Ralph Eads III, Vice Chairman, Global Head of Energy Investment Banking, Jefferies LLC
What or who inspired you to work in the oil and gas industry?
I am a fifth generation Texan and a native Houstonian, so I have been around the oil business my entire life. One of the things that drew me to the industry is all the great lore around it. I have always liked all the stories and the traditions of risk-taking and boom and bust. It is just a fascinating industry.
You have assumed various financial roles throughout your career in the industry. What roles do you or did you enjoy most and why?
I enjoy my current job the most. Here at Jefferies, we have a true combination of finance and technical expertise. It is stimulating to see interesting projects and to do technical analysis on individual plays. You get the transactional activity associated with finance, but you also get exposed to the innovation in the industry.
How do fluctuating oil prices, specifically the low oil prices seen today, affect the mergers and acquisitions (M&A) business?
It kills it; the market just stops. We mainly act for sellers and that business has stopped because buyers want to buy packages at USD 50/bbl oil, and sellers do not want to sell that low given that the price of oil was USD 80/bbl only a short time ago. If prices stay low, sellers will start selling at the lower price, or if prices recover, we will get back to a market that transacts around USD 80/bbl oil. But for now, the market is frozen.
How has Jefferies’ business changed? What fundamental changes are Jefferies making to adapt to this new price regime? What makes Jefferies different from other M&A banks?
We are reacting to the market. In truth, we will be less busy in this environment than we would be in a “normal” price environment. But companies still need capital and when you do a private transaction, the buyer of that security wants to understand the asset they are buying, what it looks like, and the development plan that goes with it. Fortunately, there is a lot of private capital available for the industry right now, and we are a leader in private capital-raising because of our technical expertise.
We have 40 engineers, geologists, and geophysicists embedded in our firm. We do not just package the data to sell; we actually think about the technical issues and say “what opportunities are there with this asset to make it more valuable, and how do we portray that to the market?” For example, we have done a complete basin analysis of the Eagle Ford Shale. One of the reasons we do this is that it allows us to understand what is happening in the different plays. We are oilmen first, financiers second. We are driven by what is happening to the underlying business of the industry.
Are many startups failing during this period of low-cost oil?
It depends. Some startups have strategies that can live in a USD 50/bbl world, and some do not. For example, if it is a company that is interested in tertiary recovery—high-cost oil—then those business plans will idle. Maybe they will not go out of business, but they will not spend any capital because they are not attracting any. There are some businesses that can adapt to a lower price environment and still make money because of the underlying investments that they are trying to create.
What are some of the social and political causes of the low commodity prices?
We have the perfect storm for low prices right now: the Saudis have the will and the money to cut prices, there is political stability in all the bad actor countries, and we have slack global demand. Those are the three variables that contribute fantastically to low oil price. Though, any one of these three variables could change quickly.
I think first, and most importantly, the Saudis want to inflict pain on Iran and the other bad actors, Syria, Iraq, etc. So they are trying to increase their political clout and to hit other countries’ pocketbooks. Secondly, they want to create uncertainty about the long-term oil price because they want the global companies to use USD 50/bbl for planning prices rather than USD 70/bbl, to cut projects and lower their production. They are just trying to drive down price and it does not take very much oil to do that.
What will it take for the oil price to increase? Do you think oil price will ever return to USD 100+/bbl?
Sure, absolutely, and maybe even in the next 6 months. When prices fell during 2008–2009, which was driven by demand fall, there was a 3 million BOPD overhang and prices recovered in 6 months. What everyone misses here is the amount of “extra” oil we have today, let us say, 1 million BOPD. That is nothing in a 90 million BOPD market. In the 1980s, it was a 10 million barrel surplus in a 70 million BOPD market. The current deliverability margin is quite low and the world depletes at around 7 million BOPD in a year. There is not that much extra oil to go around and so the market is going to tighten pretty quickly.
Once the Saudis make their point, they will turn the valve cutting off 500,000 BOPD and the low price will solve itself in 3 months. Outside of the market normalizing, the marginal cost curve for the industry continues to march up. We have found all the cheap oil and we are going to real frontier regions such as really deep water to get incremental oil; it is expensive. There is not much cheap oil lying around. This low oil price is such a weird aberration because actually the underlying economics are that the industry’s cost structure continues to march up. The world needs USD 80/bbl of oil to work.
Absent change in production from the Saudis, prices will probably stay down for a while and the industry will correct. I do not think on a global basis the industry can make money at USD 50/bbl, so natural depletion together with lack of investment will cause prices to turn around. If prices stay low, people will start to take drastic actions and the longer prices stay down, the higher they will rebound later.
What are the roles of demand and supply in the oil and gas market? What sort of projection can you make for the future global energy demand?
Demand is not decreasing, it is just not growing. First, China is becoming more efficient, which is natural in any developed economy. Second, demand in the emerging markets, where they are not as efficient, has gotten smoked by the [strengthening] dollar. Everyone buys oil in dollars and the dollar has appreciated against other currencies in the last 6 months—by a lot. A lot of the downward pressure on prices has been offset by the fact that the dollar has become a lot stronger.
On the supply side, we have enough oil and natural gas to run the planet for at least the next century. We may not choose to, but the resources exist. We won’t run out of energy, and energy efficiency is going to reduce energy demand over time. In fact, it has already reduced demand in that energy intensity per dollar of output is going down fairly rapidly. As this continues, the global economy gets less energy intensive.
How do different countries affect the demand and supply of oil and gas in the global market?
The list of countries that will contribute to incremental deliverability is tough. It is Iraq, Iran, Libya, and maybe Russia. Although these countries are stable right now, people are not rushing to invest there, because history says they are not going to stay that way.
The lease sales in Mexico will add to supply, but in the much longer term. The challenge with onshore Mexico is going to be infrastructure—they do not have roads and pipelines, and the recent oil price changes are going to delay a lot of Mexico’s production too. Then you have the US, which is stable and will continue to increase production even at today’s prices. The key to growing US production is the Permian Basin. It has become the marginal supplier of oil in the world and the industry’s center of gravity. I estimate the Permian Basin has recoverable reserves of 250 billion bbl of oil. That is a lot of oil and there is a lot of capital needed to get it.
What should be the response of policymakers to oil prices in countries around the world?
So far, no government leader has stood up and said anything about anything other than Saudi Arabia, UAE, and Kuwait all saying “we are not cutting production any time soon.” At some point, they will say they have reached the benefit that they were after, but what is that trigger? Who knows.
The US has exponentially increased oil production with the shale revolution. How sustainable is this level of oil production?
The resource plays in the US are in the third inning of the game, and they will continue to produce for a long time. In the 1950s, the San Juan basin recovery factors were estimated at 20% to 30%. Now, there are places in the basin where recovery has been 110% gas in place due to technological advances that increased recovery efficiency and unlocked neighboring horizons. That same trend is going to happen in other plays. Right now, the recovery factor in the Wolfcamp is 10%; what has to happen technologically to get to 50%?
The US has been granted a huge gift in the shale boom. It has reduced the cost of energy and it has created lots of employment in a world where we are worried about stagnation in wages and a lack of good jobs. The energy industry has been a shining beacon for the US, and it is important to remember that.
What is the impact of the current volatile oil price on shale, deepwater, and enhanced oil recovery?
People are going to try to defer deepwater capital, but you have to keep enhanced-oil-recovery projects running, because if you are doing a steamflood/ carbon dioxide flood, for example, you cannot stop. The most reactionary resource plays to the price of oil are shale and exploration. Shale plays can simply lay down rigs relatively quickly, and that is what they are doing. The exploration business, as it pertains to finding a new conventional oil field, is hard to begin with, and everyone simply defers the relatively big capital expenditure for long-cycle-time exploration projects at these low oil prices.
Which shale basins are profitable under current economic situations? Will the breakeven price for shale E&P change dramatically in the future?
The good spots in the Permian Basin can make money at USD 60/bbl, and maybe even lower. The Bakken needs a higher oil price to be profitable. If prices stay low, will service costs drop? By how much? Will that bring the breakeven down?
Where do you think the most future potential lies in the energy industry?
The North American industry looks really promising for a good long while. Secondly, the knowledge acquired from North American resource plays will expand to other parts of the world. Two examples are the Vaca Muerta shale in Argentina and coalbed methane in China. There are a lot of places in the world where oil and gas exist; it just has
to be accessed.
Another potential for the industry is the migration of the global energy economy to natural gas. Today, oil is used more or less for transportation but you could run a car on natural gas. The conversion of the global economy to natural gas would not be that hard to do and it has environmental benefits; natural gas is plentiful. It does not have to be a revolution, it can be
What advice can you give young professionals in the oil and gas industry, especially those interested in the finance side?
Technical expertise is incredibly valuable. Invest in your human capital. Be deliberate and thoughtful in that investment. Have a plan. Take a job to work in an environment where you are going to learn the most and be challenged. If you do that consistently, you will wake up one day and you will know a lot, and you will have a lot of opportunities.
Any advice to young professionals during this time of volatile commodity prices?
Think about how to make the projects you are working on today more efficient. There is a lot of benefit to a low-price environment because you learn how to be more efficient. Human capital is too scarce in the industry to see massive layoffs yet. Some people will use this as an opportunity to “upgrade,” but I do not foresee big layoffs. Companies are pretty lean in general. Everyone is just going to hunker down.
Ralph Eads is vice chairman of Jefferies LLC and global head of Jefferies' Energy Investment Banking Group. His extensive mergers and acquisitions (M&A) experience includes working on more than USD 300 billion in energy M&A transactions. Before this, Eads was president of Randall & Dewey, which was acquired by Jefferies in 2005. His previous positions were executive vice president of El Paso Corp., handling its unregulated businesses; head of the energy group of Donaldson, Lufkin & Jenrette; and senior positions at S.G. Warburg and Lehman Brothers. Eads serves on the board of trustees of Duke University.
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29 April 2020