Why Keystone XL’s delay is not such a bad thing!

Over the last fortnight the Oilholic has been examining the fallout from the US government’s announcement delaying a decision on the proposed Keystone XL pipeline and its decision to explore alternative routes for it from Alberta, Canada to Texas, USA (See map. Click image to enlarge).

To begin with, it gave Canadian Prime Minister Stephen Harper an opportunity trumpet his country's new-found assertiveness in the energy sphere. A mere three days after the US State department announced the delay, Harper told President Obama, whom he met at the Asia Pacific Economic Co-operation forum in Hawaii, that his government was working to forcefully advance a trade strategy that looks towards the Asia Pacific.

Harper had strong language for the President and told reporters that since the project will now be delayed for over a year, Canada must (also) look elsewhere. "This highlights why Canada must increase its efforts to ensure it can supply its energy outside the United States and into Asia in particular. And that in the meantime, Canada will step up its efforts in that regard and I communicated that clearly to the president,” he said.

Of course, this version differs significantly from what the White House said but it gives you a flavour of the frustration being felt in Canada. The Canadian Association of Petroleum Producers (CAPP) says the US government’s decision was disappointing given the three years of extensive analysis already completed and after the US government’s own environmental impact assessment determined the proposed Keystone XL pipeline routing would not have an undue environmental impact.

CAPP President Dave Collyer, whom the Oilholic met back in March, said, “Keystone XL is not about America using more oil, it’s about the source of America’s oil – Canada or elsewhere. It’s also about common economic and geopolitical interests between Canada and the US. While the Keystone delay is unfortunate, we respect the United States regulatory process and remain optimistic the pipeline will be approved on its strong environmental, economic and energy security merits.”

CAPP also seeks to look at the positives and maintains that Canadian oil sands production will not be impacted in the near term and other alternatives are being pursued to ensure market access over the medium term. Simply put, delaying Keystone XL will motivate exploration of other markets for Canadian crude oil products as the Canadian PM has quite clearly stated.

Moving beyond the geopolitical scenario, ratings agency Moody's feels the Keystone XL delay is credit positive for TransCanada Pipelines (TCPL) – the project saga’s chief protagonist – although it does not change TCPL's A3 Senior Unsecured rating or stable outlook given the relative size of the Keystone XL project to TCPL's existing businesses.

In a note to clients on Nov 11, the agency noted that the announcement was likely to cause a material delay in the potential construction of that pipeline, which will actually benefit TCPL's liquidity, leverage and free cash flow, providing the company with a greater financial cushion with which to undertake the project if and when it is fully approved.

Moody's also does not expect the Company to undertake share buybacks with the funds not invested in Keystone XL due to the approval delay. TCPL's liquidity will improve as the construction delay will defer over $5 billion of additional capex (compared to TCPL's total assets of approximately $46 billion).

Furthermore, 75% of additional costs associated with the delay or rerouting is expected to be largely borne by the shippers rather than TCPL. Moody's expects the shippers to agree to a project delay, but that is not certain.

“While the delay may reduce TCPL's growth prospects in the medium term, that is not a major influence in the Company's credit rating. Should the project ultimately be cancelled, Moody's expects that the pipe, which is the largest component of the $1.9 billion that TCPL has already invested in the project and which is already reflected in the company's financial statements, would be repurposed to other projects that would presumably generate additional cash to TCPL over the medium term,” it concludes.

Since then, the US state of Nebraska and TCPL have agreed to find a new route for the stalled pipeline that would ensure it does not pass through environmentally sensitive lands in the state. The deal with Nebraska would see the state fund new studies to find a route that would avoid the Sandhills region and the Ogallala aquifer.

However, the deal will not alter the timeline for a US Federal review, according to the State Department. That means, as the Oilholic noted earlier, the Obama Administration will not have to deal with the issue until after the 2012 election. While that’s smart politics, its dumb energy economics. Right now it appears that the Canadians have less to lose than the Americans.

Moving away from Keystone XL, the crude markets began the week with a bang as the ICE Brent forward month futures contract climbed over US$3 to US$109 per barrel but the rise across the pond was more muted with WTI ending the day at US$98.20 unable to hold on to earlier gains. Jack Pollard, analyst at Sucden Financial Research, feels that Middle-Eastern tensions provided significant support to the upside momentum.

“Yesterday we had the first day of Egyptian elections, with the final vote not due until early to middle January and the interim prospect of further violence could maintain volatility. Furthermore, the pressure on Syria increased even further with some suggesting a no-fly zone could be in the offing,” he said.

However, the Oilholic and Pollard are in agreement that the main market driver emanated from Iran. “Ever since the IAEA report on November 8th we have seen the possibility of supply disruptions contribute to crude oil price’s resilience relative to the rest of the commodity complex. On Monday, we heard reports that Iran’s government had officially voted in favour of revising down their diplomatic relations with the UK, ejecting the ambassador. Should the situation escalate further, the potential for upside could increase significantly, disproportionately so for Brent,” Pollard concludes.

© Gaurav Sharma 2011. Map: All proposals of Canadian & US Crude Oil Pipelines © CAPP (Click map to enlarge)

‘Quest’ for energy security vis-à-vis geopolitics

The current disruption of the geostrategic balance that had underpinned the Middle East for decades is bound to cause ripples in energy markets. But don't these recent developments only add to scares of the past. In his latest work 'The Quest', a follow-up to his earlier work 'The Prize', author Daniel Yergin notes that in a world where fossil fuels still account for more than 80% of the world's energy, crises underscore a fundamental reality - how important energy is to the world.

This weighty volume is Pulitzer Prize winner Yergin's attempt to explain that importance intertwined in a story about the quest for energy security, oil business, search for alternatives to fossil fuels and the world we live in. Three fundamental questions shape this free-flowing and brilliant narrative spread over 800 pages split by six parts containing some 35 detailed chapters. To begin with, will enough energy be available to meet the needs of a growing world and crucially at what cost and with what technologies?

Secondly, how can the security of the energy system on which the world depends be protected and finally, what will be the impact of environmental concerns? The author gives his answers to these profound questions citing international events and technological developments of the decades past and present.

Part I discusses the new and more complex world order after the Gulf War, Part II focuses on energy security issues while Part III discusses the advent of electricity and "gadgetwatts". Part IV discusses climate change, Part V clean technologies and lastly in Part VI, Yergin offers the reader his take on the road ahead.

Shale, oil sands, 'rise' of gas, wind, solar, biofuels, offshore and peak oil versus the perceptively "ever expanding range of the drillbit" have all been discussed in detail by the author. In all honestly, it is neither a pro-fossil fuel rant nor does it belittle the renewables business. Rather it highlights the complexities of both sides of the carbon divide with the macroeconomic and geopolitical climate serving a constant backdrop.

Current the book surely is, accompanied by a healthy dosage of historical contextualisation and Yergin's own take on whether nation states - chiefly the US and China - are destined for a clash over energy security. The Oilholic read page after page fascinated by an extraordinary range of 'non-fiction' characters, places, technologies, theories and the dramatic stories they resulted in.

What really struck the Oilholic was that the narrative is free from industry gobbledegook (or its duly explained where applicable) and as such should appeal to a wider mainstream readership base than just energy professionals and those with a mid to high level of market knowledge. Its crisp mix of storytelling and analysis suits petroleum economists and leisure readers alike.

While the Oilholic attaches a caveat that a book of 800 pages is not for the faint hearted, he is happy to recommend it to business professionals, students of economics and the energy business, and as noted above - those simply interested in current events and the history of the oil trade. It is of course, a must for fellow Oilholics.

© Gaurav Sharma 2011. Photo: Cover of ‘The Quest: Energy, Security, and the Remaking of the Modern World’ © Allen Lane/Penguin Publishers 2011.

UK PM flags up crude credentials

The Oilholic attended the British lobby group CBI’s annual conference earlier today listening to UK Prime Minister David Cameron flag-up his crude credentials (admittedly among other matters). The PM feels investment in the Oil & Gas sector and British expertise in it could be part of his wider economic rebalancing act.

“In last few weeks alone I have visited an £4.5 billion new investment from BP in the North Sea…And today I hosted Britain and Norway signing a 10-year deal to secure gas supplies and develop together over £1 billion of Norwegian gas fields,” he said.

That deal of course was part of British utility Centrica’s 10-year agreement worth £13 billion to buy natural gas from Norway's Statoil and jointly develop fields.

"Gas plays a central role in powering our economy, and will continue to do so for decades to come. Today's agreement will help to ensure the continued security and competitiveness of gas supplies to Britain, from a trusted and reliable neighbour," the PM concluded.

Admittedly, from a gasoline consumers’ standpoint successive British governments have long lost street cred when it comes to taxing fuel a long while ago; still the present lot fare better in relative terms if the UK ONS is to be relied upon. The British statistics body announced last week that the Government’s Share of petrol pump price dropped to 66p in the pound in 2009/10; from nearly 81p in 2001/02.

The data also show that the poorest 20% of UK households paid almost twice as much of their income in duties on fuel than the richest 20%. In 2009/10, the poorest 20% of households paid 3.5% of their disposable income on duty, compared with only 1.8% for the top 20%. Overall, the average UK household spent 2.3% of its disposable income on duties on fuel.

However, in cash terms, the richest 20% of households paid almost three-times the amount paid by the bottom 20%. In 2009/10 the richest 20% of households spent £1,062 on petrol taxes, compared with £365 for the poorest 20% of households. Overall, the average UK household spent £677 on duties on fuel in 2009/10.

Finally, the UK, US and Canada announced new sanctions against Iran following growing concern over its nuclear programme in wake of the IAEA report. In a statement the US government said that Iran's petrochemical, oil and gas industry (including supply of technical components for Upstream and downstream ops) and its financial sector would be targeted by the sanctions.

Canada will ban all exports for the petrochemical, oil and gas industries without exceptions while the British government would demand that all UK credit and financial institutions had to cease trading with Iran's banks from Monday afternoon. The Oilholic notes that this is first time the UK has cut off a petro-exporting country’s banking sector, in fact any country’s banking sector in this fashion. Its highly doubtful if the move will tame misplaced Iranian belligerence.

© Gaurav Sharma 2011. Photo: British Prime Minister David Cameron speaking at the CBI Conference, November 21^st, 2011 © Gaurav Sharma 2011.

Of Argentina, Petrobras & a few odd pipelines

Last ten days has seen the crude focus shift to Argentina for a multitude of reasons which may be construed as good or bad depending on your point of view. To begin with, BP’s move to sell assets in Argentina has fallen through after its partner withdrew from the deal. BP wanted to sell its 60% stake in Pan American Energy (PAE) to its partner in Argentina, Bridas Energy Holdings, which is subsequently owned by CNOOC, China's largest offshore oil producer.

However, on November 6th CNOOC said it was terminating the deal, signed a year ago as BP was grappling with the fallout from the Gulf of Mexico oil spill. The stake sale was worth an estimated US$7 billion and was one of the largest sales agreed by the firm following the disaster. It is understood that BP will now have to repay its US$3.5 billion deposit on the agreement which had been contingent on regulatory approval.

Barely days later, on November 8th, Spanish giant Repsol’s Argentine subsidiary – YPF Sociedad Anónima – said it had found 927 million barrels of recoverable shale oil in Argentina which could catapult the country to the energy elite league.

In a statement, YPF said the discovery – located in the Vaca Muerta basin of Argentina's Neuquen province – "will transform the energy potential of Argentina and South America, boasting one of the world's most significant accumulations of non-conventional resources".

The discovery is likely to give renewed impetus to the country’s creditors who have been chasing the Argentine government for almost a decade since its default in 2002. Most bondholders took part in debt exchanges in 2005 and 2010, but a brave crew of EM and NML Capital – an affiliate of Elliott management – along with a group of 60,000 individual Italian investors have been bravely holding out and using legal avenues to recoup the US$6 billion-worth of debt plus interest. They may think it’s about time the country paid courtesy of a commodities-led boom.

Regrettably for YPF though, the find came only days after Moody's downgraded Argentine oil & gas companies. These included YPF, Pan American LLC, Petrobras Argentina, Petersen Energia and Petersen Energia Inversora.

According to Moody’s, the ratings downgrade and review for further downgrade were prompted by the new presidential decree requiring oil, gas and mining companies to repatriate 100% of their export proceeds and convert them to Argentine pesos. Previously, oil and gas companies operating in Argentina were permitted to keep up to 70% of their export proceeds offshore.

Neighbouring Brazil’s oil & gas behemoth Petrobras has been busy too. On November 3rd, it announced a new oil discovery in the extreme South Western part of the Walker Ridge concession area, located in the Gulf of Mexico’s ultra-deep waters. The discovery confirms the Lower Tertiary's potential in this area. (see map on the left; click to enlarge)

The discovery – Logan – is approximately 400km southwest of New Orleans, at a water depth of around 2,364 meters (or 7,750 feet). The discovery was made by drilling operations of well WR 969 #1 (or Logan 1), in block WR 969. Further exploration activities will define Logan's recoverable volumes and its commercial potential.

Norway’s Statoil is the consortium's operator, with 35% stake. Petrobras America Inc. (a subsidiary of Petrobras headquartered in Houston, Texas) holds 35% of the stake, while Ecopetrol America and OOGC hold 20% and 10%, respectively.

Petrobras holds other exploratory concession areas in this region, which will be tested later on, growing the Company's operations in the Gulf of Mexico. The Brazilian major is the operator of Cascade (100%) and Chinook (66.7%) oilfields and holds stakes in the Saint Malo (25%), Stones (25%) and Tiber (20%) discoveries, all with significant oil reserves in the Lower Tertiary. Additionally, Petrobras has stakes in the very recent Hadrian South (23.3%), Hadrian North (25%) and Lucius (9.6%) discoveries, all with significant oil reserves and in the Mio-Pliocene.

The company has been pretty busy at home as well, announcing that the first well drilled after the execution of the Transfer of Rights agreement confirmed the extension of the oil reserves located northwest of the Franco area discovery well, in the Santos Basin pre-salt cluster (see map on the left; click to enlarge).

The new well, informally known as Franco NW, is at a water depth of 1860 meters, approximately 188km from the city of Rio de Janeiro and 7.7km northwest of discovery well Franco (or 2-ANP-1-RJS).

The discovery was confirmed by oil samples of good quality (28º API) obtained through cable tests. The well is still in the drilling phase with the aim of reaching the base of the reservoirs containing oil. Once the drilling phase is complete, Petrobras will continue with the investment activities provided in the Mandatory Exploratory Program (or Programa Exploratório Obrigatório, PEO as it’s referred to locally).

From South American discoveries to North American pipelines as it emerged last night that the Obama administration has chickened-out of making a decision on Keystone XL. Faced with the environmental lobby on one side and the Unions craving jobs on the other, the US government has requested further studies on the project which would in theory delay the decision to build the 2700km pipeline well after 2012 presidential election. Frustration across the border in Canada is likely to grow as the Oilholic noted from Calgary earlier this year.

If he rejected the project, Obama could be accused of destroying jobs. If allowed it to go ahead, it could lose him the support of some activists who helped him win the Presidency. So he chose to do what political jellyfish usually do before a crucial vote – nothing.

Additionally, reports surfaced earlier in the week that Houston-based Cardno Entrix – a company involved in the environmental review – had listed developer TransCanada, the pipeline’s sponsor, as a "major client".

A review is now likely to look into this as well as state department emails related to a TransCanada lobbyist who had worked in Secretary of State Hillary Clinton's 2008 presidential campaign. TransCanada says that while it is disappointed with the delay, it continues to “conduct affairs with integrity and in an open and transparent manner.”

Continuing with pipelines, Moody's has assigned a Baa3 rating to Ruby Pipeline's US$1.075 billion senior unsecured notes. The senior unsecured notes have staggered maturities and will be used to refinance US$1.5 billion of project construction loans. The rating outlook is stable.

Stuart Miller, Moody's Vice President and Senior Analyst, said last week that the pipeline is a strategic link that provides diversity of supply to the utilities and industrial markets in Northern California and the Pacific Northwest.

"Hence, the primary drivers for Ruby's Baa3 rating are its initially high leverage tempered by a high level of ship-or-pay firm contracts with counterparties with a weighted average credit rating of Baa1 as well as our expectation that the ratio of debt to EBITDA will rapidly decline to below 4.5x," he concluded.

Ruby's leverage is expected to improve over the next five years as its capital structure includes a five year amortising term loan. Because of the required amortisation, Ruby's leverage, as measured by debt to EBITDA, should decline from approximately 5.2x to less than 4.5x by the end of 2013. Any revenue earned from the 28% un-contracted pipeline capacity would reduce leverage quicker, the agency noted. Finally, Nordstream I gas pipeline came onstream earlier in the week. Here's the WSJ's Oilholic approved take on it.

© Gaurav Sharma 2011. Map 1: Petrobras prospections in Gulf of Mexico © Petrobras 2011. Map 2: Petrobras in Santos Basin, Brazil (Courtesy: Petrobras)

Crude markets & the Eurozone mess

The Eurozone sad show continues alternating from a Greek tragedy to an Italian fiasco and woes continue to hit market sentiment; contagion is now – not entirely unexpectedly – seen spreading to Italy with the country’s benchmark debt notes rates rising above the 7% mark at one point deemed ‘unsustainable’ by most economists. Inevitably, both crude benchmarks took a plastering in intraday trading earlier in the week with WTI plummeting below US$96 and Brent sliding below US$113. Let’s face it; the prospect of having to bailout Italy – the Eurozone’s third largest economy – is unpalatable.

The US EIA weekly report which indicated a draw of 1.37 million barrels of crude oil, against a forecast of a 400,000 build provided respite, and things have become calmer over the last 24 hours. Jack Pollard, analyst at Sucden Financial Research, noted on Thursday that crude prices gathered some modest upside momentum to recover some of Wednesday’s losses as equities pared losses and Italian debt yields come off their record highs.

“One important factor for crude remains the Iranian situation with Western diplomats adopting a decidedly more hard-line approach to their rhetoric. For example, the French Foreign Minister has said the country is prepared to implement ‘unprecedented sanctions’ on Iran whilst William Hague, British Foreign Secretary, has said ‘no option is off the table’. Should the geopolitical situation deteriorate, the potential for supply disruptions from OPEC’s second largest producer could provide some support to crude prices,” Pollard notes.

From a Brent standpoint, barring a massive deterioration of the Iranian scenario, the ICE Brent forward curve should flatten in the next few months, mainly down to incremental supply of light sweet crude from Libya, end of refinery maintenance periods in Europe and inventories not being tight.

In an investment note to clients, on October 20th, Société Générale CIB analyst Rémy Penin recommended selling the ICE Brent Jan-12 contract and simultaneously buying the Mar-12 contract with an indicative bid @ +US$1.5/barrel. (Stop-loss level: if spread between Jan-12 and Mar-12 contracts rises to +US$2.5/barrel. Take-profit level: if spread drops to 0.)

The Oilholic finds himself in agreement with Penin even though geopolitical risks starting with Iran, followed by perennial tensions in Nigeria, and production cuts in Iran and Yemen persist. But don’t they always? Many analysts, for instance at Commerzbank, said in notes to clients issued on Tuesday that the geopolitical climate justifies a certain risk premium in the crude price.

But Penin notes, rather dryly, if the Oilholic may add: “All these factors have always been like a Damocles sword over oil markets. And current disruptions in Nigeria, Yemen and Iraq are already factored in current prices. If tensions ease, the still strong backwardation should as well.”

Additionally, on November 1st, his colleagues across the pond noted that over the past 20 years, when the NYMEX WTI forward curve has flipped from contango into backwardation, it has provided a strong buy signal. Société Générale CIB, along with three others (and counting) City trading houses recommend buying WTI on dips, as the Oilholic is reliably informed, for the conjecture is not without basis.

There is a caveat though. Société Générale CIB veteran analyst Mike Wittner notes that it is important to take into account the fact that crude oil stocks at Cushing, Oklahoma, consist not only of sweet WTI-quality grades but also of sour grades. “Most market participants, including us, do not know the exact breakdown between sour and sweet crudes at Cushing, but the recent move into backwardation suggests that there is little sweet WTI-quality crude left,” he adds.

Société Générale CIB analysts believe market participants who are reluctant to go outright long WTI in the current highly uncertain macroeconomic environment may wish to consider using the WTI sweet spot signal to go long WTI against Brent. Any widening of the forward-month Brent-WTI spread towards US$20 represents a trading opportunity, as the spread should narrow to at least US$15 and possibly to as low as US$10 before year-end, on the apparent shortage of WTI and increasing supply of Atlantic Basin waterborne sweet crude.

© Gaurav Sharma 2011. Photo: Trans Alaska Pipeline © Michael S. Quinton / National Geographic

Is "assetization" of Black Gold out of control?

Crude oil price should reflect a simple supply-demand equation, but it rarely does in the world of oil index funds, ETFs and loose foresight. Add to the mix an uncertain geopolitical climate and what you get is extreme market volatility. Especially since 2005, there have been record highs, followed by record lows and then yet another spike. Even at times of ample surpluses at Cushing (Oklahoma) - the US hub of criss-crossing pipelines - sometimes the WTI ticker is still seen trading at a premium defying conventional trading wisdom. The cause, according to Dan Dicker, author of the book Oil’s Endless Bid, is the rampant "assetization" of oil.

The author, a man with more than 20 years of experience on the NYMEX floor, attributes this to an influx of "dumb money" in to the oil markets. Apart from introducing and taking oil price volatility straight to the consumers' wallets, this influx has triggered a global endless bid for energy security. Via a book of just under 340 pages split by three parts containing 11 chapters, their epilogue and two useful appendices, Dicker offers his take on the state of crude affairs.

While largely authored from an American standpoint, Dicker throws up some unassailable truths of global relevance. Principal among them is the fact that visible changes that have taken place in the oil markets over the past 20 years. Go back a few decades, and everyone can recollect the connection between price volatility and its association with a major economic or geopolitical crisis (economic woes, Gulf War I, OPEC embargo, etc.)

Presently, there is near perennial volatility as the trading climate and instruments of trade available place an incessant upward pressure on black gold. Reading Dicker's thoughts one is inclined to believe that at no point in history was the phrase "black gold" more appropriate to describe the crude stuff than it is now; particularly in the last six years, as investment banks, energy hedge funds and managed futures funds have come to dominate energy trading and wreak havoc on prices.

In his introduction to the book, Dicker makes a bold claim - that we've lost control of our oil markets and it has become the biggest financial story of the decade. When the Oilholic began reading it, he was sceptical of the author's claim, but by the time he reached the ninth chapter the overriding sentiment was that Dicker has a point - a huge one, articulated well and discussed in the right spirit.

Ask anyone, even a lay man, a non-technical question about why the price of oil is so high - the answer is bound be China and India's hunger for oil. A more technical person might attribute it to the US Dollar's weakening and perhaps investors playing with the commodities market as the equities markets take a hit.

But are these reasons enough to explain what caused prices to soar 600% from 2003 to 2008, only to take a massive dip and soar again over the next couple of years? Something is fundamentally wrong here according to the author and the latter half of his book is dedicated to discussing what it might mean and where are we heading.

Whether you agree or disagree is a matter of personal opinion, but the author's take on what broke the oil markets, and how can they be fixed before they drag us all down into an economic black hole, strikes a chord. He also uses part of the narrative to reflect on his life as a trader before and after passage of the US Commodities Futures Modernization Act opened up the oil markets to a flood of "dumb money."

Sadly, as Dicker notes, the biggest victim of oil markets frenzy is the average consumer, who pays the price at the pump, and in the inflated costs of everything - from food and clothing to electric power and even lifesaving medications. The Oilholic is happy to recommend this book to those interested in crude oil markets, the energy business, US crude trading dynamic, petroleum economics or are just plainly intrigued about why getting a full tank of petrol has suddenly lost the element of predictability in the last half decade or so.

© Gaurav Sharma 2011. Photo: Cover of ‘Oil’s Endless Bid’ © Wiley Publishers, USA 2011.