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

Keystone XL, politics & the King’s Speech

Even before the original Keystone cross-border pipeline project aimed at bringing Canadian crude oil to the doorstep of US refineries had been completed, calls were growing for an extension. The original pipeline which links Hardisty (Alberta, Canada) to Cushing (Oklahoma) and Patoka (Illinois) became operational in June 2010, just as another, albeit atypical US-Canadian tussle was brewing.

The extension project – Keystone XL first proposed in 2008, again starting from Hardisty but with a different route and an extension to Houston and Port Arthur (Texas) is still stuck in the quagmire of US politics, environmental reticence, planning laws and bituminous mix of the Canadian oil sands.

The need for extension is exactly what formed the basis of the original Keystone project – Canada is already the biggest supplier of crude oil to the US; and it is only logical that its share should rise and in all likelihood will rise. Keystone XL according to one of its sponsors – TransCanada – would have the capacity to raise the existing capacity by 591,000 barrels per day though the initial dispatch proposal is more likely to be in the range of 510,000 barrels.

Having visited both the proposed ends of the pipeline in Alberta and Texas, the Oilholic finds the sense of frustration only too palpable more so because infrastructural challenges and the merits (or otherwise) of the extension project are not being talked about. To begin with the project has a loud ‘fan’ club and an equally boisterous ‘ban’ club. Since it is a cross-border project, US secretary of State Hillary Clinton has to play the role of referee.

A pattern seems to be emerging. A group of 14 US senators here and 39 there with their counterparts across the border would write to her explaining the merits only for environmental groups, whom I found to be very well funded – rather than the little guys they claim to be – launching a counter representation. That has been the drill since Clinton took office.

One US senator told me, “If we can’t trust the Canadians in this geopolitical climate then who can we trust. Go examine it yourself.” On the other hand, an environmental group which tries to get tourists to boycott Alberta because of its oil sands business tried its best to convince me not to land in Calgary. I did so anyway, not being a tourist in any case.

Since 2008, TransCanada has held nearly 100 open houses and public meetings along the pipeline route; given hundreds of hours of testimony to local, state and federal officials and submitted thousands of pages of information to government agencies in response to questions. The environmentalists did not tell me, but no prizes for guessing who did and with proof. This is the kind of salvo being traded.

Send fools on a fool’s errand!

It is not that TransCanda, its partner ConocoPhillips and their American and Canadian support base know something we do not. It is a fact that for some years yet – and even in light of falling gasoline consumption levels – the US would remain the world’s largest importer of crude oil. China should surpass it, but this will not happen overnight.

The opponents of oil sands have gotten the narrative engrained in a wider debate on the environment and the energy mix. Going forward, they view Keystone XL and other incremental pipeline projects in the US as perpetuating reliance on crude oil and are opposing the project on that basis.

Given the current geopolitical climate, environmental groups in California and British Columbia impressed upon this blogger that stunting Alberta’s oil sands – hitherto the second largest proven oil reserve after Saudi Arabia’s Ghawar extraction zone – would somehow send American oilholics to an early bath and force a green age. This is a load of nonsense.

Au contraire, it will increase US dependency on Middle Eastern oil and spike the price. Agreed the connection is neither simple nor linear – but foreign supply will rise not fall. Keystone XL brings this crude foreign product from a friendly source.

Everyone in Alberta admits work needs to be done by the industry to meet environmental concerns. However, a 'wells to wheels' analysis of CO2 emissions, most notably by IHS CERA and many North American institutions has confirmed that oil sands crude is only 5 to 15 per cent ‘dirtier’ than US sweet crude mix.

The figure compares favourably with Nigerian, Mexican and Venezuelan crude which the US already imports. So branding Canadian crude as dirty and holding up Keystone XL on this basis is a bit rich coming from the US. Keystone XL increases US access to Canadian crude. Who would the Americans rather buy from Canada or Venezuela? Surveys suggest the former.

The pragmatists at CAPP

Over a meeting in Calgary, Dave Collyer, President of Canadian Association of Petroleum Producers (CAPP) told the Oilholic that they have always viewed Keystone XL as an opportunity to link up Western Canada to the US Gulf coast market, to replace production that would otherwise be imported by the US from overseas sources most notably Venezuela and Mexico where production is declining according to available data. There are also noticeable political impediments in case of the former.

“We don’t see this pipeline extension as incremental supply into that orbit, rather a replacement of existing production through a relatively straightforward pipeline project, akin to many other pipeline projects and extensions that have been built into the US,” Collyer said.

Energy infrastructure players, market commentators and CAPP make another valid point – why are we not debating scope of the Keystone XL project and its economic impact and focussing on the crude stuff it would deliver across the border? CAPP for its part takes a very pragmatic line.

“Do we think there is legitimacy in the argument that is being made against Keystone? No (for the most part) but the reality is that there has to be due consideration in the US. I would assume the US State Department is in a position where it has no alternative but to employ an abundance of caution to ensure that all due processes are met. What frustrates Canadians and Americans alike is the length of time that it has taken. However, at the end of the day when we get that approval and it is a robust one which withstands a strict level of scrutiny then it’s a good thing,” Collyer said.

T I M B E R!

Canadians and Americans first started bickering about timber, another Canadian resource needed in the US, about taxation, ethics, alleged subsidies and all the rest of it way back in 1981. Thirty years later, not much has changed as they are still at it. But these days it barely makes the local news in Canada each time the Americans take some reactive action or the other against the timber industry. Reason – since 2003 there has been another buyer in town – China.

In 2010, timber sales from Canada to China (and Japan to a lesser extent) exceed those to the US. Over the last half-decade timber exports from the province of British Columbia alone to China rose 10 times over on an annualised basis. Moral of the story, the US is not the only player in town whatever the natural resource. Canadians feel a sense of frustration with the US, and rightly so according to Scott Rusty Miller, managing partner of Ogilvy Renault (soon to be part of Norton Rose) in Calgary.

“We are close to the US, we are secure and we have scruples. Our industry is more open to outside scrutiny and environmental standards than perhaps many or in fact any other country the US imports crude oil from – yet there are these legal impediments. Scrutiny is fine. It’s imperative in this business, but not to such an extent that it starts frustrating a project,” Miller noted.

Ask anyone at CAPP or any Toronto-based market analyst if Canada could look elsewhere – you would get an answer back with a smile; only the Americans probably would not join them. The Oilholic asked Collyer if Americans should fear such moves.

His reply was, “As our crude production grows we would like access to the wider crude oil markets. Historically those markets have almost entirely been in the US and we are optimistic that these would continue to grow. Unquestionably there is increasing interest in the Oil sands from overseas and market diversification to Asia is neither lost on Canadians nor is it a taboo subject for us.”

CAPP has noted increasing interest from Chinese, Korean and other Asian players when it comes to buying in to both crude oil reserves and natural gas in Western Canada. Interest alone does not create a market – but backed up by infrastructure at both ends, it strengthens the relationship between markets Canadians have traditionally not looked at. All of this shifts emphasis on Canadian West coast exports.

“Is it going to be straightforward to get a pipeline to the West coast – we’ll all acknowledge that it’s not. For instance, Enbridge has its challenges with the Gateway pipeline. There is an interest in having an alternative market. There are drivers in trying to pursue that and I would say collectively this raises the “fear” you mention and with some factual basis. However, the US has been a great market and should continue to be a great market...while some caution is warranted,” he concluded.

The King’s speech

We’re not talking about Bertie, (King George VI of England) but Barack (The King of gasoline consumers and the US President). On March 30th, the King rose and told his audience at Georgetown University that he would be targeting a one-third reduction in US crude imports by 2025.

“I set this goal knowing that we’re still going to have to import some oil. And when it comes to the oil we import from other nations, obviously we have got to look at neighbours like Canada and Mexico that are stable, steady and reliable sources,” he added. While I am reliably informed that the speech was not picked up by Chinese state television, the Canadian press went into overdrive. The Globe and Mail, the country’s leading newspaper, declared “Obama signals new reliance on oil sands.”

Shares of Canadian oil and service companies rose the next day on the Toronto Exchange, even gas producers benefited and 'pro-Keystone XL' American senators queued up on networks to de facto say “We love you, we told you so.” Beyond the hyped response, there is a solid reason. Keystone XL bridges both markets – a friendly producer to a friendly consumer with wide ranging economic benefits.

According to Miller, “Refining capacity exists down south. Some refineries on the US Gulf coast could be upgraded at a much lower cost compared to building new infrastructure. There are economic opportunities for both sides courtesy this project – we are not just talking jobs, but an improvement of the regional macro scenario. Furthermore, however short or long, it could be a shot in the arm for the much beleaguered and low-margin haunted refining business.”

The pipeline could also help Canadians export surplus crude using US ports in the Gulf and tax benefits could accrue not just at the Texan end but along the route as well. That the oil sands are in Canada is a geological stroke of luck, given the unpredictability of OPEC and Russian supplies. The US State Department says it will conclude its review of Keystone XL later this year. Subjecting this project to scrutiny is imperative, but bludgeoning it with impediments would be ‘crudely’ unwise.

This post contains excerpts from an article written by the Oilholic for UK's Infrastructure Journal. While the author retains serial rights, the copyright is shared with the publication in question.

Gaurav Sharma 2011 © Gaurav Sharma and Infrastructure Journal 2011. Map: All proposals of Canadian & US Crude Oil Pipelines © CAPP (Click map to enlarge)

Some Crude Chatter from Moody’s & Other Stuff

There’s been some interesting chatter from Moody’s these past seven days on all things crude. Some of these stood out for me. Early last week in a note to clients, the rating agency opined that CNOOC Ltd's Aa3 issuer and senior unsecured ratings would not be immediately affected by the Chinese company's additional equity investment of US$2.47 billion in its 50% joint-venture Bridas Corp.

The investment represents CNOOC's share of funding contributions for Bridas to purchase a remaining 60% interest in Pan American Energy, which is engaged in E&P ops in South America. Bridas plans to fund 70% of its purchase by equity and 30% by debt or additional contributions from shareholders.

CNOOC is funding its equity contribution to Bridas with internal resources on hand. The transaction would give it an additional 429 million BOE of proved reserves and 68,000 bpd daily production in South America, according to Moody’s. Completion of the transaction is expected to take place during H1 2011, that’s of course government and regulatory approvals pending.

However, the crude chatter of the week not just from Moody's, but from the entire market was the agency’s interesting analytical take on oil sands producers’ operating considerations. In a report titled – Analytical Considerations for Oil Sands Producers – the agency notes that while comparing oil sands development and production projects to conventional development and production projects, the former have much larger upfront development costs[1].

Such projects are more likely to incur construction cost overruns, and quite simply take much longer to reach breakeven cash flow. Other features include higher cash operating costs per barrel of oil equivalent, very long reserve life and low maintenance capital expenditures once in production, particularly of mining oil sands operations, the report said.

One might say that parts of the report are predictable but it must be noted that in analysing companies with relatively large oil sands exposure, Moody's balances the negative aspects of the difficult construction period against the anticipated long-term positive contributions from these assets. So well, on balance, I found the principal tenets to be very convincing.

Let us face it, whether peak oil will be here soon or not, “easy oil” (interchangeable with cheap oil) is most certainly gone. Cost overruns are unlikely to deter big oil. So far Shell has invested just under US$10 billion (River Oil Sands), Chevron US$9 billion (Athabasca), ExxonMobil US$5 billion (Kearl Oil sands investment) and BP is said to be catching up via its Sunrise oil sands investment.

Elsewhere, Desire Petroleum’s saga of will they find oil in the Falklands Is. or won't they or worse still when will they give up continues. Its share price saw wild swings and ended in a damp squib (haven’t we heard that before).

On the left, for the umpteenth time, here is Desire’s undesirable share chart (see the day's price nose-dive). To quote The Daily Mail’s inimitable Geoff Foster, “Many professional punters are gluttons for punishment. They continually get suckered into seat-of-your pants oil stocks and more often than not, live to regret it.”

I do not wish to tempt fate, but Desire Petroleum is no Cairn Energy. I do hope for Desire's sake that they do strike black gold in meaningful if not bountiful quantities. However, the market response to a whiff of positive news is nothing short of barmy.

[1] The report is available on Moody's web site.

© Gaurav Sharma 2010. Photo: Oil Sands, Canada © Shell, Graphic: Desire Petroleum Share Chart with stated time frame © Digital Look / BBC

The Veraciously Detailed Analysis of Prof. Gorelick

The debate over the “peak oil” hypothesis used to keep rearing its head from time to time in media and commodities circles – but of late it has become a bit of a permanent mainstream fixture, with regular discussions in the popular press.

No one discounts the fact that oil is a non-renewable and finite hydrocarbon, but the positions people take on either side of the hypothesis often evoke fierce emotions. Enter Prof. Steven M. Gorelick – the author of the brilliant book – Oil Panic and The Global Crisis: Predictions and Myths.

In my years as a journalist who has written on oil and follows crude markets closely, I feel this book is among the most engaging, detailed and well written ones that I have come across in its genre. Gorelick examines both sides of the argument and allied “crude” topics in some detail. He notes that commentators on either side of the peak oil debate, their respective stances and the arguments are not free of some pretty major assumptions. This pertains, but is not limited, to the complex issue of oil endowments and the methodology of working them out.

The author examines data and market conjecture that both supports and rejects the idea that the world is running out of crude oil. Prior to entering the resource depletion debate, Gorelick charts the landscape, outlines the history of the oil trade and crude prospection and exploration.

Following on from that, he discusses the resource depletion argument followed by a refreshingly well backed-up chapter offering arguments against imminent global oil depletion. The veracity of the research is simply unquestionable and the figures are not substantiated by rants or guesswork, but by a methodical analysis which makes the author's argument sound extremely persuasive. If you are taken in by popular discourse or media chatter about the planet running out of oil, this book does indeed explode more than a few myths.

The text is backed-up by ample figures, graphics and forecasts from a variety of industry recognised sources, journals and organisations. Unlike a straight cut bland discourse, the narrative of this book is very engaging. It may well be data intensive, but if the whole point of the book is substantiating an argument - then the data adds value and makes for an informed argument - for which author deserves full credit.

Above anything else, I find myself in agreement with the author that the US, where production peaked a few decades ago, is a “pincushion of exploration relative to other parts of the world.” Backed-up by data, Gorelick explains that the Middle East, Eastern (& Central) Europe and Africa contain 75% of global crude reserves but account for only 13% of exploratory drilling. This must change.

Every key topic from the Malthusian doctrine to M.K. Hubert's approach, from Canadian Oil sands to drilling offshore and the relative cost of imported oil for consuming nations have been discussed in context of the resource depletion debate and in some detail.

Gorelick correctly notes that while the era of "easy" oil may well be over and how much oil is extracted from difficult sources remains to be seen. I quite agree with the author that the next or shall we say the current stage of extraction and prospection would ultimately be dictated by the price of oil.

Many commodities traders believe a US$50 per barrel price or above would ensure extraction from difficult to reach places. However, that is not to say that a high price equates to the planet running out of oil, according to the author. He writes so from a position of strength having spent years analysing industry data and I find it difficult not to be swayed by the force of his honest arguments.

© Gaurav Sharma 2010. Book Cover © Wiley