Listeners, you wrote in, and we're answering.
In this week's episode of Industry Focus: Energy, host Sarah Priestley and analyst Taylor Muckerman go through a grab bag of questions from listeners. They explain the issues surrounding Permian Basin production, why investors might want to check out midstream company Enterprise Products Partners (NYSE:EPD), a few important things to know about oil services companies Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB), and what might become of the beleaguered offshore industry.
They also take a look at the upcoming OPEC meeting: what outcomes different countries will probably want, what could come of the meeting, and when we'll know more.
A full transcript follows the video.
This video was recorded on June 21, 2018.
Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking Energy and Industrials. It's Thursday, the 21st of June, and we're going to be answering some listener questions. I'm your host, Sarah Priestley, and joining me in the studio is Motley Fool Canada Premium analyst, Taylor Muckerman. Taylor, welcome to the show.
Taylor Muckerman: Glad to be here.
Priestley: [laughs] You seem really pumped to be here.
Muckerman: I am! If only they could see it.
Priestley: I know, if only they could see how enthusiastic we are this morning. We have had a flurry of emails with some fantastic oil and gas-related questions for us to tackle. As you are the resident expert, I thought that you could help us out.
Muckerman: I love questions much more than corrections.
Priestley: [laughs] Yeah, you and me both. The first question that we had was around problems of getting oil out of the Permian Basin. For anybody listening, the Permian Basin is a sedimentary basin in Western Texas. Try saying that after a few drinks. It covers about 250 miles wide and 300 miles long. It's pretty unique geology structure and it makes it really easy to extract oil and natural gas from, so it can operate at lower prices than other fields. We've seen it operate even in pretty low prices, like even $26 a barrel, I think they were still pumping.
After a hundred years of production, it's expected to reach record volumes this year. But, there is a bit of a problem in that frackers are becoming a victim of their own success. What do you think?
Muckerman: This area continues to be a wash in oil. You're talking about the Midland Texas area, which is the unofficial capital of the Permian Basin. The unemployment rate there is 2.1%. Everybody has a job, almost, in Midland Texas, and high-paying jobs along with that, because they just can't find enough truckers, enough roughnecks, which are actually working on the fracking equipment. You're seeing six-figure salaries for these truckers and other ancillary services. Home sales are thriving, home prices are thriving, all because this is the hottest basin and has been the hottest basin in U.S. oil and gas for some time now.
You looked at almost 2,000 horizontal well permits approved in the first quarter of this year, up 22% from the previous quarter. Even with this backlog of oil that can't find its way to the Gulf Coast, drillers are still trying to drill and paying quite highly for the workers that are able to come down and do the drilling. Even private companies are making their presence felt. I think I read that over 50% of permits in 2016 went to the top ten shale producers in the region. That's down to about a third now. Private drillers going from 20% of the permits up to 25% of the permits, so everyone is getting in on the action.
A little bit of that has to do with public companies going out and saying, "We're going to pull back on spending because of the downturn." But clearly, activity is still thriving and the pipelines just can't keep up. You see a huge gap in price between Midland Texas oil and Western Texas intermediate, and even more of a gap between international brent crude because this takeaway capacity just hasn't been there. They're building more, but it's not coming online within the next six months. You're looking at a year, two years. Then, the export facilities in Texas and Louisiana, not really expanding as they need to until 2020 at the earliest.
Priestley: Yeah, as you said, some producers having no outlet, especially for the natural gas that they're bringing out, so in a lot of cases, they're flaring it.
Muckerman: Oh, yeah, natural gas price, especially, yeah.
Priestley: And that's capping their output, too, because of the regulation around how much they can do that. But, interestingly, Anadarko CEO R. Walker said on a recent conference call that the pipeline shortages are creating the haves and have-nots based on who already has established contracts. He was talking about that from their perspective. He said, "We're working hard to be among the haves by proactively aligning our production growth with midstream and downstream solutions."
But it's this crazy situation where they can get it out of the ground now in a very cost-effective way, but they can't move it to the refiners and to the liquid natural gas export centers, where it's natural gas, in a cost-effective way. They're talking about bringing rail online.
Muckerman: Yeah, rail and trucks, and they're saying most incremental production. So, any additional production will need to travel via truck or rail, costing upwards of $15 a barrel in additional transportation costs.
Priestley: You mentioned that a few pipelines are coming online. Two that are notable, Phillips 66 and Enbridge together are building the Grey Oak Pipeline. That should move about three million barrels per day to Houston. As you said, that doesn't come online until the second half of next year. Then, the Cactus II pipeline is being built by Plains All American Pipeline, and that's going to go to Corpus Christi. That's not coming online until the third quarter of next year. We know, with what we're seeing with some of the timelines for the pipelines that are meant to be coming online now, that might get pushed out by a quarter or two, most likely.
Muckerman: Yeah. Then, once it gets to places like Corpus Christi, they're having bottlenecks because the ports aren't big enough for some of the ships that Chinese and European customers like to import oil on, which they call the very large crude carriers, VLCCs, talking about two million barrel supertankers. The expansions in Corpus Christi and Brownsville, Texas aren't expected until 2020.
Priestley: What's the big liquid natural gas export hub that's in Georgia? Is that coming online soon?
Muckerman: I'm drawing a blank on the name, but you have the huge one in Sabine Pass in Louisiana, and then another one from Cheniere Energy coming online in Louisiana. I'm drawing a blank on the Georgia one.
Priestley: I think we've talked about it on the show before.
Muckerman: Dominion has Dominion Cove export facility here on the East Coast, should be coming online at some point soon for liquefied natural gas. That'll help get some Marcellus natural gas off the coast. But, yeah, the Permian driving down natural gas prices and oil prices in Texas, because they're just producing too dang much.
Priestley: It'll be interesting to watch, over the next two years, how we level out that production increase and transport capacity around there, and what that does to the market as a whole.
We've talked before about midstream companies, and a lot of the questions that we've had are around midstream companies, one in particular around Enterprise Products Partners, ticker EPD. They're an American natural gas and crude oil pipeline company. Enterprises as a $60 billion market cap company, so it's a big company. It has exposure not just to pipelines but to ports, storage, processing and even shipping via tanker ships. It's actually one of the largest master limited partnerships in the U.S. An MLP basically combines the tax benefits of a partnership with the liquidity of a publicly traded company. If we went into this, it would be a whole show, but if you want more information on it, we do have a really good article that I can send you, so feel free to email us at firstname.lastname@example.org. Back to EPD, it provides mainstream services to the oil and gas industry. They mostly focus on processing, transporting, and storing natural gas liquids. Interesting company.
And as I said, we've talked about pipelines before, we've talked a lot about natural gas and how that market is really changing. Interesting. The headline news for the next couple of years is that it won't be hiking distributions to quite the same degree that we've seen in the past. That's the big attractive thing with these MLPs, is really their yield. It has an attractive yield. It's 6% at the minute. But we're talking low single-digit increases for the next two years as they try and improve their cash position and actually use that cash inflow to fund growth, rather than funding externally, which I think is smart.
Muckerman: Yeah, self-funded growth. You can't argue with that, especially if you can keep a yield of around 4-6%. That's a pretty nice payout in today's market, with some organic growth, if they can pay it themselves. Nice exposure to the Permian. Plenty of opportunity for excess takeaway capacity, if they can provide it.
Priestley: Yeah. They have two major expansion projects that they're in the midst of right now. One is a $4.9 billion recently completed growth project. Another one, which is $5.3 million, I think, expansion is under construction. I feel like we repeat ourselves all the time, but all of these expenditures will generate reliable cash flow income because they have such long-term contracts. I think pretty much all of EDP's capacity is locked up in fairly long-term contracts.
Some investors have shied away from the company, given its open admission that it's going to pull back a little bit on distributions, but actually, it makes a lot of sense. I think they're aiming for 50% internally funded expansion projects. Compared to competitors, it just means that they won't dilute.
Muckerman: Yeah, you won't be issuing shares or paying a lot of interest.
Priestley: Yes. And to me, it really indicates -- you've been studying this whole industry for so long now, you will have seen this -- that they've learned a lot from 2014 and 2015.
Muckerman: Yeah. How long they remember it is yet to be seen, but it's certainly nice to see that, five years in, it's still top-of-mind. To some people.
Priestley: [laughs] Yes, to some people in the industry. So, yes, we were asked a question about EPD. Definitely think it's worth a look at the minute. However, if distribution growth is something that's more important to people listening, then you might be better off looking for a midstream partnership like MMP, Magellan Midstream Partners. They're targeting 8% distribution growth in 2018. They have a lower yield, it's about 5%, but it's an appropriate conservative investment for people. But, yeah, I'm actually very much in the camp that this is a pretty good move for EPD.
Muckerman: Yeah, seems like it. Just remember, it's an MLP, so additional tax forms and considerations will apply in most cases. Just a little asterisk there. But, certainly a company that's worth considering if you like the space.
Priestley: Yeah. In a great email, we were asked about oil services companies, particularly Halliburton and Schlumberger. They're the biggest rivals, I would say, but correct me if I'm wrong.
Muckerman: Yeah, they're two of the top three.
Priestley: We'll talk about Halliburton first, ticker HAL. One of the first oilfield services companies in the world, and has a reputation for being the best wellbore engineering company. I think it still maintains that title. The company's founder, Erle Halliburton, pioneered the process of wellbore cementing in the early 1920s, would you believe.
Muckerman: I will.
Priestley: [laughs] Though they operate across the world, I think they operate in about 60 or 70 countries, 65% of their revenue comes North America. So they're heavily invested in North America. They made a big strategic bet on shale. I remember you telling me about this 20 years ago. They've invested a ton in the market, which has been a double-edged sword for them, because they've been there for the boom but they've also felt the pain on the other side. They had a respectable profit for the first quarter of this year, 34% increase despite issues in Venezuela that are affecting their bottom line.
Mixed feelings, it seems like, from analysts toward Halliburton at the minute. They've made a lot of investments to try and be competitive with Schlumberger. They've got a lot of organic growth, and they have really strong exposure to shale. I guess, for me, it's really how you interpret that exposure to shale.
Muckerman: This company is, I think, No. 3 in terms of the size. It was Mo. 2 until GE took over Baker Hughes and their energy businesses combined. Schlumberger is No. 1 and Halliburton No. 3. They're mirror images. Schlumberger has the international exposure, Halliburton has the domestic exposure here in North America.
It seems like things are really clicking here. They say that their fracking horsepower, which is what they consider the available fracking equipment that they have in North America, is fully supplied. They're running at full capacity for the frack fields here in North America. They see some improvement internationally. I talked about, in the previous segment, 2,000 permits for wells in the Permian Basin in the first quarter alone. Plenty potential action out there, and still a lot of wells to be fracked that have already been drilled. That's where Halliburton really holds their specialty. A lot of backlog out there available for this company that has rebounded decently over the last couple of years.
Priestley: I think the biggest difference I've noticed in people's perception between Schlumberger and Halliburton is the integrated services. People see that Halliburton hasn't really focused on these integrated services, which people are seeing as being very efficient and a cost benefit to the oil producers. I've started on the Schlumberger section. [laughs] They're often seen as best-in-class, and their bread and butter has really been understanding oil and natural gas reservoirs and the most efficient way to drill those. But it's also pioneered directional drilling, which was pretty important.
Muckerman: Yeah, still is. That really was one of the key technologies to light this fuse of the frack boom. That and fracking combined is why we've seen the U.S. flood the world with oil.
Priestley: This company, compared to Halliburton, is really focusing on reducing cost per barrel. I mean, Halliburton is, too, but the way that they're tackling this, I think it's called SPM.
Muckerman: Yeah, that's where they actually take a stake in the production side of things. Halliburton does not do that, I don't believe. But, yeah, definitely, reservoir description and management are a key portion of that business.
Priestley: They're at a very high P/E at the minute, there's a lot of confidence in the company. They beat estimates three out of the last four earnings. I think the bullish sentiment really is around that SPM and around the integrated services and how much they can offer oil service producers through that. They also spend more on research and development than any other of these companies. They're already feeling the benefits of that.
Muckerman: Yeah, and through acquisitions. A lot of that R&D is focused on offshore, as well. OneSubsea was the partnership that they have after they acquired a couple of companies that focused on offshore. So, some nice upside there if offshore oil ever comes back to life.
Priestley: I was going to ask you; do you think that we will start to see offshore come back online? If so, what price do you think we need to be at?
Muckerman: Yeah, at some point, unless other countries catch the fracking craze, which it seems like they might. Fracking can be taken internationally. A lot of frackable oil available out there. It just depends on the takeaway capacity, the infrastructure, the buy-in from governments. If China or Argentina ever get their act together when it comes to fracking, or other countries as well, but those two, certainly, in particular, you could see offshore oil continue to get pushed out on the timeline.
Priestley: Then, as you mentioned, obviously, we have Baker Hughes, a GE company, as a sort of looming competitor for both of these, only strengthened for the moment by its GE involvement. We'll see how that all plays out.
The next thing to talk about is, tomorrow is the Organization of the Petroleum Exporting Countries, OPEC's bi-annual meeting in Vienna, Austria. The next day, they will hold a meeting with non-OPEC petroleum exporting countries, namely Russia. That's OPEC-plus, I think.
Muckerman: Yeah, OPEC-plus.
Priestley: Very different global environment to the one that they have previously met under. The oil glut is somewhat reduced. Prices have risen, and even some countries like Venezuela are struggling to meet their allocations. New sanctions on Iran mean that their output is essentially going to be capped by their lack of a customer. Some members really want to keep production low and prices high. Iran has come out and said that's exactly what they're seeking. Others are looking for an increase. They way that I see it, there are three options. They can keep it as is. Venezuela, Iran and Iraq, I think, all favor that. Keep production as is but relax compliance. Or, increase. I think it's rumored that the Saudis favor an increase right now.
Muckerman: Yeah, they announced this morning, Thursday morning, that they want to increase, collectively, a million barrels per day. Ahead of the meeting.
Priestley: Oh, wow, breaking news. [laughs]
Muckerman: Yeah, already laying down the gauntlet ahead of the meetings, publicly saying that they want to increase OPEC production -- or supply, because they could already be producing it and then just storing it -- by a million barrels per day.
Priestley: Which is definitely an increase, but I feel like the market can handle looking at some of the projections, a million barrels per day.
Muckerman: Yeah, they say without it, you could see a supply crunch in the back half of the year, early 2019. There are some different incentives here. Whether or not they actually do see a supply crunch, who knows. But if that's the case, sure, let's have it. We can't get our oil to market because we don't have the pipelines. They can.
Priestley: Yeah, absolutely. We should have some more news on that next week. It's fascinating to watch that all play out. A lot of people are attributing the recent price rises to OPEC, and undoubtedly that contributed, but there are a lot of other factors that go into this whole mish-mash, too. But, yeah, pipeline stocks.
Muckerman: Russia beat Saudi Arabia five to nil in the World Cup, so maybe that'll have some leverage, in terms of who gets to release what oil.
Priestley: [laughs] Yeah, I'd love to see the soccer jokes going on at OPEC. That's it from us today. If you would like to get in touch, please feel free to do so. As you can see, we definitely appreciate listener questions. We like to answer them. Please feel free to email us at email@example.com, or tweet us on Twitter @MFIndustryFocus.
As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thank you, as always, to Austin Morgan for mixing the show. For Taylor, I'm Sarah Priestley, thanks for listening and Fool on!