Views from Wall Street on oil market volatility

The Oilholic finds himself 3,460 miles away from London in New York, with Wall Street giving the crude market yet another reality check. In the last few months, money managers of all description, not just our friends in the hedge fund business, are scratching their heads having first seen a technical bear market in July, only for it to turn in favour of a technical bull market in August!

But now, with all that phoney talk of producers coming together to freeze oil production having fallen by the wayside, both Brent and WTI have started slipping again. 

Not one Wall Streeter the Oilholic has spoken to since arriving in the Big Apple seems to discount the theory that oil may be no higher than $50 per barrel come Christmas, and even that might be a stretch. 

In a desperate bid to keep the market interested in the production freeze nonsense, the Saudis and Russians pledged cooperation ensuring "oil market stability" at no less august a venue than the G20 summit in China earlier this month. Of course, as no clear direction was provided on how that "stability" might actually be achieved and nothing revealed by way of production alterations or caps, not many are quite literally buying it – not on Wall Street, not in the City of London.

Forget the shorts, even the longs brigade have realised that unless both the Saudis and Russians, who between them are pumping over 20 million barrels per day (bpd) of oil, announce a highly unlikely real terms cut of somewhere in the region of 1 to 1.5 million bpd at the producers’ informal shindig on the sidelines of International Energy Forum (due 26-28 September) in Algiers, price support would be thin on the ground.

In fact, even a real terms cut would only provide short-lived support of somewhere in the region of $5-10 per barrel. As a side effect, this temporary reprieve would boost fringe non-OPEC production that is currently struggling with a sub $50 oil price. Furthermore, North American shale production, which is proving quite resilient with price fluctuations in the $40-50 range, is going to go up a level and supply scenarios would revert to the norm within a matter of months.

A number of oil producers would substitute the hypothetical 1-1.5 million bpd Riyadh and Moscow could potentially sacrifice. That’s precisely why Wall Street is betting on the fact that neither countries would relent, for among other things – both are also competing against each other for market.

Another added complication is the uncertainty over oil demand growth, which remains shaky and is not quite what it used to be. Morgan Stanley and Barclays are among a rising number of players who think 2016 might well end-up with demand growth in the region of 625,000 to 850,000 bpd, well shy of market think-tank projections of 1.3 million bpd.

Trading bets are mirroring those market concerns. Money managers sharply decreased their overall bullish bets in WTI futures for the week to September 6th, and also reduced their net position for a second straight week, according to Commodity Futures Trading Commission (CFTC) data.

In numeric terms - "Non-commercial contracts" of crude oil futures, to be mostly read as those traded by paper speculators, totalled a net position of +285,795 contracts. That’s a change of -55,493 contracts from the previous week’s total of +341,288; the net contracts for the data reported through August 30th.

The speculative oil bets decline also dragged the net position below the +300,000 level for the first time in nearly a month. That’s all for the moment from New York folks, as the Oilholic leaves you with a view of Times Square! Keep reading, keep it ‘crude’! 

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© Gaurav Sharma 2016. Photo 1: Wall Street & New York Stock Exchange, USA. Photo 2: Times Square, New York, USA © Gaurav Sharma, September 2016

Hallelujah, it’s Bearish Brent!

Mercury is not rising (at least where this blogger is), it’s not half past 10 (more like half past four), and it’s certainly not for the first time in history, but Hallelujah it’s Bearish Brent!

Sorry, a rather crude attempt to re-jingle that ‘80s hit song, but on a more serious note there is a bit of a commotion in the oil markets with bears roaming the streets. As the readers of this blog would testify, the Oilholic has short called Brent for a while now. Being precise, the said period covers most of the past six and current Brent front-month contracts.

Aggressive yelling of the word 'risk' proved this supply-side scribe wrong for June, but one has been on the money most of the time since the summer. July’s high of US$115.71 per barrel was daft with speculators using the initial flare-up in Iraq as a pretext to perk things up.

The Oilholic said it would not last, based on personal surmising, feedback from physical traders and their solver models. And to the cost of many speculators it didn’t. As one wrote in a Forbes post earlier this week, if an ongoing war (in the Middle East of all places) can’t prop up a benchmark perceived to be a common proxy for oil prices on the world market, then what can?

Rather controversially, and as explained before, the Oilholic maintains that Brent is suffering from risk fatigue in the face of lacklustre demand and erratic macroeconomic data. In Thursday’s trade, it has all come to down to one heck of a bear maul. Many in the City are now wondering whether a $90 per barrel floor might be breached for Brent; it already has in the WTI’s case and on more than one occasion in intraday trading.

All of this comes on the back of Saudi Arabia formally announcing it is reducing its selling price for oil in a move to protect its share in this buyers’ market. The price of OPEC basket of twelve crudes stood at $92.31 dollars a barrel on Wednesday, compared with $94.17 the previous day, according to its calculations.

With roughly 11 days worth of trading left on the November Brent front-month contract, perceived oversupply lends support to the bears. Nonetheless, a bit of caution is advised. While going short on Brent would be the correct call at the moment, Northern Hemisphere winter is drawing closer as is the OPEC meeting next month. So the Oilholic sees a partial price uptick on cards especially if OPEC initiates a production cut.

The dip in price ought to trouble sanction hit Russia too. According to an AFP report, Herman Gref, head of Sberbank, Russia’s largest bank, said the country could repeat the fate of the Soviet Union if it doesn't reform its economic policies and avoid the "incompetent" leadership that led to the end of communism.

Speaking at the annual “Russia Calling” investment forum in Moscow, Gref said Russia imports too much, is too reliant on oil and gas exports and half of its economy is monopolised. The dynamic needs to change, according to Russia’s most senior banker, and one employed by a state-owned bank.

Away from Russia, here is the Oilholic's latest Forbes post on the prospects of shale exploration beyond North America. It seems initial hullabaloo and overexcitement has finally been replaced by sense of realism. That said, China, UK and Argentina remain investors’ best hope.

On a closing note, while major investment banks maybe in retreat from the commodities market and bears are engulfing it for the time being, FinEx group, an integrated asset management, private equity and hedge fund business, has decided to enter the rocky cauldron.

Its specialist boutique business – FinEx Commodity Partners – will be led by Simon Smith, former Managing Director and Head of OTC Commodity Solutions at Jefferies Bache. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo: Disused gas station, Preston, Connecticut, USA © Todd Gipstein / National Geographic.

Hedge Funds have been ‘contangoed’

Recent events may have pushed the Brent front month futures contract back towards US$108 per barrel; but there's no denying some have been 'contangoed'! Ukrainian tensions and lower Libyan production are hard to ignore, even if the latter is a bit of a given.

Nonetheless, for a change, the direction of both benchmark prices this month indicates that July did belong to the physical traders with papers traders, most notably Hedge Funds, taking a beating.

It's astonishing (or perhaps not) that many paper traders went long on Brent banking on the premise of "the only way is up" as the Iraqi insurgency escalated last month. The only problem was that Iraqi oil was still getting dispatched from its southern oil hub of Basra despite internal chaos. Furthermore, areas under ISIS control hardly included any major Iraqi oil production zone.

After spiking above $115, the Brent price soon plummeted to under $105 as the reality of the physical market began to bite. It seems European refiners were holding back from buying the expensive crude stuff faced with declining margins. In fact, North Sea shipments, which Brent is largely synced with, were at monthly lows. Let alone bothering to pull out a map of Iraqi oilfields, many paper traders didn't even bother with the ancillary warning signs.

As Fitch Ratings noted earlier this month, the European refining margins are likely to remain weak for at least the next one to two years due to overcapacity, demand and supply imbalances, and competition from overseas. Over the first half of 2014, the northwest European refining margin averaged $3.3 per barrel, down from $4 per barrel in 2013 and $6.8 barrel in 2012.

Many European refineries have been loss-making or only slightly profitable, depending on their complexity, location and efficiency. They are hardly the sort of buyers to purchase consignments by the tanker-load during a mini bull run. The weaker margin scenario itself is nothing new, resulting from factors including a stagnating economy and the bias of domestic consumption towards diesel due to EU energy regulations

"This means that surplus gasoline is exported and the diesel fuel deficit is filled by imports, prompting competition with Middle Eastern, Russian and US refineries, which have access to cheaper feedstock and lower energy costs on average. Mediterranean refiners are additionally hurt by the interruption of oil supplies from Libya, but this situation may improve with the resumption of eastern port exports," explains Fitch analyst Dmitry Marinchenko.

Of course tell that to Hedge Funds managers who still went long in June collectively holding just short of 600 million paper barrels on their books banking on backwardation. But thanks to smart, strategic buying by physical traders eyeing cargoes without firm buyers, contango set in hitting the hedge funds with massive losses.

When supply remains adequate (or shall we say perceived to be adequate) and key buyers are not in a mood to buy in the volumes they normally do down to operational constraints, you know you've been 'contangoed' as forward month delivery will come at a sharp discount to later contracts!

Now the retreat is clear as ICE's latest Commitments of Traders report for the week to July 15 saw Hedge Funds and other speculators cut their long bets by around 25%, reducing their net long futures and options positions in Brent to 151,981 from 201,568. If the window of scrutiny is extended to the last week of June, the Oilholic would say that's a reduction of nearly 40%.

As for the European refiners, competition from overseas is likely to remain high, although Fitch reckons margins may start to recover in the medium term as economic growth gradually improves and overall refining capacity in Europe decreases. For instance, a recent Bloomberg survey indicated that of the 104 refining facilities region wide, 10 will shut permanently by 2020 from France to Italy to the Czech Republic. No surprises there as both OPEC and the IEA see European fuel demand as being largely flat.

Speaking of the IEA, the Oilholic got a chance earlier this month to chat with its Chief Economist Dr Fatih Birol. Despite the latest tension, he sees Russian oil & gas as a key component of the global energy mix (Read all about it in The Oilholic's Forbes post.)

Meanwhile, Moody's sees new US sanctions on Russia as credit negative for Rosneft and Novatek. The latest round of curbs will effectively prohibit Rosneft, Novatek, and other sanctioned entities, including several Russian banks and defence companies, from procuring financing and new debt from US investors, companies and banks.

Rosneft and Novatek will in effect be barred from obtaining future loans with a maturity of more than 90 days or new equity, cutting them off from long-term US capital markets. As both companies' trade activities currently remain unaffected, Moody's is not taking ratings action yet. However, the agency says the sanctions will significantly limit both companies' financing options and could put pressure on development projects, such as Novatek's Yamal LNG.

No one is sure what the aftermath of the MH17 tragedy would be, how the Ukrainian crisis would be resolved, and what implications it has for Russian energy companies and their Western partners. All we can do is wait and see. That's all for the moment folks. Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Oil pipeline © Cairn Energy

OPEC vibes, a Libyan matter & market chatter

As OPEC prepares to meet for the first time this year, oil ministers of the 12 member nations should feel reasonably content. The hawks always like the oil price to be in three figures and doves usually like a support level above the region of US$85 per barrel using Brent as a benchmark. Needless to say, both camps are sitting comfortably at the moment and will continue to do so for a while.

Macroeconomic permutations and risk froth is keeping the oil price where OPEC wants it, so the Oilholic would be mighty surprised if the ministers decide to budge from the present official quota cap of 30 million barrels per day. Those going long on Brent have already bet on OPEC keeping its output right where it is.

Over the week to May 27, bets on a rising price rose to their highest level since September 2013. ICE's Commitment of Traders report for the week saw all concerned, including hedge funds, increase their net long position in Brent crude by 6% (or 4,692) to 213,364 positions, marking a third successive week of increases. Going the other way, the number of short positions fell by 7,796 to 42,096.

Wires might be saying that "all eyes" are on OPEC, but not many eyes would roll at Helferstorferstrasse 17 once the announcement is made. Futures actually slipped by around 0.5% as dullness and a minor bout of profit taking set in last week at one point. While the quota level is a done deal, what ministers would most likely discuss, when those pesky scribes (and er...bloggers) have been ejected out for the closed door meeting, is how much China would be importing or not.

Several independent forecasters, including the US EIA have predicted that China is likely to become the largest net importer of oil in 2014. By some measures it already is, and OPEC ministers would like to ponder over how much of that Chinese demand would be met by them as US imports continue to decline.

Other matters of course pertain to the appointment of a successor to Secretary General Abdalla Salem El-Badri, and where OPEC stands on the issue of production in his home country of Libya, which is nowhere near the level recorded prior to the civil war.

In order to pick-up the Libyan pulse a little better ahead of the OPEC meet, yours truly headed to IRN/Oliver Kinross 3rd New Libya Conference late last month. The great and good concerned with Libya were all there – IOCs, Libyan NOC, politicians, diplomats and civil servants from UK and Libya alike.

A diverse range of stakeholders agreed that the race to reversing Libyan production back to health would be a long slow marathon rather than a short sprint. Anyone who says otherwise is being naively optimistic.

Forget geopolitics, several commentators were quick to point out that Libya has had no private sector presence in the oil & gas sector. Instead, until recently, it has had 40 years of a controlling Gaddafi fiefdom. Legislative challenges also persist, as one commentator noted: "The road map to a petroleum regime starts first with a constitution."

That's something newly-elected Prime Minister Ahmed Maiteg must ponder over as he tries to bring a fractured country together. Then there is the investment case scenario. Foreign stake-holding in Libyan concerns is only permitted up to 49% despite a risky climate; the Libyan partner must be the majority owner. The oil & gas business has always operated under risk versus reward considerations. But a heightened sense of risk is something not all investors can cope with as noted by Sir Dominic Asquith, former UK ambassador to Iraq, Egypt and Libya, who was among the delegates.

"There is a long term potential with a bright Libyan horizon on the cards. However, getting to it would be a difficult journey, and particularly so for small and medium companies with a lesser propensity to take risk on their balance sheets than major companies," he added.

Meanwhile, a UK Foreign & Commonwealth office spokesperson said the British Government was not changing travel advice to Libya for its citizens any time soon. "We advise against all but essential travel to the country and Benghazi remains off limits. In case of companies wishing to do business in Libya, we strongly urge them to professionally review their own security arrangements."

Combine all of these latent challenges with the ongoing shenanigans and its not hard to figure out why the nation has become one of the smallest producers among its 12 OPEC counterparts and it may be a while yet before investors warm up to it. However, amid the pessimism, there is some optimism too.

Ahmed Ben Halim, CEO of Libya Holdings Group noted that sooner rather than later, the Libyans will sort their affairs out, even though the journey would be pretty volatile. Fares Law Group's Yannil Belbachir pointed out that despite everything all financial institutions were functions normally. That's always a good starting point.

Some uber-optimists also expressed hope of making Libya a "solar power" by tapping sunlight to produce electricity, introduce it back into the grid and send it via subsea cable from Tripoli to Sicily. Noble cause indeed! Being more realistic and looking at the medium term, with onshore prospection and production getting disrupted, offshore Sirte exploration, first realised by Hess Corporation, could provide a minor boost. Everyone from BP to the Libyan NOC is giving it a jolly good try!

Just one footnote, before the Oilholic takes your leave and that's to let you all know that one has also decided to provide insight to Forbes as a contributor on 'crude' matters which can be accessed here; look forward to your continued support on both avenues. That's all from London for the moment folks; more shortly from sunny Vienna at the 165th meeting of OPEC ministers . Keep reading, keep it 'crude'!

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© Gaurav Sharma, 2014. Photo 1: OPEC HQ, Vienna, Austria. © Gaurav Sharma, 2014.

Brent’s spike: Bring on that risk premium

Last week, the Brent forward-month futures contract was within touching distance of capping an 11-week high. On May 22, we saw the new July contract touch an intraday level of US$110.58; the highest since March 3. In fact, Brent, WTI as well as the OPEC crude basket prices are currently in 'three figure territory'.

Libyan geopolitical premium that's already priced in, is being supported by the Ukraine situation, and relatively positive PMI data coming out of China. Of these, if the latter is sustained, the Brent price spike instead of being a one-off would lend weight to a new support level. However, the Oilholic is not alone in the City in opining that one set of PMI data from China is not reason enough for upward revisions to the country's demand forecasts.

As for the traders' mindset the week before the recent melee, ICE's Commitments of Traders report for week of May 20 points to a significant amount of Brent buying as long positions were added while short positions were cut, leaving the net equation up by 15% on the week at 200,876. That's a mere 31,000 below the record from August 2013.

Away from crude pricing, S&P Capital IQ reckons private equity acquisitions in both the energy and utilities sectors are "poised for a comeback".

Its research indicates that to date this year, the value of global leveraged buyouts in the combined energy and utilities sectors is approaching $16 billion. The figure exceeds 2013's full-year total of $10 billion. Extrapolating current year energy and utility LBO deal value, 2014 is on pace for the biggest year for such deals since 2007, S&P Capital IQ adds (see table on left, click to enlarge).

Meanwhile, in its verdict on the Russo-Chinese 30-year natural gas supply contract, Fitch Ratings notes that Gazprom can go ahead with exporting eastwards without denting European exports. But since we are talking of 38 billion cubic metres (cm) of natural gas per annum from Gazprom to CNPC, many, including this blogger, have suggested the Kremlin is hedging its bets.

After all, the figure amounts to a quarter of the company's delivery quota to Europe. However, Fitch Ratings views it is as a case of Gazprom expanding its client portfolio, and for a company with vast untapped reserves in eastern Russia its basically good news.

In a recent note to clients, the ratings agency said: "Gazprom's challenge historically has been to find ways to monetise its 23 trillion cm reserves at acceptable prices – and the best scenario for the company is an increase in production. The deal is therefore positive for the company's medium to long term prospects, especially if it opens the door for a further deal to sell gas from its developed western fields to China in due course."

While pricing was not revealed, most industry observers put it at or above $350 per thousand cm. This is only marginally lower than Gazprom's 2013 contract price with its Western European customers penned at $378 per thousand cm. As for upfront investment, President Vladimir Putin announced a capital expenditure drive of $55 billion to boot. That should be enough to be getting on with it.

Just before one takes your leave, here's an interesting Reuters report by Catherine Ngai on why the 'sleepy market' for WTI delivery close to East Houston's refineries is (finally) beginning to wake up. That's all for the moment folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Table: Global LBOs in the energy & utilities sector © S&P Capital IQ, May 2014.

‘INA’ grumpy mood: MOL & Croatia’s government

The Oilholic finds himself in a jovial mood in sunny Zagreb. However, Hungarian oil company MOL and the Croatian Government are being rather grumpy with each other these days. The reason behind it all is the management of INA or Industrija Nafte, Croatia's national oil company in which the government holds around a 45% stake and MOL a slightly higher 47% stake.

INA has its origins in state-ownership, followed by privatisation; a trend which is not uncommon in this part of the world. It has an E&P arm with ongoing activity closer to home in the Adriatic Sea and Pannonian Basin, and abroad in Egypt and Angola. It also had gas exploration projects in Syria, brought to an abrupt halt in wake of the country's civil war.

INA's R&M operations include both of the Croatia's strategic refining assets – namely Rijeka Refinery (capacity 90,000 bpd) and Sisak Refinery (60,000 bpd) and retail forecourts. According to local analysts and whatever one can gather from media outlets, tension between MOL and Zagreb has been simmering since 2011.

Strain is evident and both parties are so at each other that it is out in the open. A scribe tells yours truly that MOL feels the Croatian Ministry of Economics is riddled with red tape and has conjured up a bad regulatory framework for the sector in general, which is hurting INA by default.

However, Minister Ivan Vrdoljak says it is MOL that has "failed" to deliver on its promise of incremental strategic investment. Another bone of contention is INA's loss-incurring gas trading arm which the government was supposed to have taken over but hasn't so far.

As if that was not enough, a Croatian court found former Prime Minister Ivo Sanader guilty of allegedly taking a bribe from MOL in 2008 for permitting it to gain market dominance. Both Sanader and MOL deny the charge. The country's Supreme Court is currently considering Sanader's appeal against his 10-year sentence, passed by the lower court while he remains behind bars on a multitude of charges.

Meanwhile, an informed source says trust between MOL and the Croatian government "is right out of the window". Sounds much better when locals say so in Croatian, but sadly the Oilholic cant replicate the sound-bite not being able speak any. Those in the outside world might be forgiven for wondering what the fuss is about and its all to do with upstream operations rather than the country's two refineries. INA operates these out of necessity to meet domestic distillate demand above than anything else.

For it, the Pannonian basin holds very good potential. According to the US Geological Survey, the area could have something in the region of 350 million barrels of oil equivalent (boe) by conservative estimates. The figure could rise to lower four digits if overtly optimistic regional projections are followed, so yours truly won't follow them.

Everyone from the Romanians to the Austrians want in, and Croats and Hungarians – should they stop their squabbling – could jointly work on their share too in this hydrocarbon hungry world. Additionally, the north Adriatic Sea offshore prospection is currently yielding INA (and its Italian partner Eni) 15.8 million boe per day.

The latest round of talks aimed at resolving the dispute have been going on since last September, with very little to show for. The next round of talks is scheduled for the end of the month. Here's hoping 'crude' sense prevails or their partnership mementos from 2003 might just end up in the City's Museum of Broken Relationships (see left). In the interim, please take any quips, claims and figures touted by either party with a pinch of salt!

Away from it all, one footnote to boot before yours truly enjoys some cultural pursuits and beverages here – ICE's latest commitment of traders report for the week ending April 29 noted that bets on a rising Brent price have risen to their highest in eight months as money managers, including hedge funds, increased their net long position in Brent crude by 0.3% to 204,488, marking a fourth successive week of increases.

Traders in the category decreased their long positions by 2,464, but the number of short positions also fell, by 3,039 to 47,800, the lowest level since the end of August. That's all from Zagreb folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo 1: St. Mark’s Church as seen from Lotrščak Tower, Zagreb, Croatia. Photo 2: The Museum of Broken Relationships, Zagreb, Croatia © Gaurav Sharma, May 2014.

US prices at the pump & that export ban

Each time the Oilholic is Stateside, one feels obliged to flag up petrol prices at the pump, often a cause of complaint from US motorists, spooking presidents to seek a release of the Strategic Petroleum Reserves.

 

So here's the latest price snap (left) from a petrol station at Mission San Jose, California captured by yours truly while in the South San Francisco Bay. And the price is per gallon, not litres, a pricing level that drivers in Europe can only dream of. With the shale bonanza, chatter is growing that the US should end its ban on crude oil exports. The ban was instituted in wake of the 1973 OPEC oil embargo and has been a taboo subject ever since.

However, the prices you see above are the very reason a lifting of that ban is unlikely to end over the medium term. Argument used locally is the same as the one mooted for the unsuccessful bid to prevent US natural gas exports – i.e. end consumers would take a hit. While in the case of natural gas, industry lobby groups were the ones who complained the loudest, in the case of crude oil, consumer lobby groups are likely to lead the fight.

That's hardly an edifying prospect for any senator or congressman debating the issue, especially in an election cycle which rears its head every two years in the US with never ending politicking. Just ask 'now Senator' and Democrat Ed Markey! But to quote someone else for a change – Senate Foreign Relations Committee Chairman Robert Menendez, another Democrat, has often quipped that lifting the ban would benefit only major oil companies and could end up "hurting US drivers and households" in the long run with higher gasoline prices.

 

Not all Democrats or US politicians are opposed to the lifting of a ban though. Senate Energy and Natural Resources Chairman Mary Landrieu and Republican Senator Lisa Murkowski support a lifting of the ban. Both recently called on the EIA to conduct a detailed study of the effects of crude oil exports.

 

"This is a complex puzzle that is best solved with dynamic and ongoing analysis of the full picture, rather than a static study of a snapshot in time," they wrote in an April 11 letter to EIA Administrator Adam Sieminski.

 

However, in all honesty, the Oilholic expects little movement in this front. Read up on past hysteria over the slightest upward flicker at US pumps and you'll get your answer why. One must be thankful that the debate is at least taking place. That too, only because US crude oil inventory books keep breaking records.

Earlier this month, the market was informed that US inventories had climbed to their highest level since May 1931. So what are we looking at here –  stockpiles at Cushing, Oklahoma, the country's most voluminous oil-storage hub and the delivery point for New York futures, rose by 202,000 barrels in the week ended April 25.

 

The news trigged the biggest WTI futures loss since November last year as a Bloomberg News survey estimated the net stockpile level to be close to 399.9 million last week. That said, nothing stops the likes of Markey from blowing hot air or speculators from netting their pound of flesh.

 

According to the Commitment of Traders (COT) data released by the Commodity Futures Trading Commission (CFTC) on Friday, traders and speculators increased their overall bullish bets in crude oil futures for a fifth straight week, all the way to the highest level since March 4 last week.

 

The non-commercial contracts of crude oil futures, primarily traded by large speculators and hedge funds, totalled a net position of +410,125 contracts for the week ended April 22. The previous week had seen a total of +409,551 net contracts. While this represents only a minor change of just +574 contracts for the week, it is still in throes of a bull run. That's all from San Francisco folks! Keep reading, keep it 'crude'!

 

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© Gaurav Sharma 2014. Photo: Gasoline prices at a station in Mission San Jose, California, USA © Gaurav Sharma, April, 2014.

Crude permutations of the Ukrainian stand-off

When the Russo-Georgian skirmish happened in 2008, European policymakers got a stark reminder of how reliant they were on Russian natural gas. Regardless of the geopolitics of that conflict, many leading voices in the European Union, especially in Germany, vowed to reduce their reliance on Russian gas.

The idea was to prevent one of the world's leading exporters of natural gas from using its resource as a bargaining tool should such an episode occur again. Now that it has, as the Ukrainian crisis brings Russia and West into yet another open confrontation, the Oilholic asks what happened to that vow. Not much given the scheme of things! What's worse, the Fukushima meltdown in Japan and a subsequent haphazard dismissal of the nuclear energy avenue by many European jurisdictions actually increased medium-term reliance on mostly Russian gas.

According to GlobalData, Russian gas exports to Europe grew to a record of 15.6 billion cubic feet per day last year. The US, which is not reliant on Russian natural resources, finds itself in a quandary as EU short-termism will almost certainly result in a toning down of a concerted response by the West against Russia in the shape of economic sanctions.

The human and socioeconomic cost of what's happening in Crimea and wider Ukraine is no laughing matter. However, President Vladimir Putin should be allowed a smirk or two at the idiocy and short-sightedness of the EU bigwigs – reliant on him for natural gas but warning him of repercussions! Therefore, sabre rattling by Brussels is bound to have negligible impact.

Meanwhile, Russia's Gazprom has said it will no longer offer Ukraine discounted gas prices because it is over US$1.5 billion in payment arrears which have been accumulating for over 12 months. Additionally, Rosneft could swoop for a Ukrainian refinery, according to some reports. While economic warfare has already begun, this blogger somehow does not see Russians and Ukrainians shooting at each other; Georgia was different.

Having visited both countries in the past, yours truly sees a deep familial and historic bond between the two nations; sadly that's also what makes the situation queasy. The markets are queasy too. Ukraine was hoping for a shale gas revolution and Crimea – currently in the Kremlin's grip – has its own shale bed. In November 2013, Chevron signed a $10 billion shale gas production sharing agreement with the Ukrainian government to develop the western Olesska field. Shell followed suit with a similar agreement.

Matthew Ingham, lead analyst covering North Sea and Western Europe Upstream at GlobalData, says shale gas production was inching closer. "Together with the UK and Poland, Ukraine could see production within the next three to four years."

However, what will happen from here is anyone's guess. A geopolitical bombshell has been dropped into the conundrum of exploratory and commercial risks.

Away from gas markets, the situation's impact on the wider crude oil market could work in many ways. First off, rather perversely, a mobilisation or an actual armed conflict is price positive for regional oil contracts, but not the wider market. A linear supply shortage dynamic applies here.

An economic tit-for-tat between Russia and the EU, accompanied by a conflict on its borders, would hurt wider economic confidence. So a prolonged escalation would be price negative for the Brent contract as economic activity takes a hit. Russia can withstand a dip in price by as much as $20 per barrel; but worries would surface should the $90-resistance be broken. To put things into perspective, around 85% Russia's oil is sold to EU buyers.

Finally, there is the issue of Ukraine as a major transit point for oil & gas, even though it is not a major producer of either. According to JP Morgan Commodities Research over 70% of Russia's oil & gas flow to Europe passes through Ukrainian territory. In short, all parties would take a hit and the risk premium, could just as well turn into a news sensitive risk discount.

Furthermore, in terms of market sentiment, this blogger notes that 90% of the time all of the risk priced and built into the forward month contract never really materialises. So this then begs the question, whose risk is it anyway? The guy at the end of a pipeline waiting for his crude cargo or the paper trader who actually hasn't ever known what a physical barrel is like!

The situation has also made drawing conclusions from ICE's latest Commitments of Traders report a tad meaningless for this week. Speculative long positions by hedge funds and other money managers that the Brent price will rise (in futures and options combined), outnumbered short positions by 139,921 lots in the week ended February 25, prior to the Ukrainian escalation.

For the record, that is the third weekly gain and the most since October 22. Net-long positions rose by 18,214 contracts, or 15%, from the previous period. ICE also said bearish positions by producers, merchants, processors and users of the North Sea crude outnumbered bullish wagers by 266,017 lots, rising 8.2% from the week before.

Away from Ukraine and on to supply diversity, Norway's Statoil has certainly bought cargo from a land far, far away. According to Reuters, Statoil bought 500,000 barrels of Colombian Vasconia medium crude, offered on the open market in February by Canada's Pacific Rubiales.

When a cargo of Columbian crude is sold by a Canadian company to Norwegian one, you get an idea of the global nature of the crude supply chain. That's if you ever needed reminding. The US remains Pacific Rubiales' largest market, but sources say it is increasing its sales to Europe.

Finally, in the humble opinion of yours truly, Vitol CEO Ian Taylor provided the soundbite of the International Petroleum Week held in London last month.

The boss of the world's largest independent oil trading firm headquartered in serene Geneva opined that Dated Brent ought to broaden its horizons as North Sea production declines. The benchmark, which currently includes Brent, Forties, Oseberg and Ekofisk blend crudes, was becoming "less effective" according to Taylor.

"We are extremely concerned about Brent already not becoming a very efficient or effective benchmark. It’s quite a concern when you see that production profile. Maybe the time has come to really broaden out Dated Brent," he said.

Broadening a benchmark that's used to price over half the world's crude could include Algeria's Saharan Blend, CPC Blend from the Caspian Sea, Nigeria's Bonny Light, Qua Iboe and Forcados crudes and North Sea grades DUC and Troll, the Vitol CEO suggested.

Taylor also said Iran wasn't going to be "solved anytime soon" and would stay just about where it is in terms of exports. The Oilholic couldn't agree more. That's all for the moment folks! Keep reading, keep it 'crude'! 

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© Gaurav Sharma 2014. Photo: Pipelines & gas tank, Russian Federation © Rosneft (TNK-BP archives)

Why Dated Brent is no ‘Libor scandal in waiting’

The Oilholic was asked at a recent industry event whether he thought or had heard any anecdotal evidence about Brent being 'crooked' and susceptible to what we saw with financial benchmarks like Libor. Perhaps much to the annoyance of conspiracy theorists, the answer is no! A probe by the European Commission (EC), which included raids on the London offices of several oil companies and Platts last year, and an ongoing CFTC investigation into trading houses stateside, seems to have triggered the recent wave of questions.

Doubts in the minds of regulators and the public are understandable and very valid, but that an offence on an industry-wide scale can be proved beyond reasonable doubt is another matter. The UK's Office of Fair Trading has already investigated and cleared all parties raided by the EC. Furthermore, it stood by its findings as news of the EC raids surfaced.

As far as price assessment mechanisms go, only Platts' Market on Close (MoC) has faced allegations. It is cooperating with the EC and nothing has emerged so far. Competing methods, for instance ones used by Argus Media, another price reporting agency (PRA), were neither part of the investigation nor have been since.

Let's set all of this aside and start with the basics. A monthly cash-settled future is calculated on the difference between the daily assessment price for Dated Brent (the price assigned on a date when North Sea crude will be loaded onto a tanker) and the ICE daily settlement price for Brent 1st Line Future. Unless loaded as cargo, a North Sea oil barrel – or any barrel for that matter – retains the wider trading metaphor of a paper barrel.

Now as far as the Dated Brent component goes, agreed the PRAs are relying on market sources to give them information about bids, offers and supply-side deals. However, the diversity of sources should mitigate any attempt to manipulate prices by a group of individuals submitting false information. In the case of Libor, the BBA, a single body used to collate the information. In Brent's case, there is more than one PRA. None of these act as some sort of a centralised monopolistic data aggregation body. For what it's worth, anybody with even a minute knowledge of oil & gas markets would know the fierce competition between the two main PRAs.

Don't get the Oilholic wrong – collusion is possible in theory whereby traders gang-up and provide the PRAs with false pre-agreed information to skewer the objectivity of the assessment. However, the supply-side dynamic can wobble on the back of a variety of factors ranging from rig maintenance to an accident, a geopolitical event to actions of other market participants. So how many or how few would be required to fix prices and which PRA would be targeted, when and by how much and so on, and so on!

Then hypothetically let's assume all the price-fixers and factors align, given the size of the market – even if rigging did happen – it'd be localised and cannot be anything on the global scale of fixing that we have seen with the Libor revelations to date. Take it all in, and the allegations look silly at best because the 'collusion dynamic', should there be such a thing, cannot possibly be akin to what went on with Libor.

The EC wants to regulate PRAs via a proposed mandatory code and there is nothing wrong with the idea on the face of it. However, one flaw is that in a global market, buyers and sellers are under no obligation to reveal the price to the PRAs. Many already don't in an ultracompetitive crude world where cents per barrel make a difference depending on the size of the cargo.

If the EC compels traders to reveal information, trading would move elsewhere. Dubai for once would welcome them with open arms and other benchmarks would replace European ones. Anyway, enough said and the last bit is not farfetched! Finally, if fixing on the scale of the Libor scandal is discovered in oil markets and the Oilholic is proved wrong, this blogger would be the first to put his hand up!

Coming on to the current Brent forward month futures price, the last 5-day assessment provided plenty of food for thought. Supply disruptions in Libya (down by 100,000 bpd) and Angola (force majeure by BP potentially impacting 180,000 bpd) kept the contract steady either side of US$109 per barrel level, despite tepid US economic data. That said, stateside the WTI remained stubbornly in three figures on the back of supply side issues at Cushing, Oklahoma. The Oilholic reckons that's the fifth successive week of gains.

Meanwhile, the ICE's latest Commitment of Traders report for the week to February 11 notes that hedge funds and other money managers raised their net long position by 29.6% to 109,223; the highest level since the last week of 2013. The Brent price rose by around $4 a barrel over the stated period. By contrast, the previous week's net long position of 84,276 was the lowest since November 2012.

Away from pricing issues to its impact,  Fitch Ratings said in a recent report that production shortfalls and strategy changes to appease equity holders were a greater threat to the ratings of major Western European oil companies than a prolonged downturn in crude prices.

The ratings agency's stress test of the sector indicated that a Brent price of $55 per barrel would put pressure on credit quality, but compensating movements in cost bases and capex would give most companies a fighting chance at preserving rating levels.

Alex Griffiths, head of natural resources and commodities at Fitch, said, "With equity markets increasingly focussed on returns, bond yields near historical lows and oil prices forecast to soften, the chances of companies increasing leverage to benefit equity holders have risen. The European companies that have reported so far this year have generally resisted this pressure – but it may increase as the year goes on."

Separately, the agency also noted that a fall of the rouble would benefit Russian miners more than oil exporters. For both sectors, the currency's limited decline will strengthen earnings and support their credit profile, but ratings upgrades are unlikely without indications that the currency has settled at a new lower level.

To give the readers some context, the rouble has depreciated by 8% against the US dollar since the first trading day of the year and is down 17% from the end of 2012.

Depreciation of a local currency is generally good news for a country's exporters, but the effect on Russian oil exporters is less pronounced due to taxation and hence is less likely to result in positive rating actions in the future, Fitch said.

From Russia to the US, where there are widespread reports of a flood of public comments arriving at door of the State Department with public consultation on Keystone XL underway in full swing. See here's what yours truly does not get – you can have your comments included in the wider narrative, but are not obliged to give your details even under a confidentiality clause. This begs the question – how do you differentiate the genuine input, both for and against the project, from a bunch of spammers on either side?

Meanwhile, the Department of Energy has approved Sempra Energy's proposal to export LNG to the wider market including export destinations that do not have free trade agreement countries with the US. The company, which has already signed Mitsubishi and Mitsui of Japan and GDF Suez of France, could now spread its net further afield from its proposed export hub in Louisiana.

Elsewhere, Total says its capex budget is $26 billion for 2014, and $24 billion for 2015, down from $28 billion in 2013. No major surprises there, and to quote an analyst at SocGen, the French oil major "is sticking to its guns with more downstream restructuring being a dead certainty."

After accusations of not being too ambitious in its divestment programme, Shell said it could sell-off of its Anasuria, Nelson and Sean platforms in the British sector of the North Sea. The three platforms collectively account for 2% of UK production. Cairn Energy has had a fair few problems of late, but actress Sienna Miller and model Kate Moss weren't among them. That's until they took issue with one of the company's oil rigs blotting the sea off their party resort of Ibiza, Spain, according to this BBC report.

Finally, the pace of reforms and general positivity in the Mexican oil and gas sector is rubbing off on PEMEX. Last week, Moody's placed its Baa1 foreign currency and global local currency ratings on review for an upgrade.

In a note to clients, Tom Coleman, senior vice president at Moody's, wrote: "Mexico's energy reform holds out prospects for the most far ranging changes we have seen to date, benefiting both Mexico's and PEMEX's growth profiles in the medium-to-longer term."

And just before yours truly takes your leave, OPEC says world oil demand will increase by 1.09 million bpd, or 1.2%, to 90.98 million bpd from 89.89 million bpd in 2013. That's an upward revision of 1.05 million bpd in 2014. Non-OPEC supply should more than cover it methinks. That's all for the moment folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo 1: Oil tankers in English Bay, British Columbia, Canada © Gaurav Sharma, April 2012. Photo 2: Oil exploration site © Lukoil.

The year that was & ‘crude’ predictions for 2014

As crude year 2013 came to a close, the Oilholic found himself in Rotterdam gazing at the Cascade sculpture made by Atelier Van Lieshout, a multidisciplinary contemporary arts and design company.

This eight metre high sculpture, in a city that was once the world's busiest port [before Shanghai overtook it in 2004], comprises of 18 stacked oil drums, which give an appearance of having descended from the sky. They combine to form a monumental column from which the life-size drums drip a viscous mass acquiring the shapes of human figures [see left, click to enlarge].

Perhaps these figures and barrels symbolise us and our sticky relationship with the crude oil markets. For all the huffing and puffing, bears and bulls, predictions and forecasts, dips influenced by macroeconomics and spikes triggered by geopolitics – the year-end Brent crude oil price level came in near where it was at the end of 2012; in fact it was 0.3% lower! On the other hand, the WTI reversed its 7 percent annualised reversal recorded at the end of 2012, to finish round about 8 percent higher in year-over-year terms on the last day of trading in 2013.

Was there an exact science in the good and bad predictions about price levels we saw last year – nope! Does the Oilholic feel both benchmark prices are running contrary to supply-side dynamics given the current macroeconomic backdrop – yup! Did paper barrels stuff the actual merchants waiting at the end of  pipelines to collect their crude cargo – you bet!

Watching Bloomberg TV on January 2 brought home the news that money managers raised their net-long positions for WTI by 4.4 percent in the week ended December 24; the fourth consecutive increase and longest streak since July, according to the broadcaster. This side of the pond, money managers followed their friends on the other side and raised net bullish bets on Brent crude to the highest level in 10 weeks, according to ICE Futures Europe.

Speculative bets that prices will rise [in futures and options combined], outnumbered short positions by 136,611 lots in the week ended December 31, according to ICE's weekly Commitments of Traders report. The addition of 7,670 contracts, or 6 percent, brought the net-long positions to the highest level since October 22. It seems for some, the only way is up, because the fine line between pragmatic trading and gambling has long gone in actual fact.

The Oilholic predicted a Brent price in the range of US$105 to $115 in January last year. As Brent came in flat at year-end, yours truly was on the money. The heart said then, as it does now, even that range – despite being proved correct – was in fact overtly bullish but workable in this barmy paper barrel driven market.

For 2014, hoping that some of the supply-side positivity would be factored in to the mindset of traders, the Oilholic's prediction is for a Brent price in the range of $90 to $105 and WTI price range of $85 to $105. Brent's premium to the WTI should in all likelihood come down and average around $5 barrel.

The Oilholic's opinion is in sync with some, but also quite contrary to many of the bullish City forecasts. That's for them to maintain – this blogger is quietly confident that more Iraqi and Iranian crude will come on the market at some point over 2014. The US isn't importing as much and incremental barrels will henceforth come on to the markets. These will hopefully trigger a much needed price correction.

Of all the price prediction notes in this blogger's Inbox over the first week of 2014, one put out by Steven Wood and Terry Marshall of Moody's appears to be the most pragmatic. Their price assumptions, used for "ratings purposes only rather than as predictions", are for Brent to average $95 per barrel in 2014 and $90 in 2015, compared to $90 per barrel in 2014 and $85 in 2015 for WTI. As both analysts noted: "Oversupply will cool oil prices in 2014."

"A drop in Chinese growth and a surge in OPEC production pose the biggest risks to oil prices as we head into the New Year. Prices could fall if Chinese GDP growth slows significantly and OPEC members go above targeted production of 30 million barrels per day (bpd)," they added.

Away from crude price predictions on a standalone basis and reflecting on the year that was, the US EIA said prices of energy commodities decreased only modestly or increased last year, while prices of non-energy commodities like wheat and copper generally fell significantly.

Natural gas, western coal, electricity and WTI crude prices increased, while Brent, petroleum products and eastern coal prices decreased slightly. "In total, the divergence between price trends for energy and non-energy commodities grew after the summer of 2013. This is in contrast to 2012 when metals prices were stable or experienced slight increases, and a severe drought drove prices of some agricultural commodities higher in the second half of the year," it added.

From the EIA to OPEC where both its meetings in lovely Vienna last year, duly attended by the Oilholic, turned out to be predictable affairs with the "official" quota still at 30 million bpd. And we still don't have a long overdue successor to Secretary General Abdalla Salem El-Badri. The Oilholic also managed to grab a moment with Saudi oil minister Ali Al-Naimi at a media scrum in May. Away from the meetings, the year actually began in terrible fashion for OPEC following a terror attack on an Algerian facility, but easing of tensions with Iran towards the end of the year, was a positive development.

It was also the year in which the Brits not only got excited about their own shale exploration prospects, but also inked their first contract to import proceeds of the US shale bonanza via Sabine Pass. Analysts liked it, Brits cheered it, but US politicians and energy intensive industries stateside didn't. The Keystone XL pipeline project, stuck in the quagmire of US politics, also dragged on.

That yours truly moaned about the banality of market forecasts based on short-termism more than once was not unexpected; a blog on the bankrolling of Thatcherism by the oil and gas sector after the Iron Lady's death in May certainly was.

Apart from routine visits to OPEC, ever the intrepid traveller, this blogger blogged from lands far away and some not so far away. The year began with a memorable visit to the Chicago Board of Trade at the kind invitation of Phil Flynn of Price Futures; a friend and analyst who never sits on the fence in any debate and is most likely to be vindicated as the Brent-WTI spread narrows over 2014.

This was followed by a hop across The Lakes to Toronto to gauge opinion on Keystone XL. Jaunts to the G8 2013 Summit in Northern Ireland, crude ol' Norway, Abu Dhabi and a first visit to Muscat and Khasab to profile Oman's oil and gas sector followed thereafter.

Before calling time on 2013 in Rotterdam, the Oilholic headed out to the Oil Capitals of Europe and North America – chasing the uptick in oilfield services sector activity in Aberdeen, and Platts' response to the Houston Glut in the shape of its new Light Houston Sweet (LHS) benchmark. Moving away from travels, yours truly also reviewed another seven books for your consideration.

For all intents and purposes, it's been a crude old year! And it wouldn't have been half as spiffing without the support and feedback of you all - the dear readers of this humble blog. For those of you, who wanted this blogger on Twitter; you are welcome to follow @The_Oilholic

There goes the look back at Crude Year 2013. As the Oilholic Synonymous Report embarks upon its fifth year on the Worldwide Web and the seventh year of its virtual existence – here's to 2014! That's all for the moment folks! Keep reading, keep it 'crude'!

To follow The Oilholic on Twitter click here.

To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2014. Photo: Cascade sculpture by Atelier Van Lieshout Company, Rotterdam, The Netherlands © Gaurav Sharma, January 1, 2014.