Resisting $40/bbl, Russia & some ‘crude’ ratings

Following two successive week-on-week declines of 6% or over, last Friday’s close brought some respite for Brent oil futures, although the WTI front month contract continued to extend losses. In fact, the US benchmark has been ending each Friday since June 12 at a lower level compared to the week before (see graph, click to enlarge).

 

Will a $40-floor breach happen? Yes. Will oil stay there? No. That’s because market fundamentals haven’t materially altered. Oversupply and lacklustre demand levels are broadly where they were in June. We still have around 1.1 to 1.3 million barrels per day (bpd) of extra oil in the market; a range that’s held for much of 2015. Influences such as Iran’s possible addition to the global crude oil supply pool and China not buying as much have been known for some time.

The latest market commotion is sentiment driven, and it’s why the Oilholic noted in a recent Forbes column that 2016-17 futures appear to be undervalued. People seem to be making calls on where we might be tomorrow based on the kerfuffle we are seeing today!

Each set of dire data from China, inventory report from the Energy Information Administration (EIA), or a gentle nudge from some country or the other welcoming Iran back to the market (as Switzerland did last week) has a reactive tug at benchmarks. The Oilholic still believes Brent will gradually creep up to $60-plus come the end of the year, with supply corrections coming in to the equation over the remainder of this year.

Away from pricing, there is one piece of very interesting backdated data. According to the EIA, Russia’s oil and gas sector weathered both the sanctions as well as the crude price decline rather well.

For 2014, Russia was the world's largest producer of crude oil, including lease condensate, and the second-largest producer of dry natural gas after the US. Russia exported more than 4.7 million bpd of crude oil and lease condensate in 2014, the EIA concluded based on customs data. Most of the exports, or 98% if you prefer percentages, went to Asian and European importers.

Where Russian production level would be at the end of 2015 remains the biggest market riddle. Anecdotal and empirical evidence points to conducive internal taxation keeping the industry going. However, as takings from oil and gas production and exports, account for more than half of Russia's federal budget revenue – it is costing the Kremlin.

Finally, two ratings notes from Fitch over the past fortnight are worth mentioning. The agency has revised its outlook on BP's long-term Issuer Default Rating (IDR) to ‘Positive’ from ‘Negative’ and affirmed the IDR at 'A'.

The outlook revision follows BP's announcement that it has reached an agreement in principle to settle federal, state and local Deepwater Horizon claims for $18.7bn, payable over 18 years. “We believe the deal has significantly reduced the uncertainty around BP's overall payments arising from the accident and hence has considerably strengthened the company's credit profile,” Fitch said.

The agency added there was a real possibility for an upgrade to 'A+' in the next 12 to 18 months, depending on how things pan out and BP's upstream business profile does not show any significant signs of weakening, such as falling reserves or production.

Elsewhere, and unsurprisingly, Fitch downgraded the beleaguered Afren to ‘D’ following the management's announcement on July 31 that it had taken steps to put the company into administration. The company's senior secured rating has been affirmed at 'C', and the Recovery Rating (RR) revised to 'RR5' from 'RR6'.

As discussions with creditors aimed at recapitalising the company failed, the appointment of administrators was made with the consent of the company's secured creditors who saw it as an “important step in preserving value of Afren's subsidiaries”. It is probably the only “value” left after a sorry tale of largely self-inflicted woes. That’s all for the moment folks, keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Graph: Oil benchmark Friday closes, Jan 2 to Aug 14, 2015 © Gaurav Sharma, August 2015.

Oil storage, Chinese imports & Afren’s CEO

When the oil price is rocky, it seems storage in anticipation of better days is all the rage. Afterall, it does take two to play contango, as the Oilholic recently opined in a Forbes column. But leaving those wanting to play the markets by the side for a moment, wider industry attention is indeed turning to storage like never before.

We are told the US hub of Cushing, Oklahoma has never had it so good were we to rely on Genscape’s solid research on what’s afoot. In trying times, the industry turns to the most economical onshore storage option on the table. For some, actually make that many, Cushing is such a port of call.

As of February-end, Genscape says 63% of Cushing’s storage capacity has already been utilised. Capacity has never exceeded 80%, since Genscape began monitoring storage at Cushing in 2009. So were heading for interesting times indeed!

Meanwhile, the country now firmly established as the world’s top importer of crude oil – i.e. China – might well be forced to import less owing to shortage of storage capacity! Well established contacts in Shanghai have indicated to this blogger that in an era of low prices, Chinese policymakers were strategically stocking up on crude oil.

With Chinese economic data being less than impressive in recent months, it probably explains where a good portion of the 7.1 million barrels per day (bpd) imported by the country in January and February went. However, now that available storage is nearly full, anecdotal evidence suggests Chinese oil imports are going to drop off.

Import volumes for April are not likely to be nearly as strong. As for the rest of the year, the Oilholic expects Chinese imports to stay flat. Furthermore, Barclays analysts believe putting faith in China’s economic growth to support oil prices would be “premature” at best, with the country undergoing structural changes.

On a related note, lower oil prices will also slow the revenue growth of Chinese oilfield services (OFS) companies as their upstream counterparts continue to cut capex. Putting it bluntly, Chenyi Lu, Senior Analyst at Moody’s noted: "In addition to the impact on revenues, Chinese OFS companies will also see their margins weaken over the next two years as their exploration and production customers negotiate lower rates."

Finally, before yours truly takes your leave, it seems the beleaguered London-listed independent upstart Afren has finally named a new CEO following its boardroom debacle. Industry veteran Alan Linn will take-up his post as soon as the company’s “imminent” $300 million bailout is in place. We wish him all the luck, given his task at hand. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Oil pipeline, Fairfax, Virginia, USA © O. Louis Mazzatenta / National Geographic

Oil prices, OPEC shenanigans & the North Sea

It has been a crude fortnight of ups and downs for oil futures benchmarks. Essentially, supply-side fundamentals have not materially altered. There’s still around 1.3 million barrels per day (bpd) of crude oil hitting the markets in excess of what’s required.

Barrels put in storage are at an all time high, thanks either to those forced to store or those playing contango. US inventories also remain at a record high levels. 

However, the biggest story in the oil market, as well as the wider commodities market, is the strength of the US dollar. All things being equal, the dollar’s strength is currently keeping both Brent and WTI front month futures contracts at cyclical lows. The past five trading days saw quite a few spikes and dives but Friday’s close came in broadly near to the previous week’s close (see graph on the left, click to enlarge).

In the Oilholic’s opinion, a sustained period of oil prices below $60 is not ideal for unconventional exploration. Nonetheless, not all, but a sufficiently large plethora of producers just continue to grin and bear it. While that keeps happening, and the dollar remains strong, oil prices will not find support. We could very well be in the $40-60 range until June at the very least. Unless excess supply falls from 1.3 million bpd to around 750,000 bpd, it is hard to see how the oil price will receive support from supply constriction. 

Additionally, Fitch Ratings reckons should Brent continue to lurk around $55, credit ratings of European, Middle Eastern and African oil companies would take a hit. European companies that went into the slump with stretched credit profiles remain particularly vulnerable.

In a note to clients, Fitch said its downgrade of Total to 'AA-' in February was in part due to weaker current prices, and the weaker environment played a major part in the downgrade and subsequent default of Afren.

"Our investigation into the effect on Western European oil companies' credit profiles with Brent at $55 in 2015 shows that ENI (A+/Negative) and BG Group (A-/Negative) were among those most affected. Both outlooks reflect operational concerns, ENI because of weakness in its downstream and gas and power businesses, BG Group due to historical production delays. Weaker oil prices exacerbate these problems," the agency added.

Of course, Fitch recognises the cyclical nature of oil prices, so the readers need not expect wholesale downgrades in response to a price drop. Additionally, Afren remains an exception rather than the norm, as discussed several times over on this blog.

Moving on, the Oilholic has encountered empirical and anecdotal evidence of private equity money at the ready to take advantage of the oil price slump for scooping up US shale prospects eyeing better times in the future. For one’s Forbes report on the subject click here. The Oilholic has also examined the state of affairs in Mexico in another detailed Forbes report published here.

Elsewhere, a statement earlier this week by a Kuwaiti official claiming that there is no appetite for an OPEC meeting before the scheduled date of June 5, pretty much ends all hopes of the likes of Nigeria and Venezuela in calling an emergency meeting. The official also said OPEC had “no choice” but to continue producing at its current levels or risk losing market share.

In any case, the Oilholic believes chatter put out by Nigeria and Venezuela calling for an OPEC meeting in the interest of self-preservation was a non-starter. Given that we’re little over two months away from the next meeting and the fact that it takes 4-6 weeks to get everyone to agree to a meeting date, current soundbites from the ‘cut production’ brigade don’t make sense.

Meanwhile, the UK Treasury finally acknowledged that taxation of North Sea oil and gas exploration needed a radical overhaul. In his final budget, before the Brits see a General Election on May 7, Chancellor George Osborne cut the country’s Petroleum Revenue Tax from its current level of 50% to 35% largely aimed at supporting investment in maturing offshore prospects.

Furthermore, the country’s supplementary rate of taxation, lowered from 32% to 30% in December, was cut further down to 20% and its collection at a lower rate backdated to January. Altogether, the UK’s total tax levy would fall from 60% to 50%.

Osborne’s move was widely welcomed by the industry. Some are fretting that he’s left it too late. Yet others reckon a case of better late than never could go a long way with the North Sea’s glory days well behind it. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Graph: Tracking Friday oil prices close, year to date 2015 © Gaurav Sharma, March 20, 2015.

The $40-50 range, CAPP on Capex & Afren's woes

The first month of oil trading in 2015 is coming to a much calmer end compared to how it began. The year did begin with a bang with Brent shedding over 11% in the first week of full trading alone. Since then, the only momentary drama took place when both Brent and WTI levelled at US$48.05 per barrel at one point on January 16. Overall, both benchmarks have largely stayed in the $44 to $49 range with an average Brent premium of $3+ for better parts of January.

There is a growing realisation in City circles that short sellers may have gotten ahead of themselves a bit just as those going long did last summer. Agreed, oil is not down to sub-$40 levels seen during the global financial crisis. However, if the price level seen then is adjusted for the strength of the dollar now, then the levels being seen at the moment are actually below those seen six years ago.

The big question right now is not where the oil price is, but rather that should we get used to the $40 to $50 range? The answer is yes for now because between them the US, Russia and Saudi Arabia are pumping well over 30 million barrels per day (bpd) and everyone from troubled Libya to calm Canada is prodding along despite the pain of lower oil prices as producing nations.

The latter actually provides a case in point, for earlier in January the Western Canadian Select did actually fall below $40 and is just about managing to stay above $31. However, the Oilholic has negligible anecdotal evidence of production being lowered in meaningful volumes.

For what it’s worth, it seems the Canadians are mastering the art of spending less yet producing more relative to last year, according to the Canadian Association of Petroleum Producers (CAPP). The lobby group said last week that production in Western Canada, bulk of which is accounted for by Alberta, would grow by 150,000 bpd to reach 3.6 million bpd in 2015. 

That’s despite the cumulative capex tally of major oil and gas companies seeing an expected decline of 33% on an annualised basis. The headline production figure is actually a downward revision from CAPP’s forecast of 3.7 million bpd, with an earlier expectation of 9,555 wells being drilled also lowered by 30% to 7,350 wells. Yet, the overall production projection is comfortably above 2014 levels and the revision is nowhere near enough (yet) to have a meaningful impact on Canada’s contribution to the total global supply pool. 

Coupled with the said global supply glut, Chinese demand has shown no signs of a pick-up. Unless either the supply side alters fundamentally or the demand side perks up, the Oilholic thinks the current price range for Brent and WTI is about right on the money. 

But change it will, as the current levels of production simply cannot be sustained. Someone has to blink, as yours truly said on Tip TV – it’s likely to be the Russians and US independent upstarts. The new Saudi head of state - King Salman is unlikely to change the course set out by his late predecessor King Abdullah. In fact, among the new King’s first acts was to retain the inimitable Ali Al-Naimi as oil minister. 

Greece too is a non-event from an oil market standpoint in a direct sense. The country does not register meaningfully on the list of either major oil importers or exporters. However, its economic malaise and political upheavals might have an indirect bearing via troubles in the Eurozone. The Oilholic sees $1= €1 around the corner as the dollar strengthens against a basket of currencies. A stronger dollar, of course, will reflect in the price of both benchmarks.

In other news, troubles at London-listed Afren continue and the Oilholic has knocked his target price of 120p for the company down to 20p. First, there was bolt out of the blue last August that the company was investigating “receipt of unauthorised payments potentially for the benefit of the CEO and COO.” 

Following that red flag, just recently Afren revised production estimates at its Barda Rash oilfield in the Kurdistan region of Iraq by 190 million barrels of oil equivalent. The movement in reserves was down to the 2014 reprocessing of 3D seismic shot in 2012 and processed in 2013, as well as results from its drilling campaign, Afren said. 

It is presently thinking about utilising a 30-day grace period under its 2016 bonds with respect to $15 million of interest due on 1 February. That’s after the company confirmed a deferral of a $50 million amortisation payment due at the end of January 2015 was being sought. Yesterday, Fitch Ratings downgraded Afren's Long-term Issuer Default Rating (IDR), as well as its senior secured ratings, to 'C' from 'B-'. It reflects the agency’s view that default was imminent.

Meanwhile, S&P has downgraded Russia’s sovereign rating to junk status. The agency now rates Russia down a notch at BB+. “Russia’s monetary-policy flexibility has become more limited and its economic growth prospects have weakened. We also see a heightened risk that external and fiscal buffers will deteriorate due to rising external pressures and increased government support to the economy,” S&P noted.

Away from ratings agencies notes, here is the Oilholic’s take on what the oil price drop means for airlines and passengers in one’s latest Forbes piece. Plus, here’s another Forbes post touching on the North Sea’s response to a possible oil price drop to $40, incorporating BP’s pessimistic view that oil price is likely to lurk around $50 for the next three years.

For the record, this blogger does not think oil prices will average around $50 for the next three years. One suspects that neither does BP; rather it has more to do with prudent forward planning. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Oil pipeline with Alaska's Brooks Range in the background, USA © Michael S. Quinton / National Geographic

Crude market, Russia & fretting over Afren

There's been an unsurprising calm in the oil market given the existing supply-side scenario, although the WTI's slip below three figures is more down to local factors above anything else.

Demand stateside is low while supplies are up. Additionally, the CVR Refinery in Coffeyville, Kansas which uses crude from Cushing, Oklahoma and churns 115,000 barrels per day (bpd) is offline and will remain so for another four weeks owing to a fire. It all means that Brent's premium to the WTI is now above US$7 per barrel. Despite (sigh) the latest Libyan flare-up, Brent itself has been lurking either side of $105 level, not as much down to oversupply but rather stunted demand. And the benchmark's current price level has triggered some rather interesting events.

Brent's premium to Dubai crude hit its lowest level in four years this week. According to Reuters, at one point the spread was as low as $1.20 following Monday's settlement. The newswire also reported that Oman crude actually went above Brent following settlement on July 31, albeit down to thin trading volumes.

Away from pricing, the Oilholic has been busy reading agency reports on the impact of the latest round of sanctions on Russia. The most interesting one came from Maxim Edelson of Fitch Ratings, who opined that sanctions could accelerate the decline of Siberian oilfields.

Enhanced recovery techniques used in these fields are similar to those used for shale oil extraction, one of the target areas for the sanctions. As the curbs begin to hit home and technology sales to the Russian oil & gas sector dry up, it will become increasingly harder to maintain rate of production from depleting West Siberia brownfields.

As brownfields are mature, major Russian oil companies are moving into more difficult parts of the existing formations. For example, GazpromNeft, an oil subsidiary of Gazprom, is increasingly relying on wells with horizontal drilling, which accounted for 42% of all wells drilled in 2013 compared to 4% in 2011, and multi-stage fracking, which was used in 57% of high-tech wells completed in 2013, up from 3% in 2011.

"In the medium term, [EU and US] measures are also likely to delay some of Russia's more ambitious projects, particularly those on the Arctic shelf. If the sanctions remain for a very long time they could even undermine the feasibility of these projects, unless Russia can find alternative sources of technology or develop its own," Edelson wrote further.

Russian companies have limited experience in working with non-traditional deposits that require specialised equipment and "know-how" and are increasingly reliant on joint ventures (JVs) with western companies to provide technology and equipment. All such JVs could be hit by sanctions, with oil majors such as ExxonMobil, Shell and BP, oil service companies Schlumberger, Halliburton and Baker Hughes, and Russia's Rosneft, GazpromNeft and to a lesser extent LUKOIL, Novatek and Tatneft, all in the crude mix.

More importantly, whether or not Russia's oil & gas sector takes a knock, what's going on at the moment coupled with the potential for further US and EU sanctions on the horizon, is likely to reduce western companies' appetite for involvement in new projects, Edelson adds.

Of course, one notes that in tune with the EU's selfish need for Russian gas, its sanctions don't clobber the development of gas fields for the moment. On a related note, Fitch currently rates Gazprom's long-term foreign currency Issuer Default Rating (IDR) at 'BBB', with a 'Negative' outlook, influenced to a great extent by Russia's sovereign outlook.

Continuing with Russia, here is The Oilholic's Forbes article on why BP can withstand sanctions on Russia despite its 19.75% stake in Rosneft. Elsewhere, yours truly also discussed why North Sea exploration & production (E&P) isn't dead yet in another Forbes post.

Finally, news that the CEO and COO of Afren had been temporarily suspended pending investigation of alleged unauthorised payments, came as a bolt out of the blue. At one point, share price of the Africa and Iraqi Kurdistan-focussed E&P company dipped by 29%, as the suspension of CEO Osman Shahenshah and COO Shahid Ullah was revealed to the London Stock Exchange.

While the wider market set about shorting Afren, the company said its board had no reason to believe this will negatively affect its stated financial and operational position.

"In the course of an independent review on the board's behalf by Willkie Farr & Gallagher (UK) LLP of the potential need for disclosure of certain previous transactions to the market, evidence has been identified of the receipt of unauthorised payments potentially for the benefit of the CEO and COO. These payments were not made by Afren. The investigation has not found any evidence that any other Board members were involved," it added.

No conclusive findings have yet been reached and the investigation is ongoing. In the Oilholic's humble opinion the market has overreacted and a bit of perspective is required. The company itself remains in a healthy position with a solid income stream and steadily rising operating profits. Simply put, the underlying fundamentals remain sound.

As of March 31 this year, Afren had no short-term debt and cash reserves of $361 million. In 2013, the company improved its debt maturity profile by issuing a $360 million secured bond due 2020 and partially repaying its $500 million bond due 2016 (with $253 million currently outstanding) and $300 million bond due 2019 (with $250 million currently outstanding).

So despite the sell-off given the unusual development, many brokers have maintained a 'buy' rating on the stock pending more information, and rightly so. Some, like Investec, cautiously downgraded it to 'hold' from 'buy', while JPMorgan held its 'overweight' recommendation on the stock. There's a need to keep calm, and carry on the Afren front. That's all for the moment folks. Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Russian Oilfields © Lukoil