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A Look Inside the Oil and Gas Industry


Is Houston the new Detroit?

Editor's Note: The following story was shared by an unnamed source / industry insider.

You don't need a penny just to hang around.  But if you got a nickel, won't you lay your money down? 
--Creedence Clearwater Revival

Dallas, Houston and Lafayette, Louisiana.
I don't know how the rest of the world views the US oil and gas business but southerners know those cities are intertwined in a co-dependent partnership that drives the oil and gas industry.  
Dallas, The Big "D," is the CEO; this is where the deals occur and the direction of the industry is determined.  That sentiment is passed to President Houston, who is tasked with implementing those directives.  President Houston tells the actual workers, the most skilled of which are scattered between Houston and Lafayette.
When I speak with insiders about where  the oil industry is heading, I'm reminded of the three blind men who were asked to touch an elephant and describe the entirety of the animal from their particular positions.  If you never heard the fable, one feels the tusk, one feels the body and one grasps the tail; each have a different experience to share.  
Here's what the blind men have to say about the elephant in the room.
The Industry Will Recover
Despite the political correctness, there is no source of energy that is as cheap, economical and of sufficient size to supply the needs of America.  So the industry won't go away.  What will happen is that when it comes back, it will look much different.
I watched the industry recover from the oil crash of the mid-1980's much differently than it once was; there weren't as many "middle-man" providing various elements, such as pipe, fishing tools, etc.  Four or five drillers shared the risk, as service companies like Schlumberger (SLB) and Halliburton (HAL) oversaw the operations and contracted service companies, who in turn contracted even more specialized vendors.  This may not sound like much of a change but it was HUGE!
No one has a clear idea on what things will look like when we come out of this down-cycle (or, crash) other than everyone agrees there will be mergers and bankruptcies.  I've heard estimates that 40% of the companies will merge or close by the time we recover; but nobody knows which which companies are walking dead.  Not knowing things like that has everyone in a tough spot on how to position for the turn.
No More Offshore
Second, there is a good chance the offshore segment will fade away with no new drilling and exploration. The Obama administration placed such burdensome restrictions and obligations on offshore drillers that it no longer is making economic sense for them to conduct business.
Federal leases are impossible to obtain, federal regulations take years to negotiate and the federal bonds required are enormous.  These factors have squeezed out all but the largest of companies even those companies (like XOM and CVX) are hedging their off-shore bets.
So producing platforms are being maintained, but no new wells are being planned and haven't been since Obama instituted the new rules (in case you ever wonder why Obama is despised along the gulf coast, this is why).
Loss of Skilled Personnel
Third, everyone is expecting that when things come back, there will be no experienced personnel left.  Right now, there are many people in the OG industry who have 20 - 30 years' experience in drilling wells; most of these people are being laid off.
If they are old enough and have enough money, they will retire.  Others will get jobs in other areas and vow not to go back into oil and gas because of the lack of job security that occurs every industry down-cycle.  That means when things do come back, there will be nobody out there who has any idea on how to drill a well and in that space, experience is far more important than diplomas.
This will happen from the top down at companies, and extend hrough engineers all the way to the roughnecks on the rigs.  And those young people who consider going to work in the oil and gas industry will remember the hardships and pain the last downturn caused their fathers and grandfathers and  quite often will seek a more secure job when they look.
Many colleges along the gulf coast discontinued their petroleum engineering programs after the crash as no one was taking the classes.  It took years to get those programs started up again; the major oil and gas companies had to fund them.
This personnel dearth caused a huge problem after the 1980's crash and it will definitely happen again. That means that drilling will be slower, with more problems, less efficiency and thus greater well costs leading to less stellar results.
Ripple Effect
There's an old formula in places where the oil and gas industry operates; that is that each job lost in the sector causes the loss of 20 other primary jobs and 50 sub- primary jobs.
That seems about right from what I gather without diving deep into the data.  A Shell executive recently spent an afternoon driving around Houston showing me all the "see through" buildings in town.  I had never heard the term before but it refers to an office building that has no tenants.  You can stand on any floor and "see through" to the other side because it's empty.  
Houston is trying to keep the problem quiet but it is very serious.  Many existing office buildings are approaching see-through status at the same time newly constructed office buildings are coming on the market with no tenants in sight.
Houston likes to claim it is well-diversified but the truth is that everything is built on the back of the oil and gas industry and if that sector goes, the rest will crumble.  There are fears among Houston city officials that if this down cycle lasts long enough, Houston could turn into another Detroit.
Personally, I would not buy municipal bonds in Houston just yet.  In fact, a large number of oil and gas law firms are breaking apart and shutting more work. If you are in the market for a former in-house counsel with twenty years' experience in the oil and gas sector, you can get one cheap right now.  In fact, if you're looking to buy human capital in the space, there's favorable supply-demand across the entire oil and gas spectrum.
What Looks Good to Me?
Right now, everyone in the oil and gas sector is praying with every ounce of their soul that oil gets above $50 and holds.  Those more nat- gas focused have given up hope as nat-gas is around $1.70 bcf.  No one ever thought the old floor of $3.00 would be breached.
The REALLY big unknown is how the current credit facilities will handle things over 2016 and 2017 as they are the life blood of the industry.  If they cut the money supply, I'm told bankruptcies in the industry could exceed 50%.  I'm watching EOG, as I believe they have one of the more solid balance sheets in the industry.  EOG hit $120 in 2014 is currently at $65, with pretty solid support below.
I wish I had a better sense of who will survive this downturn because it would be great time to buy and hold with so many companies in the dirt.  I have used several vehicles, including Stone Energy (SGY), which is down from $50 to $2, albeit for a reason.
Deals Everywhere
Everywhere I drive, I see toys in front yards with For Sale signs on them.  Boats, four- wheelers, campers, trucks, you name it.  Lafayette is approaching a twelve month supply of houses on the market with prices dropping in kind  The Dallas real estate market is still strong, but cracks have started to appear.  Houston rolled over but not yet accelerated to the downside.
During the downturn in the 1980's I bought things at unbelievable prices.  I have two full silver services that were each worth over $10,000 in the 1980's, I paid $200 for each.  I had bought a custom grand piano from a guy who paid $175,000 for it; I bought it for $2000 and sold it ten years later for $40,000.  People did what they could to eat; sad yes, but a buyers' market.
The panic and terror I see in everyone's faces today reminds me of a horrific movie scene, just like it did in the mid-1980's.  And these aren't innocent, non-experienced people.  These are people who are as tough, experienced and calloused as they come.
Not to sound like a mercenary, but there will be some buys of a lifetime in the oil and gas sector.  It's just a matter of finding which companies will survive the carnage and making sure you have the capital to deploy when the time is right.
Position in SGY
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