The Best Energy Play: Permian Infrastructure
Rob Raymond, the founder of RCH Energy (Raymond Crow Holdings – established in 2004), says the oil and gas market has left the exploration phase and entered the exploitation phase of the shale revolution, which will be dominated by major energy corporations, not private equity firms. That said, he is bullish on investing in businesses that facilitate the further exploitation of the Permian Basin, a play that he believes is a big deal – so big, in fact, that the Permian should be thought of as its own country, one that will beat Mexico, Canada, Venezuela and even Saudi Arabia.
“The Best Energy Play: Permian Infrastructure”
Privcap: We’re joined today by Rob Raymond, the founder of a boutique energy investment firm called RCH Energy. It has offices in Dallas and Houston. Rob, how are you today?
Rob Raymond, RCH Energy: I’m fine, thank you.
Privcap: Tell us very briefly what RCH Energy does.
Rob Raymond: RCH Energy was spun out of the Trammell Crow family office in 2004. Over time, we’ve created a boutique energy investment firm that specializes in both the midstream and upstream sectors of the oil and gas industry and invest both in the public and the private markets and then also looks to invest in capitalized, very unique and specific technologies related with specific functions in the energy industry and supply chain as well.
Privcap: We just recently had some bad news out of Saudi Arabia. There was an attack on some major oil refineries there, apparently by a drone. What do you think this news says about the state of security and the energy market in the Middle East and how do you think that will affect the broader markets?
Raymond: The level of security and the surety of supply in the Middle East, in one sense, has been sort of shaken to its core at this point. I sort of liken what happened here over the weekend, with Abqaiq specifically, which is the big processing facility that in turn processes all the barrels coming out of the field, which is sort of the 800 pound gorilla, if you will, of Saudi hydrocarbon production as sort of… in one sense, sort of the 9/11 moment of the Middle East here, where that asset has been relatively sacrosanct. And the idea of OPEC members attacking each other’s infrastructure really other than the Gulf War in 1991 Saddam Hussein invaded or sought to invade both Kuwait and really on the way to Saudi, really hasn’t happened over the course of the last 40 or 50 years. I think some of this is a combination of significant advancements in technology, and the ease of the acquisition of some of that technology. Some of it is, I think, obviously the willingness, if you will, of certain actors in the middle East to actually use that technology.
We all went to sleep with a false sense of security as it relates to the security and the surety of hydrocarbon production out in the middle East. And so I think this is an awakening where we’re all going to have to probably live with a more volatile crude oil curve going forward. And the last comment I’d make is this doesn’t just affect crude oil.
Privcap: Let’s back up a bit and take a look at the broader energy sector in the United States, which has been under stress for several years. What are your thoughts on the current staten of the industry and your expectations going forward?
Raymond: The last, really, sort of decade or decade and a half, certainly in the United States, there has really been around what I’ll characterize as the exploration phase of a long cycle. And that’s really been all about the concept of using technology, developing and harnessing technology defined broadly as fracking. And so that really started here in Dallas, Fort Worth in the early 2000s. And over the last sort of 15 years, has been exported to lots of other shales across North America. As we’ve gone through that exploration cycle, part of the issue here is that there’s been lots of capital deployed, think hundreds of billions of dollars, that frankly has earned little to no return. A lot of that capital was provided, funded by private equity, to some degree public equity, and a lot out of the high yield debt market as well. And so I think as we sit here today, there’s sort of an evolution going on here where the capital markets have shut down specifically for energy, investors are fatigued as a result of having deployed hundreds of billions of dollars of capital with no return.
So I think a lot of investors are looking around, rightfully wondering how is that realistically going to happen? And that’s really the remnant of sort of the last big capital market boom dating back to 2014 and 15 before oil prices really collapsed and the capital market shut down. So there’s sort of, if you will, a wall of refinancing risk coming at us in the near term. At the same time, I think we’re also transitioning from the exploration phase of the cycle to the exploitation phase of this cycle. And so I think what that really means, and we’re seeing it with the big integrated majors, with guys like Exxon Mobil and Chevron and Texaco is big examples. But what we’ve really had is the rise of the super independent, so the EOGs, the diamond backs, the conchos, et cetera in sort of the 2012 to 2017 time frame and starting really meaningfully in 2016, 17 and more aggressively now, you have the super majors coming into places like West Texas and now aggressively deploying technology and marrying that technology was substantial scale.
And so as we transition from that exploration phase to the exploitation phase, it becomes incumbent upon those large scale participants in the market to now start generating a return on invested capital and providing a return to not just the debt investor, but to the equity investor and visibility in terms of how that’s going to happen. As I look forward over the next three, five 10 years, this is going to be an industry that increasingly is going to be driven by the very large scale, low cost of capital incumbents, if you will. And in any industry, I might just comment, that it’s not uncommon to see this dynamic unfold. So the small entrepreneurs move quickly, they try and harness the technology, et cetera.
Once that technology is, in one sense, sort of “proven”, the slower moving incumbents with cost of capital and scale advantages then ultimately end up either buying and/or developing additional technology and taking it, if you will, to the next level. So I think in one sense you’re seeing the classic transition from the entrepreneur to the incumbent, specifically to the development and application of technology in the hydrocarbon industry.
Privcap: Interesting. And since you mentioned the private equity firms, many of which perhaps still haven’t seen a return on their activities over the past 10 years, what role do you see for them going forward? What are the smartest ones going to start doing?
Raymond: Well, I think in the near term, they’re all going to be faced with a very real decision of trying to figure out how to consolidate, in some cases, many, many relatively small subscale portfolio companies in an effort, in one sense, to try and create their own, if you will, “scale” in the middle of their own portfolios of assets. But at a higher level, I think we’re going to see a substantially diminished level of participation from the classic private equity model at this point. I might offer that if we go back to 2014 before the price of oil collapsed, there were oil directed rigs running in over 90 counties in North America, really, in the United States, specifically looking for oil.
Today, there are substantially fewer rigs drilling in about 35 counties. And so I think what’s really happened here is the industry is high graded. The opportunity set to understand where the really good geology is and where maybe some of the more marginal tier two and tier three geology that people had high hopes for, much of which was funded by private equity, which ultimately probably results in a big write off.
Privcap: Let’s talk about the biggest play out there, at least in the United States, the Permian basin. You used the term 800 pound grill earlier, referencing a section of Saudi Arabia. Do you agree that the Permian basin deserves, I guess, the attention that it gets? Is it that big of a deal or are there other players out there that you find to be quite attractive?
Raymond: Call it a big deal. In fact, I think I’d have to go back and look, but if we go back and look at some of our 2014 and 15 letters to some of our investors, we actually coined the term, “the country Permian.” And we did so in an effort to try and make the point that if we look at the Permian basin, not in the state of Texas and not necessarily even in the country defined as the United States, but if we looked at the country Permian is its own producing oil province and we then compared it with entire countries like Mexico, like Venezuela, in some cases, like several other OPEC countries, Iran and Iraq, and even ultimately maybe probably not on exactly the same scale, but Saudi, we would make the arguments several years ago and would continue. And so certainly, Venezuela is a good example of that. To a large degree, people really don’t focus on it, but our view here is that Mexico is in trouble. PMX has seen some substantial production declines over the course of the last three and four and five years. Higher cost basins like the Canadian oil sands up in Alberta are probably challenged at this point.
And so in one sense, the Permian basin, call it one of the five largest oil fields in the world, coupled with technology now, is giving lots of other producers a run for their money globally. And so, I think what makes the Permian somewhat unique is the idea that while there’s a lot of hydrocarbon in place… And I emphasize hydrocarbon, not just oil. We’ll come back to that point here in a little bit. But while there’s a lot of hydrocarbon in place, only a portion of it has been readily accessible with prior generation technology defined as vertical conventional production, and that’s really up on the central basin platform.
Privcap: Do you think the Permian basin has the infrastructure necessary to really capture the opportunity at hand? Do you think that that’s potentially an attractive investment opportunity?
Raymond: Well we do. And so, starting with maybe an analogy and then more to the Permian itself, if we really go back and look over the last, call it 15 years, it’s interesting to me, to and observe, the price of gold, as an example, has gone up five fold in the last 15 years. And yet if I look at, for example, Newmont Mining, as a large gold producer, that stock price has basically done nothing over that same timeframe. And so it isn’t always or necessarily the producers that necessarily make the money or earn a return associated with producing… whether it’s commodities defined as precious metals, and/or gold in my example.
As an aside, we can go look at all sort of the junior mining stocks up in Western Canada. And not only are they sort of flat to maybe up a little, a lot of them are down a lot over the same period of time when the very commodity that they produce has gone up a ton. So why is that? And so I think some of those analogies hold true. If I take that one step further… So who made the money ultimately producing and mining the gold? Well, it’s the people that transported a lot of it. To find in that example is the railroads. And so when I think about the analogy of what’s happening in the energy industry, I think they’re very low cost producers defined as the ExxonMobil probably have an ability to earn a decent rate of return relative to their cost of capital, recognizing, again, that their cost of capital is very low. Having said that, from an infrastructure standpoint, all those hydrocarbons that come out of the Permian ultimately have to find their way to specific end markets. And here, I’ll try and emphasize an important point.
The Permian basin is a basin that has a lot of hydrocarbons in place, most misconstrue that to mean oil. So yes, while there was a lot of InSpec, call it WTI grade oil, there was also an enormous amount of other byproducts or hydrocarbons that come along with the production of that crude oil. Those are largely defined as natural gas liquids and just dry gas or what’s called the residue gas. And so in the Delaware basin, the Northern Delaware basin, it’s not uncommon to see “oil wells” produce really 50 or 60% InSpec oil with the remaining 40% or 50% of the production curve being something defined as other. And that other is really natural gas liquids and/or residue gas. you’re trying to migrate relatively large and dense molecules through very, very, very small pore sizes or pore throats and the rock. So think nano Darcy permeability. And so the only way that happens in combination with fracking technology is you have to have a pressure drive or some pressure mechanism in the reservoir to in turn enable that hydrocarbon production.
So what that means is almost by definition, in the Northern Midland basin or the Delaware basin, there is going to be at a minimum, some associated natural gas and LNG production associated with every barrel of oil that comes to the surface. And that amount varies by location and by the zone at the geology specifically that one is targeting.
From an infrastructure standpoint, the industry needs to have an ability to address all three streams of hydrocarbons, crude oil, natural gas liquids, and residue gas. And so it’s really that opportunity, from an infrastructure standpoint, that we think is very attractive on a go forward basis. And so there is a lot of construction currently underway, there is a lot more capacity that ultimately needs to be developed, but we see that as a huge opportunity. So gathering, processing, transportation, fractionation and export is where we see the real value opportunity in today’s hydrocarbon landscape.
So a lot of these LNG barrels ultimately feed petrochemical facilities. Pet chem demand is growing at a rate, globally, at three or four times that of the rate of something like crude oil. So our models would say the crude oil demand is going to grow at a rate of… call it and 1%, plus or minus, per year for the foreseeable future. So when a hundred million barrel a day global crude oil market, that’s a million barrels per day per year of growth. Our models would say that demand for pet chem feedstock is going to grow at a rate of three to four times that.
So whether it’s all the way on the upstream side of the business, the gathering and processing side at the wellhead, all the way through the downstream side of the business defined as fractionation and ultimately delivery of InSpec pet chem feed stock through that NGL chain, both on upstream and the downstream side, we have a much more robust stat of both supply and demand economics that in turn colors our view in terms of where the really attractive opportunities are.
Privcap: Do you see opportunities to deploy capital, both large and small, in the sort of broader infrastructure, moving petrochemicals around the world play, or is this something that’s going to be so capital intensive that you’re going to need to have a certain heft to really be able to find the best opportunities?
Raymond: That whole supply chain is one that is very capital intensive in nature. I might comment that one of the reasons we like it is because it has some relatively high barriers to entry. So unlike some other aspects of the energy business, if you will, going and standing up rigs and poking holes in the ground and sort of seven or eight shales across the country, competing in the NGL supply chain is, if you will, in one sense, a different ballgame.
And so that right there is, if you will, sort of a competitive moat, from an economic standpoint, around that integrated supply chain. And so part of the reason we’re focused on this specific side of the business and we’re as optimistic about it from a return standpoint as we are is because we think you can do something that’s relatively unique, sort of sarcastically here, but God forbid, actually generate an attractive rate of return to the equity investor, which is what we’re really focused on.