The cost of oil is barely making a blip on the radar when it comes to profits for drilling companies. With the breakeven costs to pull the liquid gold from the earth, some companies are selling off equipment or merging with larger corporations. Could there be a world in which oil and shale work together? Find out on today's energy edition of Industry Focus.
A full transcript follows the video.
Sean O'Reilly: Schlumberger (NYSE:SLB) felt like spending $15 billion, on this energy edition of Industry Focus.
Greetings, Fools! I am Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. Today is the energy edition of Industry Focus. As always, I'm joined by Taylor Muckerman and Tyler Crowe. How's it going, guys?
Tyler Crowe: Doing pretty good, man.
Taylor Muckerman: One of these days, you're going to have to do this show by yourself.
O'Reilly: Oh my gosh. I don't even know what I would say.
Crowe: It would almost be a dictation of something.
O'Reilly: Oil prices that -- hey! Be nice. First up, Schlumberger felt that they needed to buy Cameron (UNKNOWN:CAM.DL) for $14.8 billion. They've obviously been doing that joint venture for a little while, so they know each other. Is this a good deal for Schlumberger shareholders? Is this a good deal for Cameron shareholders? Is this a good idea overall?
Crowe: Like you said, it's like going from dating to marriage because they had the joint venture going on for a little while in the subsea sector. They had a joint venture called OneSubsea, which was basically a way of trying to get more involved. When you're actually drilling for oil, you have to have those blowout preventers and a lot of safety measurements that are right at the ocean floor.
When Schlumberger was going into doing all their contract work for offshore work, they were working almost exclusively with Cameron to do that. By doing this, they've taken out the step of doing it through the joint venture, and they can do it all in a blanket statement. It's a good move if you're looking at offshore as the big-time future over the next 10, 20, 30 years.
O'Reilly: Do you think there's an argument for that?
Crowe: I think there's any argument for anywhere in oil 10, 20, 30 years from now to be made. Certainly, if you look at the projections...
O'Reilly: Drilling for oil on the moon?
Crowe: Exactly. If you look at any projection for oil, it appears on that 10- to 20-year time horizon that offshore, more specifically ultra-deep offshore drilling, is going to be a larger and larger component of it. Even with the addition of things like shale over the past couple of years. On that note, it looks like it's a pretty good deal. Everybody may be balking at the price today, saying, "You guys paid a 50% market premium for this; why are you spending so much?"
Let's keep this in context here. We're looking at an extremely down market. If you compare this to last year, that would basically be Schlumberger buying Cameron at a 10% discount.
O'Reilly: Yeah. It was funny to me because Cameron didn't want to give away the house. They didn't want to just give it away. They were obviously in a down market. Were there any significant cost savings that were noted in this deal?
Muckerman: I think it was $300 million in the first year after they close and then $600 million in the second year.
O'Reilly: So that alone is a pretty good reason to do this.
Muckerman: You would imagine so. As Tyler mentioned, they have worked together in the past, so they're just bringing a partner in-house and eliminating some of the costs there. It's a long-term play. Cameron is an offshore company, and of the service companies that are diversified, Schlumberger is one of the more offshore-focused when you look at Halliburton and Baker Hughes. That deal between Halliburton and Baker Hughes amplifies their onshore capabilities, whereas this amplifies Schlumberger's offshore capabilities.
It's definitely a long-term play. Cameron shareholders are happy today. Any traders, or short-term-minded folks, in Schlumberger probably aren't too excited about this because, other than cost savings, it's probably going to be 2017 or 2018 before this deal's full potential is totally reached.
Crowe: In the short term, there might be a bit of share dilution here because Cameron will be getting 10% of an ownership of the new company.
Muckerman: I think this is 70% or 75% funded through equity.
O'Reilly: Speaking more broadly, oil prices have obviously fallen 60%, and when this whole slide started, everyone thought that the big majors were going to have a bunch of mergers. You had Noble Energy buying Rosetta, and you have a few of the smaller ones.
Crowe: The Shell acquisition for $70 billion.
O'Reilly: Right. Were you guys expecting more acquisitions and mergers in the interest of cost-cutting?
Muckerman: I don't know that I had any expectations, but I definitely wouldn't have been surprised had there been more, even if there are more on the horizon. That's simply because you're looking for flexibility and scale at a time like this. We've been saying that for a while now. Even in a strong market you're looking for flexibility and scale as an investor.
I wouldn't be surprised to see a few more of these big players -- and it's going to take a big player in a time like this because a lot of companies are cash-strapped.
Crowe: I'm going to speculate a bit with this when I say it -- and please don't take my word as gospel -- I think one thing that could really emerge in terms of mergers is in October banks are going to do a reassessment of the credit lines for a lot of companies in this space.
O'Reilly: That's determined by PV-10, which is very dependent on oil prices.
Crowe: It's basically how much companies are worth based on their assets and how much it can get financed. Come October, there could be a lot of banks that are looking at some of these more leveraged oil and gas companies and saying they can't fund them like they've been funding them in the past and the risk profile is too high.
When we get to that point, I think there's a possibility where some of the companies that are in a better financial position can use that opportunity with a company that is currently in more of a financially strapped position. They'll need to find a way to fund themselves and that could spur a bit more of that merger and acquisition activity. Financing has been pretty accessible throughout this entire downturn so far.
O'Reilly: Even in the last six months.
Crowe: If the purse strings of the banks start to tighten up a bit, we could see more activity in terms of merger and acquisition.
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For our second segment here, we're talking about whether or not shale drilling is really resilient or if companies have not learned their lesson yet. U.S. companies appear to be continuing to pump oil. They claim they're cutting capex, but we really haven't seen a rollover in U.S. production. What's going on here?
Muckerman: You started to see it. Not necessarily from the shale producers, but June or July was the peak production this year, although you're seeing expectations for it to tail off a bit next year. Shale producers continue to pump. A lot of them are finding better cost efficiencies, so they're able to continue pumping.
O'Reilly: Is that because their backs are up against the wall?
Muckerman: There are a few companies that have gone out and said they were pulling back because they think they could make more money in the future if they don't spend a lot of money now. I think it's the smaller companies that don't have the balance sheets where they have to generate cash flow to pay off the debt. As Tyler mentioned, there are a lot of cash-strapped companies that have interest coming due.
They're drilling to drill and keep the lights on, in a lot of cases. That's not necessarily because they would go bankrupt if things were worse, but they need things to turn around in order to make profits. They can break even right now, and a lot of companies have to break even. Otherwise, they're going to start selling their equipment off at auctions.
O'Reilly: What do you think, Tyler?
Crowe: I think a lot of this discussion is on companies that are still pumping at today's prices. It's a short-term emergency thing, but on the long-term view of this, something that looks really interesting is how rapidly the breakeven price for shale has dropped in recent years. We were talking last year this time, possibly even earlier, about the most resilient shale places in the United States being breakeven at the $80 to $90 range.
Today, we're talking about certain places in the prime acreage of the Eagle Ford or in the Permian Basin, where we're at $50, maybe even a bit below that. To see that kind of cost savings is a bit like punishment to what oil prices have done to shale drillers, and has almost been the medicine that they needed. This was a wakeup call that they needed to get better at what they do.
Looking at this long term, I think this is actually a great thing for the entire industry, because for a while there, the thought was that shale would be the marginal cost producer. Basically, some of the most expensive barrels of oil out there -- as the demand started to wane, or there was a low supply -- these would be the first things to get cut.
However, if we start to get breakeven prices for shale that low, it changes that dynamic a bit, and we have to rethink the dynamics of the oil market long term.
O'Reilly: Even the strong players like EOG (NYSE:EOG) -- which hasn't been beaten up like some of the larger players -- had that slide in an investor presentation a couple months ago where they're making just as much money at $65 in oil now that they were in 2012 at $95. That's kind of crazy when you think about it.
Muckerman: That's why they've come out and said they're cutting capex by a couple hundred million. They can wait another year or two to continue drilling where they were in 2014, because the longer-term returns will be there and they can sacrifice a bit in the next year or so. That's pretty Foolish, if you ask me.
When Tyler talks about "beneficial to the entire industry," I am a little nervous when you talk about Schlumberger and Cameron, if shale oil efficiency can translate around the globe.
O'Reilly: Then they don't need them.
Muckerman: And you push offshore oil out even a few more years. I'm personally invested in Ensco, so I don't want to see that, but I could see that happening, and offshore could struggle for much longer than the rest of the industry. You look at Argentina, China, and Canada -- who hasn't tapped a lot of their shale -- there are a few other countries that have as much, or more than we do. If they can tap into that, then offshore could be in trouble.
Granted, they don't have the pipelines that we do, they don't have the political system we do, and a lot of the companies don't have the money that the companies in the U.S. do. It could be a long way off. Maybe you'll see some flip-flopping between U.S. shale, offshore, international shale, offshore; they just trade places. Long term, there's going to be some countries around the world that tap into what we've been utilizing.
Crowe: If you actually look at some of the rig companies as of late, they almost seem to be preparing for the fact that they're becoming a bit more of the marginal-cost barrel producers. As we've seen at Transocean (NYSE:RIG) in the past couple quarters, they've scrapped about 15 of their older rigs, saying that they're not going to find work for those anymore, so they're getting them off their balance sheets and not paying the operational costs for them. They even said on their most recent management call that they're looking at scrapping another 15 of them because of that.
O'Reilly: How big is their fleet?
Muckerman: They're the biggest by a long run.
Crowe: They're the biggest fleet of publicly traded rig companies. Also, Seadrill (NYSE:SDRL) just reported this morning and they mentioned they're deferring delivery of at least 10 of theirs.
O'Reilly: They have one of the youngest fleets, as I recall.
Crowe: Yes. They also have a lot coming online.
Muckerman: They have a huge backlog of work.
Crowe: With so many that they don't expect to have work, they've negotiated for at least 10 of them right now to be delayed deliveries instead of at the end of this year. At least, two more years out for some of them. That mantra of "lower for longer" appears to be hitting the offshore a bit harder than some of the shale companies.
Muckerman: Much to Carl Icahn's chagrin, Transocean just cut their dividends completely. They either suspended it or cut it.
O'Reilly: Was that you that made that tweet yesterday?
Muckerman: Yeah. He pushed them so hard for months to start a dividend and then they started it and then he said it wasn't high enough; he wanted more. Then they bumped it up a bit, shareholders were wise enough not to give him everything he wanted, but now he's getting zilch again.
Crowe: At the same time, they have a couple seats on the board, but if you want to look at someone who's a bit more of a conservative allocator and planning for this stuff, their chairman, Pete Miller, was a former CEO of National Oilwell Varco (NYSE:NOV). Their CEO is Jeremy Thigpen, who was the former CFO over at National Oilwell Varco.
Muckerman: Changing of the guard.
Crowe: They basically took all of National Oilwell Varco.
O'Reilly: They all get together and smoke cigars together.
Muckerman: National Oilwell Varco's enhanced, 3D boardroom.
O'Reilly: Oh, my! Does that mean they have holograms like in Star Wars?
Muckerman: Yes. That's absolutely what it means.
Crowe: I think they took that more conservative, capital approach. You look at someone like National Oilwell Varco and they've always got tons of cash on the balance sheet that gives them that cushion to work with. Right now, Transocean has $3 billion just sitting there waiting in case anything happens. It almost seems like a testament of that National Oilwell Varco mantra hitting Transocean, versus getting pushed around by Carl Icahn.
O'Reilly: Before we go, oil just recently touched below $40 a barrel and now I think it's rallying 5%.
Muckerman: Rally, drop.
O'Reilly: Up, down, up, down.
Muckerman: On island, off island; I can't follow it. It's like the show Lost.
O'Reilly: Any stocks on your radars before we go?
Muckerman: You mentioned EOG. I don't own any producers, but if I had to, if you put a gun to my head, I would say EOG.
O'Reilly: Motion seconded. I wrote an article about them three or four months ago. They are really good at what they do.
Muckerman: He talked about the returns of 2012 versus this year. They say that they're still making 45% after tax returns at some of the Eagle Ford basins with oil at $50 a barrel. Still cranking it out and they're prudent, so I appreciate that. With oil where it is, you want the stable, technologically advanced producers that have been doing it for a long time. You could get risky if oil starts to truly rebound, not just a couple bucks north of $40.
O'Reilly: Right. What about you, Tyler?
Crowe: One that's been interesting to me as of late -- not because it's something new or something fancy -- Chevron (NYSE:CVX). That's because it's so cheap right now. Over the past year, shares of Chevron have dropped about 40%, and right now, because of the recent drop, the company is actually trading for less than its tangible book value.
O'Reilly: Did that even happen in 2009?
Crowe: This is the first time in 20 years. In the past 20 years, all the data that I had access to and looked at over that time frame; the company has never traded below 1.3 times, 1.4 times its tangible book. Today, it's below that.
Muckerman: That's compelling.
O'Reilly: Wasn't Chevron the oil major that Buffett was in and then he threw in the towel?
Crowe: No. That was ExxonMobil.
Muckerman: And ConocoPhillips.
O'Reilly: That doesn't count.
Crowe: Yeah. He picked everyone but Chevron. I think a lot of people may be unjustly hard on the company right now because it's spending so much money on two very large projects: Gorgon and Wheatstone LNG projects.
O'Reilly: Once those get going, they'll get a lot of low-cost oil.
Crowe: Once those things come online by the end of 2016, you're going to have much more flexibility in the capital budget. That's taking up about $8 billion a year in spending.
Muckerman: And it's constantly running over.
Crowe: It's running over right now, but once it's actually online, you've got that swap where they're not spending $8 billion and these assets will actually be generating cash. You're going to have an $8 [billion] to $9 billion swing in capital expenditures and cash flow gap that will turn it around and help to really fund that dividend.
If you're looking at a company of that size, that has that resiliency of the downstream that can help it get through the downtimes like it has been as of late, and with these projects coming online, it's really compelling to me to see a company trading that low. Especially with a dividend yield in the 6% range right now. It's very compelling.
O'Reilly: Cool. Thanks, guys. I'll see you next Thursday. Same bat time, same bat channel.
Muckerman: That will never get old.
O'Reilly: If you are a loyal listener and have questions or comments, we would love to hear from you. Just email us at IndustryFocus@Fool.com. Again, that's IndustryFocus@Fool.com. 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 Tyler Crowe and Taylor Muckerman, I'm Sean O'Reilly. Thanks for listening, and Fool on!