR) has been keeping a running list of the companies  who have made such announcements of employee-related benefits directly due to the TCJA at its website.  The list has grown on pretty much a daily basis, and now is up to 312 companies with benefits going to more than 3,000,000 employees.

As I pointed out the day after the TCJA was finally approved by congress, few industries stand to benefit more substantially from the new tax law than the capital-intensive oil and gas industry.  So I have spent the last few weeks expecting to start seeing announcements that some of the companies in that industry would be joining this constantly-growing parade of corporate generosity.  That expectation has gone pretty much unfulfilled as the only independent producer that has made such an announcement was Cabot Oil and Gas, which is  awarding a one-time $1,600 bonus to each of its employees.

The ATR list came to my attention on Friday, which led to a perusal of it to see if I had missed announcements by other oil and gas companies – surely that must be the case.   After all, a 38-year career in the oil and gas industry had clearly demonstrated that oil and gas companies are incredibly generous with their employees*, with average salary and bonus levels, along with suites of employee benefit offerings outpacing those of almost every other major industry in America.

Add to that the fact that, after having gone through a terrible three-year downturn from mid-2014 through mid-2017, the industry’s fortunes had begun to turn around during the 2nd half of 2017, and it entered this year in the midst of a modest new boom.  Surely, it was safe to assume that I had just missed the announcements from companies other than Cabot.

But, it turns out that no such announcements had been missed.  Not one.  Of the 312 companies on the ATR list, Cabot is the lone oil and gas producer that is listed as offering employee bonuses or raises.  The only other company that is a significant oil and gas producer that appears on the list is ExxonMobil, but it is there thanks to its recent announcement that it will expand its capital investments in the U.S by $35 billion over the next five years due to the new tax law.

Well, what about the refining sector?  Are any of those companies on this list?  Again, only ExxonMobil, for the reason mentioned above.

Pipeline companies?  Nope, not one.

 

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The Oil And Gas Situation: Trump’s American Energy Dominance Agenda Becoming Reality

As the first month of 2018 comes to a close, the situation for the U.S. oil and gas industry remains highly positive. Several current news stories help to paint this rosy picture.

First, the U.S. rig count remains remarkably stable. 

Wait, didn’t we just see headlines that the Baker Hughes weekly rig count jumped by 11 last week? Well, yeah, but that came after a pretty flat month overall. And when you look at the current DrillingInfo daily rig count, you see that measure of drilling activity in the U.S. is essentially flat since mid-December.

So what does that tell us? Well, if we look at nothing but the number and how it goes up or down on a weekly or daily basis, not much. But if we look at it as a measure of industry activity over time — like the last six weeks, in the case of the DrillingInfo count — it tells us that the industry is not to this point engaging in the self-destructive rush to increase drilling that we saw at the start of 2017. Remember, that rush to drill resulted in dumping the price for WTI by about $10/bbl by April of last year.

This stability — unanticipated by most energy experts — appears to be holding true even as the price for WTI has climbed over $65/bbl, a level at which most forecasters would have anticipated another rush to drill. So what’s up with that?

The big independent producers are focused on capital discipline.

It’s important to remember that more than 70% of U.S. shale oil and natural gas wells are drilled by a relative handful of large, independent producers. In a really good piece published at Platt’s late last week, CEOs at several of those companies talked about their plans for 2018. The headline of the piece — “North American E&Ps to Focus on Capital Discipline” — basically tells the story.

 

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Trump Is Taking The Regulatory Shackles Off Oil Drillers. Can The Industry Avoid Messing It Up?

Back in the late 1980s and early 1990s, pickup trucks all over the U.S. oil patch could be seen sporting a bumper sticker that read “Lord, please just give me one more oil boom and I promise not to mess it up.”

Fast forward to 2017 and the first few days of 2018, and the oil and gas industry is being handed the first half of that plea by the Trump Administration in the form of radical shifts from the Obama-era energy and environmental policies of the previous 8 years.  For its own sake, those in the U.S. oil and gas industry today had better take the promise made in that bumper sticker slogan very seriously.  Because if the industry messes this opportunity up, there will be hell to pay the next time the voters decide to put a Democrat in the White House, an inevitability that could come about as soon as 2020.

In just the last week, the Department of the Interior has presented the industry with three major policy reversals that will make it easier and more efficient to conduct drilling and exploration activities on federal lands and in federal waters, but also present major opportunities for the industry to mess things up:

  • On December 29, DOI announced the formal rescission of the Bureau of Land Management’s (BLM) so-called “Fracking Rule,” on the grounds that it was unnecessary and largely duplicative of state regulations.  While that has the advantage of being true, it also means that the industry must take great care in its hydraulic fracturing operations on federal lands in the coming years, as any incident is now bound to attract major media scrutiny, and you can be sure that the industry’s opponents will be keeping a running tab in anticipation of coming back into power in the next Democratic presidency;
  • Also on December 29, DOI’s Bureau of Safety and Environmental Enforcement (BSEE) announced it is embarking on a major overhaul of a pair of safety regulations that the Obama Administration put into effect following the 2010 Deepwater Horizon blowout in the Gulf of Mexico.  While the regulations were in some respects unnecessarily onerous and unworkable, revising them will inevitably place the offshore industry under even more media and public scrutiny, and any incidents that result in spills will now inevitably be blamed on whatever changes are made.  Another very double-edged sword that elevates the need for offshore operators to beef up their own safety processes;
  • And now today, January 4, DOI Secretary Ryan Zinke announced the Administration will pursue a dramatic expansion of the Obama Administration’s 2016 5-year plan for development in the federal OCS.  As announced earlier today, the proposed new 5-year plan would open up more than 90% of the OCS to oil and gas leasing, including vast areas along the Atlantic and Pacific Coasts, the Eastern Gulf of Mexico and off the North Slope of Alaska that have long been off-limits.  Again, a very bold plan that could result in huge increases in investment and production of oil and natural gas here in the U.S., but also an opportunity that the industry must take great care to not “mess up.”

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The State Of The U.S. Oil And Gas Industry Is Strong As 2017 Comes To A Close

Now that Christmas has come and gone, and my stomach somehow remains full from all the pecan pie and sweet potatoes I filled it with on Monday, it is time to take a look back at the events of 2017 and assess the status of the domestic oil and gas industry as the year comes to a close.  To paraphrase a standard line that every U.S. president uses in every annual state of the union message, the state of the industry as 2017 comes to a close is strong.

Yes, “strong” is a good word for it.  As in, surprisingly strong, unexpectedly strong, stronger than the industry had any right to realistically hope for as the year dawned 12 months ago.  Let’s look at some of the reasons why that is the case:

  • The OPEC/Russia Export Limitation Deal has been a rousing success –Yes, ok, I know this is supposed to be about the domestic industry, but the truth is that the current healthy state of the U.S. industry has been directly impacted by the success of this agreement.  Think back 13 months ago, when OPEC, Russia and the other non-OPEC nations announced this agreement:  What was their stated target price for international crude?  If you said “$65 per barrel,” you would be correct.  As I write this piece on December 26, the Brent price is trading at just above $66/bbl.  Others can quibble about the details of this deal, whether each individual country is cheating on its quota, all the other factors that go into determining the price for crude on any given day, but when your deal has, after 13 months, pretty much nailed its target outcome, that is unarguably a resounding success.
  • The WTI price is approaching $60/bbl –this measure is more directly relevant to U.S. crude production, and, after falling to ~$43 at mid-year, has risen about 38% from that low point.  A stronger crude price pretty much always improves the health of the oil and gas industry.  Much of this is due to the OPEC/Russia deal, but much of it is also because…
  • The U.S. industry responded to price fluctuations pretty much exactly as predicted a year ago – In my year-end predictions piece from a year ago, I projected that, in reaction to the comparatively high prices that existed at the end of 2016, the U.S. industry would “activate another ~ 200  drilling rigs during the first four months of 2017.”  U.S. producers actually activated almost 300 additional rigs during that 4-month period.  I further predicted that “[t]he likely result will be higher price volatility and a probable resulting fall-back to prices in the high- or even mid-40s.”  As mentioned above, the price actually dropped all the way to ~$43/bbl.  But, as expected, U.S. shale drillers then responded to that lower price by scaling back their drilling during the 2nd half of 2016, helping the price to rebound to its current, healthier level.  They will respond to this higher price by once again ramping up their drilling budgets for the first half of 2018, a factor that I will discuss in detail in my 2018 predictions piece next week.

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The Final Trump Tax Bill: A Clear Net Positive For U.S. Oil And Gas

So, for the oil and natural gas industry, what is the impact of the new tax bill just passed by congress?  As for most other American businesses, the bill is a mixed bag of lowered tax rates and limited deductions, but at the end of the day, it appears to be a net positive.

Here’s why:

  • Tax Rates are lowered – This one’s rather obvious.  Lowering the corporate rate from 35% to 21%, and lowering all personal marginal rates will clearly benefit everyone involved in the oil and gas industry from a tax standpoint.  Not much more needs to be said there.
  • The option to expense Intangible Drilling Costs is retained – This century-old tax treatment was the number one issue for the upstream independents who produce the lion’s share of oil and gas in the U.S. today.  The industry’s lobby and upstream trade associations have worked overtime for the last eight years to educate members of congress about how critical this tax provision is to the ability of this very capital-intensive industry to raise the capital necessary to keep drilling.  Those efforts paid off in the end, as this key provision was retained in the final bill.
  • A new provision allows the expensing of some additional capital investments – The bill allows businesses to expense the full cost of new investments in certain plant and equipment for the next five years, and then gradually phases this provision out.  This will benefit many in the upstream, midstream and downstream sectors of the oil and gas industry.
  • Percentage Depletion deduction is retained – Another century-old tax treatment, this one is important to small independents and royalty owners.
  • Corporate Alternative Minimum Tax (AMT) is repealed – No one in the oil and gas industry or any other business sector will mourn the passing of this provision, which has served mainly to penalize marginally profitable corporations for decades.  This repeal is a real positive development for rapidly expanding midstream companies as well as many upstream producers.

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Clearing Up Some Confusing Headlines About The U.S. Oil And Gas Industry

In the oil and gas industry, sometimes it is hard to figure out what is real and what isn’t – what is really happening, and what really isn’t happening.  I spent 38 years in the industry, and still have a hard time figuring it all out.  Here are some good recent examples of stories whose headlines made bold claims that, upon reading the entire stories, turned out to be quite nuanced:

  • Are investors really abandoning the shale industry?
  • Did the World Bank really cut off funding of oil and gas projects?
  • Has the business case for building the Keystone XL pipeline really passed?

All are good questions, all of which have been the subject of multiple media reports in the past weeks, and all have more complex answers than the simplistic media headlines that are all most people actually read.  So, let’s clarify some things.

Are Investors Abandoning The U.S. Shale Industry?

We’ve seen many reports alleging that investor funds are drying up for the shale industry during the second half of this year, yet shale producers somehow keep managing to get their business done.  Indeed, in recent weeks we’ve seen a series of announcements of major new investments in domestic shale by private equity and institutional investors, and the Fall debt redetermination season passed without noticeable major hiccups.

So, what gives?  A look at recent presentations by the CEOs at corporate shale producers, like this one from Encana’s Doug Suttles, shows a focus on responding to demands by investors that these companies dedicate more of their resources towards actions that will increase returns on investment capital, a pressure I wrote about in early November.  One result of this investor pressure has been the announcement of a wave of stock buy-back programs since August.  Investors are also pressuring companies to change executive compensation programs that have been, in their view, too focused on increasing production at the cost of profits.

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