Crude market, Russia & fretting over Afren

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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© Gaurav Sharma 2014. Photo: Russian Oilfields © Lukoil

Iraqi situation likely to unleash crude bull runs

Just as the OPEC conference dispersed here in Vienna, the speed with which the situation in Iraq has deteriorated has taken the market by surprise. Can't even blame Friday the 13th; the deterioration started a few days before.

There was not an Iraqi official commentator in sight when the trickle of news turned into a flood announcing the rapid advance of Sunni militants (or the Islamic State in Iraq and the Levant, an al-Qaeda breakaway) across vast swathes of the country to within touching distance of Baghdad.

The market is keeping reasonably calm for now. However, both Brent spot and futures prices did spike above US$113 per barrel at one point or another over the last 72 hours. We're already at the highest levels this far into 2014. The Oilholic has always been critical when paper traders jump to attach instant risk premium to the crude price at the slightest ripple say in Nigeria or Libya. However, this alas is something else and it matters.

For starters, Iraqi production was on a slow and painful recovery run. The trickle of inward investment had started and Kurdish controlled areas weren’t the only ones seeing a revival. This is now under threat. Secondly, a visibly deteriorating situation could draw Iran into the tussle and there are some signs of it already. Thirdly, it has emboldened Kurdish security forces to take over Kirkuk, with unhidden glee. This could dent ethnic calm there in that part of the country.

Fourthly, Iraq despite its troubles remains a key member of OPEC. Finally, if you look at a map of Iraqi oilfields, the areas now held by the insurgents would trouble most geopolitical commentators as they cover quite a few hydrocarbon prospection zones. Add it all together and what's happening in Iraq, should it continue to deteriorate, has the potential of adding at least $10 per barrel to the current price levels, and that’s just a conservative estimate.

If Iraq gets ripped apart along ethnic lines, all projections would be right out of the window and you can near double that premium to $20 and an unpredictable bull run. That tensions were high was public knowledge, that Baghdad would lose its grip in such a dramatic fashion should spook most. There is one but vexing question on a quite a few analysts’ minds – is this the end of unified Iraq? The Oilholic fears that it might well be. 

Away from this depressing saga, a couple of notes from ratings agencies to flag up. Moody's says the outlook for global independent E&P sector remains positive. It expects growth to continue over the coming 12-18 months, with no "obvious catalyst" for a slowdown.

Analyst Stuart Miller reckons unless the price of crude drops below $80 per barrel, investment is unlikely to fall materially for oil and liquids-oriented companies such as Marathon Oil, Whiting Petroleum and Kodiak Oil & Gas.

"The positive outlook reflects our view that industry EBITDA will grow in the mid- to high-single digits year over the next one to two years. Stable oil and natural gas prices will enable E&P companies to continue to invest with confidence, driving production and cash flow higher," Miller added.

However, a lack of gathering, processing and transportation infrastructure will continue to plague the industry, though to a lesser extent than in the past couple of years. The completion of infrastructure improvements will unshackle production growth rates for companies such as Continental Resources and Oasis Petroleum in the Bakken Shale, and Range Resources and Antero Resources in the Marcellus Shale, according to Moody's.

Meanwhile, Fitch Ratings said fracking could help the European Union cut its reliance on Russian Gas. Germany's reported plan to lift a ban on fracking highlights one of several ways that European countries could reduce their reliance on Russian gas, it says.

Out of the major European oil and gas companies, Fitch reckons Total could have a head start over rivals if European shale gas production ramps up, because of the experience it has gained from investment in UK shale.

The group became the first Western oil major to invest in UK shale after agreeing to take a 40% stake in two licenses earlier this year. Total would also be well positioned if France followed Germany and decided to ease restrictions on shale gas production, as its home market is thought to have some of the largest shale gas reserves in Europe.

Jeffrey Woodruff, senior director at Fitch Ratings, said, “If European countries want to cut reliance on Russian gas, other potential routes include greater use of LNG. BG will be one of the first European companies to export LNG from the US, due to its participation in three of the six projects that have been approved by the US Department of Energy to export LNG.”

All of this is well and good, but as the Oilholic noted in a Forbes post earlier this month, Europeans need to be both patient and pragmatic. The US shale bonanza took 30 years to materialise meaningfully, Europe's is likely to take longer. Speaking of shale, here is one's take on why US shale would not hurt OPEC all that much, as legislative impediments prevent the US from exporting crude oil and by default do not give it the feel of a global bonanza. That's all from Vienna folks. Next stop Moscow, for the 21st World Petroleum Congress. Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Exploration site in Kurdistan © Genel Energy

EU’s Russian gas, who gets what & BP’s Bob

The vexing question for European Union policymakers these days is who has what level of exposure to Russian gas imports should the taps get turned off, a zero storage scenario at importing nations is assumed [hypothesis not a reality] and the Kremlin's disregard for any harm to its coffers is deemed a given [easier said than done].

Depending on whom you speak to, ranging from a European Commission mandarin to a government statistician, the figures would vary marginally but won't be any less worrying for some. The Oilholic goes by what Eurogas, a non-profit lobby group of natural gas wholesalers, retailers and distributors, has on its files.

According to its data, the 28 members of the European Union sourced 24% of their gas from Russia in 2012. Now before you say that's not too bad, yours truly would say that's not bad 'on average' for some! For instance, Estonia, Finland, Lativia and Lithuania got 100% of their gas from Russia, with Bulgaria, Hungary and Slovakia not far behind having imported 80% or more of their requirements at the Kremlin's grace and favour.

On the other hand, Belgium, Croatia, Denmark, Ireland, Netherlands, Portugal, Spain, Sweden and the UK have nothing to worry about as they import nothing or negligible amounts from Russia. Everyone in between the two ends, especially Germany with a 37% exposure, also has a major cause for concern.

And it is why Europe can't speak with one voice over the Ukrainian standoff. In any case, the EU sanctions are laughable and even a further squeeze won't have any short term impact on Russia. A contact at Moody's says the Central Bank of the Russian Federation has more than enough foreign currency reserves to virtually guarantee there is no medium term shortage of foreign currency in the country. Industry estimates, cited by the agency, seem to put the central bank's holdings at just above US$435 billion. EU members should know as they contributed handsomely to Russia's trade surplus!

Meanwhile, BP boss Bob Dudley is making a habit of diving into swirling geopolitical pools. Last November, Dudley joined Iraqi Oil Minister Abdul Kareem al-Luaibi for a controversial visit to the Kirkuk oilfield; the subject of a dispute between Baghdad and Iraqi Kurdistan. While Dudley's boys have a deal with the Iraqi Federal government for the oilfield, the Kurds frown upon it and administer chunks of the field themselves to which BP will no access to.

Now Dudley has waded into the Ukrainian standoff by claiming BP could act as a bridge between Russia and the West. Wow, what did one miss? The whole episode goes something like this. Last week, BP's shareholders quizzed Dudley about the company's exposure to Russia and its near 20% stake in Rosneft, the country's state-owned behemoth.

In response, Dudley quipped: "We will seek to pursue our business activities mindful that the mutual dependency between Russia as an energy supplier and Europe as an energy consumer has been an important source of security and engagement for both parties for many decades. We play an important role as a bridge."

"Neither side can just turn this off…none of us know what can happen in Ukraine," said the man who departed Russia in a huff in 2008 when things at TNK-BP turned sour, but now has a seat on Rosneft's board.

While Dudley's sudden quote on the crisis is surprising, the response of BP's shareholders in recent weeks has been pretty predictable. Russia accounts for over 25% of the company's global output in barrels of oil equivalent per day (boepd) terms. But, in terms of booked boepd reserves, the percentage rises just a shade above 33%.

However, instead of getting spooked folks, look at the big picture – according to the latest financials, in petrodollar terms, BP's Russian exposure is in the same investment circa as Angola and Azerbaijan ($15 billion plus), but well short of anything compared to its investment exposure in the US.

Sticking with the  crudely geopolitical theme, this blogger doesn't always agree with what the Henry Jackson Society (HJS) has to say, but its recent research strikes a poignant chord with what yours truly wrote last week on the Libyan situation.

The society's report titled - Arab Spring: An Assessment Three Years On (click to download here) - noted that despite high hopes for democracy, human rights and long awaited freedoms, the overall situation on the ground is worse off than before the Arab Spring uprisings.

For instance, Libyan oil production has dramatically fallen by 80% as neighbouring Tunisia's economy is now dependent on international aid. Egypt's economy, suffering from a substantial decrease in tourism, has hit its lowest point in decades, while at the same time Yemen's rate of poverty is at an all-time high.

Furthermore, extremist and fundamentalist activity is rising in all surveyed states, with a worrying growth in terror activities across the region. As for democracy, HJS says while Tunisia has been progressing towards reform, Libya's movement towards democracy has failed with militias now effectively controlling the state. Egypt remains politically highly-unstable and polarised, as Yemen's botched attempts at unifying the government has left many political splits and scars.

Moving on to headline crude oil prices, both benchmarks have closed the gap, with the spread in favour of Brent lurking around a $5 per barrel premium. That said, supply-side fundamentals for both benchmarks haven't materially altered; it's the geopolitical froth that's gotten frothier. No exaggeration, but we're possibly looking at a risk premium of at least $10 per barrel, as quite frankly no one knows where the latest Eastern Ukrainian flare-up is going and what might happen next.

Amidst this, the US EIA expects the WTI to average $95.60 per barrel this year, up from its previous forecast of $95.33. The agency also expects Brent to average $104.88, down 4 cents from an earlier forecast. Both averages and the Brent-WTI spread are within the Oilholic's forecast range for 2014. That's all for the moment folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Sullom Voe Terminal, UK © BP

The Kurdish question & a ‘Dudley’ sin?

The autonomous region of Kurdistan within Iraq's borders is drawing 'crude' headlines yet again. It's that old row about who controls what and gives rights for E&P activity in the region – the Federal administration in Baghdad or the provincial administration in Erbil?

 

The historical context is provided by Gulf War I, when allied forces imposed a no-fly zone, and the Kurds subsequently pushed Saddam Hussein's forces back outside the provincial border. That was 1991, this is 2013 – a lot has changed for Iraq, but one thing hasn't – Iraqi Kurdistan is as autonomous today, as it was back then.

 

In fact, it is more prosperous and an oasis of calm compared to the rest of the Federal state. One simple measure is that the rest of Iraq ravaged by sectarian conflict and Gulf War II still only provides its citizens with about an average of 6 to 7 hours of electricity per day. The average resident of Erbil gets 22 hours and sees infrastructural spending all around, driven by targeted revenue from oil and gas licensing and exports.

Since 2006, the Kurdistan Regional Government (KRG) has been granting rights for exploration within its borders to firms from Norway to the US, with much gusto and on better terms, many say, than the Federal administration in Baghdad. The Iraqi government in turn says KRG has no right to do so.

 

Mutual consternation came to a head in January when BP and Baghdad reached an agreement to revitalise the northern Kirkuk oilfield. Since jurisdictional mandate over the oilfield and the city is hotly contested by both sides, KRG declared the deal to be illegal on grounds that it was not consulted.

 

Firing a return salvo, Iraqi Oil Minister Abdul Kareem al-Luaibi called the production and export of oil from Kurdistan to be an act of "smuggling" and threatened to cut the region's [17%] spending allocation from the federal budget as well as take legal action against Western firms digging up Kurdistan, beginning with London-listed Genel Energy (the first such firm to export from the region).

Neither Genel Energy nor the administration paid heed to that threat. Baghdad and BP did likewise with KRG's moans over Kirkuk. Then the US State Department issued an advisory to all American oil firms operating in Kurdistan that they could be liable for legal damages from Baghdad. Doubtless, the rather handsomely rewarded legal eagles at their end advised them not to worry too much.

An "as-you-were" lull lasted for roughly 10 months, when last week in an extraordinary development, Bob Dudley, CEO of BP, joined al-Luaibi and officials from the Iraqi state-run North Oil Company to pay a controversial visit to the Kirkuk oilfield in a show of support. Why Dudley took the decision to go himself instead of sending a deputy is puzzling and paradoxically a bit obvious as well.

 

In making an appearance himself, Dudley wanted to show how important the Kirkuk deal is. Yet a deputy of his would have drawn a similar two-fingered gesture from KRG, as his visit did. Playing it cool, a source at BP said its only intention is to revive production at Kirkuk, an oilfield which at the turn of millennium saw an output of 900,000 barrels per day (bpd), but can barely manage less than a third of it today.

 

BP has the technical know-how to improve the field's output, but how it will extricate itself from the quagmire of the area's politics is anybody's guess. An Abu Dhabi based source says both sides are entrenched at Kirkuk. BP will have access to the Federally-administered side of the Kirkuk field, namely the Baba and Avana geological formations. But one formation – Khurmala – is inside the Kurdish provincial borders and being is developed by the KAR group.

 

Furthermore, there is another twist in the linear fight between Baghdad and Erbil – Kirkuk's governor Najimeldin Kareem, a man of Kurdish origin, has backed the Federal deal with BP. Dudley left the oilfield without saying anything concrete on record, leaving it to the Iraqis to do most of the talking.

 

The Iraqi Oil Ministry chose to describe Kareem's backing "as securing the complete support from the local government of Kirkuk" in order to commence developing Kirkuk. Hmm…but whose Kirkuk is it anyway? The primary beneficiary of Kurdish oil exports is Turkey; the closest market where the aforementioned Genel Energy delivers most of its output to.

 

Where the tussle will lead to is unpredictable – but it hasn't deterred either BP from signing up a deal with Baghdad or the likes of ExxonMobil, Chevron and Total with Erbil. This brings us back to why Dudley went himself – well, when his peers such as Rex Tillerson, ExxonMobil's boss, have showed-up in Erbil, there was perhaps little choice left. If the regional politics goes out of control, the bosses of oil firms would have only themselves to blame for getting so close to the Iraqi wrangles most say they are least interested in.

 

At the centre of it all is the thirst for black gold. KRG is providing generous production sharing and contract conditions within its autonomous borders, while Baghdad has quite possibly given equally generous terms to BP for Kirkuk. The oil major has already announced a US$100 million investment in the oilfield.

 

Giving KRG the last word in the verbal melee – in September 2012, even before the recent salvos had been fired in earnest and the CEOs had come calling, Ashti Hawrami, Minister for Natural Resources of KRG, said something rather blunt on BBC’s Hard Talk programme which explains it all: "To put it politely, if I have million barrels of oil to produce in two years time, the market needs it, Iraq needs it and at the end of the day we are going to win that battle."

 

There are 50 plus firms already helping him achieve that objective. With geological surveys projecting that Kurdistan potentially has 45 billion barrels of the crude stuff, many of these firms are working with the KRG contrary to advice given by their own governments.

 

And as if to rub it in further into his Federal counterpart, Hawrami quipped, "Kurdistan's investment and spending plans are more structured…Why is Baghdad buying F-16s when Iraqis have little more than 4 hours of electricity per day on average [much worse than the inhabitants of Iraqi Kurdistan]." OUCH!

 

Moving away from Iraqi politics, Brent's $106 per barrel floor has not only been breached, but was smashed big time last week. As noted, hedge funds are indeed feeling the pinch, for instance high-flier Andy Hall's $4 billion baby – Astenbeck Capital Management.

 

According to Reuters, Astenbeck is down 5% as of Oct-end, largely due to the slump in Brent prices. Even though Hall's team have diversified into palladium, platinum and soft commodities, it'd be remarkable if the fund is able to avoid its first annual loss in six years. However, one shouldn't be too hard on Astenbeck as the average energy fund on Chicago's Hedge Fund Research Index, is down 4.45%. 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: Exploration site in Kurdistan © Genel Energy plc