Talking Russia, China, shale 'debt' & more in Texas

The Oilholic finds himself in Houston, Texas for Baker & McKenzie’s 2015 Oil & Gas Institute. When yours truly was last in Texas back in February, the mood was rather sombre as leading oil futures benchmarks were still on a downward slide.

That was then, what we have now is stagnancy in the US$50-75 per barrel price range which probably encompasses both the WTI and Brent. We are not getting away from the said range anytime soon as one noted in a column for Forbes last Friday before flying out here.

Given the nature of such discourse, some delegates here at the Institute agreed and others disagreed with the Oilholic’s take on the short-term direction of the oil markets, especially as a lot is going on in this ‘crude’ world that such industry events are particularly sound in bringing to the fore.

The 2015 instalment of this particular Baker & McKenzie event had a great array of speakers and delegates – from Shell to Citigroup, Cameron International to Chevron. The legal eagles, the macroeconomists, the internationalists, the sector specialists, the industry veterans, and of course the opinionated, who never sit on the fence on matters shaping the direction of the market, were all there in good numbers.

(L to R) Louis J. Davis, Greg McNab, Natalie Regoli, James Donnell and David Hackett of Baker & McKenzie discuss the North American Market in wake of the oil price decline

The situation in Russia propped up fairly early on in proceedings. Alexey Frolov, a legal expert from Baker & McKenzie’s Moscow office, was keen to point out that it was not just the sanctions that were hurting Russia’s oil & gas industry; related macroeconomics of the day was sapping confidence away as well.

But Frolov also pointed to a degree of resilience within Russian confines, and a more flexible domestic taxation regime which was helping sustain high production levels unseen since the collapse of the Soviet Union. It does remain unclear though how long Russia can keep this up.

Meanwhile, Cameron International’s Vice President and Deputy General Counsel Brad Eastman flagged up something rather interesting. “We see Chinese companies continue to back rig building projects, even if they are being mothballed elsewhere in the world given the current market conditions. Chinese companies wish to continue their march in to the rig-building industry.”

Here’s China indulging in something that is really bold, some say unusual. So even if no one is exactly queuing up to buy or lease those Chinese rigs, it is another example that China operates on a whole different level to rest of the natural resources players and participants.

As for US shale, people say there is distressed debt out there and the end might be supposedly nigh for some small players. Well hear this – based on the Oilholic’s direct research here in Texas of looking into 37 independent US players, sometimes known as mom n’ pop oil & gas firms, and another 11 mid-sized companies; a dollar of their debt would fetch between 83 cents to 92 cents if hypothetically sold by their creditors.

That’s hardly distressed debt even at the lower end of the range. On hearing the Oilholic’s findings, Louis J. Davis, Chair of Baker & McKenzie’s North America Oil & Gas Practice, said: “An 8 to 17 cents discount does not constitute as distressed. Rewind the clock back to 2008-09 and you’d be looking at 35 to 40 cents to the dollar on unprofitable plays – that’s distress. This is not.”

Quite simply, creditors and investors are keeping the faith. But to curb the Oilholic’s enthusiasm, alas Davis added the words “for now”.

“You have to remember that many players [both large and small] would be coming off their existing oil price hedges by the end of the current calendar year. That’s when we’ll really know who’s in trouble or not.

“However, blanket assumptions that US shale, and by extension some independents are dead in the water, is a load of nonsense. Usual caveats apply to the Bakken players, but nothing I know from clients large or small in the Eagle Ford suggest otherwise,” Davis concluded.

As with events of this nature, the Oilholic of course wears several hats – most notably for Sharecast / Digital Look and Forbes. Hence, it’s worth flagging up other interesting slants and exclusive soundbites mined for these publications by this blogger.

The subject of oil & gas mergers and acquisitions in the current climate dominated the Institute’s morning session, as one wrote on Forbes earlier today. How to deal with the prospect of Iran’s possible return to the crude oil market also came up. Click here for one’s Sharecast report; treading carefully was the verdict of experts and industry players alike.

Separately, a Pemex official described in some detail how UK-listed oil and gas companies were sizing up potential opportunities in Mexico. Lastly, yours truly also had the pleasure of interviewing Anne Ka Tse Hung, a Tokyo-based partner at Baker & McKenzie, for Sharecast on the subject of the LNG industry facing a buyers’ market.

Hung noted that the market in Asia had completely turned on its head for Japanese utilities, from the panic buying of natural gas at a premium in wake of the Fukushima tragedy in 2011, to currently asking exporters to bid for supply contracts as competition intensifies and prices fall. That’s all for the moment from Houston folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2015. Photo: A panel session at the Baker & McKenzie 2015 Oil & Gas Institute, Houston, Texas, USA © Gaurav Sharma, May 2015.

‘Yukos Affair’ and its shadow over Putin’s Russia

President Vladimir Putin and what colours his vision of modern Russia are under the spotlight like never before. As Ukraine burns and western sanctions hit the Kremlin, Russia’s president remains defiant spewing yet stronger nationalistic rhetoric with a coterie of supporters in tow. Many would find internal politics in Putin’s Russia to be fascinating and repugnant in equal measure.

Yet, in order to understand the present, a past occurrence – the downfall of Yukos and its former chief Mikhail Khodorkovsky – would be a good starting point. In his latest work published by I.B. Tauris, academic Richard Sakwa not only describes the episode in some detail but also contextualises power struggles and insecurities that shaped one of the most controversial episodes in contemporary Russia.

This book isn’t merely Khodorkovsky's story from an unceremonious arrest in 2003 to a surprising release in December 2013. Rather, the author has taken that backdrop to give the readers an insight into the beginning and subsequent evolution of ‘Putinism’ as we know it. 

In just under 300 pages split by 12 chapters, Sakwa, an expert on Russian affairs with half a dozen works under his belt, has portrayed the event as an extraordinary confrontation between the two great forces of modernity – the state and the market – with Putin and Khodorkovsky as antagonists. 

“It was about their associated conceptions of freedom and at the same time – a struggle for Russia,” he writes. Putin’s determination to clip Khodorkovsky’s petrodollar powered wings marked a turning point. The oligarch’s controversial trial(s) attracted widespread international condemnation and ended in one of the world's richest and most powerful men becoming the state's prisoner. 

Far-reaching political and economic consequences in its wake left an indelible black mark about the quality of freedom in Putin's Russia. It also laid bare the complex connection between the Kremlin and big business during Russia's troubling transformation from a planned economy during the Soviet era to capitalism.

Being an outsider, it is easy to feel sympathetic towards Khodorkovsky and castigate the Russian way. However, by not overtly romanticising Khodorkovsky's resistance to Putin’s view of modern Russia, Sakwa paints a convincing picture of how the oligarch turned prisoner himself was no stranger to the contradictory essence of the country's democratic evolution.

As the author notes, Khodorkovsky was not only Putin’s antagonist, but also at the same time a protagonist of the contradictions that the president's regime reflected. Ultimately, it all leads on to how subversion of law and constitutionality has become commonplace in today’s Russia.

While the said subversion started taking hold in post-Soviet Russia, and Khodorkovsky most certainly used it to his advantage when it suited him; it was the oligarch’s ultimate downfall that made the state of affairs manifestly obvious beyond the country’s borders. It resonates today with Putin’s modus operandi as entrenched as ever. 

Through his brilliant, balanced description of a key episode in Russia’s rise towards becoming an oil and gas powerhouse, Sakwa has charted a warning from history on what to expect and where it might lead. The Oilholic would be happy to recommend Putin and the Oligarch to energy analysts, those interested in geopolitics, Russia, Yukos Affair or the oil world at large.

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© Gaurav Sharma 2014. Photo: Front Cover – Putin and the Oligarch: The Khodorkovsky-Yukos Affair © I.B. Tauris, February 2014.

Crude price, some results & the odd downgrade

We are well into the quarterly results season with oil and gas companies counting costs of the recent oil price slump on their profit margins among other things. The price itself is a good starting point. 

The Oilholic’s latest 5-day price assessment saw Brent nearly flat above US$86 per barrel at the conclusion of the weekly cycle using each Friday this month as a cut-off point (see left, click on graph to enlarge). 

Concurrently, the WTI stayed above $81 per barrel. It is worth observing the level of both futures benchmarks in tandem with how the OPEC basket of crude oils fared over the period. Discounting kicked-off by OPEC heavyweight Saudi Arabia earlier in the month, saw Iran and Kuwait follow suit. Subsequently, the OPEC basket shed over $6 between October 10 and October 24. If Saudi motives for acting as they are at the moment pique your interest, then here is one’s take in a Forbes article. Simply put, it’s an instinct called self-preservation! 

Recent trading sessions seem to indicate that the price is stabilising where it is rather than climbing back to previous levels. As the Western Hemisphere winter approaches, the December ICE Brent contract is likely to finish higher, and first contract for 2015 will take the cue from it. This year's average price might well be above or just around $100, but betting on a return to three figures early on into next year seems unwise for the moment.

Reverting back to corporate performance, the majors have started admitting the impact of lower oil prices. However, some are facing quite a unique set of circumstances to exasperate negative effects of oil price fluctuations.

For instance, Total tragically and unexpectedly lost its CEO Christophe de Margerie in plane crash last week. BP now has Russian operational woes to add to the ongoing legal and financial fallout of the Gulf of Mexico oil spill. Meanwhile, BG Group has faced persistent operational problems in Egypt but is counting on the appointment of Statoil’s boss as its CEO to turn things around.

On a related note, oilfield services (OFS) companies are putting on a bullish face. The three majors – Baker Hughes, Halliburton and Schlumberger – have all issued upbeat forecasts for 2015, predicated on continued investment by clients including National Oil Companies (NOCs).

In a way it makes sense as drilling projects are about the long-term not the here and now. The only caveat is, falling oil prices postpone (if not terminate) the embarkation of exploration forays into unconventional plays. So while the order books of the trio maybe sound, smaller OFS firms have a lot of strategic thinking to do.

Nonetheless, we ought to pay heed to what the big three are saying, notes Neill Morton, analyst at Investec. “They have unparalleled global operations and unrivalled technological prowess. If nothing else, they dwarf their European peers in terms of market value. As a result, they have crucial insight into industry activity levels. They are the ‘canaries in the coal mine’ for the entire industry. And what they say is worth noting.”

Fair enough, as the three and Schlumberger, in particular, view the supply and demand situation as “relatively well balanced”. The Oilholic couldn’t agree more, hence the current correction in oil prices! The ratings agencies have been busy too over the corporate results season, largely rating and berating companies from sanctions hit Russia.

On October 21, Moody's issued negative outlooks and selected ratings downgrade for several Russian oil, gas and utility infrastructure companies. These include Transneft and Atomenergoprom, who were downgraded to Baa2 from Baa1 and to Baa3 from Baa2 respectively. The agency also downgraded the senior unsecured rating of the outstanding $1.05 billion loan participation notes issued by TransCapitalInvest Limited, Transneft's special purpose vehicle, to Baa2 from Baa1. All were given a negative outlook.

Additionally, Moody's changed the outlooks to negative from stable and affirmed the corporate family ratings and probability of default ratings of RusHydro and Inter RAO Rosseti at Ba1 CFR and Ba1-PD PDR, and RusHydro's senior unsecured rating of its Rouble 20 billion ($500 million) loan participation notes at Ba1. Outlook for Lukoil was also changed to negative from stable.

On October 22, Moody's outlooks for Tatneft and Svyazinvestneftekhim (SINEK) were changed to negative. The actions followed weakening of Russia's credit profile, as reflected by Moody's downgrade of the country’s government bond rating to Baa2 from Baa1 a few days earlier on October 17.

Meanwhile, Fitch Ratings said the liquidity and cash flow of Gazprom (which it rates at BBB/Negative) remains strong. The company’s liquidity at end-June 2014 was a record RUB969 billion, including RUB26 billion in short-term investments. Gazprom also reported strong positive free cash flows over this period.

“We view the record cash pile as a response to the US and EU sanctions announced in March 2014, which have effectively kept Gazprom, a key Russian corporate borrower, away from the international debt capital markets since the spring. We also note that Gazprom currently has arguably the best access to available sources of funding among Russian corporate,” Fitch said in a note to subscribers.

By mid-2015, Gazprom needs to repay or refinance RUB295 billion and then another RUB264 billion by mid-2016. Its subsidiary Gazprom Neft (rated BBB/Negative by Fitch) is prohibited from raising new equity or debt in the West owing to US and EU sanctions, in addition to obtaining any services or equipment that relate to exploration and production from the Arctic shelf or shale oil deposits.

On the other hand, a recent long term deal with the Chinese should keep it going. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma, October, 2014. Graph: Brent, WTI and OPEC Basket prices for October 2014 © Gaurav Sharma, October, 2014.

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