Equinor Update

Update and Review of Equinor.  I may buy some more energy producers in a few months if we get a downturn.  Here I look at their latest numbers and their ESG plans.

Segments

Equinor is primarily an Norwegian energy play, with 90% of 2022 Net Operating Income from E&P, and three quarters of that from Norway.  

How much is oil vs gas?  In dollar terms, usually more oil, but it varies with prices.  In the first 9 of months 2023, they sold more oil than gas, but in the same period of the previous year, more gas than oil (page 29).  Due to the massive spike in European gas prices in 3Q2022:

Source: Equinor 2023 3Q Financial Statements and Review (p51)

Cashflows

They've been printing money in the past 2 years due to high oil/gas prices.  2022 was a bumper year, 2021 more normal:

Quarterly cash-inflows vs cash-outflows:

Notes:

• Quarterly CFO does not correlate with oil/gas prices, because taxes (payable) seem to be accumulated in Q1 and paid out in other quarters.
• Since quarterly data is noisy, calculate the payout ratio (CFO divided by dividends plus buybacks) for each calendar year: in 2021 it was 35%, 2022 was 48%, YTD 2023 is 94%.  In 2022, they spend almost all their generated cash on dividends/buybacks.

Balance Sheet and Capital Allocation

They've paid off their debt in 2021, accumulated cash in 2022, and have been returning capital in 2023:

But not all their cash and financial investments can be counted:

• Their 28bn financial investments "mainly relate to investment portfolios held by Equinor’s captive insurance company and other listed and non-listed equities held for longterm strategic purposes" (p177).  We don't know how much is required for insurance.  2020's annual report says the same thing for 12bn of financial investments.  I'll take a wild guess that 12bn is required for insurance, leaving 16bn as long term investments.
• For their 15bn cash, 6bn is required for hedging (p179).  Lets deduct another 2bn in case oil volatility increases. Leaving us with 8bn excess cash.
• With debt of 25bn, net debt would be ~ 1bn.

Long term liabilities are 13bn provisions, mostly asset (rig) retirements.  Plus 3bn pensions.

There is no fixed policies for dividends or buybacks - appropriate for a cyclical industry.

The company previously mentioned they would like to return to a 10-15% leverage ratio (p10) - they count all cash and financial investments in this ratio - so that would entail a massive capital distribution.  I'm skeptical about this in today's world: any leverage is too much when you have 5% interest rates and a product whose price can go negative when people catch a cold.

Their main form of capital distribution is dividends.  Not tax efficient, but better than stupid acquisitions.  Overall I think their capital allocation is quite good.

Reserves 

They had 7 years remaining based on 2022 production.  The reserve replacement ratio has averaged 62% in the past 3 years.  Meaning replacement was below production.

Reserves in Norway have remained steady over the past 3 years (p7).

By boe, over half of the reserves are gas:

Source: 2022 Oil and Gas Reserves Report (p6)

Business and Political Risks

Very few risks, which makes it a rarity for an energy producer:

• Norway is a developed, democratic country with rule of law.  Most resource rich countries are shitholes (eg: DRC, Saudi Arabia) or simply poor & corrupt (eg: Indonesia).
• Seabourne oil can be shipped anywhere.  The production areas and outbound shipping lanes are not in a potential war zone, like the Persian Gulf.
• Norway's oil tax is 78%, though investments can be deducted over a few years.  This high rate is already priced in, and is actually an advantage, because: 1) Its safe and predictable, they have not changed it eg: like the UK did, and 2) the government is already getting 78% of profits, they're unlikely to take shares away from minority shareholders.
• Norway is an net energy exporter, so they are unlikely to put a windfall tax on energy producers or restrict energy exports.
• Offshore oil has low decline rates, unlike American shale.
• Norway's oil is less carbon intensive to produce compared to Canadian oil sands.

Valuation

Getting a reasonable valuation for energy companies is hard because energy prices have been so volatile.  Lets base it on 2021 and 9M2023 results.  2022 was too much of an exceptional year.

"Cash generated" is CFO minus "capex and investments".

Based on the current stock price of USD 32, the PE would be 8 or 12.  Reasonable, but not dirt cheap,

ESG Risk 

Equinor has an Energy Transition Plan, which I think is the biggest risk to its business:

The first item (reducing carbon use when producing oil) and third item (CO2 storage) are OK.  The second one (spending lots of money on renewable production) worries me:

• Equinor aims to direct "30 of gross capex to renewables and low carbon solutions by 2025" and " more than 50% of our annual gross investments in 2030 towards renewables and low-carbon solutions" (p21).  It was 14% in 2022 and 11% in 2021:

Source: Material Topics, Equinor Website.

• They had to write down their US wind power projects this quarter.  Their UK wind farms are OK because prices are inflation adjusted.
• In negotiations, they said they "would like to see 4% to 8% real unlevered return from our businesses in -- within renewables" (p12)

Lets do some numbers.  Based on 2021 and 2022 capex:

• 2021 capex was 8bn, 2022 was 8.7bn.  Of that, 0.9bn and 1.2bn was spent on renewables and low-carbon (11% and 14% respectively).  
• To bring it up to 30%, we need to spend an additional ~2.3bn by 2025.  To bring it up to 50%, we need to spend an additional 5.3bn by 2030.  They don't need to just bring it up to 50% of current 8bn capex, they need to bring it up to 50% of new ~12bn capex....after they spend more for renewables.
• These additional sum could make low returns (4-8% real returns) in a much more risky investment.  Essentially we can see FCF (and therefore dividends/buybacks) reduced by this amount.
• Based on 2021and annualised 9M2022 estimates, the 2030 aim would reduce the cash generated (CFO minus "capex and investments" by 15-17%).  It could wipe out their Net Operating Income (before tax)....though they could now claim back the new investments over several years at a 78% tax rate.

Conclusion

Everything looks good except for the ESG risk.  Time to explore other companies.

China reopening, oil, and doing nothing

I think China is reopening.  Rising cases occur when you reopen:

But official deaths have not gone up.  A quick google search shows a median of 18 days to die from covid, so we should know the death rate by now.  The latest numbers have 1 covid death yesterday:

Source: Worldometers.com

There's 2 risks to the reopening:

• China numbers are bullshit, so no one knows what the real hospitalisation/death rates are.  Low level officials will make up whatever numbers they think are desired.  And I'm sure no one reports bad news to Xi.
• Everything depends Xi.  He can reinstate zero-covid tomorrow.

We're getting a lot of confusing scenes out of China.  Protests, lockdowns and confusion.  It will be localised cycles of easing and tightening as they try to flatten the curve.  If they don't lock down soon, it will be too late, and they will have to let it spread.  So there's a small chance Xi imposes a harsh lockdown soon, and a bigger chance - growing larger by the day - that they just let it spread and try to slow it down.

My "China reopening play" is oil.  Zero-covid reduced demand by an estimated 0.5 to 1.5m bpd.  Long term I think oil goes up anyway, but China makes me buy it now.  Bought more CNQ and Equinor in the last 2 weeks, now its a 9% position (at buying price).  1% more to go.

Its a very oily portfolio: 10% in oil producers, plus another 35% in things correlated to oil (Gas pipelines, palm oil and LNG).

Also mechanically adding to my shorts as the S&P500 goes higher.  And the existing shorts are also growing bigger as the market gets higher; my shorts are now in the red:

Need to remind myself not to get too short, else the bear market rally will rip my face off.

Can't find anything to buy with the remaining 30% cash.  Despite a year-long bear market, stocks aren't cheap enough yet to catch falling knives.  I wait, either for things to get cheaper, or for the macro tide to turn so I can buy cyclicals like capex commodities.

Its hard, sitting in cash, foregoing dividend income, not going long or short.   I try to imagine myself as a multi-millionaire in the future, after the current bear market, recession and subsequent commodity bull.

Doing nothing is the hardest thing.

Oil Prices

Two MacroVoices interviews with Dr Annas Alhajji and Art Berman give an optimistic long term view on the crude oil market.

 Dr Annas Alhajji (22 June 2020):

• The surplus is now 180m barrels in inventories in OECD (excludes China), Saudi Arabia is trying to eliminate it.
• Comparing now and 2017: in 2017, oil inventories decreased 152m bbl in 10 months,.  This was done by the Saudis cutting production, US oil production increased by 1.2m barrels per day in that period.
• This time, the rest of the world is cutting production.  US production is down by 1.8m/day compared to 2017.  Libya is at 30-40,000 barrels/day, down from 1m in 2017.  Venezuela now 600k down from 1.9m.  Iraq exports are half of 2017.  Brazil, Norway, Ghana have increased, but small amounts.  Overall, we will get serious supply side issues in the future.
• Estimates the rebalance of the oil market will take a year.  Picture is way brighter in the next few months than people believe.
• Shale: only 25% of oil has being brought back, (due to price differentials between WTI and oil areas), once the differentials improve, will see major comeback.  Expects all major companies shale wells to come back online, but there is a problem due to lack of new drilling, needed to offset rapid shale declines.  Major decline may last for 2 years.  Thinks will bottom around 9.8-10m US production, then see a recovery.

Art Bernan (18th June 2020):

• US Production is down from 13.2m bpd to 10m
• Unlikely to see negative WTI again.  The govt has opened up strategic reserve space (to lease to store oil).  And the market should resolve any issues if it happens again.
• Can oil production be switched on and off immediately?  For shale (45% of US production), yes - barring occasional repairs, you can switch on/off production with a few clicks on an ipad.  For conventional, no. 
• The  current rally is just a relief rally, too many people were short oil.  There is still too much oil around (slide 11).
• Decline rates have been increasing with newer wells. 
• Time from rig to first oil production is around 10-12 months.  Estimates 16 months lag from when oil prices rise to make shale profitable, to the time the first shale can be drilled.
• So he expects the oil price to recover, longer term: "And that next down is going to be a buying opportunity. Because it sounds to me like maybe there’s a few more waves up and down along the way, but eventually we get a moon shot when there is a full economic recovery from this crisis and the industry is just not able to respond quickly enough."   [My notes: And I guess the recovery could be around 16+ months....]
• Slide 13 shows current recovery in oil consumption so far.  It has not recovered yet.  And the recovery has been mostly in gasoline.

Equinor

Crude oil trading at negative prices is not sustainable.  How do I play it when it recovers?

Equinor (formerly Statoil) is Norway's state owned oil company.  It has very low production costs, operates in stable jurisdictions, and has reasonable finances.

I got this idea from Vitaliy Katsenelson's Contrarian Edge.

All numbers are from their 20019 Annual Report ending December (pre-virus, and pr oil crash).

Business

What do they do, and where are they exposed to?

• Almost all their profit came from Norway E&P, which consists of 70% oil, 30% Natty & NGLs (by revenue).
• Next are their operations in the US (p38), which produced around 10-20% of their oil, natural gas and NGLs.   What and where do they produce?  By revenue, most should be GOM oil.  By BOE, most is Marcellus natural gas.  There is very little shale oil - there's some from the Bakken, but their Eagle Ford assets were sold off in a well-timed November sale.
• Their International E&P (including the US) made a small loss.
• This is offset by their Marketing, Midstream & Processing making a small profit.
• They have a stake in 7 wind farms.  Makes for nice ESG photos, but meaningless for profits.
• They own an insurance company!  I think it insures the parent against operational risks (eg: workmen's compensation).  Again, not meaningful for profits.

So basically: Norwegian offshore oil production, followed by US and international (mostly) offshore oil production, followed by natty.  Minimal US shale oil.

Finances

Net debt (including IFRS 16 Leases) are 22bn, of which 4bn is due this year.  Another 4.2bn is due in 2021 and 2022.  They recently raised 5bn very long term debt on good terms.  I am ignoring long-term financial investments, which are required for insurance.  2019 interest payments were 1.5 billion.  All debt is fixed rate.  Its in a mix of major currencies (p198), but "normally swapped into USD".

2019 operating profits covered interest payments by 6 and a half times.  CFO covered it 15 times.

Despite the large debt, I don't think they have to issue new shares.  I think their status with the Norwegian government allows them to issue debt cheaply.

Net Debt has dropped from 33bn in 2016 to 22bn now.

Its unclear to me how much of their production is hedged.

Production Costs

They state they have breakeven prices for different projects between $11 and $40.  Not sure if that is extraction or full cycle costs.

In March they stated they can be "organic cash flow neutral before capital distribution in 2020 with an average oil price around USD 25 per barrel for the remaining part of the year".  I interpret this to mean their overall cash breakeven is $31 Brent.

Reserves

Charting their oil (not BOE) reserves:

Relationship with oil price

EQNR's stock price seems to follow Brent:

Conclusion

Good company that meets my criteria:

• Operates in stable, lawful jurisdiction.  No geopolitical risk.
• Low cost of production
• Minimal exposure to US Shale oil.  Product priced in Brent (seaborne), not WTI (landlocked).
• Reasonable financials, although a bit too much debt.

This is not an exhaustive look, I won't buy-and-hold forever.  And the oil industry is very difficult to study.  Who really understands break-even costs, or accounting rules for reserves and E&P?  If I buy, it is just as a trade for rising oil prices.

I would prefer to buy a basket of oil companies, but am unlikely to find many (any?) that fit the above criteria.

I use Hedgeye for timing when to buy.  I am not buying now.  The economy is still shit.  Oil producers may keep overproducing for a long time because of fixed costs and hedges.  And there's a chance Brent crashes, maybe below zero, after all the oil tankers fill up.

Misc

The Norwegian government owns 2/3rds of Equinor.  Norway has the worlds largest sovereign wealth fund, so I don't think they will push Equinor to pay dividends.

If I buy, I have to buy the ADR since Interactive Brokers does not access the Oslo stock exchange.  One ADR represents one share.  There is a fee of 0.5c per ADR for each dividend distribution.  Interactive brokers has Equinor as STL (Statoil).  Witholding tax for dividends should be 15% for Singapore residents (p8).