Oil oversupply has triggered risk premium fatigue

The Oilholic reckons it will take at least another six months in the New Year to ease the current oil oversupply glut. More so, as OPEC is highly likely to maintain its current production level, according to initial conjecture here in Vienna, Austria with the latest oil ministers’ summit currently underway.

That would probably take us to somewhere around June 2016, when we’ll see excess supply falling to somewhere in the region of 1 million barrels per day (bpd). Be that as it may, even such a decline might not be enough to bring the so-called risk or geopolitical premium into play. 

Last week, offered a clear case in point when the Turkish Air Force brought down a Russian fighter jet. Both countries are significant players in the oil and gas world – Turkey, is a custodian of the key shipping artery of the Bosphorus, and Russia, is the world’s leading oil and gas producer.

Yet, an oil futures "rally" in wake of the incident barely lasted two sessions and a few dollars, before oversupply sentiment returned to dictate market direction as per the current norm. Furthermore, both Brent and WTI futures are going sideways in the $40-45 per barrel range, as has been the case of late.

Flashpoints in the oil and gas world haven’t disappeared. Nigeria, Libya, West’s relations with Russia and Iraq are broadly where they were, if not worse. In fact, situation in the wider Middle East is pretty dire. Yet, the risk premium - so prevalent in the oil trade - is more or less nonexistent in a market struggling to park its barrels.

That will remain the case until excess supply falls to around 700,000 to 800,000 bpd. Even beyond the first half of 2016, few expect a dramatic uptick in oil prices, using Brent as a global proxy benchmark. At Fitch Ratings’ recent London Energy Seminar, this blogger found himself in the company of several experts who agreed that $60-level is unlikely to be capped before the end of 2016.

Alex Griffiths, Head of Natural Resources and Commodities at Fitch Ratings, Tim Barker, Head of Credit Research at Old Mutual Global Investors, Julian Mylchreest, Global Head of Energy at Bank of America Merrill Lynch, and Mutlu Guner, Executive Director at Morgan Stanley, all agreed there is little around to instil confidence in favour of a fast uptick above $60 being on cards within 12 months time. 

Moving away from the oil price, Genscape Oil Editor David Arno’s thoughts on the impact of Keystone XL’s rejections by the Obama administration, chimed with yours truly. Rail freight companies would undoubtedly be the biggest beneficiaries. In his blog post following the decision last month, Arno also felt denial of the pipeline provides rail shippers with “at least a year and a half more of comfort that Canadian rail opportunities will be needed.”

Finally, a couple of notes from Moody’s are worth flagging. The agency recently changed Kinder Morgan's outlook to negative from stable. Senior Vice-President Terry Marshall said the negative outlook reflects Kinder Morgan's increased business risk profile and additional pressure on its already high leverage that will result from its agreement to increase ownership in Natural Gas Pipeline Company, a distressed company. 

On November 30, Kinder Morgan announced an agreement to increase its ownership in NGPL of America to 50% from 20% for approximately $136 million. Brookfield Infrastructure Partners will own the remaining 50%. Proportionate consolidation of NGPL's debt will add about $1.5 billion to KMI's consolidated debt. NGPL's trailing twelve month September 30, 2015 EBITDA was $273 million (gross).

Moving on to state-owned crude giants, Moody's also said China National Petroleum Corporation's (CNPC) proposal to sell some of its pipeline assets is credit positive, as profits and proceeds from the sale will partially offset negative impact from low crude oil and gas prices and help preserve its financial profile during the current industry downturn.

However, Moody’s said the sale has no immediate impact on its ratings and outlook as the benefits “are marginal, given CNPC's extremely large revenue and asset size.” Nonetheless, the ratings agency expects sale proceeds to help CNPC fund the gap between its capital expenditure and operating cash flow and therefore lower its reliance on additional debt to fund its growth.

Finally, the rating agency also downgraded Pemex’s global foreign currency and local currency ratings to Baa1 from A3. Simultaneously, Moody's lowered Pemex's baseline credit assessment (BCA), which reflects its standalone credit strength, to ba3 from ba1.

The actions were prompted by Moody's view that the company's current weak credit metrics will "deteriorate further in the near to medium term. The outlook on all ratings was changed to negative." That’s all for the moment folks from Vienna folks, as the Oilholic finds his bearings at yet another OPEC summit. Plenty more from here shortly! In the interim, keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: OPEC Signage © Gaurav Sharma / Oilholics Synonymous Report.

Keystone XL farce and rail freighters' smiles

The Obama administration’s long anticipated rejection of the Keystone XL project – an extension [from Hardisty, Alberta to Port Arthur, Texas] to the already existing transnational pipeline between Canada and the US – on 5 November hardly came as a surprise to the oil and gas industry. But is it finally the end of the saga? Not quite, only for the Obama White House staff. 

Once a new US president is in, the project sponsors can, should they choose to do so (and is quite likely they will), launch a fresh application with amendments and new proposals. Quite frankly, the development might be new but the talking points aren’t.

The saga has dragged on and on for seven years and descended into a farce that even provided material for comedian Jon Stewart on more than one occasion (click here). However jokes apart whatever side of the argument you are, that the whole thing got dragged into the quagmire of US politics in the way that it did, is no laughing matter.

This blogger has always maintained that the project's rejection is not some sort of a fatal blow to Canada’s oil and gas industry, but rather an inconvenience and one that has arrived at a time of wider difficulties in the market. Several analysts in Canadian financial circles concur and rail freight companies probably cheered the rejection, despite their own problems with safety related issues and incidents when it comes to moving crude oil.

Of course, moving crude by rail to the Gulf Coast costs almost double per barrel in the region of $7.00 to $11, but for some it won't be a choice. Moving crude by rail is also probably twice as much environmentally unfriendly, something few of the pipeline extension's naysayers appear to be touching on.

There will need to be some medium term adjustments. As the Oilholic noted in 2013, TransCanada is already forging ahead with a West to East pipeline corridor aimed at bringing domestic crude in meaningful volumes from Alberta to Quebec and New Brunswick by 2017 and 2018 respectively. Additionally, considerable amount of lobbying is afoot in terms of looking towards Eastern markets, especially China (despite the recent oil price decline), via British Columbia’s coastline. 

As for the near term, Moody’s expects currently available pipeline and rail transportation to meet anticipated production growth through to the fourth quarter of 2017.

“Post 2017, we expect that as oil egress from Canada becomes constrained, additional rail capacity will fill the void until one of the three proposed major domestic pipelines – Trans Canada's Energy East, Kinder Morgan's Trans Mountain expansion or Enbridge's Northern Gateway – is approved and built,” said Moody’s analyst Terry Marshall. 

There already exists about 550,000 barrels per day (bpd) of unused rail capacity in Western Canada at present, according to the Canadian Association of Petroleum Producers' (CAPP) data. That’s over and above the approximate 200,000 bpd of capacity that will be used to ship oil in 2015, and few, including Moody’s analysts, are in any doubt that moving crude by rail will rise in all likelihood.

Rail freighters' joy is also likely to be further prolonged by the current political climate in Canada. With the oil and gas industry friendly Stephen Harper administration having been voted out after nine years in office, it is all but guaranteed the new Liberal Party Government's pre-election promise to “rework the domestic pipeline approval process” will go ahead.

Not quite clear on the minutiae and what this would entail until details are published and then put to the Canadian parliament later down the year. However, having seen plenty of such overtures in numerous jurisdictions, the Oilholic feels an increase in cost and timescale of the regulatory process is highly likely, alongside the escalating cost of environmental compliance in Canada. 

All of this comes at a time when Canadian oil exploration and production companies could well have done without it. A tough few years are on the horizon. That’s all for the moment folks! Keep reading, keep it ‘crude’! 

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© Gaurav Sharma 2015. Photo: Railway oil tankers outside of Calgary, Alberta, Canada © Gaurav Sharma, March 2011.