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Diamondback’s Permian purchases: there goes the neighbourhood

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One thing to start: markets including oil fell on news of the new coronavirus strain that forced the UK back into lockdown and raised worries about the pace of the global economic recovery. Brent threatened to dip back below $50 yesterday and this morning was $50.03 in early London trading. The reversal may mark the end of the vaccine rally — at least for now — and caps a year that has been dominated by the virus.

Our first note in a bumper festive special newsletter today is on another deal in the American shale patch, where Diamondback Energy is beefing up its Permian position. Our second reflects on some of the obstacles that await Joe Biden’s energy agenda. And our third looks ahead, picking out the main themes for 2021.

This is our last newsletter of the year. Thank you to everyone who has signed up and been present through the relaunch of Energy Source. We will be back refreshed in January and hope you will be too. Happy Christmas and new year to all.

Thanks for reading. Please get in touch at energy.source@ft.com. You can sign up for the newsletter here. — Derek

Diamonds in the rough

Diamondback Resources, a Permian shale operator, bought a pair of rival producers this week in deals worth close to $3.1bn, snapping up QEP Resources for about $2.2bn — including roughly $1.6bn in debt — and paying just over $860m for Guidon Energy, which is backed by private equity group Blackstone.

It was the latest in a string of shale deals this year. Here are three takeaways:

Betting on the Permian

For Diamondback, the deals are about absorbing assets that sit alongside its land in the Midland basin. The Permian is emerging from the crisis as the only part of the shale patch with clear growth prospects. Diamondback’s chief executive Travis Stice said he plans to plough money into the newly acquired acreage immediately, while indicating he may put QEP’s assets in North Dakota’s Bakken up for sale.

The deal also helps Diamondback keep up with its Permian rivals, especially large independent producers such as ConocoPhillips, which bought Concho Resources in October, and Pioneer Natural Resources.

“These are certainly extraordinary times, but also times that create extraordinary opportunities,” Mr Stice said on an analyst call yesterday.

QEP highlights the turn in shale’s fortunes

QEP shareholders will have mixed feelings about the deal. The producer fought off activist hedge fund Elliott Management in January when the fund’s offer valued the group’s shares at $8.75 each, nearly four times the $2.29 a share implied in the Diamondback deal.

Obviously, a lot has happened in the past 12 months, including a global pandemic, an oil price war and a collapse in crude demand. QEP’s shares have dropped roughly 75 per cent since the Elliott offer in January 2019.

Still, said Enverus analyst Andrew Dittmar, QEP shareholders “should ultimately benefit from ownership by a larger, top-tier operator like Diamondback”.

Monday’s deals show consolidation in the shale patch is continuing. © Bloomberg

Sign of things to come

The deal is the latest in a consolidation wave sweeping across the shale sector. It won’t be the last, say analysts. QEP and Guidon were among a large number of smaller companies that thrived during shale’s growth era, but now look ill-fitted to meet investor demands for higher shareholder returns and slower output growth.

Producers will tie up to create bigger companies “better able to shoulder the ebbs and flows of the commodity markets and access capital more cheaply and effectively as oil and gas funding dries up”, said Raoul LeBlanc, an IHS Markit analyst.

(Justin Jacobs)

The obstacles to Biden’s clean-energy revolution

“Personnel is policy”, they say in Washington, and Joe Biden’s cabinet nominations point squarely at the president-elect’s energy ambitions. Progressives are pleased with Mr Biden’s plans to deal with the “existential threat of our time, climate change”. His administration picks are set to take on pollution, supply-side reform, emissions and environmental justice.

And yet, legal and political experts agree: a conservative judiciary and politically divided Congress will be huge obstacles to Mr Biden’s proposed $2tn clean-energy revolution.

After losing seats in the House and failing to command a Senate majority, the Democrats lack the legislative backing for such sweeping change.

The run-offs in Georgia could change this. But even if the Democrats win both seats — leaving the chamber split 50-50, and giving Kamala Harris the casting vote — the big reforms will be tough to get through. In private, fossil fuel lobbyists confidently predict some Democrat senators will throw sand in the gears of big energy legislation from their own party.

And if Republicans retain the Senate, the party control of key committees and majority leader Mitch McConnell control of the agenda, things will move slowly indeed. Mr Biden’s cabinet nominees may be opposed. And the idea of big spending on clean energy will definitely be off the table, say Republican lobbyists.

There are options on the regulatory side. Jody Freeman, a Harvard law professor, cited examples such as the power of the Treasury secretary to push for climate disclosures from industry, or changes to procurement policy at the Department of Defense.

And the president has numerous other federal agencies at his disposal, which I explored in yesterday’s FT Big Read.

The president-elect campaigned on the most aggressive climate platform in history. © AP

Jonathan Adler, a professor at Case Western Reserve University School of Law, says that the administration can use agencies such as the Federal Energy Regulatory Commission and the Securities Exchange Commission to make life harder for polluters or to incentivise capital to back clean energy.

But the courts are going to be “sceptical” of federal bodies being “expansive”, said Ms Freeman.

Mr Adler agreed, saying any “freelancing” by the EPA — going beyond the remit Congress gave it by, for example, seeking to regulate climate change — will make courts antsy.

“The more you focus on carbon dioxide, and the more you try and do broad initiatives, like we saw in the [Obama-era] Clean Power Plan, the more dangerous it gets,” he said.

And yet there is room for compromise. David Bookbinder, chief counsel at the Niskanen Center think-tank, thinks Republicans will back spending to fix the transmission system — a crucial brick in building any new clean-energy grid. “That means jobs and money in red states,” he said.

An early sign of what will win bipartisan backing came in the new stimulus bill. It included an extension of clean-energy tax credits, more money for research and development as well as for electric-vehicle charging, and a plan to phase out hydrofluorocarbons — a potent greenhouse gas.

Kodiak Hill-Davis, the political director for Republican Women for Progress, said in a statement that the inclusions of some of those measures indicated that Republicans are “coming around” to climate legislation.

But a clean-energy revolution is not on the cards. For that, Democrats will need to wait until the 2022 midterms when they have another shot at changing the political math on the Hill.

“To make it a full-scale push, that’s going to require either a change in the American psyche, or a change in Congress,” says Mr Bookbinder.

(Derek Brower)

Is 2020 over yet?

Like almost everyone else, those in the energy sector will be happy to put 2020 in the rear-view mirror. Here are five energy stories we’re watching in 2021:

  1. The shape of the Covid recovery: The pandemic brought unprecedented disruption and chaos. What will the sector look like on the other side? Will governments use post-crisis stimulus to pump money into the green transition? How high can oil prices go if a freshly vaccinated and newly freed public returns to the skies and roads with renewed gusto?

  2. Climate diplomacy’s next act: Climate diplomacy suddenly has the wind at its back. The incoming Biden administration has signalled climate change will be a top tier foreign policy issue and major economies have set out net-zero carbon targets around the middle of the century. The COP26 summit in November, the biggest climate meeting since the Paris pact was reached in 2015, will figure prominently on the global agenda. Can governments turn fuzzy long-term ambition into meaningful action?

  3. Big oil bets on different futures: A split in the oil sector appeared in 2020 as European majors began a pivot to a low-carbon model and US oil majors held firm. The bets these companies place next year could set them down fundamentally divergent paths for decades to come — 2021 will tell us which ones are ready to stick with their plan.

  4. Shale’s new revolution: America’s tight oil producers, so critical to global energy markets and the US economy over the past decade, are emerging from the pandemic into an utterly transformed landscape. Investors have turned against the sector, cutting off access to capital. Environmental, social and governance pressures are mounting. A new president means more regulation and a lost seat at the table in Washington. Can the shale business reinvent itself for a more straitened future?

  5. Clean-tech: boom or bubble? It wasn’t just Tesla. Investors piled into clean tech start-ups promising breakthroughs in hydrogen, batteries, electric vehicles and more. The valuations of renewables-focused companies soared. Will the energy transition keep up with investor hopes or is a redux of the 2000s clean tech bust imminent?

(Justin Jacobs)

Data Drill

The Covid-19 pandemic destroyed oil demand and sent the industry into a tailspin. Here, in chart form, is a look back at what happened in a year the sector will not forget.

Line chart of Percentage change in US routing requests showing People stopped going out
Line chart of $/barrel showing The oil price plummeted
Column chart of Chapter 11 filings (cumulative) showing Oil and gas bankruptcies soared
Line chart of Percentage change since Dec 31 showing Oil stocks tanked ... but clean energy fared better
Column chart of Energy related CO2 emissions (billion tonnes) showing And carbon dioxide emissions fell

Power Points

  • Shell will slash another $4.5bn from the value of its assets, after already disclosing $18bn worth of writedowns this year.

  • Expect more soul searching and more asset impairments in 2021 from an oil industry suddenly aware of the potential for stranded assets, says Lex.

  • Vestas is investing €500m in a new tie-up with fund manager Copenhagen Infrastructure Partners, expanding a push into project development from the world’s largest wind turbine maker.

  • China’s ban on imports of Australian coal is worsening a power shortage.

  • A third of climate funds sold in the UK are invested in oil and gas companies, according to research that highlights concerns of investors being misled by sustainable investment products.

Endnote

The International Energy Agency, the US Energy Information Administration and Opec have released their final monthly oil-market assessments for 2020. For the last time this year, here is our round-up of what matters and what changed:

Energy Source is a twice-weekly energy newsletter from the Financial Times. Its editors are Derek Brower and Myles McCormick, with contributions from Justin Jacobs in Houston, Gregory Meyer in New York, and David Sheppard, Anjli Raval, Leslie Hook and Nathalie Thomas in London.



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Why it might be good for China if foreign investors are wary

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Chinese economy updates

The writer is a finance professor at Peking University and a senior fellow at the Carnegie-Tsinghua Center for Global Policy

The chaos in Chinese stock markets last week was exacerbated by foreign investors selling Chinese shares, leaving Beijing’s regulators scrambling to regain their confidence while they tried to stabilise domestic markets. But if foreign funds become more cautious about investing in Chinese stocks, this may in fact be a good thing for China.

In the past two years, inflows into China have soared by more than $30bn a month. This is partly because of a $10bn-a-month increase in the country’s monthly trade surplus and a $20bn-a-month rise in financial inflows. The trend is expected to continue. Although Beijing has an excess of domestic savings, it has opened up its financial markets in recent years to unfettered foreign inflows. This is mainly to gain international prestige for those markets and to promote global use of the renminbi.

But there is a price for this prestige. As long as it refuses to reimpose capital controls — something that would undermine many years of gradual opening up — Beijing can only adjust to these inflows in three ways. Each brings its own cost that is magnified as foreign inflows increase.

One way is to allow rising foreign demand for the renminbi to push up its value. The problem, of course, is that this would undermine China’s export sector and would encourage further inflows, which would in turn push China’s huge trade surplus into deficit. If this happened, China would have to reduce the total amount of stuff it produces (and so reduce gross domestic product growth).

The second way is for China to intervene to stabilise the renminbi’s value. During the past four years China’s currency intervention has occurred not directly through the People’s Bank of China but indirectly through the state banks. They have accumulated more than $1tn of net foreign assets, mostly in the past two years.

Huge currency intervention, however, is incompatible with domestic monetary control because China must create the renminbi with which it purchases foreign currency. The consequence, as the PBoC has already warned several times this year, would be a too-rapid expansion of domestic credit and the worsening of domestic asset bubbles. 

Many readers will recognise that these are simply versions of the central bank trilemma: if China wants open capital markets, it must give up control either of the currency or of the domestic money supply. There is, however, a third way Beijing can react to these inflows, and that is by encouraging Chinese to invest more abroad, so that net inflows are reduced by higher outflows.

And this is exactly what the regulators have been trying to do. Since October of last year they have implemented a series of policies to encourage Chinese to invest more abroad, not just institutional investors and businesses but also households.

But even if these policies were successful (and so far they haven’t been), this would bring its own set of risks. In this case, foreign institutional investors bringing hot money into liquid Chinese securities are balanced by various Chinese entities investing abroad in a variety of assets for a range of purposes.

This would leave China with a classic developing-country problem: a mismatched international balance sheet. This raises the risk that foreign investors in China could suddenly exit at a time when Chinese investors are unwilling — or unable — to repatriate their foreign investments quickly enough. We’ve seen this many times before: a rickety financial system held together by the moral hazard of state support is forced to adjust to a surge in hot-money inflows, but cannot adjust quickly enough when these turn into outflows.

As long as Beijing wants to maintain open capital markets, it can only respond to inflows with some combination of the three: a disruptive appreciation in the currency, a too-rapid rise in domestic money and credit, or a risky international balance sheet. There are no other options.

That is why the current stock market turmoil may be a blessing in disguise. To the extent that it makes foreign investors more cautious about rushing into Chinese securities, it will reduce foreign hot-money inflows and so relieve pressure on the financial authorities to choose among these three bad options.

Until it substantially cleans up and transforms its financial system, in other words, China’s regulators should be more worried by too much foreign buying of its stocks and bonds than by too little.



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Square to acquire Afterpay for $29bn as ‘buy now, pay later’ booms

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Square Inc updates

Payments company Square has reached a deal to acquire Australian “buy now, pay later” provider Afterpay in a $29bn all-stock transaction that would be the largest takeover in Australian history.

Square, whose chief executive Jack Dorsey is also Twitter’s CEO, is offering Afterpay shareholders 0.375 shares of Square stock for every share they own — a 30 per cent premium based on the most recent closing prices for both companies.

Melbourne-based Afterpay allows retailers to offer customers the option of paying for products in four instalments without interest if the payments are made on time.

The deal’s size would exceed the record set by Unibail-Rodamco’s takeover of shopping centre group Westfield at an enterprise value of $24.7bn in 2017.

The transaction, which was announced in a joint statement from the companies on Monday, is expected to be completed in the first quarter of 2022.

Afterpay said its 16m users regard the service as a more responsible way to borrow than using a credit card. Merchants pay Afterpay a fixed fee, plus a percentage of each order.

The deal underscored the huge appetite for buy now, pay later providers, which have boomed during the coronavirus pandemic.

“Square and Afterpay have a shared purpose,” said Dorsey. “We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles.”

Adoption of buy now, pay later services had tripled by early this year compared with pre-pandemic volumes, according to data from Adobe Analytics, and were particularly popular with younger consumers.

Rivalling Afterpay is Sweden’s Klarna, which doubled its valuation in three months to $45.6bn, after receiving investment from SoftBank’s Vision Fund 2 in June. PayPal offers its own service, Pay in 4, while it was reported last month that Apple was looking to partner with Goldman Sachs to offer buy now, pay later facilities to Apple Pay users.

Steven Ng, a portfolio manager at Afterpay investor Ophir Asset Management, said the deal validated the buy, now pay later business model and could be the catalyst for mergers activity in the sector. “Given the tie-up with Square, it could kick off a round of consolidation with other payment providers where buy now, pay later becomes another payment method offered to their customers,” he said.

Over the past two years Afterpay has expanded rapidly in the US and Europe, which now account for more than three-quarters of its 16.3m active customers and a third of merchants on its platform. Afterpay said its services are used by more than 100,000 merchants across the US, Australia, Canada and New Zealand as well as in the UK, France, Italy and Spain, where it is known as Clearpay.

Square intends to offer the facility to its merchants and users of its Cash App, a fast money transfer service popular with small businesses and a competitor to PayPal’s Venmo.

“It’s an expensive purchase, but the buy now, pay later market is growing very rapidly and it makes a lot of sense for Square to have a solid stake in it,” said retail analyst Neil Saunders.

“For some, especially younger generations, buy now, pay later is a favoured form of credit. Afterpay has already had some success with its US expansion, but Square will be able to accelerate that by integrating it into its platforms and payment infrastructure — that’s probably one of the justifications for the relatively toppy price tag of the deal.”

Square handled $42.8bn in payments in the second quarter, with Cash App transactions making up about 10 per cent, according to figures released on Sunday. The company posted a $204m profit on revenues of $4.7bn.

Once the acquisition is completed, Afterpay shareholders will own about 18.5 per cent of Square, the companies said. The deal has been approved by both companies’ boards of directors but will also need to be backed by Afterpay shareholders.

As part of the deal, Square will establish a secondary listing on the Australian Securities Exchange to provide Afterpay shareholders with an option to receive Square shares listed on the New York Stock Exchange or the ASX. Square may elect to pay 1 per cent of the purchase price in cash.

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Biden puts workers ahead of consumers

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US economy updates

For the past 40 years in America, competition policy has revolved around the consumer. This is in part the legacy of legal scholar Robert Bork, whose 1978 book The Antitrust Paradox held that the major goal of antitrust policy should be to promote “business efficiency”, which from the 1980s onwards came to be measured in consumer prices. These were considered the fundamental measure of consumer wellbeing, which was in turn the centre of economic wellbeing.

But things are changing. A White House executive order on competition policy, signed last month, contains some 72 discreet measures designed to stamp out anti-competitive practices across nearly every part of the US economy. But it isn’t about low prices as much as it is about higher wages.

Like the Reagan-Thatcher revolution, which took power from unions and unleashed markets and corporations, Biden’s executive order may well be remembered as a major economic turning point — this time, away from neoliberalism with its focus on consumers, and towards workers as the primary interest group in the US economy.

In some ways, this matters more than the details of particular parts of the order. Many commentators have suggested that these measures, on their own, won’t achieve much. But executive orders aren’t necessarily about the details — they are about the direction of a government. And this one takes us completely away from the Bork era by focusing on the connection between market power and wages, which no president over the past century has acknowledged so explicitly.

“When there are only a few employers in town, workers have less opportunity to bargain for a higher wage,” Biden said in his announcement of the order. It noted that, in more than 75 per cent of US industries, a smaller number of large companies now control more business than they did 20 years ago.

His solutions include everything from cutting burdensome licensing requirements across half the private sector to banning and/or limiting non-compete agreements. Firms in many industries have used such agreements to hinder top employees from working for competitors, as well as to make it tougher for employees to share wage and benefit information with each other — something that Silicon Valley has done in nefarious ways.  

This gets to the heart of the American myth that employees and employers stand on an equal footing, a falsehood that is reflected in such Orwellian labour market terms as the “right to work”. In the US this refers not to any sort of workplace equality, but rather to the ability of certain states to prevent unions from representing all workers in a given company.

But beyond the explicitly labour-related measures, the president’s order also gets to the bigger connection between not just monopoly power and prices, but corporate concentration and the labour share.

As economist Jan Eeckhout lays out in his new book The Profit Paradox, rapid technological change since the 1980s has improved business efficiency and dramatically increased corporate profitability. But it has also led to an increase in market power that is detrimental for people in work.

As his research shows, firms in the 1980s made average profits that were a tenth of payroll costs. By the mid 2000s that ratio had jumped to 30 per cent and it went as high as 43 per cent in 2012. Meanwhile, “mark-ups” in profit margins due to market power have also risen dramatically (though it can be difficult to see this in parts of the digital economy that run not on dollars but on barter transactions of personal data).

While technology can ultimately lower prices and thus benefit everyone, this “only works well if markets are competitive. That is the profit paradox,” says Eeckhout. He argues that when firms have market power, they can keep out competitors that might offer better products and services. They can also pay workers less than they can afford to, since there are fewer and fewer employers doing the hiring.

The latter issue is called monopsony power, and it is something that the White House is paying particularly close attention to.

“What’s happening to workers with the rise in [corporate] concentration, and what that means in an era without as much union power, is something that I think we need to hear more about,” says Heather Boushey, a member of the president’s Council of Economic Advisors, who spoke to the Financial Times recently about how the White House sees the country’s economic challenges. 

The key challenge, according to the Biden administration, is that of shifting the balance of power between capital and labour. This accounts for the emerging ideas on how to tackle competition policy. There are many who regard the move away from consumer interests as the focus of antitrust policy as dangerously socialist — a reflection of the Marxian contention that demand shortages are inevitable when the power of labour falls.

But one might equally look at the approach as a return to the origins of modern capitalism. As Adam Smith observed two centuries ago, “Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased.” Reprioritising it is a good thing.

rana.foroohar@ft.com



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