Crude thoughts, an event, few articles & a lecture!

Brent’s decline continues with the forward month futures contract now well and truly below the US$110 per barrel level. In fact, when the Oilholic last checked, a price of US$108.41 was flashing on the ticker. Given that over the past seven days – OPEC, EIA and IEA – have all come out with bearish reports, the current price level should hardly be a surprise.

 

Additionally, both OPEC and IEA appear to be in broad agreement that overall concerns about economic growth in the US and the Eurozone will continue to persist over the short term at the very least. As if that wasn’t enough, the US dollar has reached a seven-month high against a basket of currencies, not least the pound sterling!

 

At such points in recent trading history, geopolitics always lends support to the oil price. Yet further evidence is emerging about the oil & gas community largely regarding the risk premium to be neutral, a theme which this blogger has consistently stressed on since September last year. Many delegates at the recently concluded International Petroleum Week (IP Week) in London, a signature European event, expressed pretty much the same sentiments.

 

Rather than relying on the Oilholic’s anecdotal evidence, here’s an observation from Société Générale analyst Michael Wittner who wrote in an investment note that, “On the geopolitical front, there seemed to be a sort of fatigue (at the IP Week), if not boredom, with the various issues and countries. In addition to Syria and Iran, there was talk about risks in Iraq and Nigeria, and even Chinese-Japanese tensions. Given recent events in Algeria, Egypt, and Mali, we were surprised at how little concern there was about North Africa.”

 

“All agreed that the geopolitical elephant in the room was still Iran, but even here, the fatigue was evident. People were well aware of Israel’s late spring/early summer “deadline”, but they were not excited about it. Some pointed to higher Saudi spare capacity (after recent cuts) and much higher pipeline capacity that could be used to avoid the Straits of Hormuz. Others simply thought that, posturing aside, there was little real appetite for a war against Iran, and that an Iranian bomb was inevitable,” he wrote further. Need we say more?

 

So in summation – tepid crude demand plus fatigued risk premium equals to no short term hope for the bulls! But at least there’s hope for the Brent-WTI spread to narrow, with the former falling and the latter rising on the back of the supply glut at Cushing, Oklahoma showing signs of abating.

 

Away from pricing matters, given that yours truly has been travelling a lot within good old England these past few weeks, there has also been plenty of time to do some reading up on trains! Four interesting articles came up while the Oilholic was experiencing the joys (or otherwise) of British railways.

 

First off, the Wall Street Journal’s Jerry A. Dicolo screams: “Brent barrels to prominence: European oil benchmark poised to overtake WTI as a global gauge.” The Oilholic has some news for the WSJ – Er…Brent is not ‘poised’ to overtake WTI as a global gauge, it has already overtaken it in terms of market sentiment! This blog first mulled the subject as far back as May 2010! Since then, even the EIA has decided to adopt Brent as a benchmark that’s more reflective of global conditions.

 

The second interesting piece of reading material yours truly encountered was a republished Bloomberg wire copy that carried feedback from an Indian refiner. In it, he suggested that the country’s refiners may be forced to halt purchases of Iranian crude as local insurers refuse to cover the risks for any Indian refinery using the Islamic Republic’s oil.

 

Bloomberg cites a certain P.P. Upadhya, Managing Director of the Mangalore Refinery in Southern India as having said, “There’s a problem with getting insurance for refineries processing Iranian oil. If there’s no clarity very soon, we all have to stop buying from Iran or risk operating the refineries without insurance.” Looks like the squeeze on Iran is going into overdrive!

 

Moving on to the third article, here is The Economist's sound take on the late Hugo Chavez’s rotten economic legacy. And finally, a Reuters’ exclusive would have you believe we Brits are planning to bid for US gas to be imported to our shores.

 

An abundance of gas, courtesy of the country’s shale bonanza has certainly lent credence to the US’ gas exporting potential. One would think if the US were to export gas, it would one fine day make its way to the UK. However, a “source” spoken to by Reuters seems to suggest that day is not that far away.

 

Speaking of shale, the Oilholic had the pleasure of listening to a brilliant lecture on the subject from Prof. Paul Stevens, the veteran energy economist and Chatham House fellow. Delivering the Institution of Engineering and Technology’s Clerk Maxwell Lecture for 2013, Prof. Stevens set about exploding the myth of a shale gas revolution taking place in Europe anytime soon.

 

He joked that North Dakota might become the next member of OPEC, but one thing is for certain Poland and other European shale enthusiasts are not getting there any time soon. Apart from the usual concerns, often mulled over by the Oilholic, such as jurisdictional prospection moratoriums and population density, pipeline access, environmental regulations etc. being very different between the US and Europe, the good professor pointed out a very crucial point.

 

“Shale rock formation in Europe is very different from what it is in North America. When ExxonMobil was disappointed in Poland, it was not for want of trying. Rather US technology was found lacking when it came to Polish geology. There is no one size fits all! The American shale revolution got where it is today through massive investment and commitment towards research and development (and over two decades of perseverance). I don’t see that level of commitment in Europe,” he said.

 

Speaking to the Oilholic, following his lecture, Prof. Stevens said the export of US gas to the UK was plausible, but that Asia was a much more natural export market for the Americans. “Plus, let’s not forget that the moment US exports start to rise meaningfully, there is always a chance the likes of Congressman Ed Markey might take a nationalistic tone and try to stunt them,” he added.

 

Quite true, after all we got a glimpse of Markey’s intellect via his ‘Bolshoi’ Petroleum remark! 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. Sullom Voe Terminal, UK © BP Plc

Crude talking points of the last two weeks

In a fortnight during which the Bank of England hired a man whose signature appears on Canadian banknotes as its new governor, the oil & gas world reiterated its own cross-border nature, when an American firm sold a Kazakh asset to an Indian company. That firm being ConocoPhillips, the asset being its 8.4% stake in Kazakh oil field Kashagan and the Indian buyer being national oil company (NOC) ONGC Videsh – all signed, sealed and delivered in a deal worth around US$5.5 billion.

 

Even with an after-tax impairment of US$400 million, the deal represents a tidy packet for ConocoPhillips as it attempts to cut its debt. Having divested its stake in Russia’s Lukoil, the American oil major has already beaten its asset sale programme target of US$20 billion. So when the final announcement came, it was not much of a surprise as Kazakhstan government officials had revealed much earlier that a move was on the cards.

 

Still it is sobering to see ConocoPhillips divest from Kashagan – the world's biggest oilfield discovery by volume since 1968. It may hold an estimated 30 billion barrels of oil. Phase I of the development, set to begin next year, could yield around 8 billion barrels, a share of which ONGC is keenly eyeing.

India imports over 75% of the crude oil it craves and is in fact the world's fourth-biggest oil importer by volume. Given this dynamic, capital expenditure on asset with a slower turnaround may not be an immediate concern for an Indian NOC, but certainly is for investors in the likes of ConocoPhillips and its European peers.

On the back of a series of meetings between investors and its EMEA natural resources & commodities team in London, Fitch Ratings recently revealed that elongated upstream investment lead times and a (still) weak refining environment in Western Europe remain a cash flow concern for investors.

 

They seemed most concerned about the lead time between higher upstream capex and eventual cash flow generation and were worried about downward rating pressure if financial metrics become strained for an extended period. It is prudent to mention that Fitch Ratings views EMEA oil & gas companies' capex programmes as measured and rational despite a sector wide revised focus on upstream investment.

 

For example, the two big beasts – BP and Royal Dutch Shell – are rated 'A'/Positive and 'AA'/Stable respectively; both have increased capex by more than one-third for the first 9 months of 2012 compared to the same period last year. Elsewhere in their chats, unsurprisingly Fitch found that refining overcapacity and weak utilisation rates remain a concern for investors in the European refining sector. Geopolitical risk is also on investors' minds as they look to 2013.

 

While geopolitical events may drive oil prices up, which positively impact cash flow, interruptions to shipping volumes may more than offset gains from these price increases – negatively impacting both operating cash flow and companies' competitive market positions. Away from capex concerns, Fitch also said that shale gas production in Poland could improve the country's security of gas supplies but is unlikely to lead to large declines in gas prices before 2020.

In a report published on November 26, Arkadiusz Wicik, Fitch’s Warsaw-based director and one of the most pragmatic commentators the Oilholic has encountered, noted that shale gas production in Poland, which has one of the highest shale development potentials in Europe, would lower the country's dependence on gas imports. Most of Poland's imports currently come from Russia.

 

However, Wicik candidly noted that even substantial shale gas production by 2020, is unlikely to result in large declines in domestic gas prices.

 

"In the most likely scenario, shale gas production, which may start around 2015, will not lead to a gas oversupply in the first few years of production, especially as domestic gas demand may increase by 2020 as several gas-fired power plants are planned to be built. If there is a surplus of gas because shale gas production reaches a significant level by 2020, this surplus is likely to be exported," he added.

 

In actual fact, if the planned liberalisation of the Polish gas market takes place in the next few years, European spot gas prices may have a larger impact on gas prices in Poland than the potential shale gas output.

 

From a credit perspective, Fitch views shale gas exploration as high risk and capital intensive. Meanwhile, the UK government was forced on the defensive when a report in The Independent newspaper claimed that it was opening up 60% of the country’s cherished countryside for fracking.

 

Responding to the report, a government spokesperson said, "There is a big difference between the amount of shale gas that might exist and what can be technically and commercially extracted. It is too early to assess the potential for shale gas but the suggestion more than 60% of the UK countryside could be exploited is nonsense."

 

"We have commissioned the British Geological Survey to do an assessment of the UK's shale gas resources, which will report its findings next year," he added.

 

Barely had The Independent revealed this ‘hot’ news, around 300 people held an 'anti-fracking' protest in London. Wow, that many ‘eh!? In defence of the anti-frackers, it is rather cold these days in London to be hollering outside Parliament.

 

Moving on to the price of the crude stuff, Moody’s reckons a constrained US market will result in a US$15 per barrel difference in 2013 between the two benchmarks – Brent and WTI – with an expected premium in favour of the former. Its recently revised price assumptions state that Brent crude will sell for an average US$$100 per barrel in 2013, US$95 in 2014 and US$90 in the medium term, beyond 2014. While the price assumption for Brent beyond 2014 is unchanged, the agency has revised both the 2013 and 2014 assumptions.

 

For WTI, Moody’s has left its previous assumptions unchanged at US$85 in 2013, 2014 and thereafter. Such a sentiment ties-in to the Oilholic’s anecdotal evidence from the US and what many in City concur with. So Moody’s is not alone in saying that Brent’s premium to WTI is not going anywhere, anytime soon. Even if the Chinese economy tanks, it’ll still persist in some form as both benchmarks will plummet relative to market conditions but won’t narrow up their difference below double figures.

 

Finally, on the noteworthy corporate news front, aside from ConocoPhillips’ move, BP was in the headlines again for a number of reasons. Reuters’ resident Oilholic Tom Bergin reported in an exclusive that BP is planning a reorganisation of its exploration and production (E&P) operations. Citing sources close to the move, Bergin wrote that Lamar McKay, currently head of BP's US operations, will become head of a new E&P unit; a reinstatement of a role that was abolished in 2010 in the wake of the oil spill.

 

Current boss Bob Dudley split BP's old E&P division into three units on his elevation to CEO to replace Tony Hayward, whose gaffes in during the Gulf of Mexico oil spill led to his stepping down. BP declined to comment on Bergin’s story but few days later provided an unrelated newsworthy snippet.

 

The oil giant said it had held preliminary talks with the Russian government and stakeholders in the Nordstream pipeline about extending the line to deliver gas to the UK. BP said any potential extension to the pipeline was unlikely to be agreed before mid-2013.

 

The pipeline’s Phase I, which is onstream, runs under the Baltic Sea bringing Russian gas into Germany. A source described the move as “serious” and aimed at diversifying the UK’s pool of gas supplying nations which currently include Norway and Qatar as North Sea production continues to wane. As if that was not enough news from BP for one fortnight, the US government decided to "temporarily" ban the company from bagging any new US government contracts.

 

The country's Environmental Protection Agency (EPA) said on November 28 that the move was standard practice when a company reaches an agreement to plead guilty to criminal charges as BP did earlier in the month. New US E&P licences are made available regularly, so BP may miss out on some opportunities while the ban is in place but any impact is likely to be relatively ephemeral at worst. No panic needed!

 

On a closing note, in a move widely cheered by supply side industry observers, Shell lifted its force majeure on Nigeria's benchmark Bonny Light crude oil exports on November 21 easing supply problems for Africa’s leading oil producer. The force majeure, implying a failure to meet contractual obligations due to events outside of corporate control, on Bonny Light exports came into place on October 19 following a fire on a ship being used to steal oil. It forced the company to shut down its Bomu-Bonny pipeline and defer 150,000 barrels per day of production.

 

However, Shell said that force majeure on Nigerian Forcados crude exports remains in place. Forcados production was also stopped owing to damage caused by suspected thieves tapping into the Trans Forcados Pipeline and the Brass Creek trunkline. As they say in Nigeria - it’s all ok until the next attempted theft goes awry. That’s all for the moment folks! Keep reading, keep it 'crude'!

 

© Gaurav Sharma 2012. Photo: Oil Rig, USA © Shell

Canadian & Russian supply risk scenarios

Happy Easter folks! Following on from California, the Oilholic is once again back in Beautiful British Columbia, as vehicle licence plates from the province would point out, should you need reminding in these serene picturesque surroundings. When talking non-OPEC supply of the crude stuff – Russia and Canada always figure prominently in recent discussions, the latter more so than ever.

In fact, when it comes to holding exposure to oil price sensitivity, as recommended by some analysts for the next two quarters, via mixed bag of investments – Russian equities and “natural resources linked” (and not yet showing signs of Dutch disease) Forex including the Russian Rouble and the Canadian dollar are flagged-up more often than ever. In fact the Canadian Dollar, often called south of the border by Americans as the “Loonie” (based on a common bird on the CAD$1 coin), is proving pricier and more worthy than the world’s reserve currency itself in the post-Global financial crisis years.

Between Russia and Canada, given that the latter has a more diverse range of exports, the Russians have a bigger problem when it comes to oil price swings. In fact, ratings agency S&P reckons that a sustained fall in the price of oil could damage the Russian economy and public finances and consequently lead to a cut of the long-term sovereign rating.

"We estimate that a US$10 decline in oil prices will directly and indirectly lead to a 1.4% of GDP decline in government revenues. In a severe stress scenario, where a barrel of Urals oil drops to, and stays at, an average US$60, we would expect the general government to post a deficit above 8% of GDP. In that scenario, the long-term ratings on the Russian Federation could drop by up to three notches," says S&P credit analyst Kai Stukenbrock.

The rise in oil prices over the past decade has supported an expansionary fiscal policy, while still allowing the country to build up fiscal reserves. Still, fiscal expansion, not least significant countercyclical spending during the recent crisis, has led to a significant increase in expenditures relative to GDP.

As a result, despite record revenues from oil in 2011, S&P estimates the general Russian government surplus at merely 0.8% of GDP. To balance the budget in 2012, the agency thinks the government will require an average oil price of US$120 per barrel.

While former Russian finance minister Alexei Kudrin has also expressed fears of Russian over reliance on the price of oil, most analysts have a base price range of US$90 to 100 for 2012. So a fear it may well be; it remains what it is – a fear! Another ratings agency – Moody’s noted last month that as a result of financial flexibility built up over the past two years, rated Russian integrated oil & gas companies will be able to accommodate volatility in oil prices and other emerging challenges in 2012 within their current rating categories.

"In 2011, rated Russian players continued to demonstrate strong operating and financial results, underpinned by elevated oil prices," says Victoria Maisuradze, an Associate Managing Director in Moody's Corporate Finance Group. "Indeed, operating profits are likely to remain stable in 2012 as an increased tax and tariff burden will offset the benefits of high crude oil prices. All issuers have stable outlooks and our outlook for the sector is stable."

Nevertheless, developing reserves in new regions remains a major challenge for Russia as traditional production areas deplete; a problem which the Canadians don’t have to contend with. In 2006, Prime Minister Stephen Harper, whose hand is now politically more stronger than ever, told an audience in London that Canada was ranked third in the world for gas production, seventh in oil production, the market leader in hydroelectricity and uranium. He described it six years ago as “just the beginning.”

Harper’s journey to make Canada an ‘energy superpower’ is well and truly underway. The Oilholic charted the view from Calgary on his visit to Alberta last year and has followed the shenanigans related to the US ‘dis’-approval of Keystone XL pipeline project over the course of 2011-12. Over the coming days, yours truly would revisit the subject with a take on prospective exports to Asia via British Columbia.

Continuing with non-OPEC supplies, the Oilholic’s old contact in Warsaw – Arkadiusz Wicik, Director of Energy, Utilities and Regulation at Fitch Ratings – believes Shale gas in Poland could still be a game changer for the country's energy sector despite the disappointing shale gas reserve estimate published in March by the Polish Geological Institute (PGI).

PGI assessed most likely recoverable shale gas reserves to be between 0.35 and 0.77 trillion cubic meters (tcm), which is about one-tenth the 5.3 tcm estimated by the US Energy Information Administration in April 2011. PGI estimates maximum recoverable shale gas reserves at 1.92 tcm.

Wicik believes it is still too early to make any meaningful assumptions about the future of shale gas in Poland, believed to have one of the highest development potentials in Europe. “Less than 20 exploration wells have been drilled by domestic and foreign companies, in many cases with disappointing results. From a credit perspective, we view shale gas exploration as high risk and capital intensive. Partnerships among domestic companies to share exploration risks and costs, or more participation by foreigners would be positive,” he says.

Exploration by Poland's energy companies at an early stage gives them a chance to become major players should the commercial availability of gas be proven over the next several years. This was not the case in the US, where the shale gas industry was developed by a number of smaller, independent players as the Oilholic noted in a special report for Infrastructure Journal. Large US oil and gas companies have only recently started to be active in the sector, mostly through acquisitions.

Wicik notes, “We do not expect that the success in the US, which led to about a 50% decrease in US gas prices between 2008 and 2011, will be easily replicated in Poland. Commercial production in the first five to 10 years is unlikely to substantially lower gas prices given high breakeven costs. Also, Poland and the US differ both in terms of shale formations and the gas market structure.”

A number of foreign companies already have exploration concessions for shale gas in Poland, including ExxonMobil, Chevron, ConocoPhillips (through a service agreement with Lane Energy), Marathon Oil and Eni. Local players that have been granted exploration concessions include PGNiG, PKN Orlen, Grupa Lotos and Petrolinvest.

Another three large domestic companies - PGE, Tauron, and KGHM - also plan to enter shale gas exploration. In January 2012, they signed three separate letters of intent with PGNiG regarding cooperation in shale gas projects. That’s all for the moment folks! Keep reading, keep it ‘crude’!

© Gaurav Sharma 2012. Photo: Oil Refinery, Quebec, Canada © Michael Melford / National Geographic.