That 1980s feeling, Saudi Oil, Ebola & more

Brent dipped below US$84 per barrel at one point this week while the WTI is holding above the $80 level. It’ll be interesting to note how the December futures contract fares as the Northern Hemisphere winter approaches with bearish headwinds lurking in the background. From here on, much will depend on what happens at the next OPEC meeting on November 27, where a production cut has the potential to partially stem the decline.

By the time of the meeting in Vienna, we’d already be well into the ICE Brent January contract. The mere possibility of a production cut isn’t enough to reverse the slide at the moment given wider market conditions. But as ever, OPEC members are presenting a disunited front diluting any market sentiments aimed at pricing in a potential cut.

The answer lies in an interesting graphic published by The Economist (click here) indicating price levels major producers would be comfortable with. There are no surprises in noting that Iran, Venezuela and Russia are probably the most worried of all exporters. While several OPEC members prefer at least a $100 price floor, in recent weeks Saudi Arabia has quite openly indicated it can tolerate the price falling below $90.

The Saudis also lowered their asking price in a bid to maintain market share. That’s bad news for most of OPEC, excluding Kuwait and UAE. In turn, Iran responded by lowering its asking price as well even though it can't afford to. So the debate has already started, whether in not wanting to repeat the mistakes of the 1980s which left it with a weakened market share; Saudi Arabia might in fact trigger OPEC discord and a slump akin to 1986.

While the Oilholic doubts it, certain OPEC members wouldn’t be the only ones hurt by the Saudi stance which abets existing bearish trends. US shale and Canadian oil sands exploration and production (E&P) enthusiasts will be troubled too. While the oil price is tumbling, the price of extracting the crude stuff isn’t.

Fitch Ratings says Brent could dip to $80 before triggering a self-correcting supply response with shale oil drillers cutting investment in new wells. Anecdotal evidence sent forth by the Oilholic’s contacts in Calgary point to similar sentiments being expressed in relation to the oil sands. 

The steep rate at which production from shale wells declines mean companies have to keep drilling new wells to maintain production. Fitch estimates median full-cycle costs for E&P companies have fallen to about $70 in the US. The marginal barrel, not the median one, balances supply and demand and determines price, so the point at which capex falls will probably be higher.

Over the short-term, Fitch considers a resurgence of supply disruptions and positive action from OPEC as the most likely catalysts for a rebound in prices. “But without these, further declines might be possible, especially if evidence grows of further weakening of global demand or increasing OPEC spare capacity,” the agency adds.

Longer term, an uptick in economic activity in China and India will contribute to a growth in oil demand. However, what we’re dealing with is short-term weakness. IEA demand growth for 2015 has been revised by 300,000 barrels per day (bpd) and 2014’s estimate by 200,00 bpd. The Oilholic suspects Saudi Arabia, Kuwait and UAE are only too aware of this and capable enough to withstand it.

Dorian Lucas, analyst at Inenco, says, “We’re seeing the largest in over two years spurred by accumulating evidence of waning global demand, whilst buoyant supply continues to drown the market. The extent to which supply has buoyed is evident when assessing September 2014 in isolation. Global oil supply rose over 900,000 bpd to total of 93.8 million bpd, this is over 2.5 million bpd higher than the same time last year.”

What happens at OPEC’s next meeting would depend on the Saudis. The Oilholic still rates the chances of a production cut at 40%. One feels that having the capacity to withstand a short-term price shock, Saudi Arabia wouldn’t mind other producers squirming in the interest of self-preservation.

Meanwhile, the industry is also grappling with the unfolding Ebola outbreak which has claimed thousands of lives in West Africa. Unsurprising anecdotal evidence is emerging of companies having difficulty in finding engineering experts, roughnecks or support staff willing to work at West African prospection sites.

In order to get a base case idea, browse job openings at a recruitment site (for example – Rigzone) and you’ll find pay rates for working in West Africa climb above sub-zero winter working rates on offer at Fort McMurray, Alberta, Canada. Three recruitment consultants known to this blogger have expressed similar sentiments.

While most of the drilling is offshore, workers' compounds are onshore in Guinea, Sierra Leone and Liberia. Additionally, local workers return to their homes mingling with the general population at risk of getting infected. The fear is putting off workers, and many companies have internal moratoriums on travel to the region.

Forget workers, even investors are having second thoughts for the moment. Both Reuters and USA Today have reported caginess at ExxonMobil about the commencement of offshore drilling in Liberia at the present moment in time.The company already restricts non essential travel by its employees to the region. Shell and Chevron have similar safeguards in an industry heavily reliant on expat workers.

GlobalData says of the affected African countries only Nigeria is equipped to handle the Ebola outbreak.  GDP of the said countries is likely to take a hit from loss of lives and revenue. International SOS, a Control Risks Group affiliate company which provides integrated medical, clinical, and security services to organisations with international operations, has been constantly updating advice for corporate travel to Guinea, Liberia or Sierra Leone, the current one being to avoidance all non-essential travel to the region.

Fitch Ratings says at present, the Ebola outbreak does not have any credit ratings implications for E&P companies in the region. Alex Griffiths, Head of EMEA, Natural Resources and Commodities, notes: “Our key consideration is how well the companies manage the Ebola risk. From a risk rating standpoint, we’re in early days. Fitch will continue to monitor the situation over the coming months.”

Away from Ebola, here’s the Oilholic’s take via a Forbes post on the future of integrated IOCs. Lastly, news has emerged that Statoil CEO Helge Lund has been appointed CEO of the much beleaguered BG Group with effect from March 2015. The soon to be boss said he was looking forward to working with BG’s people “to develop the company’s full potential.”

The announcement was roundly cheered in the City given the high regard Lund is held in by the wider oil and gas industry. To quote Investec analyst Neill Morton, “BG still faces challenges, but we believe it has a better chance of addressing them with Lund on board.”

We shall see whether Statoil’s loss is indeed BG Group’s gain. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2014. Photo: Vintage Shell Fuel Pump, San Francisco, USA © Gaurav Sharma.

Buyers' market & an overdue oil price correction

Recent correction in the price of crude oil should come as no surprise. The Brent front month futures contract fell to a 26-month low last week lurking around the US$98 per barrel level.

The Oilholic has said so before, and he’ll say it again – there is plenty of the crude stuff around to mitigate geopolitical spikes. When that happens, and it has been something of a rarity over the last few years, the froth dissipates. In wake of Brent dipping below three figures, a multitude of commentators took to the airwaves attributing it to lower OECD demand (nothing new), lacklustre economic activity in China (been that way for a while), supply glut (not new either), refinery maintenance (it is that time of the year), Scottish Referendum (eh, what?) – take your pick.

Yet nothing’s changed on risk front, as geopolitical mishaps – Libya, Sudan, Iraq and Ebola virus hitting West African exploration – are all still in the background. What has actually gotten rid of the froth is a realisation by those trading paper or virtual contracts that the only way is not long!

It’s prudent to mention that the Oilholic doesn’t always advocate going short. But one has consistently being doing so since late May predicated on the belief of industry contacts, who use solver models to a tee, to actually buy physical crude oil, rather than place bets on a screen. Most of their comparisons factor in at least three sellers, if not more.

Nothing they've indicated in the last (nearly) five months has suggested that buyers are tense about procuring crude oil within what most physical traders consider to be a "fair value" spot trade, reflecting market conditions. For what it’s worth, with the US buying less, crude oil exporters have had to rework their selling strategies and find other clients in Asia, as one explained in a Forbes post earlier this month.

It remains a buyers’ market where you have two major importers, the US and China who are buying less, albeit for different reasons. In short, and going short on crude oil, what’s afoot is mirroring physical market reality which paper traders delayed over much of the second quarter of this year from taking hold. Furthermore, as oversupply has trumped Brent’s risk premium, WTI is finding support courtesy the internal American dynamic of higher refinery runs and a reduction of the Cushing, Oklahoma glut. End result means a lower Brent premium to the WTI. 

However, being pragmatic, Brent’s current slump won’t be sustained until the end of the year. For starters, OPEC is coming to the realisation that it may have to cut production. Secretary General Adalla Salem El-Badri has recently hinted at this.

While OPEC heavyweight Saudi Arabia is reasonably comfortable above a $85 price floor, hawks such as Iran and Venezuela aren’t. Secondly, economic activity is likely to pick up both within and outside the OECD in fits and starts. While Chinese economic data continues to give mixed signals, India is seeing a mini-bounce. 

Additionally, as analysts at Deutsche Bank noted, “With refineries likely to run hard after the maintenance period, this will support crude oil demand and eventually prompt crude prices, in our view. This may be one of the factors that could help to eliminate contango in the Brent crude oil term structure.”

While the general mood in the wider commodities market remains bearish, it should improve over the remainder of the year unless China, India and the US collectively post dire economic activity, something that’s hard to see at this point. The Oilholic is sticking to his Q1 forecast of a Brent price in the range of $90 to $105 for 2014, and for its premium to WTI coming down to $5.

Meanwhile, Moody's has lowered the Brent crude price assumptions it uses for ratings purposes to $90 per barrel through 2015, a $5 drop from the ratings agency's previous assumptions for 2015. It also reduced price assumptions for WTI crude to $85 per barrel from $90 through 2015.

The agency’s price assumptions for 2016 and thereafter are $90 per barrel for Brent crude and $85 for WTI crude, unchanged from previous assumptions. Moody’s continue to view Brent as a common proxy for oil prices on the world market, and WTI for North American crude.

On a closing note, here’s the Oilholic’s second take for Forbes on the role of China as a refining superpower. Recent events have meant that their refining party is taking a breather, but it’s by no means over. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2014. Photo: Russian Oil Extraction Facility © Lukoil. Graph: Brent curve structure, September 19, 2014 © Deutsche Bank