Fueling Growth: Energy Market Trends and Opportunities in 2023

Most of the oil and gas companies have seen strong earnings. They've had pretty good free cash flows, which as you know, that's what the investors are looking for, free cash flow to basically pay out in terms of dividends, share buybacks, those types of things. On the demand side, actually, global energy demand is supposed to go up. I mean, the demand for oil globally for this year is supposed to average about 102 million barrels a day. That would be a new record for global oil consumption. So I think there's been some very, very bright spots this year thus far.

Richard Stepler:Yeah, thanks, Tom. It's interesting to see how far we've come over the last couple years and some of the challenges. What are some of the greatest opportunities you see for oil and gas companies as we move into the second half of the year?

Tom Seng:I think there's kind of several things going on. I think one of the benefits that came out of the Inflation Reduction Act was that the federal government, now, they've been mandated that they have to make lease sales, lease sales on federal properties in Alaska, Gulf of Mexico, places like New Mexico, where the BLM has the right to offer leases there, some of those have been held up prior. I'm a big proponent of hedging, and I think to the extent that oil prices are staying above 70, I think there's opportunities there for companies. I mean, if you look back just four weeks ago, we were at about 82, $83, and that was mostly on that decision by the OPEC plus group to cut back production by 1.6 million barrels a day.

I think some folks get caught up, it's like, "Wow, we're at 82, 83, we're going to 100." Obviously, that did not happen. I mean, this morning we're sitting around 72. So again, like I said, I'm a big proponent of that. I mean, to me, that's always a business decision, but we do know that above 70, that's a fairly healthy margin. Companies know their lifting costs, they know what type of profit they'd like to achieve per barrel. A lot of them convert that to an EPS. So to me, I've always been, lock in some portion of your production at numbers that make sense for you. If it goes to a 100, good for you, but as we just saw recently, it's dropped $10 within a four-week period.

I think some of the things too is there have been, the costs of operations have come down, lower costs for supplies for oil field service companies. And then one other area that I truly think is an opportunity, and that's the idea of the carbon capture and sequestration. I think as the industry starts to look at that, especially in field operations, essentially we are literally cleaning up our act if we can basically capture the carbon emissions and reduce methane emissions, and I think that's a positive thing for the industry.

Richard Stepler:How about natural gas, Tom, you talked a lot about oil there, and we've seen a pretty significant drop in natural gas over the last six months?

Tom Seng:Yeah, Richard, that's been absolutely surprising. You go back just to December, and I realize that was about five months ago, but we were at $7 on the New York Mercantile Exchange for Henry Hub Natural Gas. We've just continued to produce it. One of the things that a lot of times gets missed is every oil well has natural gas, and so something has to be done with that, and obviously the states have clamped down on things just like flaring the natural gas. And so lacking the midstream infrastructure, there is a lot of flaring that has gone on, but a big part of it has been the associated natural gas that's coming out of the ground along with oil, and then you have prolific basins like the Marcellus, Utica. I mean, Haynesville picked up again over the past 12 months, which it's a dry play, the Fayetteville's dry, the Barnett is dry.

But because of the LNG exportation and the geographic proximity to the outlet points in the Gulf, those three basins have pretty much been benefiting. But you're right, we had a mild winter. I mean, we have a surplus in storage right now that we shouldn't have for this time of year normally, I mean, we're over 20% above the five-year average, and it's only May, and we have technically a few more months to go. So it has been a very dramatic shift in the supply demand dynamic that we just saw back in December.

Richard Stepler:Right. You mentioned natural gas going up to $7. I think when we saw that there was quite a bit M&A activity in the industry as a result. Now we see where prices have come, do you see a shift in investment activity from companies and investors alike?

Tom Seng:I think so, Richard, I think we see that there's sort of this dichotomy that happens. On the one hand, as we talked about, a lot of these companies, they've been generating free cash flow, obviously, in addition to paying out dividends or share repurchases, they can look at acquisitions, and I think some of that was driven by cash flow positions. I mean, when you look at Exxon talking about buying Pioneer, when was the last time Exxon got in the acquisition mode in terms of onshore producing properties? So that was a bit surprising.

But to your point, the thing that we might see now, Richard, are the bargain hunters? When you're talking about $2 and 20 cents, Henry Hub, Louisiana, there'll be companies out there looking at potentially distressed properties or companies that are saying, "All right, fine. This is the time to buy some properties because the prices are depressed." So it kind of goes from one extreme to the other, cash rich companies saying, "Yep, let's spend some of that on acquisitions," to, "Hey, guess what? There's opportunities here with these lower price natural gas. Those reserves get valued a bit lower, and yeah, we might see more of that activity." Of course, the downside, Richard, is, as you know, at lower prices, you might have some companies that are pure natural gas play companies, and financially they may find themselves in a situation where they have to sell.

Richard Stepler:Right. Yeah, that makes sense, Tom. So we've talked a little bit about some of the opportunities in hedging and margin expansion as costs have come down. On the other side of that, what are some of the biggest challenges you think that companies need to be prepared for in the second half of the year?

Tom Seng:I think there's a lot. I mean, obviously we're seeing a headwind in terms of inflation, mainly because then when the Fed wants to curb inflation, their targets 2%. We came in at five and a half percent for last month. Obviously, that raising of rates impacts the cost of capital for these companies. We had a global energy symposium here at TCU a couple of weeks ago, and a lot of the experts were talking about that they believe that sources of capital are going to become somewhat tight for EMP companies, and then the EMP companies have this decision, basically, how do you put together a strong CapEx budget to maintain or at least maintain your production level, let alone increase it, while maintaining free cash flow to satisfy the investors? So you kind of have that dichotomy going on.

But then also, and this was sort of under occurring theme, was everyone's running into permit challenges. Yeah, we want to do carbon capture and sequestration, carbon capture utilization and storage, but this permitting process is still dragging along at the federal level, permits for new pipelines that we're going to have to have, dragging along. So kind of this idea that some of it has to happen, somebody has to give in terms of accelerating the permit process to get most of these things done.

Richard Stepler:That makes sense, Tom, thanks for your perspective there. Let's transition the discussion and let's talk about the energy transition. We hear a lot about the energy transition, and I know you spend time covering that topic. What's the status of the energy transition as we view it today, Tom?

Tom Seng:Yeah, it's interesting. It's kind of like if you went back a year ago, Richard, sort of like a shotgun blast, everybody was going to do everything. You heard companies saying, "Well, we're going to have this strategic group now and new energy group, the clean energy group," everybody was going to do hydrogen, and so the dust is starting to settle. Carbon capture sequestration, there are tax incentives under the 45Q Bill, and then those have been boosted by the Inflation Reduction Act. In fact, I would point to last August as a point at which this whole process has been accelerated because of the incentives that are in that package. Prior to last August, I mean, let's face it, three years ago, transition was transition away from fossil fuels.

That's what we're being told, that was based on the agreements at the UN Climate Conference, but we've realized it's not a transition away from fossil fuels. It is one that includes fossil fuels, but we have these other sources that we're going to be adding, and I would hope that generally everyone's aware now it's D, it's all of the above. So carbon capture sequestration is going to take off because of the incentives. Carbon capture utilization in storage, there's a lot of things going on there. You're going to see increased wind and solar, geothermal, again, because there are incentives involved, but we know without those incentives, we wouldn't see that growth. Well, the wind and solar, they're battery dependent, that is not going to succeed because we know those are intermittent energy supplies and without battery, they're going to continue to be a problem for the grid operators. Well, then battery storage brings up a whole new problem that is the critical minerals that we need. Things like lithium and cobalt, and unfortunately right now the world's largest producer of lithium is China.

However, there are a lot of initiatives in the United States. We're looking at mining hard lithium again, there's a project at the Salton Sea in California, which is basically a dry lead, excuse me, lake bed, where they're going to extract lithium from the salt water. There are studies, you think about the hydro fracturing and the disposal water that gets put in disposal well is highly brine water, it's a huge percentage of supersaturated salt water. Well, there's research there, we can extract lithium from that brine. So it's kind of the acceleration is happening, some of these things are going to happen faster than we thought. And hydrogen is an interesting one because in terms of hydrogen as a combustible fuel, let's say as a replacement for methane, for power generation or even household use, that's going to be way down the road. I mean, that's an entire infrastructure revamp.

However, what's making advances is hydrogen use in fuel cells. There's a company called Nikola, they make semi tractor trailers. They have EV tractor trailers, they have LNG tractor trailers. They're now looking at hydrogen fuel cell semi tractor trailer. Right now, you can buy a hydrogen fuel cell car from Hyundai. I honestly don't know where you fill the hydrogen tank up, but these are the things they're going to advance first. The Department of Energy has put out bids, they're looking at establishing four major hydrogen hubs in the United States. There is one project I'm familiar with, it's called HALO, it's hydrogen, Arkansas, Louisiana, Oklahoma. And so those three states and universities from those respective states have put forth a proposal to the DOE. But what they're going to do there is they're going to use fertilizer companies first and foremost.

So fertilizer companies take methane, and right now they use a thermal cracking process to extract the hydrogen from the methane, which they use then to make the ammonia, the fertilizer. So the idea is ramp up their production, separate the hydrogen, and now deliver that hydrogen to basically companies who can use it now. You have companies like Walmart that, believe it or not, they're actually using hydrogen fuel cell forklifts. So the idea would be supply Walmart with this hydrogen that you're getting from these fertilizer companies. So again, it's not hydrogen as a combustible fuel, that's pretty far down the road, but we're seeing these small advances right now in extracting hydrogen and then using it for fuel cell vehicles.

Richard Stepler:Oh, interesting. So you clearly see a very significant impact of hydrogen down the road. Now, you referenced the recent legislation and guidance continues to come out every week it seems, regarding the Inflation Reduction Act and the various clean energy incentives and tax credits that are in there. How has this legislation impact energy so far, Tom, and then going forward, where do you see it having the largest impact on the industry?

Tom Seng:I think first of all, the largest impact, once again, as you read that, is going to be on renewables, I mean, renewables and EVs and everything in that category, which we know, again, without those subsidies, these things would not survive in an open market place. There were some incentives, obviously for the oil and gas industry, as I mentioned earlier, this mandate about leases, tax incentives for things like carbon capture, sequestration, carbon capture utilization, and storage. But I think more than anything, this provided a major impetus for people to start looking at it. In other words, look, let's face it, a lot of entities weren't going to go about this on their own. It's an added cost. Now there's an incentive, but let's face it again, number one, this is deficit spending. We know that. Number two, when you throw that kind of money out there in terms of funding and tax credits, you've got everybody and their brother scrambling to do this.

Okay, well, now in the marketplace, you just raised the cost to do it, because there are so many entities competing. I mean, I think in the long run, if we're willing to live with the deficit spending, in the long run, this is going to be a good thing. It's going to accelerate the process. We're going to find answers, we're going to come up with solid solutions. But yeah, we have to live with the reality of what it really is. It's deficit spending, and it is going to cost the cost of the goods and services to basically perfect these technologies, it's all going to go up.

Richard Stepler:That makes sense. So along these same lines, ESG reporting gets a lot of attention, and investing in ESG has attracted a lot of money in recent years. How do you see companies positioning themselves for the current state and what is to come on on ESG?

Tom Seng:Yeah, I honestly think that this idea of taxing, basically taxing emissions or putting scores on companies based on their ESG, I'm not a big fan. I don't think it's necessarily a fair thing. But if you look at the Inflation Reduction Act, it's kind of like, okay, if we're going to start capturing our emissions, we now have an incentive to do so. But you're right, it's been an interesting evolution. I mean, three years ago, a lot of this, to your point, a lot of shareholders, activists, investors were like, "Look, we want to see that you have formal ESG plans and guidance, and we want to see these put in act." And to your point, there are groups that are just out there looking for companies that have solid ESG guidance and performance, and they invest in those. There were university endowments that said, "Well, we're walking away from fossil fuels and we're going to look at ESG investing."

We're starting to see a little bit of a turn. In fact, I've read recently some of those same investment firms that were saying, "Oh, we're getting out of fossil fuels," all of a sudden they're sort of sneaking back in, I think, for obvious reasons, they realize the profitability. But I still think the key to me really does come down to things like capturing methane emissions, carbon capture sequestration, carbon capture utilization, it literally cleans up the industry. It cleans up our image, it's something that we can point to. Now, we're always going to have problems with building infrastructure. You can't get around that. You've got the not in my backyard people, but if we can get these emissions under control and say, "Look what we're doing." I mean, the United States has been the beneficiary of cheap natural gas over time, that has allowed us to reduce the amount of coal that we use for power generation.

So emissions have come down just sort of naturally through that process. But now we have this opportunity to capture the emissions from the wellhead, all the way through to the delivery points. And then, I mean, additionally, I think there's opportunities there to, as we look at companies that are starting to, okay, you have scope one issues, fine, they're starting to focus on scope two. Scope three is tough to do, that's down the value chain. But you see more and more companies start to do that. And I think some of that's because there's sort of public pressure, but there's definitely investor pressure. So I mean, I'm optimistic about things transforming over the next decade, for sure.

Richard Stepler:Yeah, it'll certainly be interesting to see how the energy transition continues from here, Tom, I appreciate your perspective on that. As we close our conversation here, what would you say is the most important takeaway you think oil and gas organizations should be thinking about right now going into the second half of the year?

Tom Seng:I just think they need to stay on top of these developments. I really do. I think they need to be aware of what we're calling the energy transition or these new technologies and these new additions. One of the things I do like, to be honest with you, is I think when we're talking about all these things, to me, first of all, it's exciting, we haven't had sort of a shift or a change like this, let's just say since hydro fracturing came around, if this is another dynamic shift in the energy industry in the United States, I think it's good. What I love is there's transferrable skills out there. Geothermal's going to take off. Why? Because someone taught them how to basically go down with horizontal drilling and completion and extract more heat from those zones than they were used to doing. So there's a lot of these things that are going to happen.

I mean, carbon capture sequestration, carbon capture utilization storage, that's going to be done by existing oil and gas people, reservoir engineers, geologists, drillers. I mean, all those things are going to happen. So I don't know, I feel very positive that this is good for the oil and gas industry. I mean, may it be at the onset, the mindset is, oh gosh, we're still shifting away. That shift away from fossil fuels is decades down the road. I mean, one of the things I like to do if I'm ever giving a public talk about the industry, is the Energy Information Administration, on their website, they have a pie chart that shows what are the sources of energy consumption in the United States, and they do it every year. And the total consumption of alternative renewable energy is around 14%.

So that's everything. That's wind, solar, hydrogen, biomass, wood pulp, you name it, it's only 14% of what we consume in the United States. And I think the more the people understand the actual energy mix that we use, versus the perception that's out there, they've got to realize fossil fuels are going to be with us for a long time, and to the extent that we can clean up that production of it, I think it's a winner.

Richard Stepler:Makes a lot of sense, Tom. Thanks again for sharing your perspective with our listeners today. That was Tom Seng, Associate Assistant Professor of Professional Practice in Energy at TCU in Fort Worth. Thanks for listening today.