September 2023 – Commentary from Dan Pickering

September was marked by continued rising interest rates, weak equity markets and rallying crude.

Chipping away – September 2023 saw Diversified Energy (S&P 1500 Energy, S15ENRS) gain +2.4% with subsector performance as follows - Midstream +3.2% (AMZ), Oilfield Services +1.3% (OIH), Upstream/E&P - flat (XOP) and Clean Energy -9.1% (ICLN). Energy drubbed the broader markets (S&P500 -4.8%, Nasdaq Composite -5.8%). The YTD gap remains wide but has improved (+6.6% vs. +13.1% S&P500 and +27.1% Nasdaq). WTI oil moved up strongly to ~$90.80/bbl (+8.6%) and natural gas gained +5.8% (~$2.90/mcf). (1)

September was marked by continued rising interest rates, weak equity markets and rallying crude. Following the early September announcement that Russia and Saudi were extending production cuts through year end 2023, WTI topped out at ~$93.70/bbl on September 27th and closed the month at almost $91/bbl. In the stock market, energy equities were the clear winner, gaining while the broad indices turfed. Investors soaked up more than $8B of energy equity via 15+ offerings with sellers ranging from E&Ps financing acquisitions (Civitas, Vital Energy, SilverBow) and private equity selling shares received from portfolio company exits (NGP reducing EQT position) to midstream companies funding asset purchases (Enbridge). The green shoots are growing a bit.

But forget September, October has started with significant tumult.

Oil selloff:

  • From the low $90’s in late September, oil fell to the low $80’s in early October, including an air-gap day on October 4th (WTI down almost -6%). The market spent a lot of brainpower trying to decipher the move. Was it economic fears associated with higher interest rates? Was it the fact that OPEC+ merely confirmed its prior cuts in the early October meeting rather than making incremental cuts? Was it the EIA report showing a decline in US gasoline consumption? Was it something else? We put the downdraft into the category of risk-off and profit-taking. Oil had a spectacular Q3 - rising ~30% while the S&P500 fell ~4%. Oil rose while other economically sensitive commodities like copper were falling. Oil pulled in financial traders from underinvested postures to market/overweight exposure. As macro conditions deteriorated in early October, we believe oil just took a breather. No need to panic. No major change in the fundamental outlook. Just a breather.

Violence in Israel:

  • Note – we try to bring an apolitical approach to analyzing energy markets.  This means looking at any given situation through the lens of what is/could/will happen, not through the lens of right/wrong.  This may make our commentary seem cold, but hopefully it increases the odds of being right.
  • The Hamas invasion of Israel makes global oil markets incrementally more complicated.  Israel and Gaza on their own are basically irrelevant to global oil supply and demand. However, conflict in the Middle East is very relevant to the oil supply equation.  The Wall Street Journal has reported that Iran backed the Hamas action. What now?  Will Iran use other proxies to escalate the Israel conflict?  Will Israel retaliate against Iran?  Will Israeli allies tighten up oil-related Iranian sanctions?  Will Iran move to restrict oil tanker traffic in the Straits of Hormuz?  Will Iran lash out at Saudi Arabia (they’ve done it as recently as 2019)?  Will Saudi Arabia maintain production cuts or increase oil supply to offset any conflict-related deficits?
  • On the first trading day after hostilities broke out, October 9th, spot WTI oil prices bounced +4% to $86/bbl.  A big move, but not a massive move (and still ~8% below recent highs).  Longer-dated crude also increased +2-3%, but the market certainly hasn’t discounted major Middle East disruptions.
  • Like everyone, we are in wait-and-see mode.  The odds of an upside price spike have increased.  Our bullish view on oil would be supported by a Middle East escalation but is certainly not dependent upon it.  As we said prior to the recent violence, we’re more likely a seller than a buyer of $100/bbl crude on nervousness around demand sensitivity.

The Exxon/Pioneer combination:

  • Friday October 6th press reports of a possible Exxon/Pioneer merger brought a sense of déjà vu. The deal was rumored in April 2023, but didn’t materialize. The current go-round of the story felt more real. The Wall Street Journal writeup seemed more specific and the investor reaction was more aggressive (+10% October one-day move vs. +6% April one-day move). Everything sniffed like the deal was going to happen. And yet there was no Merger Monday announcement. Instead, it was Merger Wednesday with an all-stock transaction representing an approximately +18% premium for Pioneer.
  • Exxon and Pioneer fit well. Exxon is the biggest global oil player not named Aramco. Pioneer is the biggest pure play Permian producer. The Permian is a core operating area for Exxon. Exxon paid a premium and the deal is still accretive. Synergies are significant. Inventory additions are meaningful. Valuation is not outrageous (and may look cheap down the road as the cycle plays out). It all makes sense.
  • Competing offer? Very unlikely as any other buyer has had many months to come forward with their best deal.
  • Problems getting through the FTC/Justice Department? Unlikely. There will be mucho political squawking, but it is very hard to call the deal uncompetitive when PXD has no downstream/gas station exposure, and the combined companies represent a small portion of global and US production. While they will be a big player in the Permian, they still only represent ~15% of the basin’s production. They run only a small fraction of US rigs, so no OFS issue. They don’t control any meaningful percentage of Permian ingress/egress on the Midstream side.
  • Interestingly, this combination brings Exxon’s short-cycle production to ~40% of its global total. CEO Darren Woods indicated this gives the company resiliency in a commodity price downcycle. Shale spending can be halted within months, if necessary, rather than having most of capital spending committed to long cycle projects where it is virtually impossible to turn off the capex spigot even if oil prices crash. Most of the public E&Ps wouldn’t be able to cut shale-related spending aggressively because production would crater and investors would freak out. However, a company like Exxon with a global portfolio of long-duration and short-duration assets could scale back opportunistically without dramatic production profile impacts. Interesting optionality.
  • It remains to be seen if the behemoth Exxon organization can quickly brake when conditions change. However, it does appear with this deal that the corporate organization can get more aggressive when the conditions warrant. With the Pioneer announcement, Exxon raised the combined company’s 2027 Permian production forecast. Essentially going faster/harder given the current strong oil price environment. If this is more than just lip service to politicians, it puts Exxon in the ranks of the fastest growing Permian players at +11%/year through 2027.
  • Investors gave an initial raspberry to the deal, with Exxon stock trading down ~4% on the day of announcement. PEP’s institutional investor conversations indicated many didn’t believe Exxon’s $2B/year synergy targets, while others were unimpressed with the +18% premium received as a Pioneer shareholder. Finally, some questioned Exxon’s deal history/timing, with the 2009 XTO acquisition as their proof point. This seems too harsh from our perspective, but there are always proponents and detractors any time a big deal hits the market.
  • Bottom line – we believe this Exxon + Pioneer deal is going to look more interesting to the market over time as Exxon plugs Pioneer into its machine and goes to work. Exxon paid 6x 2024 cash flow and made the company better. That's a win in almost any industry.

Industry implications of Exxon/Pioneer – the consolidation train rolls forward: More, more and potentially faster.

  • Consolidation has already been active as we have discussed on a monthly basis for the past year. Recent public company mergers include: Permian Resources/Earthstone, Chevron/PDC Energy, Exxon/Denbury, ONEOK/Magellan, Patterson Energy/NexTier. In addition to public-to-public mergers, upstream players have been gobbling up billion-dollar private equity assets like candy. Buyers have included Devon Energy, Civitas, Diamondback Energy, Vital Energy, Earthstone and Ovintiv.
  • Now we have a mega-deal. The biggest oil major just did a $60B deal. The biggest stand-alone company in the Permian is now gone. We’ve seen this movie before back in the late 1990s. FOMO kicks in. In today’s oil patch that is particularly true given the growing scarcity of sizeable in-basin players, especially in the coveted Permian Basin. Anyone thinking about buying Permian assets over the next few years now has to accelerate their timetable. Companies like Chevron and Conoco seem logical continued acquirors, while companies like Diamondback, Devon and even Oxy could be both predator or prey.
  • Exciting times are ahead!

Reading the current tea leaves, even oil at $80+ and a meaningful deal like Exxon/Pioneer isn’t really creating a sustained buzz around the energy sector.  Bullish investors remain bullish, but fence sitters and bears don’t seem to be converting.  Crude oil volatility, spare OPEC capacity, economic/demand fears and geopolitical uncertainty are all overhangs.  Overhangs we expect to be resolved while still allowing $80/bbl WTI through 2027, but overhangs nonetheless.  Our confidence in cycle duration keeps us calm during volatility, allowing us to buy during downticks and stubbornly hold during rallies.  The market will eventually arrive at a similar spot.    
Please remember the PEP organization is standing by to help – whether it be investment exposure, capital needs, energy market intelligence or help with a specific problem. As always, we appreciate your interest and welcome your questions. 
(1)    Source: Bloomberg