MORNING NOTE - Energy Thoughts for August 23, 2018
See bottom of note for important research disclosure
 
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MORNING NOTE

Energy Thoughts for August 23, 2018

 
ENERGY THOUGHTS

Morning Note Summary

August 23, 2018: E&P From the Road; SM stock thoughts; DJ Basin update; Global Heat Transfer (Part 1 & 2); Kerr Pump catchup (Part 1 & 2); DOE Recap; Future SPR Release

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NORTH AMERICAN E&P

E&P From the Road

Capex, Permian, and DJ Basin most topical in NYC

Sector: Nam E&P | Ticker: Brent | Recommendation: NR | Target: NA | Close: $74.92/bbl

Halfway through a week-long marketing trip in NYC, the most common topic has been capex regarding both rationale behind budget increases during Q2 earnings and if there's risk of incremental budget raises from here. Despite negative reactions during earnings, investors are generally receptive to improved completion efficiency and cycle times representing fundamental improvements to operations, but remain concerned that budgets may not have been raised enough given pace of spending YTD and recent comments on service cost inflation. Bigger picture, there are also some concerns that budget increases may be more indicative of unfavorable acceleration and a departure from FCF objectives. Permian A&D was topical as expected following recent transactions, as was takeaway given emerging thoughts of sooner than expected resolution. The former has focused on likely transactions, with the latter focused on pinpointing both pricing and activity troughs over the next twelve months. Lastly and still least, we've had some discussions on gas names as investors are digging into a potential short term positive trade given encouraging near term fundamentals, and operators are highlighting moderated growth plans. Most topical names have been APC, DVN, EOG, MRO, MTDR, NBL, OXY, RRC, WPX, WRD, and XOG.

SM Stock Thoughts

Continue to see beat-and-raise on oil growth in H2'18

Sector: NAm E&P | Ticker: SM | Recommendation: BUY | Target: $42 | Close: $29.85

We model Q3'18 prod'n at 127mboepd (55 oil) vs. Street's 126mboepd (54 oil) with TPHe late-Q2 TILs combined with a heavy Q3'18 TIL schedule at RockStar (37 net) driving the oil beat. From an asset perspective, we'll be keenly watching the Middle Spraberry pilot this year, the WCD pilot next year, and upspacing results in the Eagle Ford over the next couple of quarters. Looking ahead, H2'19 marks a FCF inflection point which combined with an improving 2019 hedge book (TPHe ~50% basis) provides flexibility for a host of options as the balance sheet compresses from TPHe ~2x YE'18 to ~1x by YE'20. As the company starts to inflect, material FCF starting in 2020 could be directed towards: i) paying off LT callable debt to enhance debt-adjusted per share growth, or ii) further development of the Eagle Ford or other zones in the Permian. Equity remains our preferred way to play our beta bucket offering 40% upside to 3P NAV, trading at a 3.1x 2020 EV/EBITDA, while generating TPHe ~14% FCF on average '21-'25 at $58/bbl WTI.

Latest Dose of DJ

Polis declares 97 is the wrong solution for Colorado

Sector: Nam E&P | Ticker: Brent | Recommendation: NR | Target: NA | Close: $74.92/bbl

Incrementally positive to see Polis openly speak out against Initiative #97 yesterday, (i) acknowledging that it “would all but ban fracking in Colorado” and (ii) declaring “it is the wrong solution for Colorado”. Earlier in his remarks at the 2018 Energy Summit, put on by the Colorado Oil and Gas Association, Polis also gave credit to the role that the O&G industry has played and will continue to play in the growth of Colorado's economy. Given his ongoing campaign and his history of both promotionally and financially supporting anti-O&G initiatives, it's too early to get excited on this data point alone as Polis' comments could only be speaking to Initiative #97 as it's currently written. In the meantime, it'll be more important to stay watchful for news from the CO Secretary of State's office regarding whether or not the valid voter signature requirement is met (deadline to find out is Sep 5, but could be sooner). Consensus is that the initiative makes the ballot, but fails in November voting as voters become educated on the severe potential economic ramifications of both #97 and #108.

 
OIL SERVICE

Who's Global Heat Transfer Again?

Simply put, these guys have changed the frac radiator game

Sector: Oil Service | Ticker: OSX | Recommendation: NA | Target: NA | Close: $145.58

Always fascinating to speak with oil patch entrepreneurs who've created a differentiated product that customers fancy. GHT pioneered the cube-shaped cooling system for pump trucks, which helps solve a number of cooling-system issues, thereby limiting non-productive time. The company also sells radiators to onshore drillers (~4 per rig) and the industrial/mining complex. Within gas compression, GHT holds a strong presence in Vapor Recovery Units (known as VRUs in the market). We recently caught up with the company; our notable pressure pumping market takeaways can be found in the below blurb.

GHT Updated Frac Market Thoughts

Radiator manufacturer to the stars remaining busy as R&M work ramps

Sector: Oil Service | Ticker: OSX | Recommendation: NA | Target: NA | Close: $145.58

As frac fleet newbuild orders dwindle, mucho horsepower (“hhp”) remains busy (TPHe 380-390 US fleets active) and hhp “in the yard” needs some TLC thus GHT is ramping up its service / overhaul work. Earlier in the year GHT was performing ~5% / 95% overhaul / newbuild; today that's more like 50/50 with the belief we're headed to 75/25 by Q4'18. A modicum of new-build frac fleet orders for 2019 are being mulled over with 3k hhp pump orders under consideration, but major component delays continue to drive preexisting frac fleet deliveries to slip. Worth noting International quoting activity is ramping and it appears there's more clear visibility in Canada vs. the US today.

Catching Up With Kerr Pumps (Part 1)

Disrupting the fluid-end biz continues, progress being made

Sector: Oil Service | Ticker: OSX | Recommendation: NA | Target: NA | Close: $145.58

When we first caught up with Kerr Pumps in 2017, we realized they were designing / manufacturing fluid-ends differently vs. (much of) the competition; that hasn't changed. At that time, the company was in the nascent stages of truly tackling the frac space, building upon their long history in the well serving and industrial arenas. As a reminder, Kerr designs and sells ~$50k super stainless fluid ends (much cheaper vs. competing stainless steel products at $60-70k). Kerr's products “transfer the wear” and extend the lives of fluid-ends and flow/treating-iron. They're now working on improving their Frac One Connect product to further reduce pumper R&M expense.

Catching Up With Kerr Pumps (Part 2)

Disrupting the fluid-end biz continues, progress being made

Sector: Oil Service | Ticker: OSX | Recommendation: NA | Target: NA | Close: $145.58

When we wrote about Kerr in April 2018, their pressure pumping fluid-end market was ~10% and we described their presence as an inch deep and a mile wide. That's changing as customers get more reps under their belt with Kerr's products and adoption rates accordingly increase. The company's relentless focus on inhibiting full fluid-end failure persists via current goal of increasing fluid-end valve life (go from ~20-50 hours today to 200-400 hours) thereby reducing the quantity of times customers “go back in the fluid-end” and change valves...ultimate aim is to push that work to occur between (vs. during) individual jobs. We'll be keeping an eye on Kerr's continued innovation / progress moving forward; you should too.

 
MACRO

DOE Recap

Crude draw marred by trend of weakening crude exports

Sector: Macro | Ticker: WTI | Recommendation: NR | Target: NA | Close: $68.00/bbl

US crude inventories drew 5.8mmbbls, confirming the APIs and dwarfing consensus estimates (~2.0mmbbl draw). Close to ~1.0mmbpd w/w swing in crude balancing item raises a red flag, but is somewhat offset by plunging crude imports (down ~1.5mmbpd w/w). Together, signs point towards a timing issue as we expect data to clean up next week. Cushing saw inventories rise for the 2nd straight week (up ~0.8mmbbls), in-line with expectations. Conversely, we are becoming increasing concerned with the trend of weak crude exports, exports fell 437mbpd w/w to ~1,155mbpd. MTD, August crude exports have average ~1,500mbpd compared to July (~1,900mpbd) and June (~2,400mbpd). Gasoline rose 1.2mmbbls, counter to expectations, while distillates rose 1.8mmbbls, slightly more than expectations.

Future SPR Releases

Expect another 11mmbbl SPR release in FY'19; Biased higher based on legal interpretation

Sector: Macro | Ticker: WTI | Recommendation: NR | Target: NA | Close: $68.00

Congress has authorized the release of ~283mmbbls from the SPR by YE'30 which will result in inventories falling to ~400mmbbls (~40% reduction). The drawdown is allocated on an annual basis (or across several years), providing guidance /oversight on how much the DOE can draw inventories in a given year. For example, only ~43mmbbls were authorized from FY'19-FY'21. FY'19 SPR drawdown requirements are estimated at ~22mmbbls (EIA) with the Oct/Nov SPR release meeting 50% of the congressionally mandated release. Remaining 11mmbbls pro-rated for FY'19 exists in a grey area as language authorizes a drawdown equivalent to $2.0B between FY'17-FY'20. On one hand, the EIA calculated volumetric requirements at $50/bbl, but on the other hand, volumes have been allocated to FY'20 where, legally, such a requirement does not exist.

Please contact your TPH salesperson for the accompanying report.

 
CONFERENCE CALLS

GMLP-US, 11:30 EDT, Golar LNG Partners LP, 888-599-8686, Pwd: 7929666, Webcast

 
INTERESTING ARTICLES

Saudi Aramco Could Still Sell a Stake---to China, WSJ -- Link

Texas Permian Basin driving 'extreme' demand for frac sand, MRT -- Link

Polis and Stapleton lay out their energy plans, The Gazette -- Link

 
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Pembina Pipeline Corp Peyto Exploration & Dev Saguaro Resources
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Price History for SM Energy Co. as of June 30, 2018

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