On non-OPEC distress & the road ahead

Having spent the entire week gauging the oil market mood in Houston, Texas, several key themes seem to be emerging. US shale oil exploration has come to symbolise non-OPEC production rises over the past three years and how it performs over the coming years would go some way towards providing an indication on when the market rebalances and where the oil price goes from here.

In that respect, the Oilholic’s third outing at the Baker & McKenzie Oil & Gas Institute provided some invaluable insight. Delegates at the Institute and various panels over the course of the event invariably touched on the subject, largely opining that many fringe shale players might well be on life support, but the industry as a whole is not dead in the water (see above left).

The problem is the paucity of high-yield debt for the oil & gas sector, where private equity (PE) firms were supposed to step into the breach vacated by big banks, but it is something which is not (currently) being meaningfully reflected in the data. 

One got a sense, both at the Institute and via other meetings across town, that PE firms are not quite having it their own way as buyers, and at the same time from sellers’ perspective there is also a fair bit of denial in a cash-strapped shale industry when it comes to relinquishing asset, acreage or corporate control.

Sooner, rather than later, some struggling players might have little choice and PE firms might get more aggressive in their pursuit of quality assets over the coming months, according to Mona Dajani, partner at Baker & McKenzie.

“You must remember that the PE market is quite cyclical. The way I view it, now would be as good a time as any for a PE firm to size-up and buy a mid-sized exploration and production (E&P) company as the oil price gradually creeps upwards. Jury is mixed on bid/ask differentials narrowing, but from what I see, it is happening already,” she added. 

William Snyder, Principal at Deloitte Transactions and Business Analytics, said, “To an extent hedge positions have protected cashflow. Going forward, PE is the answer right now, for it will be a while before high-yield comes back into the oil & gas market.”

The Deloitte expert has a point; most studies point to massive capital starvation in the lower 48 US states. So those looking to refinance or simply seeking working capital to survive currently have limited options. 

Problem is the PE community is cagey too as it is embarking on a learning curve of its own, according to John Howie, Managing Director of Parallel Resource Partners. “Energy specific funds are spending time working on their own balance sheets, while the generalists are seeking quality assets of the sort that have (so far) not materialised.”

Infrastructure funds could be another option, Dajani noted. “These (infrastructure) funds coming in at the mezzanine level are offering a very attractive cost of debt, and from a legal perspective they are very covenant light.”

Nonetheless, given the level of distress in the sector, the Oilholic got a sense having spoken to selected PE firms that they are eyeing huge opportunities but are not willing to pay barmy valuations some sellers are coming up with. The thinking is just as valid for behemoths like BlackRock PE and KKR, as it is for boutique energy PE specialists from around the US whom Houston is playing host to on a near daily basis these days. 

There are zombie E&P companies walking around that should not really be there, and it is highly unlikely that PE firms will conduct some sort of a false rescue act for them at Chapter 11 stage. Better to wait for the E&P company to go under and then swoop when there is fire-sale of assets and acreage. 

Nonetheless, while we are obsessing over the level of industry distress, one mute point is getting somewhat lost in the ruckus – process efficiencies brought about by E&P players in a era of ‘lower for longer’ oil prices, according to John England, US Oil & Gas Leader at Deloitte (see right, click to enlarge). 

Addressing the Mergermarket Energy Forum 2016, England said, “Of course, capital expenditure cuts have triggered sharp declines in rig counts globally except for the Middle East. However, production decline has not been as steep as some in the industry feared. 

“This has been a tribute to the innovations and efficiencies of scale across North America, and several other non-OPEC oil production centres. A sub-$30 per barrel oil price – which we recently saw in January – drives innovation too; for a lower oil price environment motivates producers to think differently.”

Over nearly twenty meetings spread across legal, accounting, financial and debt advisory circles as well as industry players in Texas, and attendance at three industry events gives one the vibe that many seem to think the worst is over.

Yet, the Oilholic believes things are likely worsen further before they get better. Meanwhile, Houston is trying to keep its chin up as always. That’s all from the oil & gas capital of the world on this trip, as its time for the plane home to London. Keep reading, keep it crude!

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© Gaurav Sharma, 2016. Photo I: Panel at the Baker & McKenzie Oil & Gas Institute 2016 © Lizzy Lozano, Baker & McKenzie. Photo II: John England of Deloitte addresses the Mergermarket Energy Forum 2016 © Gaurav Sharma.

It’s about the ‘crude’ bid/ask differential stupid!

That there are distressed oil and gas assets stateside is pretty obvious. The damage was done, or rather the distress was caused, long before the crude oil price started lurking in its current $40-50 per barrel range, with no guarantees and only calculated guesses on where it is going next.

Actually, nowhere but the current range, as some, including the Oilholic, say. We’d agree that the high yield debt market is in the doldrums, and pretty much since the oil price slump began in 2014 we are told private equity players are sizing up the level of distress and waiting for a timely swoop for assets armed with billions of dollars. 

There is only one problem – the bid/ask differential. Some, not all, sellers of distressed assets are still in denial and holding out for a better price. Buyers themselves, to be read as private equity buyers, are no mugs either and won’t buy any old asset at any old price. It then bottles down to the buying the right asset at the right price in a high stakes game, to quote not one but several of this blogger’s friends who addressed the Baker & McKenzie Oil & Gas Institute.

Then again other industry contacts, whom yours truly interacted with at the Mergermarket Energy Forum, say there is evidence of the bid/ask differential narrowing considerably relative to last May because some sellers literally have no choice and are desperate.

But now the PE guys want ‘quality’ distressed assets and some, as has become apparent in the Oilholic’s discussions with no less than 20 industry contacts and having participated in three oil and gas events (and counting) since Monday.

Anecdotes go something like this – some PE firms no longer want to buy an asset from a distressed oil and gas firm in Chapter 11 bankruptcy proceedings, but rather wait for it to actually go bust and then go for the target asset on much better terms, despite the obvious risk of losing out on the deal should another suitor emerge during the game of brinkmanship.

The debate will rumble on for much of 2016 with close to 70 US oil and gas firms having filed for bankruptcy this year alone! You get a sense in Houston that PE firms have the upper hand, but aren’t having it quite their own way, just as plenty of zombie small to mid-sized oil and gas companies that do not deserve to survive continue to muddle along. That’s all for the moment from Houston folks; keep reading, keep it crude!

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© Gaurav Sharma 2016. Photo: Oil pump jacks in Texas, USA © National Geographic Society.

Oil prices, OPEC shenanigans & the North Sea

It has been a crude fortnight of ups and downs for oil futures benchmarks. Essentially, supply-side fundamentals have not materially altered. There’s still around 1.3 million barrels per day (bpd) of crude oil hitting the markets in excess of what’s required.

Barrels put in storage are at an all time high, thanks either to those forced to store or those playing contango. US inventories also remain at a record high levels. 

However, the biggest story in the oil market, as well as the wider commodities market, is the strength of the US dollar. All things being equal, the dollar’s strength is currently keeping both Brent and WTI front month futures contracts at cyclical lows. The past five trading days saw quite a few spikes and dives but Friday’s close came in broadly near to the previous week’s close (see graph on the left, click to enlarge).

In the Oilholic’s opinion, a sustained period of oil prices below $60 is not ideal for unconventional exploration. Nonetheless, not all, but a sufficiently large plethora of producers just continue to grin and bear it. While that keeps happening, and the dollar remains strong, oil prices will not find support. We could very well be in the $40-60 range until June at the very least. Unless excess supply falls from 1.3 million bpd to around 750,000 bpd, it is hard to see how the oil price will receive support from supply constriction. 

Additionally, Fitch Ratings reckons should Brent continue to lurk around $55, credit ratings of European, Middle Eastern and African oil companies would take a hit. European companies that went into the slump with stretched credit profiles remain particularly vulnerable.

In a note to clients, Fitch said its downgrade of Total to 'AA-' in February was in part due to weaker current prices, and the weaker environment played a major part in the downgrade and subsequent default of Afren.

"Our investigation into the effect on Western European oil companies' credit profiles with Brent at $55 in 2015 shows that ENI (A+/Negative) and BG Group (A-/Negative) were among those most affected. Both outlooks reflect operational concerns, ENI because of weakness in its downstream and gas and power businesses, BG Group due to historical production delays. Weaker oil prices exacerbate these problems," the agency added.

Of course, Fitch recognises the cyclical nature of oil prices, so the readers need not expect wholesale downgrades in response to a price drop. Additionally, Afren remains an exception rather than the norm, as discussed several times over on this blog.

Moving on, the Oilholic has encountered empirical and anecdotal evidence of private equity money at the ready to take advantage of the oil price slump for scooping up US shale prospects eyeing better times in the future. For one’s Forbes report on the subject click here. The Oilholic has also examined the state of affairs in Mexico in another detailed Forbes report published here.

Elsewhere, a statement earlier this week by a Kuwaiti official claiming that there is no appetite for an OPEC meeting before the scheduled date of June 5, pretty much ends all hopes of the likes of Nigeria and Venezuela in calling an emergency meeting. The official also said OPEC had “no choice” but to continue producing at its current levels or risk losing market share.

In any case, the Oilholic believes chatter put out by Nigeria and Venezuela calling for an OPEC meeting in the interest of self-preservation was a non-starter. Given that we’re little over two months away from the next meeting and the fact that it takes 4-6 weeks to get everyone to agree to a meeting date, current soundbites from the ‘cut production’ brigade don’t make sense.

Meanwhile, the UK Treasury finally acknowledged that taxation of North Sea oil and gas exploration needed a radical overhaul. In his final budget, before the Brits see a General Election on May 7, Chancellor George Osborne cut the country’s Petroleum Revenue Tax from its current level of 50% to 35% largely aimed at supporting investment in maturing offshore prospects.

Furthermore, the country’s supplementary rate of taxation, lowered from 32% to 30% in December, was cut further down to 20% and its collection at a lower rate backdated to January. Altogether, the UK’s total tax levy would fall from 60% to 50%.

Osborne’s move was widely welcomed by the industry. Some are fretting that he’s left it too late. Yet others reckon a case of better late than never could go a long way with the North Sea’s glory days well behind it. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Graph: Tracking Friday oil prices close, year to date 2015 © Gaurav Sharma, March 20, 2015.

Bright lights, energy finance & PE in Hong Kong

It is jolly good to be back in Hong Kong after nearly a decade and half. The city is home to some 7 million souls who live, work and sleep mostly in high-rise buildings given it is one of the world’s most densely populated places and space is at a premium.

Having soaked in the dazzling lights, magnificent views from the Victoria Peak (see left) and the ubiquitous Star Ferry ride from Central pier on Hong Kong Island to Tsim Sha Tsui in Kowloon, the Oilholic decided to probe what’s afoot in terms of energy sector finance, and the market in general, in this part of the world. 

The timing couldn’t be better as the Hang Seng Index recently soared to a six-year high and that can only bode well for the 48 companies on there who account for 60% of market capitalisation of the Hong Kong Stock Exchange. While Alibaba.com might have opted to list in New York, rather than here, CGN Power Co, mainland China’s largest nuclear power producer by operational capacity, has decided to file for a US$2 billion initial public offering in Hong Kong.

For regional energy companies, Asia’s self-styled capital of finance has always been a key destination for equity finance, even though real estate and services stocks understandably dominate the market. In CGN Power’s case, the move is part of its strategic goal to turn-on more nuclear reactors and turn-off coal-fired power plants. The listing will see it in the company of China Resources, CLP Holdings, Hong Kong and China Gas Company, Hong Kong Electric Holdings (Towngas), Kunlun Energy (formerly CNPC Hong Kong) and of course trader SS United Group Oil & Gas Company to name a few prominent players. 

Away from public listings, the search for liquidity and capital raising exercises bring many mainland, regional and (of late) Western energy firms to the doors of Hong Kong’s Private Equity (PE) players, a trend that’s now firmly entrenched here and continues to rise. According to a local contact, there are currently just under 400 major PE companies operating in Hong Kong. The Chinese special administrative region (SAR) and former British colony is Asia’s second largest PE centre, second only to mainland China.

The energy sector (including oil & gas and cleantech), one is reliably informed, comes third in terms of PE finance after real estate and regional start-ups. A striking feature of PE funding flows originating in Hong Kong is the depth of international investment. The Oilholic noted oil & gas investments in Australia, India, Japan, South Korea and of course mainland China.

Furthermore, synergy and happy co-existence with PE groups based in mainland China is seeing funding stretch to jurisdictions previously untouched by them with the sizing up of international assets well beyond Australasia with oilfield services companies and independent E&P companies being the unsurprising targets (or shall we say beneficiaries).

For instance, Denise Lay, Chief Financial Officer of Tethys Petroleum, a London and Toronto-Listed oil and gas exploration firm, recently told yours truly in a Forbes interview about her company’s decision to sell 50% (plus one share) of its Kazakh assets to SinoHan, part of HanHong, a Beijing, China-based private equity fund.

Some notable PE players on everyone’s radar for oil & gas investments include Affinity Equity Partners, Baring PE Asia and Silver Grace AM. The funding pool, according to three local analysts is set to expand. One even complained of there being too much investment capital around and not enough deals, which is causing assets to go for inflated prices.

“But amid the synergy and seamless funding flows, there’s a bit of competition as well between SAR Hong Kong and China. For instance, the Hong Kong local administration is unashamedly pro-PE. Part of its overtures to attract more PE funds to be domiciled in Hong Kong includes amendment and extension of the current offshore fund exemption,” adds another.

Away from PE, most state-owned Chinese oil & gas firms have approached Hong Kong’s capital markets although the extent of their presence varies. While it’s a view that is not universally shared, for the Oilholic, the SAR with a convertible Hong Kong dollar (unlike the Yuan RMB which isn’t) serves as a good base for regional expansion and overseas forays for these guys.

On an unrelated note, one isn’t trying to establish any connect between gambling and the preferred currency, but the Hong Kong dollar is also the  legal tender of choice in the casinos of nearby Macau. 

The Oilholic discovered it the hard way this afternoon, having paid a visit to the Wynn Casino and trying to insert a Macau pataca note into the slot machine only to be told to use Hong Kong dollars. 

As of last year, gambling revenue in the former Portuguese colony and another Chinese SAR of US$45.2 billion, seven times the total of the Las Vegas strip, has made it the world’s largest gambling destination. Since photography is not permitted inside casinos, even with the presentation of an international press ID as the Oilholic did, here’s the exterior of the Wynn Casino with rival MGM in the background.

According to the World Bank, Macau’s GDP per capita came in at US$91,376 last year. That makes it the richest country globally after Luxembourg, Norway and Qatar. Mainland money flowing around Macau is pretty apparent, but not sure how much of it is filtering through to the masses.

There have been repeated calls of late for a better wages by casino workers facing higher inflation. It is a soundtrack gamblers from many countries ought to be pretty familiar with - wages not keeping pace with inflation. That’s all from Hong Kong and Macau folks! It’s time to head off to Shanghai. Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo 1: Hong Kong evening sky as seen from the Victoria Peak, Central, Hong Kong. Photo 2: Wynn Casino & Resort with MGM in the background, Macau © Gaurav Sharma, September 2014.