President Trump is making good on his campaign promise to take the United States out of the Paris climate accord -- much to the chagrin of many companies both inside and outside the energy sector.
In this week's episode of Industry Focus: Energy, Sean O'Reilly and Taylor Muckerman -- speaking before Trump's announcement that he was pulling the U.S. out of the Paris accord -- explain what significance this move has for the energy sector and the world. Also, the hosts look at this week's other big news items in energy: a report of mild production declines for the Permian Basin from the Department of Energy, an update on General Electric's (NYSE:GE) merger with Baker Hughes (NYSE:BHI), and more.
A full transcript follows the video.
This video was recorded on June 1, 2017.
Sean O'Reilly: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, June 1, 2017, so we're talking about energy, materials, and industrials. I'm your host, Sean O'Reilly, and to my left is one of the best analysts in the business, Mr. Taylor Muckerman. What's up, sir?
Taylor Muckerman: Thank you very much. Did you take a poll on Twitter for that?
O'Reilly: No. I looked around the office and I was like, I think he's good at his job. I don't know. They did make him the co-manager of Fool Canada, up-and-coming guy.
Muckerman: OK, deductive reasoning.
O'Reilly: It may be a leap, but I also built you up simultaneously.
Muckerman: I like that, I appreciate it. If I was hosting, I would do the same for you.
O'Reilly: Oh, what a guy. Thank you. On today's show, we're diving into General Electric's busy week, and the first signs of production declines in the Permian Basin, although it's not quite what you would think. But first, we have to talk about the big energy policy news of the week. Donald Trump is likely to withdraw the United States from the Paris climate agreement. Trump has called the pact a bad deal for the United States and made withdrawing from it a key component of his campaign when he ran for president. At an April rally, about two months ago, he called the agreement one-sided and said the United States pays billions to be in compliance with the agreement while China, India, Russia, any country you can think of, they signed the agreement but they're not doing anything financially. Taylor, what do you think?
Muckerman: He's thinking about this from the perspective of manufacturing companies and petrochemical companies and coal power producers.
O'Reilly: Because it's expensive to not put out carbon dioxide.
Muckerman: Yeah, they have to change a lot of their operations in order to comply, because basically what this is trying to do is prevent global temperatures from rising 3.6 degrees Fahrenheit to avoid ice caps melting, rising sea levels, carbon dioxide entrapment in the atmosphere. So the science is still out. Some people say that climate change is real; some people still say that it's not. Regardless of what you think, if it is real, he doesn't have the best interest of his citizens in mind, from a health perspective and a safety perspective. He's looking at this from a couple different sectors of the economy's perspective.
O'Reilly: He's definitely playing to the base, for sure.
Muckerman: Well, yeah, when you think about it that way. But if you look at who was trying to convince him to remain in it, you have, the three biggest coal companies wanted him to stay in the Paris climate agreement.
O'Reilly: Did you see the letter?
Muckerman: I didn't read it.
O'Reilly: Basically, every CEO of every big company you can think of. Elon Musk, Bob Iger over at Disney -- this list was, like, 40 people.
Muckerman: OK, they're tech companies.
O'Reilly: Disney isn't a tech company; they're an entertainment company.
Muckerman: Well, Pixar is tech.
O'Reilly: But you're right. The fact that a coal company and ExxonMobil is saying --
Muckerman: Yeah, and a lot of the big petrochemical companies, and a lot of the big fossil-fuel companies out there are saying --
O'Reilly: That has a lot of weight.
Muckerman: It should, but it didn't. Even his secretary of state, Rex Tillerson, who is the former CEO and ExxonMobil lifer until he jumped to the public sector, was against him pulling out of the accord. Interesting note -- us and Syria are the only two countries not in agreement with the rest of the world that climate change is real. Nicaragua, also not in the Paris accord.
O'Reilly: Is North Korea in it?
Muckerman: I don't know if they're considered a country on a global scale.
O'Reilly: [laughs] Oh, man! This is going to be like The Interview.
Muckerman: Either way, Nicaragua said, "It doesn't go far enough, so we're not going to be a part of it." Syria and now the United States are the only ones not in it because it goes too far, or that climate change doesn't exist.
O'Reilly: In doing my research for this, I was reminded -- I'm kind of surprised. This is, one, relatively new. It went into effect after 147 nations ratified this sweeping emissions-reduction agreement, and that was just in November 2016.
Muckerman: It was an attack on former President Obama's climate change initiatives. Basically, for the United States, President Obama had said that by 2025, we would have our emissions 27% below 2005 levels. In seven and a half years, we would be producing a quarter less carbon emissions than we did in 2005.
O'Reilly: Do you know anything offhand about the cost increases for any industry to comply with any of this stuff?
Muckerman: Not offhand. But when you look at the coal industry, they have to deal with, you're looking at basically the suppression of pollutants in their emissions, and when we're pulling out of this, the forward progress that they were making, the billions of dollars that they were spending, are now arguably for naught. Even though 50% of our electricity came from coal in the early 2000s, now we're down to about 30% of our electricity from coal today. Some of those technologies are carbon capture and sequestration. And Southern Company and some of the bigger coal and electricity producing companies, like I said, spent billions of dollars over the past five or 10 years, even before the Paris climate accords were in effect. But discussions about such things were in effect. And now they're left scratching their heads as to "Why did we do this, and should we continue to do it? Because in four years, what if another president comes along and says, "We're going to jump back in?"
O'Reilly: It seems like the smart play for these companies to actually just keep doing it, try and make it more efficient.
Muckerman: Smart, humane, the list goes on of words that you can use to describe the benefit of going forward with this. Regardless of the climate change, carbon trapped in the environment, that's been known to be bad for humanity, regardless of the impact on temperature. So by pulling out of this accord, he's throwing carbon in all of our faces.
O'Reilly: And in our lungs.
Muckerman: And in our lungs. And when you look at some polls that were taken to see how Americans felt about this, 62% of Americans over all supported staying in the accord, including more than six of 10 independents, 87% of Democrats, according to a Politico Harvard poll. So, well over the majority of Americans, based on these polls, supported staying in. So he's not necessarily talking to his entire base.
O'Reilly: Mr. Muckerman, General Electric has been busy. Good week for -- what's the nickname of that place? GE? They used to have a nickname. It was started by Thomas Edison. That's always fun. First, its merger with Baker Hughes has been cleared by the European Commission. Was that on the line at all? Was anybody nervous?
Muckerman: I don't know if they were necessarily nervous or not, but it's one step closer to having this deal approved. The next step is the Department of Justice, who not too long ago asked for additional information, much like they did with Halliburton (NYSE:HAL) and Baker Hughes when they tried to do that a while back.
O'Reilly: Right. The way these antitrust regulators work is comical to me, it's always been comical. They really dive in and look at the individual markets that are affected. It's not just, "These are big oil-service firms." They're trying to prevent monopolies in any market.
Muckerman: Yeah, so you have to imagine there will be some sales of some assets.
O'Reilly: Listen to this. They looked into multiple markets that the two companies competed in. Onshore electric submersible pumps was one of the markets.
Muckerman: Huge industry.
O'Reilly: Offshore electric submersible pumps, chemicals, and, of course, derivative petrochemical products used in oil refining, and, of course, sensors used in drilling. Wow. It would actually be really cool to have them a monopoly of some sort in sensors.
Muckerman: That sensor one is interesting because, they're looking at that because GE supplies Baker Hughes and competitors. So can they cut out some competitors and only supply Baker Hughes? Can they overcharge competitors versus Baker Hughes? Could they spill the beans on some of the IP [intellectual property] that Baker Hughes' competitors have been providing GE in order to produce sensors that are specific to their competitors?
O'Reilly: The structure of this deal was weird.
Muckerman: It's basically the oil and gas assets of GE combining with Baker Hughes. So just a subset of GE and all of Baker Hughes. That's just how big GE is. It could match the size of the third biggest oil-services company with just a portion of its assets. And when you think about this, it would definitely help make both of their businesses more competitive, when you compare them to the world's largest oil-services company, Schlumberger, and the world's No. 2, Halliburton. But it's not introducing new competitors. So, if you're a shareholder of Schlumberger and Halliburton, you don't need to start freaking out that, "Oh my God, this is a brand-new competitor!" What it's doing is just making the competition more competitive. Ideally, GE and Baker Hughes would be able to strip out some costs, they'd be able to combine technology and make things more efficient, not only on the operation side but also on the technological side. It's making competition more competitive, not introducing new competition. And if they do have to sell some assets, you would imagine Schlumberger and Halliburton would have more cash than the rest of the competition to potentially purchase some of these assets, specifically Halliburton, since they tried to merge with Baker Hughes at one point. So they might be interested in some of the spare parts that are cast off.
O'Reilly: Awesome, we'll have to wait and see.
Muckerman: Yeah. I don't know when they're expecting the DOJ announcement, but they're probably a ways off, because they did just ask for a little bit more information.
O'Reilly: Right. Which, as I recall -- it's been a little while since I looked at an antitrust review, but that usually happens a third of the time. So it's definitely already in the minority of --
Muckerman: Yeah, I think it happened twice, maybe three times, with Baker Hughes and Halliburton when they tried to merge.
O'Reilly: Oh, they asked for another?
Muckerman: Yeah, at least twice. And obviously, we all know that took over a year before they shot it down.
O'Reilly: Anyway, to help pay for the acquisition by GE, the U.S. Commerce Department just announced on June 1 that 13 trade deals were created between the U.S. and Vietnam, following a trade-focused trip by Vietnam's prime minister to the United States, where he met with President Trump. The biggest beneficiary was GE. They signed deals in Vietnam worth $5.6 billion for power generation and, unsurprisingly, aircraft engines. Seems like if you want aircraft engines, it's either GE or Rolls-Royce.
Muckerman: Yeah that's about it. You think you're getting it from the actual plane manufacturer, but that's not the case.
O'Reilly: Right. I always wonder whenever I see a deal like this how necessary -- like, had that guy not made that trip, would GE have gotten these contracts?
Muckerman: That's a good question. I'm not sure. It's definitely part of Donald Trump and his administration's announced plan to try and right the ship in terms of global trade. Vietnam does have a $32 billion trade surplus with the United States. So these deals go a little bit of a way toward --
O'Reilly: Just for our listeners, Vietnam sells us $32 billion more business and services than we get from them. So we're in deficit there, technically. They get more of our dollars than we get in their currency.
Muckerman: So the total amount of the deals that you mentioned, over $8 billion; $3.4 billion of that will be produced in the United States. So not the entire thing, but almost 50%. So about a tenth of the trade surplus right there. Big deal for GE. Any time you can land a deal $5.5 billion spread across a few different segments of your business --
O'Reilly: Not bad.
Muckerman: Not bad at all. And good news out of the European Trade Commission. So, like you said, good week for GE. We talk about GE quite a bit on the show. It's one of my favorite ways to play energy and industrials at the same time.
O'Reilly: I think they're going to be extremely interesting in the years ahead. We might have to do an entire show about them.
Muckerman: We absolutely could.
O'Reilly: They're about to get completely rid of the finance arm. They've done, like, $200 billion in asset sales. This took a while. But they were deemed to be existentially important to the financial system, and they had a problem during the financial crisis. [Warren] Buffett made that preferred stock investment just to shore them up, which sounds insane.
Muckerman: To shore up GE, yeah.
O'Reilly: So now they'll have more cash to focus on their industrial operations and dividend.
Muckerman: And renewable energy.
O'Reilly: Yeah. Nice plug there, GE's renewable future. That's the title of our next show.
Muckerman: Regardless of what Trump has to say, GE is still focused on it. They'll sell wind turbines to anyone but the United States if they have to.
O'Reilly: Right. It's GE and ... Siemens?
Muckerman: Siemens is pretty big. There's a few different players. But yeah, GE and Siemens are the publicly traded ones that you hear most about.
O'Reilly: Our last little thing we have to rap about: The Energy Department just came out with a report that says the Permian Basin, which is, of course, the most profitable shale basin, it's in West Texas.
Muckerman: It's the high horse.
O'Reilly: It gets even better within the Permian Basin; within that is the Delaware Basin.
Muckerman: Delaware in Texas? What?
O'Reilly: What? Oh, gosh, that's a tweet; we need to tweet that out later. Their productivity is about to drop. I need you to explain this to me and our listeners. They cite that the daily production of a new Permian well drilled by an average rig -- that's really specific there, by the way -- will drop by 10 barrels to 630. This seems really small. That is a 1.56% drop.
Muckerman: Small drop in a barrel.
O'Reilly: Is this that big of a deal? How did they come up with such a minute detail? That seems really specific. I don't quite buy ...
Muckerman: Yeah, that's a good question. I think they have a lot more time on their hands than we do to really analyze the per-well production. Granted, there are probably some hedge funds out there that are doing the same analysis. But I think the big news is that it's going down.
O'Reilly: Are we at peak oil in the Permian? Is that what this is?
Muckerman: No, because when you look at it, they have a crazy high amount of -- we talked about this a few months ago -- the wells that are drilled but not completed, they're drilled, they're not fracked. Fracking is the most expensive part; fracking is the part that unleashes the oil from the ground. We're up to 1,995 [wells] in the Permian Basin alone that are drilled but not completed. That's up from 1,348 last August.
O'Reilly: And each one of those could produce hundreds --
Muckerman: 630 barrels a day.
O'Reilly: So this statistic literally means, you and I go get a lease in the Permian Basin, never done it before. We get an average rig, we go down there, we drill, the odds are we'll get 630 barrels a day.
Muckerman: Right off the bat.
O'Reilly: Had we done this a year ago, it would be 640. This sounds crazy.
Muckerman: Right, but that's right off the bat. Obviously, we've talked about the precipitous decline in the production of these wells over time, predominantly up front for shale. So you're losing a lot of that production within the first couple months, at least the rate of production. So I just think it's interesting to see, maybe the low-hanging fruit has been plucked, or maybe some of the wells that aren't completed yet can right the ship a little bit. But basically, what you're seeing from a lot of people is, they're saying that because of the downturn and because of companies like Schlumberger, Halliburton, Baker Hughes and the rest of the services there and equipment business, they were tearing apart the rigs to replace parts on ones that were in operation rather than having them all in operation and producing new parts.
O'Reilly: Oh, you think this might be because of the average rig, not because of the land?
Muckerman: I think that's why there's a lot that aren't completed yet. I don't think that's why production decline is being talked about.
O'Reilly: This even seems like too round a number. Why is it not dropping to 629 or 631? This sounds ridiculous to me.
Muckerman: There are a lot of round numbers in the news. They're very rarely uber-specific.
O'Reilly: I'm going to get lunch at 12:28 and 48 seconds.
Muckerman: No, that's too specific; people can't understand that. If you read that, you're like, "I'm going to forget that." You can remember 630 and 10. But then, you look at expectations of overall production.
O'Reilly: I can't believe I'm nitpicking the Energy Department. I'm sorry, Energy Department.
Muckerman: The Permian Basin is supposed to rise by 71,000 barrels next month. That's a nice, round number. To 2.5 million barrels total. That's a nice, round number. It's just easier to digest. So, overall production in the Permian, still going up. But expected average production per well might drop. Over time, that could impact overall production.
O'Reilly: It sounds like they could just get an above-average rig. That's what I think.
Muckerman: Yeah, they're trying to build some more of those, if you listen to the services business. But they've been a little hesitant, because they don't want to get caught with surplus again.
O'Reilly: As they should be.
O'Reilly: All right, Mr. Muckerman, always a pleasure!
Muckerman: Indeed it is.
O'Reilly: Have a good one!
Muckerman: You, too!
O'Reilly: That is it for us, folks. Be sure to tune in tomorrow for the Technology show with Dylan Lewis. If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at email@example.com, or feel free to tweet at us @TMFEnergy. As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Taylor Muckerman, I am Sean O'Reilly. Thanks for listening, and Fool on!