Higher for longer rates is paired with global cuts in production? Russia pledged last month to curtail oil production as OPEC+ elects to maintain voluntary cuts. Russia’s production is expected to be 9MMbbl/d through the month of June, which may support higher oil prices. This should somewhat offset the strength seen in domestic US production, which has sustainably remained above 13MMbbl/d since mid-October 2023.
Though I’d like to see some production pulled out to support higher oil prices, it is prevalent that domestic producers are sticking to their plan of 2-5% production growth for eFY24. From what I have gathered, IOCs are focusing efforts in offshore/deepwater production to take advantage of the long-cycle, low-carbon emitting production. This should ideally drive up dayrates for companies followed, including Noble Corp. (NYSE: NE) and Transocean (NYSE: RIG). Per Transocean’s recent press release, ultra-deepwater drillship utilization has surpassed 90%, which should push dayrates above the current $432k average.
Pureplay shale producers are focusing on managing their inventory, rightsizing their assets, and strategically buying/selling acreage to better cluster assets. Producers are also focusing less on drilling & completion and more on well optimization. For example, Devon Energy (NYSE: DVN) is working with refrack spacing across their Eagle Ford assets to squeeze every drop out of those wellheads. Oxy (NYSE: OXY) is pushing to create a full carbon capture loop in which the firm will utilize carbon captured in their direct air capture facility by injecting the carbon into their producing wells, dubbed their Enhanced Oil Recovery program.
The industry has benefited from improved OFS by drilling longer laterals. All of these programs have benefited the industry tremendously in that producers are able to extend out the decline curve, drill less, and lease fewer drill rigs. OFS companies like Baker Hughes (NASDAQ: BKR) and Schlumberger (NYSE: SLB) are each experiencing this phenomenon in a different way. Schlumberger more or less doesn’t focus efforts in domestic production as much as digital technology and offshore/deepwater. Baker Hughes, on the other hand, remains a dominant player in domestic drilling and will experience more pain from fewer rigs deployed.
Macroeconomics
ISM released their final PMI figures for the month of March which look promising. The Manufacturing PMI settled at 50.3% while services came in at 52.6%.
Manufacturing PMI
- Backlogs contracting
- Employment contracting
- Raw materials inventories contracting w/ low customer inventories
- Production growing
- Faster supplier deliveries
From my perspective, this reads that companies are undergoing a destocking phase in the cycle and are getting back to just-in-time manufacturing. This isn’t necessarily a bad thing given that lower inventories result in lower carry costs. This may not necessarily be a recessionary indicator for rightsizing inventories for lower demand; but rather, I view this as a positive as manufacturers experience fewer supply chain constraints and have the ability to better source materials.
The rationale could also lean towards the hope for lower commodity prices going forward. In a normal economy, I’d argue for this last point; however, producers have gotten smart. Micro-adjustments are being made in production all across the board to better match supply to demand. As our favorite CEO, Lourenco Goncalves of Cleveland Cliffs (NYSE: CLF) has pitched numerous times, he is willing to turn off a furnace if prices do not support production. I haven’t seen any other commodities producers rush to the mines or smelters to go against this new way of thinking, so I wouldn’t hold my breath on drastic price swings on the commodities front. Using the Bloomberg Commodities Index, BCOM, as a proxy, commodity prices don’t appear to be waning in aggregate.
Using the producers price index, PPI, as a second example, costs remain relatively elevated and will continue to pressure economic activity from materials all the way down to consumer spending habits. The blue line depicts PPI and the orange, CPI.
I do not believe costs will be coming down anytime soon. The rate of change may fluctuate here and there; however, I do believe pricing pressure will only continue to worsen as domestic policy creates further impediments for cheap materials and labor. As described in last week’s report covering Ramaco (NASDAQ: METC), the US and China trade war will create significant pricing pressures on rare earth elements that are commonly found in electronics, electric vehicles, and aerospace & defense. As a consumer, higher prices are definitely being felt on the wallet. As an investor, this is a rare opportunity to selectively invest in companies that have the highest potential to benefit from these pricing pressures.
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