The Consolidation Of U.S. Shale

1. Demand stalls on COVID resurgence

- “We think that the oil market would mount a significant rally if the flow of global demand data was strong,” Standard Chartered wrote in a note. “However, there is no fuel for any such rally currently; demand recovery has disappointed, and in some regions prospects are worsening.”

- The investment bank estimates that global oil demand in August stood at 90.39 mb/d, down 592,000 bpd from a month earlier. Demand was down 11.58 mb/d year-on-year, worse than July’s figure of down 10.61 mb/d from a year earlier.

- Looking forward, top analysts at the IEA and U.S. EIA see demand improving in the fourth quarter to down just 5mb/d from a year earlier. “We think those views may prove optimistic,” Standard Chartered wrote. “[I]t seems unlikely that the y/y gap will more than halve in the face of tighter restrictions, and in some cases a return to full lockdown.”

- The bank sees fourth-quarter demand down 7.7 mb/d from the same period in 2019.

2. Copper market in deficit

- The copper market faces a slight deficit of 52,000 tons in 2020, versus a previous estimate of a surplus of around 281,000 tons

- “The deficit is to be generated chiefly by robust apparent Chinese copper demand, as reflected so far in very high imports,” Commerzbank wrote in a note. China’s surge in demand will offset the demand hit to “all other regions,” the bank added. On net, global demand remains mostly unchanged from a year earlier.

- At the same time, mining production will slump by 1.5 percent this year.

- Next year, the balance flips to a surplus of 70,000 tons as supply recovers.

3. Refining margins depressed amid oversupply

- Refined product inventories spiked this year because of the glut, and will take time to work off. Refining margins “remain near zero across most regions even as refinery utilization rates remain ~10% below year ago levels,” Bank of America Merrill Lynch wrote in a note.

- Despite the slump, new refinery capacity is in the works. An estimated 6 mb/d of greenfield refinery projects are starting up between 2021 and 2023.

- The investment bank sees oil demand rebounded in 2021, with gasoline demand up 5 mb/d from 2020. But jet fuel demand lags behind. “In aggregate, oil demand could take 2-3 years to reach pre-Covid levels, but this will be heavily dependent on when a vaccine is readily available,” Bank of America said.

- The bank sees refining capacity rising by 2.1 mb/d in 2021 even as oil demand struggles to get back to 2019 levels. “During 2022-23, refining sector is set to grow at an above average pace, adding nearly 4.5mn b/d of net capacity, which should ensure that the refined product markets remain cut-throat and force another wave of refinery closures,” Bank of America wrote.

4. Shale consolidation begins

- A series of high-profile M&A deals signal increased momentum towards consolidation in the shale industry is underway. Chevron (NYSE: CVX) previously bought Noble Energy for $5 billion.

- This week, ConocoPhillips (NYSE: COP) announced its plans to buy Concho Resources (NYSE: CXO) in a $9.7 billion deal, and Pioneer Natural Resources (NYSE: PXD) is buying Parsley Energy (NYSE: PE) for $4.5 billion.

- The deals will consolidate shale acreage in a handful of much larger companies – EOG Resources (NYSE: EOG), Occidental (NYSE: OXY), ExxonMobil (NYSE: XOM), plus the larger ConocoPhillips, Chevron and Pioneer.

- “There’s only going to be three or four independents that are investable by shareholders,” Pioneer Chief Executive Officer Scott Sheffield said on a conference call with analysts.

5. Energy debt gets cheap

- Investors bailed on the energy sector earlier this year, but thanks to a steadier oil market, and firepower from the Federal Reserve, energy debt is cheap again.

- Investment grade energy debt is cheaper than at any point since before the last crash in 2015, Bloomberg notes.

- But junk debt is seeing much higher yields. The gap between the two will widen the gulf between the strong and the weak.

- This backdrop, and the latest in the M&A deals, further illustrates the shift towards consolidation. Far from killing the shale industry, the large companies growing larger will be able to cut costs and lower breakevens.

- At the other end of the market bust will be fewer companies, but the survivors will be stronger and healthier.

6. Tesla riding high

- Tesla (NASDAQ: TSLA) reported its fifth consecutive quarterly profit. The company earned $331 million in the third quarter, and delivered a record number of vehicles.

- “Tesla continues to put the red ink in the rear view mirror,” Wedbush Securities said.

- However, Tesla earned $397 million in the third quarter from selling emissions credits to other automakers, without which Tesla would not have been in the black.

- With a market cap of $393 billion, Tesla is the world’s most valuable carmaker and is now worth more than two and a half times that of ExxonMobil (NYSE: XOM).

7. U.S. ethane exports set to jump next year

- Natural gas prices have climbed in recent weeks on the back of colder weather in the Northern Hemisphere, with Henry Hub back at $3/MMBtu for the first time since early 2019.

- The market for LNG has also tightened due to some outages in the U.S., Europe, and Australia.

- But while tighter gas markets are positive for drillers, they create headaches for petrochemical producers, increasing costs.

- U.S. ethane exports and consumption are both set to surge next year, with new capacity scheduled to come online. Ethane crackers with capacity of 180,000 bpd came online in 2020, and another 160,000 bpd will start-up in 2021.

- “Hence, both, natural gas and ethane prices, have to be relatively high to incentivize drilling of dedicated natural gas wells on the one side (break-even prices are in the high $1/mmBtu to low $2/mmBtu range) and sufficient recovery out of the gas stream on the other side,” JBC Energy wrote in a note.

- Ethane, thus, faces questions of competitiveness in the medium- and long-term.