There was a solid pop in oil futures Tuesday, June 23, with August crude holding above $61.00 a barrel as the API and EIA supply reports this week are expected to show tightening in domestic supply figures. Platts polling data indicates an anticipated reduction of 2.3 million barrels amid heightened tension between the U.S. and Russia, the world’s number two oil producer, with U.S. SecDef Carter having announced a firm reinforcement of Europe and massively increased logistical support to NATO’s rapid reaction force, in order to face threats from the east or from extremists in the increasingly deteriorating Middle East. Significant reduction in CAPEX over the last several months by U.S. E&Ps of around 25 percent or higher, extending through Q1 this year, has organized a groundswell in oil futures, which are forecast to continue rising over the longer-term despite a stronger dollar.
Also, the continued moves by China and Russia to sign landmark energy deals show a continued dedollarization of crude that threatens to unseat the petrodollar. Massive potential investment in Rosneft’s (OTC: RNFTF) huge new Vankor field in eastern Siberia by China and India is clearly in the cards, with delegations from both countries having made recent visits to Vankor and statements from Russia’s Deputy Prime Minister indicating that the country has cleared a psychological barrier that previously prevented Russia from giving China a measure of control over its hydrocarbon reserves. The entire 440k BOPD output from Vankor is already being shipped out to feed Asia via the ESPO pipeline, with the vast majority of output ending up in northeastern China.
In this near-term environment of reduced upstream activity among domestic E&P operators, the larger sector players stand to do best, because they have the kind of geographical and infrastructural diversity, economies of scale, widespread exposure and overall size needed to survive and thrive. The impending Halliburton (NYSE:HAL)-Baker Hughes (NYSE: BHI) merger and other such consolidation in the sector is a clear indicator of the underlying market dynamics here and it is also a key expression of the sector finding its footing. In fact, Denver-based Markwest Energy Partners (NYSE: MWE), which derives much of its operational cash flow from fees, has established agreements with more than 160 producers, roughly 4.7k miles of pipelines and around six billion cubic feet per day in natural gas processing capacity, is actually firmly focused on growth. With as much as $1.9 billion in CAPEX lined up for this year alone, across 20 major projects that are currently under construction on over nine million acres throughout the country’s top producing basins in Texas, Oklahoma and the northeast (emphasis on the Marcellus shale), Markwest is even on track to do four major plant expansions in Ohio.
For a company like energy-related EPCM (engineering, procurement and construction management) and automation specialists ENGlobal (NASDAQ: ENG), which is one of the most well-positioned and top-ranked providers of full spectrum services in the field today, the aforementioned market dynamics are good news. Because in order to thrive in this arena, especially under the current conditions, a reputation for excellence and the ability to deliver on time and within budget is paramount when it comes to attracting business from the biggest players. A long, established track record of success with top sector players will serve ENGlobal well in helping to further court the business of those energy sector juggernauts which are most able to withstand the temporary slowdown in capital expenditures, as well as the smaller contrarians who are shrewdly doubling down into the sector nadir.
Even with the downturn in energy commodity prices having impacted ENGlobal’s overall upstream related orders in Q1 this year, the company has maintained profitability, with a strong working capital position of over $24 million, and zero borrowings under their current credit facility. Automation operating profit margin outpaced the company’s EPCM division during the first quarter of 2015, posting a still healthy 13.9 percent, whereas engineering and construction profit margins were on par with Q1 2014. This is thanks in large part to the company’s vast expertise in both automation integration and automation engineering. ENGblobal’s ability to deliver a full range of integrated process, power and control solutions, handling everything in-house from the fabrication, assembly and programming, to documentation and system testing, has helped win the company a reputation as a rock-solid reliable supplier of integration solutions.
By being able to provide integration support ranging from analytical units like continuous monitoring, analyzer maintenance and data acquisition systems, to custom industrial HVAC (heating, ventilating, air-conditioning) systems and hydrocarbon moving infrastructure, like pipelines and rail/truck or sea terminals, ENGlobal has firmly cemented itself in the minds of some of the industry’s biggest companies as a provider who can handle anything that is thrown at it. Other automation integration systems provided by the company include a vast array of power solutions, like switchgear shelters and micro-turbine power islands, as well as complex control systems like master panels, burner management systems, SCADA (supervisory control and data acquisition using coded signals) controls, and fire/gas protection systems.
The company actually specializes in the kind of robust modular enclosures needed for everything from general operator shelters and control rooms, to heat and blast resistant cabinets used in some of the energy industry’s most dangerous environments, such as refinery process units and on drilling rigs. Far more than just a successful integrator, ENGlobal can design, fabricate, manufacture and fully test the kinds of highly modular, fully integrated control cabins that are ideal for today’s most advanced automated drilling rigs. A highly experienced automation staff with years under their belts, doing everything from DCS (distributed control system) migrations, plant re-instrumentations and complete expansions, to customized electrical, control system and instrument initializations, stands at the ready to help the company’s clients.
By providing everything from commissioning and process control start-up support, to power distribution and generation, as well as loop check, complete analytical verification and even EPA-regulated system automation services, ENGlobal is able to stay profitable and attract new business, even when times are tough in the industry, maintaining profitability on the strength of reputation and a diversity of offerings. It is this capacity to deliver automation and control system services that span the gamut, covering almost any task imaginable, from conception through to execution, which will continue to make the company attractive amid further industry consolidation as we potentially head towards a more lively sector rebound sometime in mid to late 2016.
Research and investing information provider Cowen & Co analysts are projecting small to mid-cap E&P’s are in for some rocky terrain next year, with a $16 billion shortfall between cash flow projections and spending estimates, requiring some $8.6 billion in order to meet production growth projections for 2016. This reality will continue to fuel M&A activity within the sector and for companies like ENGlobal, an ability to court the biggest players will be a deciding factor, whether the work is at home or abroad.
Significant domestic tightness in crude supply over the next two months into July and August, driven by increased drawdowns like those we have seen over the preceding seven weeks, but clocking in at as much as eight million barrels per week, could push crude to over $70 a barrel according to recent analysis from OptionSellers. As Americans increasingly hit the roads for the peak of driving season, associated draws in secondary products like gasoline should also rise, putting even more wind in the energy market’s sails. This price activity could seriously pan out longer term as the true impact of the recent, dramatic reduction in upstream activity like new well starts becomes more and more obvious. New well starts were off by 105 percent compared to last year in May, down to 1,761 from 3,625 according to RigData. A trend tracked by permits, which were also off substantially from the same period last year, showing a 75 percent reduction from 2014, to around only 898 in May. People keep talking about a supply glut, but unless upstream activity picks back up to levels seen before the crude price crashed in late 2014, supplies could dry up quickly and ignite a bull market in E&P capital expenditures, as we scramble to meet demand without having to return to a paradigm dominated by OPEC exports.
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