This post was authored by Clarity AI, a leading sustainability data science and technology company and a Sentieo partner.

The recent move by the Securities and Exchange Commission to require disclosures of climate-related risks, including greenhouse gas emissions, is a positive step towards a more sustainable world. The announcement by the world’s largest economy came years after their European counterparts. The draft rule will disclose companies’ direct and indirect greenhouse gas emissions, otherwise known as Scope 1 and Scope 2 emissions. In a somewhat surprising but reassuring move, the proposal also indicates that firms will need to disclose, eventually, greenhouse gas emissions generated by suppliers and partners, known as Scope 3.

“At Clarity AI, we believe there is no pathway to net zero without fully incorporating Scope 3 emissions into regulation and reporting standards. And even then, regulation will only take us so far. Technology allows investors to access robust and transparent Scope 3 emission data at scale, which will be critical to check the reliability of the reported data and to start to understand the key drivers of those emissions. Deep granularity and full transparency will be needed for investors to manage their paths to decarbonization, while also keeping companies “on track” to meet the Paris targets,” our Head of Product Research and Innovation, Patricia Pina, said. To gain a better understanding of the challenges and opportunities surrounding Scope 3, Clarity AI has published a recent article on the topic, Why Have Scope 3 emissions data has become essential. 

Although the SEC regulation looks like a promising step there are a lot of details to iron out in the coming months and years. While we wait for additional details, it may be helpful to look to our neighbors across the pond to see where they encountered challenges on their sustainability journey.

The EU has dealt with a variety of challenges in implementing their various regulations; a couple include:

• Establishing clear definitions – Many of the EU regulations included content that was ambiguous and open to interpretation which could lead to different implementations of the regulation.
• Providing realistic timelines – The implementation timelines for SFDR and EU Taxonomy have been incredibly tight and due to the lack of internal resources, teams have struggled to meet the deadlines, causing overall delays in the process.

Regardless of regulatory challenges, the EU and UK are making progress. This all comes with a backdrop of rising demand for ESG investment products, so much so that it is becoming table stakes to have ESG offerings available.

The increased demand for ESG products has also increased the need for ESG-related resources. The demand is being seen across a variety of stakeholders, from in-house ESG teams to IR officers, to ESG consultants and many more. To meet these needs Sentieo has responded with ESG-specific dashboards and synonym groups, as well as integrating content and data with providers like Clarity AI. To further assist clients, Sentieo published a recent guide, 33 Accelerating ESG Trends, outlining ESG themes in proxy statements that are highlighted both at the broad and granular levels. 

Rising demand for ESG products and increasing regulatory initiatives are all a signal that sustainability interest is here to stay. If the volume of Google searches is any indication of interest, searches for Scope 3 recently hit a near all-time high. Now it’s a waiting game to see what comes next on the United States’ sustainability journey. 

Worldwide Google Trends: “Scope 3” Searches – 5-years Ending 4/9/2022.

The post The U.S. is Playing Catch Up on the Risk of ESG appeared first on Sentieo.

Jason Fake is Strategy & Business Development at ITT.

At a prior company, a recent acquisition resulted in the parent’s entrance into a new industry. In the early months post-acquisition, processes and methodologies were being put into place to integrate with the parent’s operating model and set of deliverables and reporting. The monthly goals forecast for the portfolio was built from a bottoms-up analysis of the pipeline (stage, propensity-to-close, etc.), and produced a figure of X-thousand units. After soundly beating the forecast, the company – naturally in high spirits – was presenting to senior leadership when they were asked the following question:

Was our performance good?

When I think about the topic of flying half blind, I am reminded of this moment; the Portfolio Management team had generated a forecast, which the operation crushed, but nobody in the room could confidently answer how the performance stacked up against industry benchmarks, much less against our peers. The company had absolutely spent its early months operating half blind.

BACKDROP

COVID-19 has impacted virtually all industries, some of which have been completely upended. The impact has varied in intensity and duration across geographies; certain end-markets are recovering more quickly than others, and there are areas that have been boosted as a result of the current pandemic. It is under these circumstances that we look at some of the harder hit areas: commercial aerospace, industrial manufacturing, and oil & gas.

AROUND THE WORLD IN 90 DAYS

It’s roughly 90 days between earnings calls. These fairly structured windows into an organization’s financial performance, thought processes, and go-forward actions contain a wealth of information.

In late January / early February, the biggest concern for Commercial Aerospace was the 737 MAX issue. Outside of those companies with operations in China, COVID-19 was mostly an afterthought; even then, the impact was usually treated as an isolated blip. Companies reported record quarters / years in categories ranging from revenue to OM to Adjusted EPS, and their FY2020 guidance – outside of commercial aerospace – was good news for their investors.

In late April / early May, the biggest concern across industries (and especially Commercial Aerospace) was COVID-19. This was no longer just a China problem – in fact China had mostly recovered – this had become a global pandemic. Companies withdrew their FY2020 guidance, provided an impacted financial performance along with the proclamation that the next quarter would be worse, and then spent the bulk of the call talking about three things: safety actions, liquidity (incl. CapEx freezes, credit revolvers, debt, burn rates, etc.), and preserving margins (restructuring actions, cost cuts, decremental targets, etc.).

Think about that change. The A&D peers went from bragging about record operating margins and cash flow to targeting decremental margins and maintaining liquidity. In 90 days.

THE NEED FOR STRATEGY AND COMPETITIVE INTELLIGENCE

Clearly, this didn’t all happen on day 90, and it didn’t all happen at once. There were many events (remember negative oil prices?), some quite impactful, that happened in the interim. Social distancing and travel restrictions were imposed in the U.S. in March, and unemployment quickly spiked. In addition, as the different geographies found themselves at different phases and trajectories, the actions of their governments and their businesses varied significantly. This sent shocks throughout the supply chain.

If there was ever a testament as to why it’s essential to stay on top of your industry as well as the actions / performances of your peers, customers, and suppliers, it’s the last 90 days. Don’t fly half blind!

Some of the questions to consider, and examples of reactions:

1. What exposures do I have, and how diversified is my end market mix?
   1. Industrial Conglomerates such as 3M and Honeywell pivoted toward their medical end markets and focused on PPE production
   1. High-speed data, industrial automation, and warehousing are seeing some intensified focus
   1. The recent restructuring actions by GE were most heavily borne by its Aviation division
2. What are the impacts to the supply chain? Who is open / taking deliveries, what are the OEMs doing?
   1. In aerospace, both Boeing and Airbus have announced multiple production decreases
   1. As businesses in different geographies have had to comply – or seek exception to – their government’s mandates, the ability to manufacture / ship / receive goods along the supply chain has been affected, and companies have had to navigate around these impacts
3. What shape will the recovery take (V, U, L)? What are my plans for each of these circumstances?
   1. As mentioned earlier, there is a heavy focus on liquidity. Companies are being very judicious with their CapEx, and have scaled back most of their discretionary spending
   1. Some high-profile mergers, acquisitions, and JVs have been scrapped; M&A activity is down
   1. As companies try to understand what the level of demand will look like throughout and post-recovery, they are making the strategic decisions to align capacity with that demand

EYES WIDE OPEN

Given the need for up-to-date competitive intelligence and an evolving strategy, the natural question is how to get started. Consider this a primer, and by no means an exhaustive list:

1. Transcripts, 10-Qs / Ks, presentations, and press releases (Credit to Stacy Turnof for the summary she provided during the “Earnings Calls Perfected” Webinar in June; I’ve expanded on it in a few areas, but her recommendations were really spot-on)
   1. Create a list of peers, customers, and proxies for the pertinent industries / end markets,  both direct and indirect
   1. Key issues: What’s company-specific, what’s industry-wide, what are companies a-z doing, what are the consensus actions, and where are the disconnects
   1. On the transcripts, don’t restrict yourself to the earnings calls; there are transcripts of Investor Day presentations, Industry Conference presentations, and others that contain a lot of information
2. Industry Publications
   1. There are likely already organizations keeping the pulse on your industry. These companies usually produce monthly newsletters / state of the industry reports, which you can have sent to your inbox. In addition, they often have an archive of relevant articles
3. Subscriptions
   1. There are aggregating sites such as Sentieo (my preferred) and FactSet
   1. There are industry-specific sites like Forecast International for A&D
   1. There are function-specific sites like MergerMarket for M&A
4. Internet Search
   1. Using Boolean searches to find news on companies / industries / end markets can help uncover a lot of good information. You can bookmark sites and opt-in to news feeds if you find a particularly useful site
5. Synthesize the Information
   1. Most importantly, learn to aggregate all of this data in the context of – and in concert with – your core strengths, strategic fit, the market characteristics, and the future of the industry

FINAL THOUGHTS

While the theme has been, more or less, why strategy and competitive intelligence are essential right now, I hope that the above has illustrated the importance of the function in both good times and bad.

As we head into the next earnings season, it is absolutely key to understand the industry and macro events, how they’ve shaped the current environment (and how things tracked against expectations), and what kind of climate companies see going forward.

A well-informed strategy, developed in cooperation with / full support of Operations and other key stakeholders, can allow a company to take advantage of opportunities and capture market share… even during a pandemic.

Want to learn more? Join our webinar “Planning Through Uncertainty: Are You Flying Half Blind?” featuring Jason on Wednesday, August 12 at 12PM ET / 9AM PT. Register here.

The post Planning Through Uncertainty: Are You Flying Half Blind? appeared first on Sentieo.

At Sentieo, we care about helping equity analysts become more successful. It is core to our mission as a company. While we have broadened our purview to finance and general knowledge professionals, we still have buy-side in our DNA. Our CEO and co-founder, as well as many of our executives and product owners, were analysts in their previous lives.

The mountain of data that analysts have to process to find nuggets of unique truths is growing more massive each year, leading to information overload. In the face of these challenges, we still believe there is a role for human analysts, augmented with better technology and process to help them fight off those challenges. Thus, we’ve updated our most popular whitepaper, The 7 Habits of Highly Effective Analysts. Read the preview below, or download the whole thing!

Looking Beyond The Echo Chamber For Ideas

The world of finance tends to be an enormous echo chamber where even ostensibly intelligent participants can get caught up in manias and panics of groupthink: how much of your communication is with fellow buy-siders versus outsiders? We actually found it more instructive to steal ideas from outside of finance.  

All three of the above have similar constraints on resources and relevance to the ultimate research output. Of course, we don’t think there is any better authority on general personal effectiveness than the original Franklin Covey book (The 7 Habits of Highly Effective People), which also obviously served as an inspiration for this paper.

Three Individual Equity Analyst Habits:

1) Be Proactive: Optimize Your Coverage Universe and Expand Your Circle of Influence 

You only have so many hours in a day. Valentine (book referenced above) and most major hedge funds recommend covering up to 40-50 stocks at most. If you can’t find a good idea — long or short — in those, you are doing something wrong. If you are trading hundreds of stocks a year, you are going too broad to have any edge over quant-driven processes (and probably paying too much in commissions). The only way humans will have a sustainable and permanent advantage in investing is by doing deep fundamental research. Fortunately, we at Sentieo are continuously working on building technology to augment, not replace, the human. The universe of thousands of stocks can be hard to narrow down. Luckily, Sentieo’s platform has a built-in powerful screener with thousands of categories just for that purpose. 

Use Sentieo’s Screener to filter down to the companies you care about.

Once they have a sensibly defined investment universe, effective equity analysis are ready to go deep. Buy side analysts have a wealth of broker research resources at their fingertips, but often drown in the floods of daily push emails. Your inbox is valuable real estate; the most effective Equity Analysts access information on a “pull” basis—on demand, instead of having their time and attention demanded by outside parties.

Analysts should approach search with a specific intent in mind, and gather as many relevant facts as possible. Sentieo enables this by bringing users access to the full spectrum of Broker Research inside our Document Search platform.

Drill down by document type (or even document section) to only get the information you want. 

2) Begin With the End in Mind: Don’t Miss the Macro for the Micro, or the Structural for the Near-Term

All too often, analysts get worked up about basis point moves and minor catalysts when they should be focused on the tectonic shifts under their feet. Think beyond the movements of macro model inputs like commodity costs and currency fluctuations. The shifts from major global trends, ranging from “Software Eating the World” to regulatory and political shifts can serve as either incredible headwinds or tailwinds to investment theses that can far outweigh any modeling considerations for the next fiscal year.

Models are only as good as the assumptions going into them, and no amount of Excel wizardry will help if, for example, you try to buy the dip in global mining stocks ahead of a Chinese slowdown, or you seek value in consumer packaged goods while well-funded startups (instead of stale brands) are gaining ground in every category.

Although one should constrain their coverage universe (see Habit 1), no stock is an island. Our platform allows effective equity analysts to quickly get a read across adjacent sectors, to stay informed through plotting market data and document mentions. 

Sentieo’s Search Summary Analytics give you insight into the most keyword mentions by Company, Document Type, Sector, and Region

3) Put First Things First: Maintain A Catalyst Calendar and Do The Work Well Ahead

Stocks often run ahead of earnings. It is not an infrequent occurrence for a company to beat, but trade down. This cues puzzled commentary from the Street about the “inexplicable” reaction, while a 30% pre-earnings run-up was ignored. Funds need to be sized up at the start of these pre-event moves, not just the day or week beforehand. The proactive analyst with this end goal in mind should maintain a priority list that includes a catalyst calendar, and should ideally organize their work around the profit potential.

Key catalysts to track include earnings announcements, product launches, and transactions. Sentieo’s Calendar can feed in from a user’s watchlist, and it makes the forward calendar plain as day:

Track your tickers using an earnings calendar in Sentieo, on both desktop and mobile.

These are just 3 of the 7 Habits of Highly Effective Analysts. To read about all 7, download the full white paper. 

The post The 7 Habits of Highly Effective Analysts: The First 3 Habits appeared first on Sentieo.

2016 was a volatile year for oil and gas. WTI traded to lows in the mid $20s, then rebounded to finish the year around $54. The road to recovery for the energy industry in 2017 can be characterized as cautiously optimistic as WTI prices have stabilized over the past couple of weeks and energy companies have started to slowly hire and ramp activity.

There were a number of themes that emerged as the year progressed including:

• Rebounding rig counts and the return of service cost inflation
• The Dallas Fed and Permian-focused E&Ps expressing concerns over rich Permian Basin acreage valuations
• Another year of low oil prices and OPEC production cuts
• The RINsanity of ethanol blending and a possible border adjustment tax
• Natural gas coming out from the shadow of oil with demand catching up to supply

We will review the themes of 2016 and those themes going forward into 2017.

Oil Field Service Cost Inflation

After the rig count recovery of 2016 and stabilization of oil prices, it is clear that the North American land market has clearly turned the corner. For the oilfield services sector, 2015-2016 was dominated by cost deflation as drillers dramatically reduced activity. The most resilient E&Ps that were able to maintain some level of drilling activity were able to push OFS providers for costs reductions to bring down their economic breakevens.

Now that North American onshore has turned the corner and activity is increasing, we need to monitor for service cost inflation, either from materials like proppant or labor. With a relatively tight labor market and unemployment rate of 4.70%, other industries like construction are competing for the same labor pool. The next couple quarters should begin to reveal whether cost inflation is beginning to bite and what sort of pricing power OFS companies have in early stages of the upswing.

With Doc Search you can set up keyword searches to monitor this. A search for “cost inflation OR price increase” filtered by sector and only transcripts has started to return instances of those keywords on Q4 earnings calls:

$SLB

As the upcycle begins, growth in E&P investments will be led by the North America land operators who appear to remain unconstrained by years of negative free cash flow, as external funding seems more readily available and the pursuit of shorter-term equity value takes precedence over full-cycle return. E&P spending surveys currently indicate that 2017 North America E&P investments will increase by around 30% led by the Permian Basin, which should lead to both higher activity and a long-overdue recovery in service industry pricing.

(http://snt.io/gn2MGjLz2)

$HAL

There’s been a lot of change in North America over the last few months. Dave shared with you how we used our market share strategy to regain profitability. The next step in boosting profitability is increasing prices, so let me start by talking about where we see pricing. Wild rumors are circulating in the industry about huge price increases. That’s just not a universal fact. Given our position in North America, no one knows more about pricing than we do and here is what I do know.

 First, I like talking about price increases more than decreases. It’s a nice change. Second, the service price recovery is starting from an extremely low base; in many cases, below variable cash cost. Third, the level of pricing that satisfies a particular service company depends on where they are on the profitability continuum. And finally, even though the industry is starting at different profitability levels, every company will have to march back up the same path to profitability.

 During the downturn, our industry went through a steep regression in profitability as pricing and activity declined. The industry moved from positive operating margins to negative operating margins, then to negative EBITDA and ultimately wound up struggling to cover variable cash costs. It was a fast and hard road that caused a dramatic shift in the landscape of the service industry and wiped out a significant amount of shareholder equity.

 The pricing brawl continues as the industry recovers and equipment availability tightens. Pricing at the margin is ultimately set by whoever is satisfied with the lowest returns. It’s important to understand that our competitors’ motivation for margin returns is largely built around where their pricing is anchored today. For example, if they are at negative variable costs, then they are trying to get to a negative EBITDA. If they are at negative EBITDA, then they are trying to get to negative margin and so on.

 I can tell you, despite what you hear in the market, it’s clearly a bridge too far to skip from negative variable cash to positive operating margin in one step. So the industry pricing regression I discussed earlier needs to become a pricing progression. This means that for now, Halliburton will have to compete with companies that are satisfied with lower levels of short-term profitability, but we don’t believe their pricing is sustainable. You can’t have negative margins forever. In the meantime, Halliburton will continue to maintain our focus on execution and service quality as we defend our position without sacrificing price. I believe that superior service quality is a prerequisite to having a meaningful pricing discussion and our dedication to service quality helped create the profitable results for the quarter.

(http://snt.io/LY2MGjgpk)

$BHI

However, as we also said previously, the North American shale segment remains a wildcard in all of this. Since details of OPEC’s plans surfaced, rig counts have increased by 33% in the United States with over 170 rigs added and a corresponding increase in US shale production already underway.

 Second, we said that commodity prices needed to stabilize for confidence in the customer community to improve and investment to accelerate. We continue to believe that North American operators need sustained prices in the mid to high $50 range for this to occur. The North American shale operators’ ability to rapidly increase production has resulted in commodity price recovery being shallower than expected and bringing uncertainty to the sustainability of these recent price increases.

 Third, we said that activity needed to increase meaningfully before access service capacity could be absorbed and pricing recovery could take place. We are seeing the first signs of this in select product lines in a few of the North American basins, but I still believe there remains a fair amount of capacity that must be absorbed before service pricing will become more tightly correlated with higher commodity prices and increased activity. With this backdrop it’s clear the market has taken a positive turn and we have all the elements in play for recovery.

(http://snt.io/fA2MGjxL3)

$PTEN

Marc Bianchi, Cowen and Company – Analyst [13]

Okay. What sort of cost inflation items are you watching? Where do you think we’ll see cost increase first? Any comment on how much those could increase, or have increased?

 Andy Hendricks, Patterson-UTI Energy, Inc. – President & CEO [14]

 You know, it’s going to be the traditional cost inflation. The first one and probably the most challenging for the whole industry, not just us, is going to be around labor. In drilling, for instance, we kept the wages at the drilling rigs the same for the position. In pressure pumping we’ve cut back on overtime. We’ve cut back on per diem. It’s just been a more challenged business environment.

 And so there is going to be some inflation in labor in pressure pumping. I think everybody is going to have it, not just us. It’s going to be more challenging to recruit.

 I think a lot of people don’t realize if you go to Midland, Texas today, even though we’ve been in this downturn for two years, the unemployment rate in Midland, Texas is still lower than the national average. Many of the people that work in the oilfields in West Texas typically rotate in from other cities around Texas or other cities around the US. And if they’ve been gone for six or nine months, they’re starting to get absorbed into their local workforce and may or may not be so interested to come back to work in an oilfield.

(http://snt.io/N42MGjyY7)

As HAL’s Jeff Miller mentioned, service companies like talking about price increases.  Unsurprisingly, E&Ps do not.  Both sides always have a tendency to talk their book, with service providers emphasizing price increases and E&Ps downplaying them, so it’s worth monitoring the same or similar search but filtered for E&P sector.

While it is likely that a tight labor market will lead to some wage inflation,  this needs to be taken in context of the likely trajectory of rig count and drilling activity. Efficiency gains like pad drilling mean that much fewer rigs (and therefore labor) are needed to drill the same amount of wells than a few years ago.  Therefore, even if oil prices were to increase enough to warrant substantial increases in activity in the Bakken and other relatively higher cost basins, rig count is not going to return to 2014 levels of around 1500 US oil directed rigs. For example, this comment from Vicki Hollub, CEO of Occidental $OXY on their Q2 2016 earnings call:

We have the capacity to increase significantly. We will be more limited by our disciplined approach, but we certainly have kept the capability within our organization. We have the ability to put the infrastructure in the Permian, so we have, I would say, significant ability.

At one time we were running over 25 rigs and we could, if prices were in the range that would warrant that, we could get back to that. But bearing in mind now that back when we were running 25 rigs, we were not as efficient as we are today. We are significantly improved with our efficiencies so we could get actually the same amount of productivity with half the number of rigs that we were at, at that time.

(http://snt.io/QE2MTuMBo)

The Permian Basin:

2016 was the year of the Permian. With stacked pay, existing infrastructure and other advantages, it has been a clear low cost, high return leader. The market finally came around to that view in 2016. I set up a keyword alert in 2015 and it really lit up this past year as capital flowed into the basin as the market saw an increase in oil flowing out despite low prices. This is in contrast to the Eagle Ford and Bakken where production had started to decline.

A production table from the EIA:

Permian, Eagle Ford, Williston and DJ-Niobrara Rig Counts:

Permian deal activity from 2015 and 2016:

As of January 2017, there have been over 30 Midland and Delaware deals since 2015.  Deal activity accelerated in 2016, in both Midland and Delaware with the price paid per acre roughly doubling. Already this year, Exxon acquired privately held assets for $6.6B and Noble bought Clayton Williams for $3.2B. (Exxon and Noble Stoke Permian Passions)

Below is a valuation table with all E&Ps and IOCs that have mentioned Permian acreage positions in their most recent filings, with acreage holdings and split between Midland and Delaware sub-basins if disclosed.

However, things may be getting frothy. The Dallas Fed recently published its quarterly energy survey of industry participants. For Q4 2016, special questions about Permian acreage prices were added. Below are some excerpts:

Comments expressing concern over acreage prices:

“The Permian transactions are approaching price multiples associated with a bubble or a Ponzi scheme. Multiple private equity (PE)-backed buyers are simply trading assets from one to the other—very similar to transactions we witnessed in the early ‘80s real estate bubble, the tech bubble of ‘98–‘01 when venture capital firms co-invested with each other to drive up paper gains, and the oil transactions prior to 2014 when every PE fund, pension and endowment manager needed shale in their portfolios.”

Comments mixed on whether current acreage prices are overvalued:

“Stacked plays and improving technology make the Permian Basin very prolific for the production of oil and gas, so relatively high acreage prices are justified. That said, current acreage prices have reached an exuberant level that leaves little protection against extended periods of sub-$60 per barrel oil. Leasing Permian acreage at current acreage prices is not something that we would do.”

“With companies suggesting that as many as 64 wellbores are possible in one section in the Delaware Basin, it is not surprising that acreage prices have skyrocketed. In many cases, this is a multi-decade proposition. To suggest to investors that this is possible is probably acceptable … but to suggest that it is achievable, is, at least, suspicious. There will be a day of reckoning in how high the acreage cost goes. If we stay in the $45–$55 range, then many of these ‘prospects’ will be uneconomic.”

“No. I believe acreage prices are overvalued in certain areas based on speculation on what oil prices may become and what production may be proved in the future from those areas. Some areas prices are justified based on current data, but others are not. This is not atypical for oil and gas investing.”

(http://snt.io/872MTyuHJ)

Permian E&Ps have been noting similar concerns on calls

Parsley Energy ($PE) is a pure play Permian E&P and was very active acquiring assets in the basin the past year or so, making five acquisitions since December of 2015, including a deal for Midland and Delaware assets on January 10th of this year.  Using Doc Search for “delaware acreage prices” returns Parsley CEO Bryan Sheffield’s comments from the company’s Q2 2016 earnings call in August of 2016:

John Freeman, Raymond James – Analyst [48]

 And if I shift over it to Delaware, you know, Bryan, you have always been really candid on what you are seeing in sort of the A&D arena, and obviously when we look at the acreage prices. You picked up acreage from the Delaware in the spring and then as recently as last year’s call you sort of said in the Delaware you were seeing acreage prices like $10,000 to $5,000 acre, and obviously last month we’ve seen like a double. I’m just curious from your perspective what you think drove such a huge increase just all of a sudden? Is there anything you can point to in terms of confidence of additional zones, costs or anything like that? 

 Bryan Sheffield, Parsley Energy Inc – CEO [49]

 I’m still little bit in shock what I’ve seen in the past couple months. I mean we just paid last April came out and you look at April, we paid around $9,000 an acre, and I know some of these sellers, recent transaction sellers, paid about equivalent, about six months ago, or nine months ago, if look at the [Ogder Stevens on his bond], and [as research] you know how much — you can kind of put together what the transaction is and then six months later.

 So it’s truly amazing. We’ve gone from $9,000 acre print to a $25,000 acre print and now a $35,000 acre print. I think we’re in the world of $20,000 to $25,000 in the Delaware. I really think that’s the reality. Anything north of $30,000, I think that’s kind of — we can’t get to it on a map in the return on acquisitions.

(http://snt.io/c42MU49Gh)

Looking at Parsley’s January acquisition, if we take the Delaware portion of the deal, which is $205 million for 5,300 net acres, back out 1,100 flowing Boe/d at $40,000/Boe/d, price per acre is roughly at the $30,000/acre ceiling Sheffield mentioned back in August.

Parsley isn’t the only one noting high acreage values.

Anadarko ($APC) Q3 2016 earnings call in November:

Arun Jayaram, JPMorgan – Analyst [2]

 Good morning. Al, I wanted to start a little bit in the Delaware. We saw a pretty punchy evaluation for the Silver Hill asset package in Loving and Winkler with the transaction, I think, fetching more than $40,000 per acre.

 I was wondering first if you could remind us of your acreage position in Loving, and if you could discuss your broader delineation efforts beyond the Wolfcamp A because clearly the industry is pretty excited about the stacked pay potential in the Delaware.

 Al Walker, Anadarko Petroleum Corporation – Chairman, President and CEO [3]

 Well Arun, thank you. I might have Darrell help me a little bit with some of the questions you ask. But let me just say, as we looked at Silver Hill — and obviously you know the geography quite well, you know they’re quite right next door to us in terms of how their acreage is very close — as I’ve looked at how these acreage values have increasingly gone to places I would never have imagined — I mean, we are paying — or seeing people, rather, pay price per acre today that exceeded acreage values when oil was over 100. And so consequently I think we have a little bit of pause around just the valuations and how certain of these have escalated in places.

(http://snt.io/Sp2MU57TT)

OPEC

Another significant event in 2016 was the landmark OPEC decision to cut production by 1.16MM barrels per day.

Saudi Arabia, Iraq, Kuwait will shoulder 966k barrels per day of the total. Non-OPEC countries agreed to cut by 562k barrels per day, with Russia cutting 300k of that total and other non-OPEC producers like Mexico and other smaller producing countries through natural declines.

The reason OPEC changed strategy from its prior strategy of maintaining market share is for a handful of reasons.

1. US Lower 48 production has fallen from a peak of 9 million barrels per day to a trough of 8 million barrels per day in mid-October and has since rebounded to 8,250 barrels per day based on EIA 4-week average of L48 production. OPEC’s market share strategy succeeded in that it forced producers to scale back drilling, especially highly levered producers (some of which have filed for bankruptcy), while others are impaired due to high debt burden and lack of access to capital markets.
2. OPEC country fiscal situations are deteriorating due to falling oil revenue. OPEC effectively acknowledged that they have to live with low-cost shale producers in the Permian and other basins that were able to take advantage of cost deflation that lowered break-evens. At the same time, they acknowledged that they too, were feeling the pain of low prices. Especially countries like Venezuela. As far as market impact, the announced cut should serve to set a floor.  However, returning production from the Permian as well as the lingering threat of cheating on production quotas serves as another factor helping keep a ceiling on prices, thereby discouraging the over-levered high-yield debt-fueled exuberance of US E&Ps that characterized the shale boom leading up to 2014-2015. While it’s unlikely the deal will fall apart, compliance will have to be monitored.  Examining the news flow reveals this headline about record exports from Iraq which sent oil lower and this headline about Saudi Arabia cutting exports to some customers.

One potential wildcard is the Trump and GOP border adjustment tax. See Why OPEC should fear the Trump administration and Trump Tax a Wild Card for Oil for more details. Another potential wildcard is a border wall tax on Mexico- Border Wall Tax on Mexican Crude Oil Would Cost U.S. Drivers.

If either is passed, which seems unlikely at this point because of WTO Rules, it’s very difficult to gauge impact with any reasonable certainty. The only certainty will be extreme volatility in the short term. Goldman Sachs estimated that a border adjustment tax impact could be a move in WTI of $13/bbl immediately and a resulting pass through to gasoline increase of $0.30/gallon. Absent a wild card like the border adjustment tax being passed or political volatility, fiscal stimulus, etc. it’s reasonable to assume oil prices will remain range bound in the mid-high $50s to high $40s. That said, political risk to markets going forward is much higher than on November 8th.

RINsanity

President Trump has made very clear that he is not a fan of regulation, with particular ire directed at the EPA and the Renewable Fuel Standard (RFS).  A detailed look at the RFS and problems with it are beyond the scope of this post, but you can read more here. Trump advisor and refinery owner Carl Icahn has been very vocal as well. Basically, the RFS requires that refiners blend a biofuel, either ethanol or biodiesel, into every gallon of fuel produced and sold in the US (exports are exempt).  Or, refiners can buy a RIN instead. RINs are generated with every gallon of biofuel produced.  These can then be sold to refiners that choose not to blend biofuel. Prices can be volatile (What caused the run-up in ethanol RIN prices during early 2013?) which makes compliance for refiners without blending capability expensive as RIN prices rise. One of the problems with the RFS mandate is the “blend wall”: a practical limit beyond which refiners say the amount of ethanol in a gallon of gasoline will begin to damage engines. You can read more about the blend wall here.  Using Doc Search with the query “RIN OR “blend wall”” and Plotter, we can see a clear trend of mentions in 2013 and 2016.

Given President Trump’s statements and GOP majority in both House and Senate, it seems very likely that RFS will be at minimum changed to relieve the burden on refiners like Icahn’s $CVI.  As I mentioned above, a potential wild card for oil and gas (and any company or industry that imports substantial amounts of goods) is the border adjustment tax.  It was mentioned on Q4 2016 earnings calls of Exxon($XOM), Marathon($MPC) and Valero($VLO). But it’s not just oil refiners that are discussing the potential tax, GM, UPS, AT&T, Domino’s have all mentioned it so far this year. It’s probably a good idea to save a border adjustment tax search on all public companies to be aware of potential winners and losers if the tax becomes law.

Natural Gas

The oil glut of the past few years has overshadowed the natural gas market. 2017 should bring it out from the shadows. In 2016, natural gas production is expected to decline 1.3 Bcf/day to 77.5 Bcf/d from 2015 levels (EIA STEO). It marks the first annual decline since 2005, which was the year just before the advent of fracking kicked off the shale gas boom. Because natural gas can only be transported by pipeline and it takes time to build power plants and incentivize industrial consumers to build natural gas-fed plants, demand is much less elastic than shale gas supply. This has led to a protracted glut that first emerged around 2009-2010. 2017 demand is expected to bring the market more into balance as domestic demand is expected to increase, together with exports to Mexico increasing and LNG exports ramping up as Cheniere brings its third and fourth liquefaction trains online. While the demand outlook is improving, we still need to watch a few things:

1. How quickly gas producers increase rig count in response to higher prices.
2. The associated gas coming out of the Permian.
3. The emerging SCOOP/STACK play in Oklahoma which produces oil and liquids-rich natural gas. It’s worth remembering how associated gas from the Eagle Ford and other liquids-rich gas plays exacerbated the gas supply glut. How much of an impact it may have on gas supply is difficult to say for sure at this point, but something to keep in mind.

With North American drilling activity turning the corner and on the upswing, OPEC, and natural gas supply/demand balance, 2017 certainly won’t be boring for oil and gas.

Full disclosure: I, Philip Dunham, am the primary author of this article, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article, beyond trading small numbers of shares of Parsley Energy, Inc. in the normal course of my trading activities. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, neither Sentieo nor I can guarantee their accuracy. Please do your own research and contact a qualified investment advisor before making any investment decisions. Neither Sentieo nor I are responsible for investment decisions you make.

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