We had a great discussion with Marshall Adkins, Managing Director for Raymond James. Marshall was bullish on the outlook of energy in the next five years. In the near term, he believes we’ve already hit the low and the next few months are not as bad as was previously predicted.
A few key takeaways:
Tom Fish (TF): Okay, well, we’ve got a couple minutes after the hour. I’d like to thank everybody who is making time to be on this call today, and it looks like we’ve got a great turnout. I think we had over 120 registrants, so we’ll see what our attendance is, but I'm Tom Fish, part of our Walker & Dunlop Houston team, along with Tom Melody, Mike Melody, Paul House, and Jonathan Payne, Larry Perez, Braden Doyle, Wes Wallace, John Melody, and Tara Soyal.
It's been about a month or so since we last got together. The real estate capital markets remain constrained in a number of areas. However, we have seen some green shoots, both in pricing and liquidity. A recent successful CBS issuance was a real confidence booster in the market. We're still very active in our Fannie Mae, Freddie Mac and HUD businesses and there's a lot of capital available for the right transactions. A lot of rescue capital has been formed at which you can imagine is rescue capital pricing and we'll see if it gets the opportunity to get deployed and at what price it does get deployed.
We have everyone's phone on mute, and we ask that you stay muted through the presentation. We will have a Q&A after Marshall gives his talk, so if you have a question, please just use the chat feature. Send me your question or you can just send me a message and I'll call on you, at which time you can unmute.
We are really pleased to have Marshall Atkins with us today to give us his perspective on the oil and gas industry. If you're vested in Houston, like it or not, you're invested in the oil and gas business. Houston real estate people get asked all the time, “What's going on in the oil business?” And so, we thought we’d bring in Marshall to give us a far better answer to that question than any of us real estate guys could answer.
Marshall got out of the University of Texas with a petroleum engineering degree, spent 10 years in the oil field service business, and then put on a tie and spent 25 years as the director of energy research for Raymond James. He now heads their energy investment banking practice. So, I think you've got a great perspective on the industry from many viewpoints.
Marshall, we really appreciate you taking the time to visit with us today and it only cost me one nice bottle of tequila. So, maybe you could start us off with a primer on where the energy industry was headed pre-crisis and bring us to present day.
Marshall Adkins (MA): Well, first let's start off with, that's probably the nicest few things you've ever said about me, having known you for 20-something years, so very kind of you in front of everyone else.
Yeah, so I have spent a lot of time obsessing on oil and gas the last 30 years of my life, and obviously we're in unprecedented times right now, with regards to the amount of demand destruction that’s occurred over the past three months. If you go back in history and look at major recessions, major financial upheaval times in the United States, in our lifetime, you know, ‘08, ‘99, oil prices fell below 10; all demand never fell anywhere close to even 2% in any of those disastrous years even back in the early ‘80s. You did string a few years together where demand was negative, but it was, you know, 1-2% per year demand destruction. We're looking at something on the order of 20%ish-type demand destruction in oil in the month of April alone from all the shutdowns. That's just crazy. That's off the charts, and that's what's driven all prices down to a level where producers were forced to shut in. The market was saying, look, we can’t take your crude. There’s no place to put it. You have to shut in your production. And the prices we found out a month ago where that occurs here in the U.S. is, you know, about 10 bucks.
Yeah, the headlines of the day a month ago were, we had negative all prices; that was a training anomaly. The reality is most people locked in their May contracts, which is what we're seeing today, at about $10 a barrel. That's what producers today are getting unless you're in a spot market. And that's what the market needed to see happen. We needed a ton of oil shot in to rebalance the system, and based on the demand numbers that we were seeing a month ago, we were like, “Oh my gosh, we’re going to see $10-15 oil for three months. You’re going to destroy the oil service business in the U.S. by destroying”—I mean, down 75-80% from where we started the year and that will probably last a year to 18 months. The consequence of that reduced U.S. activity is a meaningfully lower level of production in the U.S. in ‘21 and ‘22, so as we ran the numbers out, you know, past 12 to 18 months, we actually were coming up with really, really bullish oil scenarios in late ‘21 and ‘22.
So, in the last month, a bunch has changed. Three things in particular, make me much more bullish on the next three months than I would have been a month or two ago. Number one, I don't think we've seen as much demand destruction as all the headlines have suggested in April and into May. Number two, the recovery and demand is much more robust and much faster than most everyone had modeled a month or two ago. Number three, the cuts out of OPEC Plus have been more substantial than any of us thought. Looking at history, there's a huge portion of OPEC that has never cut, Russia really never cut, so we weren’t expecting a lot out of them. They’re actually seeing cuts there. And so, if I run my models now, it’s way different than a month ago. Let me walk through some specifics.
Of the model month ago where we had ballpark 25 million barrels of demand destruction in April, improving to maybe 20 or 21 of demand destruction in May and improving from there, when we look at the post-mortem of what happened, in the actual numbers to make the equation balance, I think demand was only down 17 or 18 million a day, not the 25 to 35 million a day that consensus out there has been looking for. So that’s a real important point. I just don’t think the demand destruction was as great as we thought. Now, hey, 18 million a day, 18% demand destruction, is off the charts. That’s a huge number, but it’s not nearly as big as 25-30% like everyone was talking about.
The second thing that's happening as we open up the economies around the world is a resurgence of consumption that far exceeds what we thought. China, as an example, who is a couple months ahead of us in the recovery, is already seeing demand for driving-related fuels meaningfully higher year over year, and the reason they’re doing that is—nobody wants to get on mass transit. They don’t want to get on the train or a bus or a subway; they’re all driving their cars, and I think you’re going to see something similar here, but it’s going to be on steroids. When we talk about people going on vacation, it's no longer getting on a Southwest Airlines flight, it’s, “Hey, let’s pack the kids up in the suburban and head to wherever.” And so, I think there’s a reasonable case that as we get into the summer, we actually see even perhaps an increase year-over-year in gasoline consumption, which nobody was talking about two months ago or a month ago.
So that—number one, you haven't had as much demand destruction as we thought; number two, we're recovering faster than we thought. And then you layer in more cuts out of OPEC then we were thinking before, and I get a model now where I was thinking we were going to have to send prices low enough to force U.S. producers to shut in for at least three months, April, May, June. I think we're seeing already the prices for June say, “No, you need to open the taps.” We are drawing inventories down in May, and that wasn’t even in anyone’s vocabulary a month or two ago. And the reason you’re drawing them down again is that your demand is recovering faster, and we’ve taken more crude off the market, then we’ve lost demand due to COVID. So short-term, I think you’re going to see inventory draws as we go through this year.
What’s going to be interesting to see is, as oil prices recover and we’re up huge—we more than doubled from what we averaged four or five weeks ago—as oil prices recover, at what price are we going to start to see activity increase again? You know, we’re celebrating because oil’s up meaningfully, but we’re still at 35 bucks. 35 bucks, nobody’s making money drilling a new well! You’re making money producing a well, so you’re not shut in anymore, and I know a lot of producers now are starting to open up the taps; they’re going to continue to do that as we move into June, and we need that to happen because we’re drawing inventories. So, the market’s working efficiently in that regard. So when I look at how it plays out over the next three or four months, I think the market’s going to need to send a price signal to force U.S. producers to produce more, open up the taps, but not go so high as to where we start drilling more. In fact, I still think we're going to see very depressed levels of oil field activity, certainly through the end of the year, probably into early ‘21. If that happens—if prices stay generally below $45 or $50 through the end of the year, which I think is realistic—then the amount of supply reduction that occurs in ‘21 and ‘22 leads me to believe we are going to be setting up for a situation where oil supply and demand is way under-balanced in late ‘21 and ‘22. And by way under balanced, I'm talking about inventory levels falling to places we've never seen, and oil prices in ‘22 going to triple-digit-type levels.
The problem is getting the bridge to that point. Yes, producers are opening up wells, they're actually making free cash flow, but at 35 bucks, we're not making a lot of money. Your cash flow positive, you're not generating return. So again, I don't expect a big recovery in activity. The consequence of that is a meaningful destruction of U.S. production capacity in ‘21 and into ‘22.
So, what does that mean for us here in Houston? Well, there are three main constituencies that I think about in the energy supply chain: you’ve got your service guys out there drilling it; you got the MP guys funding it; and then you go to the downstream side where you have to move it on pipes and then refine it. On the service side, they're going to be harder to sit by far. I think the service side is still looking at on the realm of a 70-plus percent destruction of activity that probably lasts close to a year from when it started; massive layoffs; there’s no capital available, it is a complete disaster for service companies. And I think that sustains itself through at least the end of the year.
E&Ps, a little bit better. They were hedged, so they were more protected than the service guys, so not as many bankruptcies, but you are going to see strong incentive to see substantial mergers, and the consequence of that there will be layoffs and stuff like that. Midstream, not as bad. You know, I am looking at U.S. production being down on the range of 15% next year, so pipelines, think about it as: their throughput goes down 15%, so they're hit, but that's 15%, not 75% like you see in the service side. And so, in order of pain, service, by far, is going to be hit the hardest. I think you're going to see numerous bankruptcies there, massive consolidation there over the next six to 12 months. E&Ps, less painful, but still a lot of consolidation to occur. Midstream is probably fine. I mean, their distributions go down a little bit; they suffer to a modest degree, but I have a scenario, you know, as you get into ‘22, where the U.S. is going to have to see massive activity gains. We're going to have to start growing production again in ‘22, ‘23, ‘24, so the whole chain reverses as we get into late ‘21 and early ‘22.
MA: Bottom line is this: actually, things are not that bad, at least not as bad as I thought, for the next three to six months. I still think we’re in a situation where we’re headed for a meaningful shortfall in crude by late ‘21 and through ‘22; this will last five years. I think we’re headed towards a five-plus-year upswing in our industry because of the damage being inflicted today. Unfortunately for service companies, that damage is going to be significant over the next probably nine months to 12 months, and then prices will move above 50 sometime early next year, and we start going back to work again. But there's a lot of damage to be fixed in the industry; that sets us up for the Bull Run for the five years after that. So that’s it in a nutshell. Sorry about the technical difficulties. Tom, any questions?
TF: Yeah, sure. And I'll start off with a couple of them. If you guys, anybody else wants to ask a question, please chat with me and I will call on you or ask your question. So, we talked about the reduction in supply being burned off—two impediments to restarting that increase in supply again. One is, if you're talking about a 70% destruction of the oil field service sector, how fast can that sector reboot and come back if oil prices demand or, you know, justify more E&P?
MA: That all depends on how long it stays down. If it stays down into early ‘21 as I expect, you're going to lose a lot of people, your capital is starved in that industry, and you’ve got an atrophy of equipment. You know, every time you see equipment parked, it's rusting, it’s deteriorating, and it doesn't start up when you want it to a year later. So, I think if we go from 800 range where we were in January, we probably end up in the low 200s here in the next, you know, by August, say, and you hover in that sub-300 rig range and an equivalent amount of frack crews and other oilfield stuff. So, when we say rigs, I'm equating that to all the oil field activity.
But you stay at those very depressed levels until oil—I think you need at least 54 to start and really you need 65, 74; we really incentivize meaningful increases in U.S. oilfield activity. Then the question is, can we attract those people back to the industry, and will you have capital to rebuild? And I think it's going to be very slow. Maybe we could get back to 600—let's say you hit the Go button on the first of January of ‘21; I think, at best, you get up to 600 rigs from, you know, low 200s by the end of ‘21. Again, we were 800 at the beginning of this year.
And then that next three or 400 is going to be much harder because you haven't been putting in, you're not putting any money into maintaining and keeping all the equipment up. Here’s an interesting one: to keep U.S. production flat, you’re going to need somewhere between six and 800 rigs running—just to keep it flat. Right? And we're obviously way below that. To grow it—the amount we will need to grow in ‘22, ‘23, ‘24, you’re going to need 1,500 rigs working. No way. No way you're getting anywhere close to that in the next three years. It's just, it's impossible.
TF: Yeah, we're getting a couple of questions about, maybe the decrease in jet fuel, but will that be offset by an increase in just demand on the gasoline side?
MA: Yeah, this is—we're in totally uncharted waters on this demand destruction and corresponding recovery. You know what, let's talk about the broader recovery picture. Gasoline, I think, particularly in the U.S., will be a bright spot. As I mentioned before, I think people are going to be much more willing to take vacations and drive to a seaside rather than fly to Panama City and whatnot, so things like that I think will cause gasoline consumption, which is the biggest component of U.S. oil demand by far. To pick up sooner, gasoline prices are number two.
Number three, everyone wants to get out of the house. Go to the lake. Let's hook up the boat. Take a few laps around the lake, you know. All in, I think that that you do see this summer, a substantial pickup in gasoline. Jet fuel’s a lot harder. I mean, we all are intuitively saying, “Well, no. It's too dangerous to get on a plane,” and I'm on a call with my team yesterday morning, and we're trying to schedule something. And we're going to do it next week. And one of the guys said, “Well, that's a holiday week, there’s not going to be anyone in.” I'm like, “Holiday?! There’s no difference between a holiday and any other day right now.” There's like six guys on the call and three of them say, "Well, I’m flying to Phoenix,” and the other says, “I'm flying to Florida. I'm flying—” and I'm like, “What?” And they all said the flights are booked. I’m like, “Are you kidding me?” So, you know, I think what I learned there is we may be surprised at how willing people are given just being cooped up, how willing we are to get on a plane.
TF: So let’s address, Houston is a town of a big producers, but a lot of small independents, and a lot of the things that you read about the oil and gas sector is, you know, “Burn me once, shame on you; burn me twice, shame on me,” and that this industry has produced such, you know, terrible returns, especially on the debt side because that's what fueled a lot of this, that capital is—they really mean it this time, capital is going to stay away. And by capital staying away, it's going to impact the smaller producers. Those are a lot of the people that live in our apartments or offices in our buildings and shop at our stores. Can you give any perspective on job losses, maybe what happens if your predictions of oil pricing are true—what might happen to corresponding job growth.
MA: Okay, sure. So, I think obviously this year, you're going to see massive layoffs throughout the oil service side. Doesn't affect Houston directly as much because most of these are field-level hands working on frack crews or whatnot, but the manufacturing jobs that are here in Houston that support that—you drive down beltway eight and you see an NOV sign on every other building—and those are the guys that make the stuff that’s used—they’re laying off people; Halliburton's laying off office people. So, that's going to be the single biggest impact. E&Ps are doing something similar, but not to the degree, and you're really not seeing anything meaningful happen on the downstream side, so there is going to be a lot of pressure. Again, it's going to be focused on service side. Now, to the point of lack of capital, capital to this sector is drying up across the board. There's no bank financing, there’s no debt markets open, there’s certainly no equity markets open, and so it’s going to be really tough, I think, for the industry as a whole, for the next year. But if oil plays out like I think it will, we’ll start to see some of those open up in ‘21.
That said, the market will demand a much higher return than we’ve ever seen in the past, because the market’s been burned so many times over the past decade. And so I think overall, the terms that are going to be demanded by the energy of business need to be in the 20% total return base—it's kind of like tobacco, when they came out of their settlements, for the next 10 years. I think we are in that same situation.
TF: Put that in context, against what some small guy who’s just out there putting deals together, what was capital demanding before all this?
MA: You know, you look in the broader market, certainly sub-10%. Interest rates as it is, as low as they are, I think we will need to be double what the rest of the broader market will need to do it. And then, the only other thing you have to introduce here is, all of these energy companies are still working, even though we’re sheltering in place. A lot of guys I've talked to—this, to me, is probably the bigger consequence on real estate—a lot of these guys determine, “Wait a minute, this stuff works pretty efficiently from home. I don't need as much office space as I needed before.” Now can we quantify that? I have no idea, but I think you’re going to have fewer people driving in from the Woodlands, Sugarland or wherever, into downtown, because they’ll say, “You know what, I don’t need that 45-minute drive. I’ll work from home,” and so you lose gasoline, but you also just technically don’t need as much office space as we did pre- this change in how we live our lives.
TF: Well, I don't doubt that, and hopefully some of that gets offset by an increase in demand that came from all those RVs that are now being purchased, and the fact that no one’s going to get on a bus for the foreseeable future. So, what about—back on the downstream, we have a question about the refineries in plants along the Gulf Coast, maintaining their employment. Can you speak to downstream demand? That’s really more just, I guess, as much consumer driven as anything, but do you have any thoughts on that?
MA: Right. I mean, we've obviously seen a big hit here in the U.S. overall. You know, we’re finding utilization has dropped meaningfully; normally it runs in the 90% range, we got down into the 60% range, but you know, that’s one of the things where you’re not laying off a bunch of people. You can't, you know—if you go from 800 rigs to 200 rigs, you can just lay off and let go three-quarters of those people. In a refinery, if you go from 90% to 6% utilization, everyone still has to be there.
So, I don't see nearly as much negative impact. We're already seeing signs that it’s picking up. Crack spreads are going up, profitability is going to start to go up for refiners—again, it's not going to be overnight. I really don’t see a lot of risk on that side of the business. Now the expansions, maybe, we're thinking about before will slow, and you're not going to see that the growth rate that we saw in the last 10 years in petrochem and other areas, because natural gas prices will probably be a little bit higher in the next few years as well. So, there will be some consequences there. But generally speaking, I'm not nearly as worried about the downstream side as I am the actual upstream and service side for the next 12 months.
TF: Okay, and back on more of the structural changes. We talked a little bit about the people working more from home. And there's a potential reduction in demand side. There's also the electric vehicle—you know, potential continued increase in usage of electric vehicles. What do you see the impact of that being, if at all?
MA: You know, the impact of electric vehicles on the energy business has been so overblown by the national media, it's ridiculous. You know, in reality, the total percentage of electric vehicles on the road is 0.3% of all vehicles today. 0.3%. And this is going to be the thing that puts us out of business? I don't think so. Certainly not in the next decade, right? I mean, things can change; people way underestimate the requirements of these different metals that go into batteries and the limitations on the lithium and cobalt and whatnot. I mean technically, you can't even get enough vehicles in circulation to really make as big a difference as all these forecasts are out there saying, so I view that as, at least in the next decade, as a fairly low-impact event. Now again, what I'm telling you is that I think oil prices will be three times higher than what the futures market is telling you in ‘22. So, if we’re in $100 oil all of a sudden, gosh, you know, that is kind of expensive to fill up the tank, and electric vehicles do start to compete more favorably and whatnot. So, there are some dynamics that could accelerate that; those don't exist today. They certainly don't exist at the futures prices that exists today.
TF: The greatest enemy to alternative energy is low oil prices, right?
MA: Yeah, no question. You know, the sales of those vehicles is crashed this year.
TF: Yeah. And by the way, according to Jeff Curry at Goldman Sachs, Tesla and Apple combined, account for 50% of the consumption of the world’s lithium. So, there’s certainly a potential ceiling there. I've got another question here. Can you give your outlook for natural gas prices over the next few years?
MA: Yeah. Gas is almost inverse quoted, so the more bullish, typically, we've been on crude, the more bearish you want to be on gas; that's borne itself out in the last, you know, 10 years or so, because you produce so much associated gas with all these big horizontal oil wells. I think that's changing for a couple reasons. But first of all, we're going to see a massive destruction of oil supply and associated gas supply over the next year or two, which was that 15% reduction I was talking about before. And I think that happens—you know, that's almost, you know, the writings already occurred there, it's going to happen for ‘21. And that means less gas supply. So ‘21 gas prices, I'm actually pretty optimistic on.
Secondly, I think it's going to be very difficult to get the number of rigs back working and get the capital to this industry to where you can meaningfully increase U.S. supply over the next five years. And so, if that's the case—in other words, we were producing close to 30 million barrels a day of crude as we entered this year. I don't think we can get back to 13 million barrels a day in the next seven years. And if you can't, then that's less gas supply, that's more bullish for gas. I'm actually—we've been very bearish on gas for a while and we finally, over the last few months, are like, “Wait a minute, ‘21 and ‘22 gas look pretty good,” i.e., $3 or better type natural gas prices, which I know relative to prices we might have seen a decade or two ago, so isn't that good, but it's certainly better than the $1.50 gas we've seen this year.
TF: And, you know, one of the things that—and we're coming up on 45 minutes, which is a good stopping point for these calls—but, in all these previous oil cycles and you've been through I don't even know how many but a lot, it seems as though every down cycle, the energy companies figure out a way to become more efficient.
You know, whether it's through technology or just forced downsizing they come back with maybe fewer employees and been run more efficiently. Do you see that happening this time around?
MA: Yeah, that's a great question. Absolutely. I mean, and it occurs in several forms. Number one, you have massive layoffs, which we've had and continue to have, but number two, it is—also, with mergers. I mean, you know, you have way too many competitors in many of these subsectors such as pressure pumping; they need to be put together. And when you do, then you rationalize more costs, you get more efficient, but you come out of it much healthier. So if you go back to the 80s, mid-80s, or the early 2000s, in both of those situations where you get a collapse in crude and a collapse in activity, the industry saw massive consolidation and you had fewer players and much healthier players coming out of it.
TF: Right. And as we've seen before, because we always think that the energy industry is going to get more efficient and it's going to lay off people, and as a result, it's not going to need as many people on a going forward basis yet, over the long arc of time, the industry has—when it’s healthy, it grows, and when it grows it hires people, and when it hires people they live in our apartments, in our offices, in our buildings, and they shop at the retails, right?
MA: Yeah, I would put it in world model terms for you. Historically, oil consumption has been growing 1.4 million barrels a day per year for 30 years. Let’s assume, you know, we get past this and we go back to a more normalized global economic growth in ‘22, ‘23, ‘24--to grow global consumption 1.4 million day, number one, I don't think it's possible. There's just, you know, we don't have the stuff and/or the access to oil to do that.
But to get anywhere close, you're going to have to take the U.S. rig count to 1500 rigs or more. We were at 800 at the beginning of this year; you're going to 200, so that gives you some sense of the magnitude of improvement. I think that that will need to occur in the next three to four years, you go from 200 active rigs to 1500 active rigs and associated for our crews and wireless and trucks and worker rigs and everything else. So that's why I'm so bullish on the outlook for energy over the next five years. The only difference in my opinion from a month ago is, I think we've already hit the bottom. I think we move up from here, gradually, gradually, mind you, but the worst is behind us and the amount of improvement that should occur in the next five years should be pretty amazing.
TF: Fantastic. Well, I tell you what, if there's anybody that has a question, please unmute and ask away, and if not, then I want to say thank you, Marshall, very much. It was really informative and sorry about the little glitch there but, yeah, we got to see what you look like, and then turn you off, that's not the end of the world. But I hope everybody got something out of this, and since Marshall lives right down the street from me, your tequila is in route. So, everybody, have a great day. Thanks for being a part of this. And we will talk soon.