Crude Observations

Stop the Presses!

It’s Labour Day!


Ah Labour Day. That annual celebration of the righteousness of the downtrodden worker, the brave collectives, union members putting it all on the line day after day in order to enrich the greedy corporate capitalist fat cats who live for exploiting the masses.


And which union am I talking about most specifically here? Why none other than the NFLPA (NFL Players Association) and their hardworking members as they head into what is the 104th season of NFL football.


As most of you know, I am a huge NFL fan. And occasionally I do an NFL preview blog, and I am going to do one. Just not a full one. Call it a soupcon, which will come a bit later.


And that is mainly because I have another Labour Day tradition and that involves an assessment of the M&A environment. So, I guess it means that I’ve gotta do both. So here goes.


Last year at this time, energy prices were literally blowing the doors off as the Russian invasion of Ukraine has roiled markets and discombobulated the energy sector. Both oil and natural gas prices were at decade highs as the global supply situation was so uncertain. On the back if those prices, many believed that the year to come was finally going to be a full-on CAPEX as we faced into a perfect storm of high commodity prices, escalating costs of, well, everything, supply chain blockages, natural disasters taking out entire swaths of industry, LNG prices so high that purchaser tenders are going unfulfilled, growing demand for all forms of fossil fuels and a societal desire for cheap, cheap, cheap energy and you would be forgiven for thinking that the energy sector was on the verge of something big.


And it looked that way for a while, rig counts certainly recovered as did provincial, state and national treasuries. Oil and gas companies started to spew out horrendous amounts of cash in the form of dividends, share buy backs and debt repayment. Except not so much in the way of CAPEX.


Then the reality of Russia and Ukraine and a protracted war set in. Ugh. Recession fears. Double Ugh. Interest Rate increases. Triple ugh. The evisceration of China’s real estate sector and the on again, off again re-opening that has yet to deliver the global boost that everyone was breathlessly expecting. Or maybe our expectations for China were overly optimistic. Like, you can’t grow at precisely 7% forever.


Regardless, volatility and uncertainty ruled the day. Interest rate increases and inflation ruled the day and the Biden administration opened the taps on the Strategic Petroleum Reserves to secure a mid-term victory and combat rising gas prices.


It worked. Up to a point. Gas prices moderated. The world adjusted to new flows for LNG and crude oil. Iran and Russia perfected the art of smuggling sanctioned oil to China and prices moderated.


But then a funny thing happened on the way to low price stability. First, OPEC+ and Saudi Arabia decided they weren’t happy with the direction of prices so they started slashing exports. Second, the much anticipated post-inflation interest rate induced recession failed to materialize. Third, producers exercised continued capital discipline.


So, we have made it through the “shock” phase of scarcity and stabilized. Except now we find ourselves in a world where global inventories of oil are shockingly low. And something, finally, has to give.


Suffice it say that while capital discipline has been great for cash flow generation and producer balance sheets, it hasn’t been so great for what should be a production boom given all the supply issues that are staring us in the face.


So, where are we at now? Well, true to form, as the world returns from a two-month orgy of summer vacations and forest fire watching, oil and gas prices are rallying into the fall, as they often do.


OPEC continues to cut production to support prices. Despite not as robust as expected capex, Canada and the United States have managed to moderately increase production. Brazil continues to disappoint.


In addition, there are a couple of headfakes to deal with as we close out the year, not all of which are specific to the energy industry.


The first is Iran. Notwithstanding the fact that Iran continues to sell drones to Russia and support its war efforts and that the ongoing repression of women in Iranian society shows no sign of stopping, Iran is strangely still at the table for the nuclear deal and the Biden administration has strangely turned a blind eye to the ongoing exports of Iranian oil – running completely contrary to the sanctions they have imposed. I have read that Iran is exporting something on the order of 2-3 million barrels per day. This si significant. And really great for China as the most likely destination.


The second is the depletion of the Strategic Petroleum Reserve. While this has been a boon to motorists over the summer there is no actual plan to replenish those reserves, so it has not been so good for producers. I guess there is no deed to refill the tank if you’ve got all these secret barrels floating around.


Added to the mix is the de-industrialization of Europe and their ongoing energy crisis which continues to be bullish for every energy producing country with a business case for LNG.


But these, as they say, are temporary.


There is still a war. Consumption of all forms of energy is still sky-high. Energy insecurity is real. OPEC+ does not have a ton of spare capacity. Mexico is still a basket case. China and India are still the fastest growing markets for fossil fuels in the world. 5% interest rates aren’t actually that scary and Russia is still bad.


Prices are below where it feels they should be but are at a level where everyone, I mean everyone, is making bank and this year feels like the one where activity could really take off. If only we could find any people to do the work.


It is actually starting to look as if some things may be lining up for us rubes in Canada.


I mean seriously, we have weathered pretty much every sling and arrow that can come our way, right? The only way things could have been worse is if Bernie Sanders or Donald Trump’s 89th indictment was President or if Justin Trudeau suddenly stepped aside to make room for his successor Steven Guilbeault whose plans for the energy industry include a 100% reduction in emissions and a 0 boepd production cap along with repurposing all the pipelines to carry maple syrup.


I will say this though, Minister Guilbeault will more than likely achieve his desired massive reduction in emissions for Canada if he continues the way he has because at this moment he is the single biggest force for Alberta Separation around. Even I am starting to consider #Wexit as a viable option.


In all seriousness, if the only way to get rid of this disrespectful clown and ideologue is to go our own way, we may just have to go ahead and declare the free state of Alberta!


All hail the Empress Danielle the First! Ruler of the sands of oil, first princess of Athabasca, Baroness of High River and Queen of the Duvernay. Marchioness of Medicine Hat. Knight of the Royal Order of Calgary and Duchess of Sherwood Park. Countess of Coutts and Grande Vizier of Vulcan.


Sorry, I digress.


Where was I? Oh yeah, Labour Day weekend, the sun is shining and the price of oil is holding at $83 and change and natural gas is a whopping $2.50 (yes, I know about AECO, don’t even get me started).


Here in Calgary, Labour Day can bring a snowfall, a thunderstorm or a 32 degree sun splash for the Labour Day Classic football game. Or all three – we can be pretty volatile here.


What is also for sure is that as we enter the Labour Day weekend, the proverbial back to school/back to work switch gets triggered and Calgary’s business community gets busy again in preparation for a hoped for “busier than last year” drilling season, since like any true energy industry participant, we are nothing if not eternally misguided optimists.


And true to form for every year around this time, kids go back to school, the leaves turn (trust me – it’s Calgary), budgets for 2024 start getting set and the pace of M&A heats up, regardless of stage in the commodity cycle or the commodity price, the only difference being whether it is upstream, midstream or downstream and which particular subsectors lead the charge.


As we discuss with clients in the energy services space, there are certain ideal times of year when deals get more attention in the market or start getting done. These times are just after Labour Day but before American Thanksgiving, just after Christmas and before March and then, uniquely for Western Canada, post spring break up.


For a variety of reasons, these times of year work, driven mainly by the service sector activity cycle but also by the buyer demographic and energy company capital budget timing.


In the context of the current market, where producers are harvesting cash and not barrels, one would assume that activity should be in the tank, but the reality is that the current market is pretty bullish for service companies in general, largely as a result of the self-selection and “culling of the herd” that has occurred over the last few years.


Scarcity is the name of the game and if you have equipment and more importantly, bodies, you are busy.


Layered on top of that is the imminent completion of the TransMountain Expansion and the Coastal Gas Link pipeline. The increased capacity will allow significantly additional barrels to be sent to the BC coast for export (largely to California, but many to China as well) and facilitate the export of Montney gas to the LNG Canada facility in Kitimat.


Things, as they say, are looking up.


So there will be jobs and capex. Manpower pressures and inflation have allowed service companies to raise their rates and cash-flush producers are paying them. Well, except for CNRL.


Service companies are finally making some money again. Which finally leads to M&A and the usual rogues gallery of buyers: young and hungry start-ups, savvy veterans giving it one last kick because they sat on the sidelines for three years and, finally, private equity.


As I never get tired of saying, good companies will always attract quality buyers and that is true no matter what the economic environment or the cost of capital. There is just too much capital in the world and the industry is too important for the M&A market to go away. In many ways this is an ideal time for smart buyers to start doing deals as we are far enough away from the desperation of 2016 and close enough to a resolved egress environment to allow well-financed and patient buyers to pick up businesses with a lot of runway ahead of them.


As to the opportunity, we see buyers looking to consolidate industry segments, build asset bases, acquire customers and otherwise position themselves for the next few years, driven in large part by the larger infrastructure projects that are actually happening – LNG Canada, Trans Mountain Expansion and the NGTL work that seeks to get more WCSB gas out of the country at prices that reflect economic reality.


Against this is record oil production, massive profits and world that is about as insecure about energy as it has ever been. Sell Russia, buy North America.


I’m not predicting anything close to a return to heady, frothy, 2013-2014 crazy times, but we expect a robust M&A market going forward, led by gold standard, efficient Canadian operators.


An additional point to consider as activity increases is a sector rotation from “safer” mid and downstream related businesses into upstream oriented service providers whose growth prospects are suddenly more real than just a fancy slide deck saying “it’s coming”.


On the upstream side, industry subsectors that are typically the most beaten up during a downturn are often the ones to see the first levels of interest – mainly companies that provide front end services such as engineering, planning, infrastructure services like road and right of way clearing, smart rentals and most anything site service related such as safety, security and medical services. Next up are the drilling and completions companies and judging by activity levels reported, these companies are getting much busier.


On the midstream side, along with the mega projects currently underway, there is an ongoing flow of dollars into pipeline and processing infrastructure whether it is new-build or maintenance, turnaround and integrity related. The thesis on investing and maintaining critical infrastructure will always hold regardless of market dynamics.


As far as who the buyers are, we anticipate a mix between Canadian strategic buyers including mid-market players and opportunistic private equity funds looking to support these mid-market players and pursue their own particular investment theses. We also anticipate that more US based buyers will be coming to kick the tires in Canada, as Canadian multiples are much more reasonable and we have great prospects with LNG Canada on track.


Canadian companies are leaders in ESG and, of course, are among the most highly regulated in the industry. This makes them attractive on a relative basis compared to other basins.


So, we are as always cautiously optimistic on the M&A front, both from a business cycle and seasonal perspective.


Which I think I say every year, eternal optimist that I am. Plus M&A never rests. We are closing deals and signing new clients all the time. More on this later in September.


Now, on to the NFL.


This 1,000,000,000th NFL season is going to be epic. I feel it. Lots of exciting young stars, emerging teams, holdouts, surprise retirements and team altering injuries, trades and suspensions. The pre-season was, as always, abysmal and excruciating. Unless you are a QB signing a new contract. Then you’re just absurdly rich.


But… But…


Much like Calgary after Labour Day and the M&A market, the NFL is in many ways predictable.


Teams and players that are meant to win, win. Losers will always lose. Cities that exist on heartbreak will get their hearts broken.


The Super Bowl this year will be in Las Vegas BABY.


This is the first time it will be there and it is going to be EPIC????


Last year was Mahomes vs Hurts. Kansas City against the mighty Eagles.


Last year I had Tampa playing Buffalo and Buffalo, true to form, losing.


While I had the losses right, my pick was ultimately wrong so I need to do a better job this year.


This year we don’t have a Brady and the Vegas Raiders are going to be led by his one time understudy who just so happens to be kind of his boss, since Brady now owns a piece of the Raiders.


Raiders will be lucky to make the playoffs this year. They aren’t even a sleeper pick.


Consensus seems to be 49ers vs Kansas City. But I’m not catching the fever.


Why don’t I do this. I am going to pick my division winners and we can go from there.


AFC East – Buffalo

AFC North – Bengals

AFC South – Jacksonville

AFC West – Kansas City

NFC East – Eagles

NFC South – New Orleans

NFC North – Vikings

NFC West – 49ers

Wow – those are some good teams. I could easily see Bengals/Chiefs and Eagles/Vikings in the championship games.


And the Bengals beating the Vikings in the Super Bowl.


Joe cool.


Have a lazy weekend. Back to work in earnest on Tuesday!

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