$100 Oil Is Here To Stay – ‘Drill, Baby, Drill’

Oil and natural gas (NG) have been in the headlines continually since Russia invaded Ukraine seven weeks ago but some of the virtual ink has been misleading if not outright wrong. In this article, I review the hydrocarbon landscape and conclude that oil and gas prices will remain higher for longer, and that fact, combined with a changing attitude toward hydrocarbon production, will incentivize North American producers to produce more oil and gas. Although I claim no special expertise in the mechanics of pulling oil and gas out of the ground, I do consider myself an expert in the global geopolitics of oil, and especially the politics of the Middle East, Eastern Europe and Russia.

I find that a fair number of oil experts quoted on TV-and many oil company executives-are not that familiar with geopolitics, whereas a more global view would be much more helpful to oil/gas management decision-making.

Before I start on the article, it goes without saying-but I’ll say it anyway-that my heart goes out to the people of Ukraine suffering an unimaginable attack on themselves and their country. It is frankly hard to believe that such events can occur so far into the 21st century. The rest of my thoughts on the topic are more appropriate to another forum, so let me begin with the topic at hand.

It Is Different This Time-This Upturn In Oil And Gas Prices Will Last For Years.

Before I start on the article, I realize that when you read this, WTI may not be quite at $100 (it is $94 as I write this on 4/11/22), which may qualify the title of this article as a bit of clickbait (though Brent IS at $100). Notwithstanding the precise price of WTI–and as you will see below–the real import of this article (as shown by the title of this section) is that crude oil prices will likely stay higher for longer than perhaps may people expect. Read on and make your own assessment!

American companies that explore for and produce oil and gas (E & P’s) had made it clear before Russia’s attack on Ukraine that despite this latest recovery in oil and gas prices, they were NOT going back to the cycle of overproduction and the subsequent tanking of hydrocarbon prices, and some had said that they were sticking to that mantra regardless of whether oil hit $100 (as it already has), $150 or, incredibly, even $200 per barrel. Various rationales have been given for that position, none of which are valid today, in my opinion. Here are those rationales and why I believe they are not valid:

1. Capital discipline-we want to return cash to shareholders.

This was a great policy in 2020, 2021 and even earlier this year, but it no longer makes sense. As everyone knows, oil and NG prices have been recovering in an almost straight line since the pandemic-induced lows of early 2020. WTI hit $70 in September 2021, $80 in Jan and $90 in Feb 2022. There was essentially no increase in US hydrocarbon production once WTI hit $70, but the (reasonable) rationale was that E & P’s had to pay down debt, and had to finally satisfy their long-suffering shareholders by increasing dividends and/or buying back their shares. The E & P’s did a great job of the foregoing in 2021, capping the year with great Q4 earnings reports of debt paydowns and cash return to shareholders.

Although domestic oil production gradually increased from 2020 to 2021, it’s been very stable at 11.6 mbd over the last few months (went to 11.7 mbd for first time the week before last!). This discipline was certainly different from previous industry custom of over production but made sense because there were concerns of slow demand recovery post-COVID, the possible return of Iran’s barrels to the market, decreased oil imports by China, the world’s biggest importer, and most recently, a slowdown of our own economy as the Fed increases interest rates.

There were certainly bullish counterarguments to the foregoing “bear” points but none of those counterarguments could challenge the mantra (religion?) of “capital discipline” and “gotta return cash to shareholders.” As a substantial shareholder of multiple companies in this space, I certainly appreciated that capital discipline in 2021, when WTI averaged less than $70.

But I will submit that those “capital ‘discipline” arguments make little sense now, given that WTI spent most of March and April in triple digits and is likely to remain over $90 for at least another year.

To understand why, we must recognize that during Q4, WTI averaged in the mid-$70’s, compared to almost $100 in Q1’22. It is also likely that WTI will average very close to, if not above, $100 in Q2. Even assuming WTI “only” averages $90 this quarter (the 3-month strip is a bit under $95), that is still $15 more per barrel than WTI averaged in Q4 2021. And because most E & P’s are only lightly hedged in 2022, they will achieve much better realized prices in 2022 than they did in 2021. Therefore, E & P’s should easily be able to pay down debt and return cash to shareholders-as most of them did in Q4-while ALSO increasing their production by a meaningful amount (see below the discussion about REI, which indicated its intention to increase production in 2022 by about 10%). Therefore, assuming continued high oil prices (discussed in more detail below), E & P’s should be able to do all three-pay down debt, return cash to shareholders (and note that paying down debt is itself a return of cash to shareholders, whether they appreciate it or not) AND meaningfully increase production without incurring any debt (ie, accomplish all three of these objectives out of the increased free cash flow resulting from higher oil prices)

2. Sure, oil prices are high now, but this won’t last and therefore spending precious capex now is unwise.

This is another argument that E & P’s have made to justify maintaining production and until Russia’s attack on Ukraine, this was a valid argument supporting a lack of increase in production.

Ever since WTI hit $70 in September 2021, there has been an active debate as to where oil was going. Some folks argued-for a lot of very valid reasons such as OPEC or American overproduction, another COVID wave, slow demand recovery, Iranian barrels coming back to market, etc.–that oil would never see $75 and might even go back to the $60’s and maybe even to the $50’s.

Though reasonable, these bear arguments ended up being wrong. Demand returned despite Delta and Omicron, the shale patch continued to exercise capital discipline, OPEC did not overproduce and sanctions on Iran remain (although I believe a deal with Iran may still materialize, with oil at triple digits helping Iran’s cause tremendously-even though I think we are simply setting up another Putin-like situation by handing Iran leverage over the West just like Europe did with Putin. But I digress, into politics, no less.)

Russia’s Attack On Ukraine Will Revamp Oil And Gas Flows Around The Globe And Keep Oil And Gas Prices Higher For Longer

I think the war in Ukraine has upended a lot of the foregoing bear arguments, which is a central focus of this article which I will now address.

Unlike the West’s response to Putin’s forays in Chechnya, Georgia and Crimea, the West’s response to Russia’s attack on Ukraine has been extraordinary (though still insufficient, in my view). Even though direct sanctions on Russia’s oil and gas have yet to be implemented by Europe, Russia’s big customer, it kind of doesn’t matter. The extensive banking sanctions on Russia, the withdrawal of BP, Shell, Exxon and other oil companies from Russia, difficult oil tanker logistics (2/3rds of Russia’s oil exports are overwater), the refusal of oil traders (and refineries and other oil hydrocarbon consumers) to buy Russian hydrocarbons, etc., are without a doubt going to substantially decrease Russian oil exports within the next few weeks-probably by at least 2 mbd. Incredibly, even China-no friend of the West–is getting nervous about buying Urals crude (Russia’s main petroleum export), even though Urals is trading at huge discounts ($25 to $30) versus dated Brent.

In addition to the West’s new-found aversion to buying Russian hydrocarbons, I believe Russian production of oil and gas will be dropping significantly over the months (and perhaps years) to come. There are three reasons for this. First, the draconian economic sanctions against Russia have caused substantial upheaval in Russia’s economy (some experts are projecting an unheard-of 15 to 20% decrease in Russia’s GDP over the next year), and that upheaval will likely lower hydrocarbon production by Gazprom, Rosneft and other Russian hydrocarbon producers. Second, it is likely that all Russian companies that participate in Russia’s hydrocarbon supply chain are finding their access to capital substantially limited compared to before the Ukraine war. Finally, the exit of Western oil-producing companies from Russia will undoubtedly have a meaningful negative impact on Russia’s ability to produce oil and gas.

I don’t see the above circumstances reversing over the next year. In fact, even if the war is resolved soon–which does not seem likely–I doubt that Russia’s isolation (discussed above) will change anytime soon. I do not see the West’s “self-sanctions” ending in 2022 (nor probably in 2023) and I certainly do not see Shell, Halliburton, Schlumberger and the rest of them rushing back to Russia anytime soon.

In fact, I think the world’s disgust with Putin may actually INCREASE once the missiles stop flying and the war crime investigations begin and more atrocities are revealed.

But even if I am wrong about everything I have said above, there is one more reason that convinces me that global oil prices (ie, Brent and Arabian light and related crudes) are likely to remain in triple digits this year, and that reason is a sea change in European attitudes toward continuing to depend on Russian hydrocarbons.

Although Europe has not sanctioned its current purchase of Russian hydrocarbons, there is no question that Europe has finally recognized the self-inflicted vulnerability it has created in terms of its critical dependence on Russian hydrocarbons. The Europeans banned fracking, shut down hydrocarbon production in Europe, shuttered nuclear power plants and sourced huge amounts of their hydrocarbons from Russia. This might have been forgivable if Putin’s Ukraine attack had been a surprise, but after his forays into Chechnya, Georgia and Crimea (the latter just 8 years ago)-not to mention his repeated statements that all of Ukraine (not just Crimea) belonged to Russia, his support of the separatists in eastern Ukraine, and his repeated use of Russia’s hydrocarbon production to blackmail Europe, it is hard to argue that Putin’s attack on Ukraine was a surprise.

Be that as it may, Europe now recognizes that relying on Russia for over one-third of its hydrocarbon needs (a percentage that is almost 50% in Germany) is unwise policy, and therefore, there is little doubt that Europe is going to wean itself off Russian hydrocarbons over the next 2-3 years.

I estimate that approximately 2 mbd of Russian oil is going to be sidelined over the next couple months, which may increase to 3 mbd by the end of the year, and removing 2-3% of the world’s supply of oil is going to maintain oil in the triple digits, especially since current estimates suggest that global spare capacity is only 2-3 mbd, meaning that Russia’s underproduction/global undersupply will essentially eliminate global spare capacity (if Iran is not taken into account).

Although I have focused on global supply above, one must also consider demand, but I believe that demand-just like the undersupply–will be supportive of triple-digit oil prices. As long as oil does not climb much beyond where it is now (Brent a bit under $100, WTI a few dollars less), I believe oil demand will keep increasing over the next few years until global oil demand peaks around 2027 or 2028, and then drops gradually to half of peak demand by 2040.

What About Natural Gas?

I believe that everything I have said above regarding oil will also apply to natural gas. My guess is that Nord Stream 2 will never be certified by Germany and that although Europe will continue to receive gas from Russia in the near future, Europe will progressively replace that gas by partially and temporarily reversing its anti-hydrocarbon policies and by increasing gas purchases from the US, Qatar and Australia.

The removal of Russia’s NG from the global market will keep NG pricing high-probably well over $4/MMBTU in the U.S. (NG is $6.52 as I write this) and several times that in Europe and Asia, and U.S. E & P’s will be able to sell all the gas they can produce and get to the Gulf Coast-up to the liquefaction capacities of those existing and upcoming facilities (new facility at Calcasieu Pass is undergoing commissioning right now and Lake Charles is progressing quickly to FID, though it won’t produce LNG until 2026).

Therefore, Europe’s increased purchases of American LNG will also support increased drilling and fracking to increase U.S. NG production (rig count up 16 this past Friday).

What About The 240-Million-Barrel Release From The SPR (Strategic Petroleum Reserve) And From Other Allies?

Demonstrating the administration’s panic over the impact that high gasoline (and even higher diesel) prices will have on the Democrats’ prospects in the November midterm elections, Biden announced last week an unprecedented release of 180 mb of crude from the nation’s SPR over the next 6 months-ie, 1 mbd. Front month crude prices dutifully responded, dropping by several dollars, going down to $94 today.

A few days ago, other countries agreed to add another 60 mb to the US’s 180 mb release, for a total release of 240 million barrels of crude. If all barrels are released over the next 6 months, that would amount to a daily release of 1.33 mbd.

As large as that release is relative to the SPR’s current holding of about 580 million barrels (about 1/3 of the SPR’s contents), and considering that 240 mb amounts to about 1/6th of global oil reserves of about 1.5 billion barrels, I believe it will turn out to be a bandaid because as discussed above, Russia’s decreased exports will likely exceed 1.33 mbd. But as I explain below, Biden’s intervention demonstrates the point that I made at the beginning of this article-that American oil experts (which I’m sure Biden has plenty of) often do not understand the geopolitical considerations that have a huge impact on global oil supply and pricing. Specifically, I explain below that OPEC may reduce production to at least partially (if not totally) moot the SPR releases–even without taking Russian under-exports into account.

OPEC+ Has Undergone A Huge Change In The Past Year-But American E & P’s And Oil Experts Haven’t Noticed.

Let me use the SPR release to illustrate my point. All things being equal, it would make sense that adding an extra 1.33 mbd onto global markets would lower crude prices, but things are rarely “all equal.” In this specific case, it is likely that Russian exports this month will be lower than they were in March, so if Russian exports drop by more than 1.33 mbd, crude prices may rise this month despite the 1.33 mbd SPR releases (which may not actually hit the market until late April or even May).

More importantly, huge changes in the geopolitics of the Middle East in the past year may lead to OPEC responding to Biden’s release in a way that not only negates the release but potentially increases crude prices further. It is no secret that since his inauguration 15 months ago, Biden has been hostile to Saudi Arabia and the United Arab Emirates (UAE). As explained in a recent Guardian article, that friction has reached new heights (Biden rebuffed as US relations with Saudi Arabia and UAE hit new low). I also suggest this article from Reuters.

No “ally” in the Middle East (and probably around the world) trusts the Americans to have their back anymore. The belief that we cannot be trusted to have our allies’ back was underscored by our botched exit from Afghanistan and the U.S.’s (and NATO’s) refusal to militarily protect Ukraine by (at the very least) establishing a no-fly zone there.

While the US has been abandoning the Middle East, both China and Russia have been doing the opposite. As the Saudis and the UAE – the only countries in the world who have enough spare capacity to replace Russian barrels – see that America has abandoned other US allies, it makes sense that Saudi Arabia and the UAE are going to do what’s best for Russia, not America. This explains why Saudi Arabia and the UAE have refused to pump more oil and that refusal–not widely appreciated–is the key reason why I say “This time it’s different.”

As al Yahya explained above, the US was “married” to the Middle East for 70 years and was viewed as the protector of the oil-producing countries there. Given America’s abandonment of the Middle East while Russia and China have made major inroads there with both soft (business and cultural connections) and hard (military) power, is it a surprise that Saudi Arabia and the UAE are going to do (and have done) what is good for Russia rather than what is good for the US? And obviously, keeping global oil supplies limited and oil prices high is good for Russia.

Which brings us back to Saudi Arabia’s and the UAE’s possible (likely?) response to Biden’s SPR release. Given the foregoing discussion, these two Gulf countries could easily underproduce by a collective 1 mbd and nullify Biden’s SPR release (in fact, there is already evidence that these two Gulf countries are already doing so). This underproduction would mitigate (or entirely gut) the significance of the SPR releases and allow these Gulf countries (and Russia) to collect more for their crude. What’s not to like-if you are Russia, Saudi Arabia and the UAE?

In conclusion on the above point, it is clear to me that today’s OPEC is different from OPEC at Biden’s inauguration, 15 months ago. Whereas OPEC previously stated it was happy with $75 oil, OPEC actually refused to add more production when crude nearly hit $140 a few weeks ago. OPEC feels that the US “divorced” it (see above comments of al Yahya) and recognizes that while the US has abandoned the Middle East, China and Russia have done the opposite. Given the foregoing-and since OPEC (ie, Saudi Arabia and the UAE) can absolutely determine global crude prices by changing their production-I believe OPEC’s new price “setpoint” for crude on a long-term basis will be at least $95 to $100 and as high as $110 to $120 (they would probably want to avoid sustained prices over $120 to prevent meaningful “demand destruction”) because while the US may not like that setpoint, the new sheriff in town (Russia) will benefit from high oil prices, and so will Saudi Arabia and the UAE.

Unfortunately, the above point has not been appreciated by either the Biden administration nor by domestic E & P’s.

What About “Demand Destruction”?

This is a topic that I believe has been addressed very poorly by the “experts” on TV and in the press. Here are several considerations to keep in mind regarding the concept of “demand destruction”:

1. “Demand destruction” is a misnomer.

Economists call this concept “elasticity of demand,” which simply says that all things being equal (which in the real world, they never are!), as the price of something increases, the demand for that item decreases. If demand is very “elastic,” a small price increase causes demand to decrease by a lot. It is well-known that demand for gasoline and other finished petroleum products is relatively inelastic-ie, even if the price increases a lot, demand does not fall by much. The reason for that is obvious. Take the commuter who drives her vehicle to work-she’s unlikely to quit her job or get a different car because gasoline prices have increased. Instead, she’ll continue filling her gasoline tank, regardless of price (within limits, of course). Same thing for a trucker’s consumption of diesel or Southwest’s consumption of jet fuel-the trucker needs diesel to do his job, and the airline needs jet fuel to carry on its business. It is true that some gasoline/diesel/jet fuel use is discretionary, but not very much.

Therefore, demand for hydrocarbons is not only not going to be “destroyed” as prices increase, it’s not really going to decrease very much with gasoline at $4.10 (as it is now). In fact, gasoline use may well increase as we enter driving season this spring and even more so this summer-despite gasoline averaging in the low $4’s across the US and even $5 and $6 in some markets.

The other point to keep in mind about demand “destruction” is that it’s not an all-or-none phenomenon, but rather, it’s a continuum. Therefore, if gasoline goes to $5.00, demand will decrease somewhat, but that decreased demand will lower the price and demand will rise again. Therefore, an equilibrium will be found where supply and demand match each other and some price stability will be found.

2. Contrary to what you read, gasoline at $4.10 is not a “record” price.

Let me ask a question: What was the average price of gasoline between 2011 and 2014? If you answered, “about $3.60 per gallon,” give yourself a pat on the back.

Next question: If gasoline averaged $3.60 about 10 years ago-why is it that gasoline at $4.10 now is somehow outrageously priced?

Answer: At $4.10 today, gasoline is NOT outrageously priced. Gasoline expenditures as a percent of household income are lower today than they were 10 years ago.

Nobody expects to buy a car, or a house, or a loaf of bread, or a dozen eggs today for the same amount they paid 10 years ago, so why is it that all the talking heads and journalists are declaring that gasoline is outrageously priced? Obviously, nobody wants to pay more for anything (gasoline prices don’t concern me because I have been driving an electric car for the past 10 years!), but failing to account for inflation while discussing gasoline prices is intellectually dishonest.

Obviously, the above observation has its limits, but as discussed above, I do not think $115 oil (translating into retail gasoline prices of about $4.30) will generate much demand “destruction,” especially as employment and economic activity, as well as airplane travel, is actually increasing in the US today. Of course, I might be less sanguine about lack of demand destruction if average national prices hit $5.00, but we’re not there yet, and even at those prices, gasoline would still be a little bit cheaper than it was in 2012 on an inflation-adjusted basis. In addition, if some decrease in demand occurs if oil hits $140 (and gasoline hits $5.00), that may well slow down further increases in the price of oil-or maybe send it back toward $100, but I do not see a scenario that sends oil meaningfully back below $100 for a sustained period of time anytime soon.

There Is Another Reason Why I Believe E & P’s Will Increase Production-The Vilification Of Oil Producers Is Going To Be Muted.

Although capital discipline has certainly been a big factor in limiting oil production growth in the US, I believe that the continued vilification of oil producers and the focus on ESG has also been a substantial factor in tamping down oil production. When Congress grills oil company CEOs about price-gouging without any evidence of that, when the administration and legislators repeatedly aim their hostile rhetoric at the hydrocarbon industry, when Biden asks OPEC-but not American producers-to ramp up production, oil company CEOs have a good reason to stay outside the limelight by disregarding calls to increase production.

I believe that hostility will be somewhat muted in 2022-and perhaps for longer than that. With Russia’s exports declining, and OPEC unwilling to fill the void, and with Europe BEGGING for hydrocarbons, I think the rhetoric against American hydrocarbon producers will decrease. Indeed, American producers will now argue-with good reason-that they are being patriotic by increasing their production because doing so will help our European allies, help reduce Putin’s influence over Europe and help lower (or prevent further increases of) gasoline prices in the US..

Counterarguments To The Foregoing Thesis.

The following might sustainably lower oil prices below $90 and prevent a domestic oil production increase:

1. Iranian oil comes back after a new nuclear deal is signed.

Although I think handing Iran tens of billions of dollars so it can further develop its nukes and long-range missiles (hello, North Korea) is a worse decision than Europe’s reliance on Russian hydrocarbons, this may happen. I think such an event-especially given that Iran has somewhere between 60 and 80 million barrels in floating storage-is likely to lower oil prices meaningfully, possibly below $90 and maybe even below $80. But there are a couple of factors that may minimize the impact of Iranian barrels. First, it appears that Iran can only add about 1 mbd to global supplies (after the initial release of floating storage), and if Russia’s exports decrease by 2 to 3 mbd, Iran’s increased exports plus the SPR release together will about match the Russian barrels that are lost. In addition, if Iranian barrels come back, Europe may eliminate Russian hydrocarbon imports sooner, which will also mute some of the impact of Iranian barrels.

Second, if sanctions are lifted, Iran’s production may come under OPEC control so that Iran’s extra production/exports may end up being limited by OPEC policy to maybe only 1 mbd, even if Iran could actually produce more.

Third, although they would prefer not to, Saudi Arabia and the UAE may reduce their own production to account for additional Iranian barrels, therefore maintaining crude prices close to triple digits.

Therefore, although crude prices would initially drop if (and when) a nuclear deal is signed, the actual impact of such a deal on the oil markets may be more limited than some anticipate.

2. Global recession.

Obviously, a global recession will lower demand for hydrocarbons, which may well decrease oil prices back to $80 or even less. There are valid arguments to be made supporting-and rebutting-the likelihood of a recession, and in my book, it’s way too close to call. But even if a recession is on the horizon, my guess is that it will not happen till late this year, and even if it does, I think OPEC and domestic E & P’s will show enough restraint (as they have already) that WTI will not drop much below $80, especially with a big producer such as Russia under-exporting to the tune of 2 to 3 mbd.

3. Even if WTI stays in triple digits, some E & P’s will choose to return more money to shareholders rather than use some of the free cash flow to increase production.

There is no question that even if WTI returns to $100 and stays there, some companies-including some of the big ones-will choose to continue to lower debt, and increase dividends or buybacks more aggressively rather than increasing production. Of course, such restraint will support oil prices staying higher for longer.

If My Thesis Of “Higher-For-Longer” Is Correct, What’s The Best Way To Play It?

In early March 2022, I published an article on TETRA Technologies, Inc. in which I argued that Russia’s attack on Ukraine would lead to major realignments in global hydrocarbon supply . Because I wrote that article just a few days after Russia attacked Ukraine, my thesis constituted a projection of what I thought would happen, but there was not much evidence (at that time) to actually support my thesis. Part of my thesis was based on an understanding of Putin-my belief that he would pursue his attack with vengeance, as he had in Chechnya and Georgia, as well as his use of chemical weapons in Syria and his support of the separatists in eastern Ukraine since annexing Crimea in 2014. Unlike many talking heads who spouted the common (and sometimes wrong) “wisdom” that geopolitical events are usually short-lived and have minor impact on global markets, I believed the war would be prolonged, and that Putin might well resort to attacks on civilians, especially if the war wasn’t going as well as he had hoped. I further posited that the longer the war lasted, and the more draconian the attacks on civilians, the more determined the West would be to terminate its self-inflicted dependence on Russian hydrocarbons.

Unfortunately, since I submitted my TTI article in early March, my fears of civilian targeting have been realized to an even greater degree than I had envisioned. In essence, subsequent developments in the Ukraine war-and the West’s response to it-have provided strong support for the belief I expressed that the West would be moving away from Russian hydrocarbons. Russia’s attack on Ukraine and the resulting motivation (discussed above) to increase hydrocarbon production in the US (and elsewhere, of course) has further enhanced the value proposition of virtually all companies involved in the production of hydrocarbons, and although many oil and gas equities have risen as WTI and NG prices have gone up, those increases do not adequately reflect what I believe to be a sea change in global hydrocarbon supply channels.

If what I have said above is correct, rig counts, drilling and fracking are going to increase meaningfully (but not really “Drill, Baby, Drill”–which was also a bit of clickbait) this year-and maybe next year as well. There are five companies in my portfolio that I believe offer very compelling value if you agree with me that oil is likely to stay in the triple digits (or very close to it because $90 WTI is more than enough to make extra production very profitable) and NG is likely to average more than $4.00 per MMBTU this year.

Two of the companies I discuss below–Callon Petroleum (NYSE:CPE) and Ring Energy (NYSE:REI) are E & P’s, Energy Transfer (NYSE:ET) is a midstream, CSI Compressco (NASDAQ:CCLP) is an NG-compression company, and the last one–TETRA Technologies (NYSE:TTI)-is probably my favorite because it offers not only a legacy oil/gas services business that is recovering nicely but also because TTI has three renewable initiatives that could add substantial value to the stock price over the next 12 months. I will briefly summarize my thoughts about these five bargain equities below.

1. Energy Transfer (ET) has 50% upside over the next year.

I have written 5 articles on ET-I first recommended ET when it was trading at $6.65 in my first ET article in Jan. 21. I wrote a second article in Feb. 21, and then a series of 3 articles in May, 2021 (third article, fourth article (Energy Transfer (ET): Q1 Operational Performance Augurs Well For Stock) and fifth article (Energy Transfer (ET) Stock: Setting A 12-Month Price Target Of $14 Per Share).

Although ET has done very well since I recommended it (total return of almost 80% since January 2021), today, my 1-year price target for ET is $17, amounting to an additional 50% return over the next year (ET is $11.08 as I write this). ET had a very good 2021 and I think 2022 will be at least as good-and probably even better. ET uses its 114,000 miles of pipelines to move about 30% of the natural gas that is shipped around the United States every day and Europe’s goal of replacing Russian NG is going to increase domestic NG flows (as well as NG liquids-another big profit center for ET) in 2022, filling ET’s pipelines and increasing ET’s revenues.

In addition, ET just increased its distribution about 15%, to 70 cents per year, and has stated its intent to raise its distribution back to its previous level of $1.22/share. I think there is a good chance of approximately a 10% increase in distribution per quarter over the next 4 quarters, reaching a distribution of around $1.10 in 12 months, which would constitute an almost-10% yield on today’s price. Also, a $1.10 distribution would support my price target of $17 (a 6.5% yield).

Therefore, I think ET is a very good buy under $12, which would give you a tax-advantaged 5.8% distribution yield, likely to go over 6% at next earnings (next month).

2. Callon Petroleum (CPE) has at least 50% upside, and even double-bagger potential if WTI averages $100+ during 2022, which I think is plausible.

Although stock prices of the E & P’s have recovered in 2021 and YTD 2022, many of these equities are still trading at low metrics. For example, consensus earnings estimates (which I believe are too low) for Callon Petroleum in 2022 are $14.42, resulting in a P/E ratio for this year of 4.1 (CPE is $59.09 as I write this). Analysts at Capital One Financial just increased their Q1 earnings estimate to $3.96 and I think annualizing that number to $16 in 2022 earnings will come much closer to the actual earnings this year-resulting in a forward P/E of well under 4 for a company whose metrics in 2022 are likely to be almost double what they were in 2021. Although P/E ratios are not a common metric for evaluating E & P’s, a P/E of less than 4-however you slice it–is ridiculously low, and likely reflective of investors believing that WTI is going back to the $70’s (or even $60’s) before 2022 is out. As you can tell from the discussion above, I do not believe WTI will close out this year anywhere near $70.

Looking at a more relevant metric (free cash flow), here is what CPE’s CEO had to say in CPE’s Q4 earnings release on 2/23/22, the day before Russia attacked Ukraine:

Based on our planned operational activity and leading operating margins, we expect to generate over $500 million in adjusted free cash flow in 2022, based on $75 per barrel. This level of free cash flow puts us on a path to further reduce our absolute debt levels and achieve a leverage ratio of less than 1.5x by year end 2022.

In an attempt to be very conservative, many E & P’s have provided 2022 guidance based on assumed 2022 WTI prices of $75 (or even less, in some cases), but I believe that is unrealistically low. In fact, the 2022 calendar strip for WTI today is about $90 (WTI is $94 as I submit this to Seeking Alpha), so if CPE chose to, it could sell its unhedged 2022 forward production at about $15 more than the $75 price they used in their 2022 FCF projections.

A recent SA author wrote an article on CPE in which he calculated that CPE’s 2022 FCF would hit $724 million assuming strip prices which are similar to today’s strip. I think CPE might make >$724 million in 2022 FCF, for several reasons. First, CPE just bought out a company called Primexx whose operating costs are higher than CPE’s. I think there is a good chance CPE will lower those costs as the year progresses, adding to CPE’s overall netback per barrel. Second, between 2021 and 2022, CPE expects to reduce debt by about $1.5 billion, saving tens of millions of dollars of interest, and likely getting upgraded credit ratings, which will lower interest cost further, thereby increasing FCF. Third, if I am right and WTI averages $100 in 2022, CPE stated that as the year progresses, they will reduce their hedging, allowing CPE realized prices to increase during 2022, again adding to FCF.

In addition to believing that 2022 FCF will be close to (and perhaps above) $800 million, a couple of other catalysts may also goose the stock price. Most important of these is management’s signposting during the Q4 earnings call that CPE may initiate a dividend or buyback later this year:

The “positive outlook for cashflow [in 2022] puts us in a good position to start having meaningful discussions about returning money to shareholders”

and

We will be evaluating this throughout the year.

I think that when CPE presents Q3 earnings in Nov 2022, or Q4 earnings in February 2023, they are likely to announce the initiation of a buyback or a dividend (or a little of each), which I think will boost the stock price.

Given the foregoing, my 1-year price target for CPE is $90-based on strip pricing in the low $90’s-representing about 50% upside from its current price ($59.09 as I write this). If WTI averages over $100 in 2022, and looks like to repeat that feat in 2023, I think CPE’s stock price in one year may well exceed $100, representing an almost double-bagger.

3. Ring Energy (REI) also has at least 50% upside, and even double-bagger potential if WTI averages $100+ during 2022, which I think is plausible.

My thoughts about REI are similar to my comments about CPE. Like CPE, REI was overleveraged and struggling to survive as the pandemic hit in 2020. But also like CPE, REI has recovered brilliantly since 2020. REI recorded an excellent Q4 2021, despite being heavily hedged in 2021. But most of REI’s low-priced hedges have rolled off in 2022, with only 30% of 2022’s production hedged in the $60’s and 10% at a fairly decent $85. Therefore, REI’s realized prices in 2022 could be almost 50% greater than 2021’s realized prices of $67.56, which could result in almost a doubling of netbacks on each barrel of oil.

REI has been fine-tuning its production methods, leading to almost-unheard-of well breakevens of $25 to $30/barrel (earnings call, p. 18) for which Neal Dingman, an analyst at Truist complimented REI during the earnings call (“I don’t know that you guys have even given yourselves enough credit.”)

Whereas REI made $20.5 million in FCF in 2021, I think they will more than double that amount in 2022, both because of much higher netbacks and because they plan to drill and complete 25-30 wells (compared to 11 wells in 2021). This should increase daily production from an average of 8519 BOE/d in 2021 to 9300 BOE/d in 2022 (midpoint of guidance), an almost 10% increased production.

My one-year price target for REI is $5.50, delivering 50% upside above its price of $3.75 as I write this. There are a couple ways to arrive at that PT. First, consensus earnings for 2022 are 65 cents per share. I think earnings will be closer to 80 cents rather than 65 cents, but even at 65 cents, an 8X P/E yields a stock price of $5.50.

Second, EBITDA in 2021 was $83 million with realized oil pricing of $67.56. I think 2022’s realized pricing will be closer to $90, about 35% higher than 2021, suggesting a 2022 EBITDA of about $115 million. REI had $290 M of debt at the end of 2021, and I think they will pay down close to $40 million in 2022 (they paid down $23 million in 2021, despite much weaker oil and gas prices in 2021), yielding debt of $250 million at year-end 2022. Multiplying projected EBITDA of $115 million by 7 (some people would use much lower multiples but I believe that 7X makes sense in an upgoing market with rapidly decreasing debt and continually increasing FCF generation) yields an enterprise value of $805 million. Subtracting $250 million in debt yields a market cap of $555 million for a stock price a bit over $5.50 (there are about 100 million shares of REI).

For those of you familiar with it, Zacks just upgraded REI to a “Strong Buy.”

4. CSI Compressco (CCLP) has at least 50% upside, and potentially over a 100% return if nat gas stays above $4 during 2022, and if the new management executes well.

Like the other companies I discuss here, CCLP has already enjoyed some recovery in 2021 and will see continued recovery in 2022. Peak EBITDA for CCLP in the last up cycle (2019) was $128M, and if management executes well and NG pricing remains over $4.00 (it is $5.82 as I write this), there is a fair likelihood that this level of EBITDA will be approached, if not exceeded, by the end of this year, for the following reasons.

The most important reason is that I believe NG production will increase meaningfully this year as American NG producers ramp up to help Europe kick its addiction to Russian gas. LNG exports are making new records every month, and that will continue as the year progresses. With European NG prices in excess of $30/MMBTU, there is a tremendous incentive to liquefy more gas in the US and ship it to Europe. Since compression and gas treatment (CCLP does both) is needed in order to produce and ship NG to liquefaction facilities, increased NG production will lead to increased demand for CCLP’s compression and treatment services.

Second, late last year, CCLP bought out the assets of a company called Spartan, which treats NG (removes impurities and cools it) so Spartan’s EBITDA will now be added to CCLP’s EBITDA, which should enable CCLP this year to exceed its 2019 EBITDA of $128 million

Third, CCLP’s compression horsepower has increased a few percent since 2019, so that should add to EBITDA as that idle compression (about 19% of the fleet was idle at the end of 2021) is placed with customers, and inflation over the past 3 years should also add to revenues and hence, EBITDA.

Given the foregoing, if management executes well, I think CCLP’s Q4 2022 EBITDA could reach $35 million, yielding an annual run rate of $140 million (which is interesting because CCLP’s market cap as I write this is $197 million).

Multiplying CCLP’s anticipated year-end-run-rate EBITDA of $140 million by 7 yields an EV of $980 million and subtracting long-term debt of $600 million (assuming debt paydown of $31 million during 2022 from year end 2021 debt of $631 million) yields a market cap of $380 million, almost exactly double the current market cap of $197 million, implying 100% upside in the stock price by this time next year.

One interesting aspect of CCLP is that it actually pays a 4-cent annual distribution, good for a 3% yield and that distribution is amply covered by CCLP’s DCF (coverage ratio was 6.6 in Q4). On the negative side, CCLP has a sky-high debt-to-EBITDA ratio of 6.2, although if debt drops to $600 million by yearend and EBITDA hits $140 million, the debt coverage would drop to a bit over 4.0.

Another concern (in addition to the debt) I have is that the current management, who has been running CCLP for just a bit over a year, is unproven. Obviously, 2021 was a cataclysmic year in many regards, so it’s hard to tell how managements performed. Generally, although they all recovered somewhat, none of the compression providers showed great progress, largely due to capital discipline of the NG producers. As I explained above, I think recent geopolitical changes will constitute a substantial tailwind for NG producers-and consequently for the compression providers-so CCLP’s management will have an opportunity to demonstrate their management skills in a supportive macro environment.

Given that supportive environment, I see little downside risk from the $1.40 base that CCLP has established this year, and if management does well, I think hitting $2.50 to $3.00 in one year is attainable.

5. TTI has at least 50% upside-with very low downside risk-and potentially more than 100% upside if its zinc bromide battery storage and its lithium initiatives succeed in 2022, which I think is likely.

I have written two articles on TTI this year “Tetra Technologies Stock: A Potential Double In One Year” and “Tetra Technologies, Inc. – 100% Return In One Year.” TTI was at $2.74 when I first recommended it on 2/22/22, before earnings. TTI is at $3.85 as I write this, sporting a return of 41% in the past seven weeks. If my brief discussion of TTI here interests you, I suggest you go back and read my earlier articles.

I submitted my second TTI article just a few days after Russia attacked Ukraine, resulting in the West’s moving away from Russian hydrocarbons, which is enhancing TTI’s value proposition in two ways-by strengthening both TTI’s legacy oil services business as well as amplifying the potential of TTI’s renewable initiatives which are themselves enhanced as hydrocarbons become more expensive.

First, the profitability of TTI’s oil-services business correlates with hydrocarbon production and with WTI close to $100 and NG likely to stay over $4.00 this year ($6.52 as I write this), I believe TTI’s legacy business will recover somewhat faster in 2022 than I had projected in my earlier articles. Therefore, I have increased my 1-year price target for TTI’s legacy business from $5.00 to $5.50.

Second, the increasing cost of petroleum products will serve as a tailwind to TTI’s renewable initiatives, two of which are likely to add $1-$3 in stock value this year, yielding an overall price target of $6.50 to $8.50 (midpoint of $7.50) in one year, and representing almost 100% upside from TTI’s current price.

TTI stated during its 3/1/22 earnings call that it was actively drilling its 100%-owned lithium/bromine resource and that results from those drill samples would be available in Q2. Given that the well was being drilled 6 weeks ago, I’m guessing those results should be out in the next few weeks. Positive results-which is what I expect because previous results in the same brine aquifer (the Smackover formation) have been positive–could definitely be a catalyst to TTI’s stock price within the next 30 days. Adding to the upside potential is the fact that while spot lithium prices were $70,000/ton a month ago, they hit $80,000/ton about 10 days ago and most experts believe that lithium prices are not likely to recede meaningfully anytime soon.

Although very little lithium is sold at the spot prices I quoted above, increases in spot price (which was under $10,000 a year ago!) also increase long-term contract prices. I believe the likely sales price for lithium on a long-term agreement (which is how most lithium is sold) will probably end up being well above $20,000/ton-which itself is more than double the contract prices entered into last year. As you can imagine, $10,000 increase in sales price makes a huge difference to the profitability of a lithium-production operation.

The other renewable initiative that I believe is likely to add to TTI’s stock price this year has to do with a new market for TTI-the sale of zinc bromide for batteries that are used to store renewably-generated solar- and wind power. As I explained in my previous article, TTI announced in December, 2021, that it had entered into an agreement with Eos Energy Enterprises (NASDAQ:EOSE) whereby TTI would supply its high-purity zinc bromide for EOSE’s storage batteries. In my previous article, I speculated that EOSE might sell $50 to $75 million-worth of its batteries in 2022, and in fact, EOSE just recently guided to $50 million in 2022 battery sales.

Even more exciting is EOSE’s announcement on 3/9/22 (after I wrote my second TTI article) that Bridgelink Commodities, LLC would buy 240 to 500 MWh of EOSE’s zinc bromide batteries over a term of 3 years, representing a total order value of up to $150 million (3X their previously-expected $50 million in 2022 sales). Speculating that this $150 million order is divided at $30 million-$50 million-$70 million in 2022-2023-2024, the $30 million amount in 2022 represents a big increase on top of the $50 million that EOSE had previously guided for 2022 sales (although it is possible that some part of Bridgelink’s anticipated purchases were already included in EOSE’s $50 million 2022 guidance).

Regardless of the precise extra 2022 sales that the Bridgelink agreement represents, the fact that Bridgelink, a company with a huge pipeline (8 GWh– ie, 8,000 MWh) of renewable generation projects chose to purchase up to half a gigawatt of EOSE’s batteries is a huge vote of confidence in EOSE’s batteries, and may well lead others to source EOSE’s zinc bromide batteries. In addition, having such a big contract from a big player in this field makes it easier for EOSE to expand their production capacity beyond the already-ongoing expansion to 800 MWh/year.

It is reasonable to posit that if EOSE’s battery sales grow from $5 million in 2021 to $50 (or $80) million in 2022, EOSE’s 2022 demand for zinc bromide will increase 10-to-16-fold over 2021. Although we do not know how much those zinc bromide sales could add to TTI’s 2022 bottom line, these sales could be meaningful–maybe a few extra million dollars in 2022 EBITDA to TTI, which sales are, of course, in addition to existing zinc bromide sales from TTI’s legacy business. More importantly, within one year from today, EOSE’s 2023 demand for zinc bromide will be known and is likely to be substantially higher than 2022’s demand, which will lead to a meaningful increase in zinc-bromide-related EBITDA to TTI in 2023.

Finally, EOSE is not the only company that makes zinc bromide batteries (Australia-based Gelion Technologies and Redflow Limited are also commercializing zinc bromide-containing batteries), and given the high purity of TTI’s zinc bromide-and the fact that TTI is a domestic producer of that compound-it is certainly possible (if not likely) that TTI will announce zinc bromide sales to other companies (in addition to EOSE) in the next month or two.

For the reasons discussed above, I now believe that TTI’s legacy business is worth $5.50 within one year, and the renewable initiatives should add $1 to $3 in additional stock price, for a total one-year price target of $7.50.

Therefore, I believe TTI is a good deal today anywhere in the low-to-mid $4’s-but ONLY if you agree with me that oil will stay over $90-95 and that NG will stay above $4.00 in 2022.

Finally, if both the lithium and zinc bromide renewable initiatives achieve key milestones, TTI may, over the next year or two, start being thought of as a leading innovator in the renewable space (rather than being thought of just as an oil-and-gas services company), leading its EV-multiple valuation to expand, adding even more value to the stock price on top of a meaningfully expanding EBITDA.

Risks

There are several geopolitical risks to my analysis. For example, because Russian crude is trading at a huge discount of about $30/barrel, that will (and has) incentivized countries (India and China come to mind, as well as some smaller importers) to continue buying Russian crude. In addition, workarounds will be found to evade Western sanctions. Although I have attempted to take the above into account in making my estimate that 2 to 3 mbd of Russian oil will not make it to market this year, I could be wrong in my estimate.

Second, as the reality hits that sanctions will have negative economic consequences, the West itself may find excuses not to enforce sanctions against Russia’s hydrocarbons even as the West gives lip service to maintaining those sanctions.

Another possibility is that OPEC does a 180 and decides to increase crude exports around the globe or that more Iranian barrels magically come onto the global market-even if the nuclear deal is not renewed and sanctions aren’t formally withdrawn.

Although all of the above are plausible, I have attempted to take them into account in my 2-3 mbd estimate of Russian export reduction. In doing so, I have given substantial weight to the belief that the West’s revulsion with Russia’s attack will actually increase once the atrocities are fully revealed. Having said that, and given that such predictions are complicated, I could end up being wrong.

On the domestic (non-geopolitical) front, the number one risk I am concerned about today-and not just with the above 5 equities-is overall market risk. Many experts consider the market overvalued and many are calling for an additional correction of 10-20-30%, and some (Jeremy Grantham comes to mind) are calling for an even greater downdraft. Since I bought my crystal ball at the dollar store, I have no idea as to the likelihood of a meaningful correction in the stock market, but I do know the possibility exists and the recent inversion in the Treasury yield curve support a belief that a recession is in our future late this year or sometime next year

If the market corrects meaningfully over the next year or two-and especially if we have a recession that leads to lower oil and gas prices and therefore lower drilling and fracking activities-the oil/gas business recovery which underlies the foregoing equity recommendations is unlikely to be realized. In my view, even a recession is unlikely to drop WTI below $70 (OPEC can easily prevent oil from going back to $70, and I believe they will do exactly that), assuring that the equities cited above will still be able to generate some FCF while simultaneously reducing capex, but obviously that sort of environment would not be conducive to increasing stock prices. That concern is further minimized for TTI because its renewable initiatives-if successful-may allow TTI to buck the trend of falling stock markets because even a recession isn’t going to stop (or even slow down) continually-increasing lithium sales and storage battery penetration.

A second domestic market risk is that the whole energy field is unloved by investors–although that lack of love has definitely moderated recently, as highflying stocks have come back to earth, leading to a rotation toward energy stocks, a process that may well continue this year. There is a reasonable “risk” that the market’s dislike of oil and gas equities may not change much, and thus, even though the above 5 companies may generate increasing EBITDA, the market may continue to undervalue them, as it has in the past-and the present. On the other hand, it is possible that as the economy slows down and as high-flying-but-non-profit-making companies continue to lose their appeal, companies that are actually making money (like the ones mentioned above) may garner more investor interest. Recent events suggest that the latter is happening, but not to the degree that it should, and how that plays out going forward is up for debate.

Conclusion

I believe Russia’s attack on Ukraine-regardless of how it turns out for the Russians and Ukrainians-will cause a sea change in global hydrocarbon production and flows. Although there remain many uncertainties-how successfully will Russia avoid sanctions? Will India and China continue buying Russian crude? Will Iran start adding barrels to the global supply? Etc.-I strongly believe that hundreds of millions of Russian crude and products barrels and many BCF’s of Russian NG will fail to come to market over the next couple of years. Although this involves looking out several years and is more uncertain, I personally think this will be a permanent change once supply channels have been redirected, meaning that I believe Russian hydrocarbon production will drop from this point forward and never return to its previous levels. As an aside, I also think that due to high prices and geopolitical considerations (especially for Europe), the transition to electric cars and renewably generated electricity will be faster than it would have been otherwise, to the benefit of our planet and our children-and to TTI’s renewable initiatives.

Regardless of how things actually play out, I believe domestic E & P’s (and probably international ones, as well) will not throw capital discipline out the window, but rather, increase production when demand and prices justify it and moderate that increase in drilling (which, due to shale decline rates, may actually reduce production) if demand and prices support that approach. Finally, I believe the days of E & P’s borrowing money to increase production are over-if E & P’s increase production, they will almost always do it within cash flows while still returning cash to shareholders, just as REI and CPE, discussed above, are doing.

Regardless of the exact price levels-which nobody can predict (although we often try)-I think hydrocarbon prices will remain high, I think domestic E & P’s will increase production this year, and I think the 5 companies I have discussed above (and many others I haven’t discussed) will both benefit financially and help the West isolate despots that belong in the Middle Ages, not in the 21st century.