Oil markets & producers on a tricky skating rink

So we had a crude oil price plunge early January, followed by a spike that promptly "un-spiked", only to rise from the ashes and subsequently go down the path of decline again. Expect further slippage, more so as the last week of profit taking takes place before the March futures contracts close, which in ICE Brent’s case would be February 13.

Amid the ups and downs of the last six weeks, headline writers were left tearing their hair on a daily basis switching from "Brent extends rally" to "Oil slides despite OPEC talk of a floor" to "Falling Premiums" to "Crude oil getting hammered" and back to "Oil jumps". All the while commentators queued up with some predicting a return to a US$100 per barrel Brent price "soon", alongside those sounding warnings about a drop to $10.

The actual market reality is both here and nowhere, as we enter a period of constant slides and spikes between $40 and $60. There are those who say the current oil price level cannot be sustained and supply-side analysts, including the Oilholic, who say the current oil production levels cannot be sustained. Both parties are correct – a price spike and a supply correction will happen in tandem, but not overnight.

It will take at least until the summer for sentiments about lower production levels to feed through, if not longer. More so, as many are gearing up to produce more with less, for example in Western Canada where fewer wells would be dug this year, but the production tally would be higher than the previous year. Taking a macro viewpoint, all the chatter of bull runs, bear attacks and subsequent rallies is just that – chatter. Market fundamentals have not materially altered.

Despite the latest Baker Hughes data showing fewer operational rigs compared to this point last year, the glut persists and there is some way to go before it alters. Roughly around 5% of current global oil production is taking place at a loss. Yet producers are biting the bullet wary of losing market share. It'll take a lot longer than a few weeks of negative rig data in the new year, before someone eventually blinks and makes a substantial impact on production levels. The Oilholic reckons it will be around June.

Until then, expect the market to continue skating in the $40 to $60 rink. In fact, there is some justification in OPEC Secretary General Abdalla Salem El-Badri’s claim that oil prices have bottomed out. While we could have a momentary dip below $40, something which the Western Canadian Select has already faced. However, by and large benchmark prices have indeed found resistance above $40. 

Having said so, the careful thing to do between now and (at least) June would be to not get carried away by useless chatter. When Brent shed 11.44% in the first five trading days of January, only to more than recover the lost ground by the end of the month (see chart on the right, click to enlarge), some called it a mini-bull run.

Percentages are always relative and often misleading in the volatile times we see at the moment, as one noted in a recent Tip TV broadcast. So mini-bull run claims were laughable. As for the eventual supply correction, capex reduction is already afoot. BP, Shell, BG Group and several other large and small companies have announced spending cuts. A recent Genscape study of 95 US exploration and production (E&P) companies noted a cumulative capex decline of 27%, from $44.5 billion last year to a projected $32.5 billion this year.

Meanwhile, Igor Sechin, the boss of Russia’s Rosneft has denied the country would be the first to blink and lower production in a high stakes game. Quite the contrary, Sechin compared the US shale boom to the dotcom bubble and rambled about the American position not being backed up by crude reserves.

He also accused OPEC along familiar lines of conspiring with Western nations, especially the US, to hurt Russia. Moving away from silly conspiracy theories, Sechin does have a point – the impact of a lower oil price on shale is hard to predict and is currently being put to test. We’ll know more over the next two to three quarters.

However, comparing the shale bonanza to the dotcom bubble suggests wilful ignorance of a few basic facts. Unlike the dotcom bubble, where a plethora of so-called technology firms put forward their highly leveraged, unproven, profit lacking ventures pitched to investors by Wall Street as the next big thing, independent shale oil upstarts have a ready, proven product to sell in barrels.

Of course, operational constraints and high levels of leveraging remain burdensome in a bearish oil market. While that might cause difficulties for fringe shale players, established ones will carry on regardless and find ways to mitigate exposure to volatility.

In case of the dotcom bubble, where some had nothing of proven tangible value to sell, independents tipped over like dominos when the bubble burst, apart from those who had a plan. For instance, the likes of Amazon or eBay have survived and thrived to see their stock price recover well above the dotcom boom levels.

Finally, in case of US shale players, ingenuity of the wildcatters catapulted them to where they are with a readily marketable product to sell. There is anecdotal evidence of that same ingenuity kicking in tandem with extraction process advancements thereby making E&P activity viable even at a $40 Brent price for many if not all.

So it's not quite like Pets.com if you know what the Oilholic means. Sechin’s point might be valid but its elucidation is daft. Furthermore, US shale players might have troubling days ahead, but trouble is something the Russian oil producers can see quite clearly on their horizon too. Additionally, shale plays have technological cooperation aimed at lowering costs on their side. Sanctions mean sharing of international technology to sustain or boost production as well as lower costs is off limits for the moment for Russia.

On a closing note, its being hotly disputed these days whether and by how much lower oil prices boost global economic activity, as one noted in a recent World Finance journal video broadcast. Entering the debate this week, Moody’s said lower oil prices might well give the US economy a boost in the next two years, but will fail to lift global growth significantly as headwinds from the Eurozone, China, Brazil and Japan would dent economic activity.

Despite lower oil prices, the agency has maintained its GDP growth forecast for the G20 countries at just under 3% in both 2015 and 2016, broadly unchanged from 2014. Moody's outlook is based on the assumption that Brent will average $55 in 2015, rising to $65 on average in 2016. 

It assumes that oil prices will stay near current levels in 2015 because demand and supply conditions are "unlikely to change markedly" in the near future, as The Oilholic has been banging on many a blog post including this one. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Danger of slipping sign. Graph: Oil Benchmark Prices, January 2015 © Gaurav Sharma

‘Frackers’ & US coffers plus other crude matters

US Interior Secretary Sally Jewell should be a happy bunny this week say contacts in Houston town. In fact since morning, no fewer than nine have pointed this out to The Oilholic.

That is because Jewell's Interior Department has collected and disbursed over US$14.2 billion this week courtesy of a record royalties and fees windfall from oil & gas drilling on public land and US territorial waters for the fiscal year ending September 30. The figure is the second-highest collection on file and represents an annualised increase of $2 billion over the last fiscal year.

Fracking and horizontal drilling coupled with increasing interest in offshore E&P are being seen as the drivers. There is one caveat though, the figure does include proceeds of a bonus licensing bid in the Gulf of Mexico that took place in 2012, but was put on ledgers for 2013. In a statement, Jewell said, "The figure reflects significant energy production from public resources in the United States and serves as critical revenue stream for federal and state governments and tribal communities."

While the Interior Secretary stopped short of blessing the frackers, they are chuffed to bits and there is a fair bit of table thumping here. Let's also not forget that despite the frenetic pace of E&P activity in North Dakota, the state of Texas remains the country's largest producer of the crude stuff. That position is likely to be retained on account of fracking, enhanced oil recovery techniques being deployed, horizontal drilling and many established extraction sites that are chugging along nicely.

There is one positive domino effect which is largely going under the radar – Houston is leading the global race in the manufacture and shipping of oil & gas equipment manufacturing from blowout preventers to wellheads. Some of equipment can be loaded conventionally, but the rest – i.e. break bulk (heavy equipment which cannot be shipped in conventional containers) loading is also creating additional revenue streams in the state.

According to the Port of Houston, the facility handles nearly 70% of the US' entire break bulk cargo. Some here say jobs have more than doubled since 2005; Texas (along with North Dakota) also has the lowest unemployment rates in the country to brag about. Recent research conducted by McKinsey and IHS Global Insight came out bullish on the industry's long term potential for job creation – with both forecasting the creation of 1.7 million and 3.9 million jobs by 2020 and 2025 respectively.

Now that tells you something, especially as the US is poised to overtake Russia and Saudi Arabia and become the world's largest producer in barrels of oil equivalent terms. Strangely enough though, some of the majors such as Shell and BHP Billiton have apparently not got it right. The former has cut its shale production projections while the latter has put up half of its oil & gas land holdings right here in Texas as well as New Mexico for sale.

ExxonMobil's exit from shale exploration in Poland has also slightly dented the hypothesis of America exporting its nous on shale overseas. Some geologists have long warned that no one size fits all shale beds! Nonetheless, its early days yet on the knowledge export front at least.

Going beyond Texan borders, the positive impact of major upstream project start-ups on cash generation in the global integrated oil & gas industry in 2014-15, as well as continuing robust crude price conditions, have resulted in a change of outlook for the sector by Moody's to 'positive' from 'stable'. Up until this month, the ratings agency's outlook had been stable since September 2011.

Francois Lauras, senior credit officer in Moody's corporate finance group, said, "With crude prices set to remain robust, we expect that the start-up and ramp-up of major upstream projects over the next 12-18 months will benefit companies' production profiles and operating cash flow generation, and lead the industry's EBITDA to grow in the mid-to-high single digits year-on-year in 2014, albeit with more of the improvement showing in the latter part of the year."

"Downstream operations will remain under pressure, but EBITDA from refining and marketing operations will stabilise near their 2013 levels," he adds. Furthermore, Lauras feels that the global integrated oil and gas sector's capital investment in 2014 will remain close to its record levels of 2013.

The completion of the major upstream projects currently under construction will hold the key to the sector's return to positive free cash flow in the medium term. Integrated oil & gas companies will also continue to manage their asset portfolios actively and will execute further asset sales, supporting their financial profiles, Moody's concluded.

Finally, the Oilholic leaves you with glimpses of The Woodlands (see above, click to enlarge), a suburb of Houston, dedicated by none other than the late George Mitchell, a man credited for pioneering fracking.

Founded in 1974 as a largely residential area, today it houses commercial operations of many companies including those of a crude variety such as Anadarko, Baker Hughes and one GeoSouthern energy, a Blackstone Group backed company. It was one of the first to take a punt on the Eagle Ford shale prospection area and has just sold shale acreage to Devon Energy.

That's all for the moment from Houston folks! Keep reading, keep it 'crude'!

To follow The Oilholic on Twitter click here.

To email: gaurav.sharma@oilholicssynonymous.com 

© Gaurav Sharma 2013. Photo 1: Pump Jacks, Perryton © Joel Sartore / National Geographic. Photo 2: Collage of The Woodlands, Texas, USA © Gaurav Sharma, November 2013.

The subtle rise of the OFS innovators

Going back to the turn of 1990s, vertical drilling or forcing the drill bit down a carefully monitored well-shaft into a gentle arc was the best E&P companies could hope from contractors in their quest for black gold.

That’s until those innovators at Oilfield Services (OFS) firms - the guys who often escape notice despite having done much of heavy work involved in prospection and extraction - came up with commercially viable ways for directional drilling. The technique, which involves drilling several feet vertically before turning and continuing horizontally thus maximising the extraction potential of the find, transformed the industry. But more importantly, it transformed the fortunes of the innovators too.

The Oilholic has put some thought into how 21st century OFS firms ought to be classified, if a linear examination by market capitalisation and size is ignored for a moment. After acquiring gradual industry prominence from the 1970s onwards, OFS firms these days could be broadly grouped into three tiers.

The first tier would be the makers and sellers of equipment used in onshore or offshore drilling. Some examples include Cameron International, FMC Technologies and National Oilwell Varco with a market capitalisation in the range of US$10 billion to $30 billion. Then come the 'makers-plus' who also own and lease drill rigs – for example Seadrill, Noble and Transocean with a market cap in a similar sort of a range.

 

And finally there are the big three 'full service' OFS companies Baker Hughes, Halliburton and the world’s largest – Schlumberger. The latter has a market cap of $110 billion plus, last time the Oilholic checked. That’s more than double that of its nearest rival Halliburton. Quite literally, Schlumberger's market cap could give many big oil companies a run for their money. However, if someone told you back in the 1980s that this would be the case in August 2013 – you could be excused for thinking the claimant was on moonshine!

 

The reason for the rise of OFS firms is that their innovation has been accompanied by growing global resource nationalism and maturing wells. The path to prosperity for the services sector began with low margin drilling work in the 1980s and 1990s being outsourced to them by the IOCs. Decades on, the firms continue to benefit from historical partnerships with the oil majors (and minors) aimed at maximising production at mature wells alongside new projects.

 

However, with a rise in resource nationalism, while NOCs often prefer to keep IOCs at arm's length, the same does not apply to OFS firms. Instead, many NOCs choose to project manage exploration sites themselves with the technical know-how from OFS firms. In short, the innovators are currently enjoying, in their own understated way, the best of both worlds! Unconventional prospection from deepwater drilling to the Arctic is an added bonus.

 

If you excluded all of North America, drilling activity is at a three-decade high, according to the IEA and available rig data trends. The Baker Hughes rig count outside North America climbed to 1,333 in June, the highest level in 30 years. Presenting his company’s seventh straight quarterly profit last month, a beaming Paal Kibsgaard, chief executive of Schlumberger, named China, Australia, Saudi Arabia and Iraq among his key markets.

 

Of the four countries named by Kibsgaard, Australia is the only exception where an NOC doesn’t rule the roost, vindicating the Oilholic’s conjecture about the benefits of resource nationalism for OFS firms.

 

Rival Halliburton also flagged up its increased activity and sales in Malaysia, China and Angola and added that it is banking on a second half bounceback in Latin America this year. By contrast, Baker Hughes reported a [45%] fall in second quarter profit, mainly due to weak margins in North America, given the gas glut stateside.

 

Resource nationalism aside, OFS players still continue (and will continue) to maintain healthy partnerships with the IOCs. None of the big three have shown any inclination of owning oil & gas reserves and most of the big players say they never will.

 

Some have small equity stakes here and a performance based contract there. However, this is some way short of ownership. Besides, if there is one thing the OFS players don’t want – it's taking asset risk on their balance sheets in a way the likes of Shell and ExxonMobil do and are pretty good at.

 

Furthermore, the IOCs are major OFS clients. Why would you want to upset your oldest clients, a relationship that is working so well even as the wider industry is undergoing a hegemonic and technical metamorphosis?

 

Success though, does not come cheap especially as it's all about innovation. As a share of annual sales, Schlumberger spent as much on R&D as ExxonMobil, Shell and BP, did using 2010-11 exchange filings. And sometimes, unwittingly, taking the BP 2010 Gulf of Mexico oil spill as an example, the guys in background become an unwanted part of a negative story; Transocean and Halliburton could attest to that. None of this should detract observers from the huge strides made by OFS firms and the ingenuity of the pioneers of directional drilling. And there's more to come!

 

Moving on from the OFS subject, but on a related note, the Oilholic read an interesting Reuters report which suggests oil & gas shareholder activism is coming to the UK market. Many British companies, according to the agency, have ended up with significant assets, including cash, relative to their shrunken stock market value.

 

Some of these have lost favour with mainstream shareholders and are now attracting investors who want to push finance bosses and board members out, access corporate cash and force asset sales. An anonymous investment banker specialising the oil & gas business, told Reuters, rather candidly: "It's a very simple model. You don't have to take a view on the value of the actual assets or know anything about oil and gas. You just know the cash is there for the taking."

 

Finally, linked here is an interesting Bloomberg report on how much the Über-environmentally friendly Al Gore is worth and what he is up to these days. Some say he is 'Romney' rich! That's all for the moment folks! Keep reading, keep it 'crude'!

 

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To email: gaurav.sharma@oilholicssynonymous.com
 

© Gaurav Sharma 2013. Photo: Rig in the North Sea © BP

Col Gaddafi, crude euphoria & last 7 days

The moment Libyan rebels or the National Transitional Council (NTC) as the media loosely describes them, were seen getting a sniff around the Libyan capital Tripoli and Col. Gaddafi’s last bastion, some crude commentators went into euphoric overdrive. Not only did they commit the cardinal sin of discarding cautious optimism, they also belied the fact that they don’t know the Colonel and his cahoots at all. Well, neither does the Oilholic for that matter – at least not personally. However, history tells us that this belligerent, rambling dictator neither has nor will give up that easily. In fact at the moment, everyone is guessing where he is?

To begin, while the end is nigh for the Gaddafi regime, a return to normalcy of oil production outflows will take months if not years as strategic energy infrastructure was damaged, changed hands several times or in some cases both. As a consequence production, which has fallen from 1.5 million barrels per day (bpd) in February to just under 60,000 bpd according to OPEC, cannot be pumped-up with the flick of a switch or some sort of an industrial adrenaline shot.

In a note to clients, analysts at Goldman Sachs maintain their forecast that Libya's oil production will average 250,000 bpd over 2012 if hostilities end as "it will be challenging to bring the shut-in production back online."

These sentiments are being echoed in Italy according to the Oilholic's, a country whose refineries stand to gain the most in the EU if (and when) Libyan production returns to pre-conflict levels. All Italy’s foreign ministry has said so far is that it expects contracts held by Italian companies in Libya to be respected by “whoever” takes over from Gaddafi.

Now, compound this with the fact that a post-Gaddafi Libya is uncharted geopolitical territory and you are likely to get a short term muddle and a medium term riddle. Saudi (sour) crude has indirectly helped offset the Libyan (sweet) shortfall. The Saudis are likely to respond to an uptick in Libyan production when we arrive at that juncture. As such the risk premium in a Libyan context is to the upside for at least another six months, unless there is more clarity and an abrupt end to hostilities.

Moving away from Libya, in a key deal announced last week, Russia’s Lukoil and USA’s Baker Hughes inked a contract on Aug 16th for joint works on 23 new wells at Iraq's promising West Qurna Phase 2 oil field. In a statement, Lukoil noted that drilling will begin in the fourth quarter of this year and that the projected scope of work will be completed “within two years.”

While tech-specs jargon regarding the five rigs Baker Hughes will use to drill the wells at a depth exceeding 4,000 meters was made available, the statement was conspicuously low on the cost of the contract. The key objective is to bring the production in the range of 145,000 to 150,000 bpd by 2013.

Switching tack to commodity ETFs, according to early data for August (until 11th) compiled by Bloomberg and as reported by SGCIB, energy ETPs have attracted their first net inflows in five months with US$9.5 billion under management. This represents a net inflow of US$0.7 billion in August versus an outflow of US$1.5 billion recorded in January. Interest in precious metals continues, even after a very strong July, but base metal ETPs have returned to net outflows. (See adjoining table, click to enlarge)

Meanwhile, Moody’s has raised the Baseline Credit Assessment (BCA) of Russian state behemoth Gazprom to 10 (on a scale of 1 to 21 and equivalent to its Baa3 rating) from 11. Concurrently, the ratings agency affirmed the company's issuer rating at Baa1 with a stable outlook on Aug 17th. The rating announcement does not affect Gazprom's assigned senior unsecured issuer and debt ratings given the already assumed high level of support it receives from the Kremlin.

Moody's de facto regards Gazprom as a government-related issuer (GRI). Thus, the company's ratings incorporate uplift from its BCA of 10 and take into account the agency's assessment of a high level of implied state support and dependence. In fact raising Gazprom's BCA primarily reflects the company's strengthened fundamental credit profile as well as proven resilience to the challenging global economic environment and negative developments on the European gas market in 2009-10.

"Gazprom has a consistent track record of strong operational and financial performance, which was particularly tested in 2009 - a year characterised by lower demand for gas globally and domestically, as well as a generally less favourable pricing environment for hydrocarbons," says Victoria Maisuradze, Senior Credit Officer and lead analyst for Gazprom at Moody's.

Rounding-off closer to home, UK Customs – the HMRC – raided a farm on Aug 17th in Banbridge, County Down in Northern Ireland, where some idiots had set-up a laundering plant with the capacity to produce more than two million litres of illicit diesel per year and evade around £1.5 million in excise duty. Nearly 6,000 litres of fuel was seized and arrests made; but with distillate prices where they are no wonder some take risks both with their lives, that of others and the environment. And finally, Brent and WTI are maintaining US$100 and US$80 plus levels respectively for the last seven days.

© Gaurav Sharma 2011. Photo: Veneco Oil Pumps © National Geographic. Table: Global commodities ETPs © Société Générale CIB/Bloomberg Aug 2011. 

Rig Building Industry Remains in a State of Flux

Post-recession, if one may use the expression, the global rig building industry remains in a state of flux. Often oil market commentators give due attention to global rig counts as a way of gauging the prosperity of oil business. The simple conjecture is that when oil price is high, it makes it worthwhile for oil companies to order jack-ups and semi-submersibles in greater numbers for usage at difficult offshore extraction spots.

The latest overall Baker-Hughes rig count, suggests that in year over year terms, 1282 rigs were in operation in the U.S., 233 fewer than the corresponding week last year. Over a comparable period, Canada saw 495 rigs in operation, up by 69. Internationally, excluding U.S. and Canada, 1024 rigs were in operation, down 54 using December 2009 as a cut-off point.

The stated figures are by no means excellent. However, they are not catastrophic either according to those in the rig building business. The first real rig building boom was seen in the early 1980s. Subsequently, American shipyards as well as their European counterparts lost ground of sorts when demand flattened.

Manufacturing sector analysts partly attribute this to the average age of a jack-up being 20 years, which in truth, most oil firms extend by a further two years. Hence, when the next boom arrived in 2001, Asian players seized the initiative. Of particular significance is the global emergence of two Singapore-based companies – SembCorp and Keppel Offshore & Marine. In between 2002 and 2007, both firms became the world’s leading suppliers of rigs.

As oil prices soared over 2007-08, touching $147 a barrel at one point, both saw their collective order books swell to $8 billion. Apart from being listed companies whose share prices were soaring, direct investment from the Singaporean Government, which has a stake in both, undoubtedly boosted confidence.

Inevitably, the rig count took a beating when the oil price plummeted. Prior to that, Hurricanes Katrina and Rita (2005) took five rigs offline completely and damaged several others. However, that proved to be a different sort of a growth trigger. To begin with, both hurricanes added to order books of rig builders. Furthermore, as the U.S. economy began to take a beating in 2007, drilling companies signed long-term deals to send rigs overseas. It meant the Gulf of Mexico, widely held as the birthplace of offshore drilling, ceased to dictate contract terms benchmarks for drilling equipment.

Emergence of several offshore zones off the coasts of Africa, Middle East, Indian subcontinent and China along with a partial rebound in crude prices has stabilised rig building activity, admittedly at a level below that of fiscal year 2005-06. Rig builders worldwide had 91 major offshore rig manufacturing contracts in 2005-06, up from less than 10 in 2002-03, according to ODS-Petrodata, a research and analysis firm.

Since then, the recession and fluctuation in oil prices has made building trends forecasting extremely tricky. ODS-Petrodata’s latest research reveals that 577 of 751 mobile offshore drilling units were under contract worldwide with global offshore rig fleet utilisation at 76.8%; the highest level since July 2009. Speaking in November 2009, at the IADC Annual General Meeting in Miami, Florida, Tom Kellock, head of consulting and research, ODS-Petrodata, highlighted some of the difficulties faced by forecasters and rig builders alike.

He noted that over 100 jack-ups were idle at the time, i.e. assembled but not online. Another 60 or more were nearing completion and Kellock felt that most but not all will enter the market. Furthermore, ODS-Petrodata had seen a trend of rising gas prices and falling jack-up utilisation from 2002 into 2008.

“No longer do we have the close correlation between gasoline prices and jack-up activity. And the only obvious explanation and the one I would support is that, this is such a mature market, the prospects are just not there anymore. Analysts and even some contractors say, well, when gas prices get back to $5, $6 or $7, (at U.S pumps/per gallon) it’s all going to be OK. I really have difficulty with that,” Kellock told IADC delegates.

“I think industry needs to move on from shallow-water Gulf of Mexico, quite honestly.…This is not where people are going if they have a choice these days to look for oil and gas,” he concluded. Pretty much the same arguments are being put forward to explain the difficulties faced by North Sea as an offshore extraction zone.

Looking ahead, ODS-Petrodata forecasts a supply of 506 jack-ups worldwide by the end of 2015, assuming no additional new-builds or attrition. Its middle of the road forecast, based on gradually increasing oil and gas prices, puts jack-up demand at 334 rigs by end-2015, while the conservative forecast is set at 282 units.

Depending on the type of rigs being ordered, costs could range from US$200 million to $900 million. Hire-purchase and subletting rates of oil rigs, which were seen stabilising in 2008, are likely to remain stable over the next three years before a possible shortage develops. The silver lining is that offshore opportunities in China and India are thought to be growing rapidly. The industry also hopes that Petrobras’ prospecting and subsequent extraction off the coast of Brazil would provide a much needed boost.

While many players fret over pragmatically tight market forecasts, SembCorp and Keppel Offshore & Marine have shown the way by diversifying heavily since 2005. SembCorp builds as well as repairs shipping liners. Keppel has real estate and infrastructure divisions. Both Singaporean firms have expanded overseas and currently operate not just rig-building yards but also ship-repair yards around the world.

© Gaurav Sharma 2010. Photo Courtesy © Cairn Energy Plc