A crude rout & all those downgrades

Both Brent and WTI futures are trading at their lowest levels since 2008 and previous weeks have offered some spectacular declines, if there is such a thing as that!

Biggest of the declines were noted when Brent fell by 12.65% and WTI by 11.90% between Friday, December 4th and Friday, December 11th using 2130 GMT as the cut-off point for 5-day week-on-week assessment. Following that, like January, we had another spread inversion in favour of the WTI, with the US benchmark trading at a premium to global proxy Brent for a good few sessions before slipping lower, as both again got dragged lower in lacklustre post-Christmas trading.

It all points to the year ending just as it began - with a market rout, as yours truly explained in some detail via a recent Forbes post. With nearly 3 million barrels per day of surplus oil hitting the market, the scenario is unavoidable. While the situation cannot and will not last, oversupply will not disappear overnight either. 

The Oilholic reckons it will be at least until the third quarter of 2016 before the glut shows noticeable signs of easing, mostly at the expense of non-OPEC supplies. That said, unless excess flow dips below 1 million bpd, it is doubtful ancillary influences such as geopolitical risk would come into play. 

For the moment, one still maintains an end-2016 Brent forecast near $60 per barrel and would revisit it in the New Year. Much will depend on the relative strength of the dollar in wake of US Federal Reserve’s interest rate hike, but Kit Juckes, Head of Forex at Societe Generale, says quite possibly commodity markets fear even a dovish Fed!

Meanwhile, with the oil market rout in full swing, rating agencies are queuing up predictable downgrades and negative outlooks. Moody’s described the global commodity downturn as “exceptionally severe in its depth and breadth” and expects it to be a substantial factor driving the number of defaults higher on a global basis in 2016.

Collapsing commodity prices have placed a significant strain on credit quality in the oil and gas, metals and mining sectors. These sectors have accounted for a disproportionately large 36% of Moody’s downgrades and 48% of defaults among all corporates globally so far this year. The agency anticipates continued credit deterioration and a spike in defaults in these sectors in 2016.

Over the past four weeks, we’ve had Moody's downgrade several household energy companies, including all ratings for Petrobras and ratings based on the Brazilian oil giant's guarantee, covering the company's senior unsecured debt rating, to Ba3 from Ba2. Concurrently, the company's baseline credit assessment (BCA) was lowered to b3 from b2. 

“These rating actions reflect Petrobras' elevated refinancing risks in the face of deteriorating industry conditions that make it more difficult to raise cash through asset sales; tighter financing conditions for companies in Brazil and in the oil industry, coupled with the magnitude of eventual needs to finance debt maturities; as well as the company's negative free cash flow,” Moody’s explained.

It also downgraded Schlumberger Holdings to A2; with its outlook changed to negative for Holdings and Schlumberger. "The downgrade of Schlumberger Holdings to A2 reflects the expected large increase in debt outstanding related to the adjustment of its capital structure following the Cameron acquisition," commented Pete Speer, Moody's Senior Vice President.

Corporate family rating of EnQuest saw a Moody’s downgrade to B3 from B1 and probability of default ratings to B3-PD from B1-PD. Of course, it’s not just oilfield and oil companies feeling the heat; Moody’s also downgraded the senior unsecured ratings of Anglo American and its subsidiaries to Baa3 from Baa2, its short term ratings to P-3 from P-2, and so it goes in the wider commodities sphere.

In the past week, outlook for Australia’s Woodside Petroleum outlook was changed to negative, while the ratings of seven Canadian and 29 US E&P companies were placed on review for downgrade. And so went the final month of the year. 

Not just that, the ratings agency also cut its oil price assumption for 2016, lowering Brent estimates to average $43 from $53 per barrel in 2016, and WTI to $40 from $48 per barrel. Moody’s said “continued high levels of oil production” by global producers were significantly exceeding demand growth, predicting the supply-demand equilibrium will only be reached by the end of the decade at around $63 per barrel for Brent. 

While, the Oilholic doesn’t quite agree that it would take until the end of the decade for supply-demand balance to be achieved, mass revisions tell you a thing or two about the mood in the market. Meanwhile, at a sovereign level, Fitch Ratings says low oil prices will continue to weigh on the sovereign credit profiles of major exporters in 2016. Of course, the level of vulnerability varies.

“In the last 12 months, we have downgraded five sovereigns where oil revenues accounted for a large proportion of general government and/or current external receipts. Another three - Saudi Arabia, Nigeria, and Republic of Congo - were not downgraded but saw Outlook revisions to Negative from Stable,” the agency said in a pre-Christmas note to clients.

It is now all down to who can manage to stay afloat and maintain production as the oil price stays ‘lower for longer’. Non-OPEC producers will in all likelihood run into financing difficulties, as one said in an OPEC webcast on December 4, with Brent ending 2015 over 35% lower on an annualised basis.

Finally, the Oilholic believes it is highly unlikely a divided OPEC will vote for a unanimous production cut even at its next meeting in June. For what’s it worth, $35 per barrel could be the norm for quite a bit of 2016. So in 12 months’ time, the oil and gas landscape could be very, very different. That’s all for 2015 folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Graph: Oil benchmark Friday closes, Q4 2015 © Gaurav Sharma / Oilholics Synonymous Report, December 2015. Photo: Gaurav Sharma speaking at the 168th OPEC Ministers' Meeting in Vienna, Austria © OPEC Secretariat.

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.

Maintaining 2014 price predictions for Brent

Since the initial flare-up in Iraq little over a fortnight ago, many commentators have been revising or tweaking their Brent price predictions and guidance for the remainder of 2014. The Oilholic won't be doing so for the moment, having monitored the situation, thought hard, gathered intelligence and discussed the issue at length with various observers at the last OPEC summit and 21st World Petroleum Congress earlier this month.

Based on intel and instinct, yours truly has decided to maintain his 2014 benchmark price assumptions made in January, i.e. a Brent price in the range of US$90 to $105 and WTI price range of $85 to $105. Brent's premium to the WTI should in all likelihood come down and average around $5 barrel. Nonetheless, geopolitical premium might ensure an upper range price for Brent and somewhere in the modest middle for the WTI range come the end of the year.

Why? For starters, all the news coming from Iraq seems to indicate that fears about the structural integrity of the country have eased. While much needed inward investment into Iraq's oil & gas industry will take a hit, majority of the oil production sites are not under ISIS control.

In fact, Oil Minister Abdul Kareem al-Luaibi recently claimed that Iraq's crude exports will increase next month. You can treat that claim with much deserved scepticism, but if anything, production levels aren't materially lower either, according to anecdotal evidence gathered from shipping agents in Southern Iraq.

The situation is in a flux, and who has the upper hand might change on a daily basis, but that the Iraqi Army has finally responded is reducing market fears. Additionally, the need to keep calm is bolstered by some of the supply-side positivity. For instance, of the two major crude oil consumers – US and China – the former is importing less and less crude oil from the Middle East, thereby easing pressure by the tanker load. Had this not been the case, we'd be in $120-plus territory by now, according to more than one City trader.

Some of the market revisions to oil price assumptions, while classified as 'revisions' have been pragmatic enough to reflect this. Many commentators have merely gone to the upper end of their previous forecasts, something which is entirely understandable.

For instance, Moody's increased the Brent crude price assumptions it uses for rating purposes to $105 per barrel for the remainder of 2014 and $95 in 2015. In case of the WTI, the ratings agency increased its price assumptions to $100 per barrel for the rest of 2014, and to $90 in 2015. Both assumptions are within the Oilholic's range, although they represent $10 per barrel increases from Moody's previous assumptions for both WTI and Brent in 2014 and a $5 increase for 2015.

"The new set of price assumptions reflects the agency's sense of firm demand for crude, even as supplies increase as a response to historically high prices. New violence in Iraq coupled with political turmoil in that general region in mid-2014 have led to supply constraints in the Middle East and North Africa," Moody's said.

But while these constraints exist, Moody's echoed vibes the Oilholic caught on at OPEC that Saudi Arabia, which can affect world global prices by adjusting its own production levels, has appeared unwilling to let Brent prices rise much above $110 per barrel on a sustained basis.

Away from pricing matters to some ratings matters with a few noteworthy notes – first off, Moody's has upgraded Schlumberger's issuer rating and the senior unsecured ratings of its guaranteed subsidiaries to Aa3 from A1.

Pete Speer, Senior Vice-President at the agency, said, "Schlumberger's industry leading technologies and dominant market position coupled with its conservative financial policies support the higher Aa3 rating through oilfield services cycles. The company's growing asset base and free cash flow generation also compares well to Aa3-rated peers in other industries."

Meanwhile, Fitch Ratings says the Iraqi situation does not pose an immediate threat to the ratings of its rated Western investment-grade oil companies. However, the agency reckons if conflict spreads and the market begins to doubt whether Iraq can increase its output in line with forecasts there could be a sharp rise in world oil prices because Iraqi oil production expansion is a major contributor to the long-term growth in global oil output.

The conflict is closest to Iraqi Kurdistan, where many Western companies including Afren (rated B+/Stable by Fitch) have production. However, due to ongoing disagreements between Baghdad and the Kurdish regional government, legal hurdles to export of Iraqi crude remain, and therefore production is a fraction of the potential output.

Other companies, such as Lukoil (rated BBB/Negative by Fitch), operate in the southeast near Basra, which is far from the areas of conflict and considered less volatile.

Alex Griffiths, Head of Natural Resources and Commodities at Fitch Ratings, said, "Even if the conflict were to spread throughout Iraq and disrupt other regions, the direct loss of revenues would not affect major investment-grade rated oil companies because Iraqi output is a very small component of their global production."

"In comparison, disruption of gas production in Egypt and oil production in Libya during the "Arab Spring" were potential rating drivers for BG Energy Holdings (A-/Stable) and Eni (A+/Negative), respectively," he added.

On a closing note, here is the Oilholic's latest Forbes article discussing natural gas pricing disparities around the world, and why abundance won't necessarily mitigate this. That's all for the moment folks. Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Oil drilling site © Shell photo archives

The subtle rise of the OFS innovators

Going back to the turn of 1990s, vertical drilling or forcing the drill bit down a carefully monitored well-shaft into a gentle arc was the best E&P companies could hope from contractors in their quest for black gold.

That’s until those innovators at Oilfield Services (OFS) firms - the guys who often escape notice despite having done much of heavy work involved in prospection and extraction - came up with commercially viable ways for directional drilling. The technique, which involves drilling several feet vertically before turning and continuing horizontally thus maximising the extraction potential of the find, transformed the industry. But more importantly, it transformed the fortunes of the innovators too.

The Oilholic has put some thought into how 21st century OFS firms ought to be classified, if a linear examination by market capitalisation and size is ignored for a moment. After acquiring gradual industry prominence from the 1970s onwards, OFS firms these days could be broadly grouped into three tiers.

The first tier would be the makers and sellers of equipment used in onshore or offshore drilling. Some examples include Cameron International, FMC Technologies and National Oilwell Varco with a market capitalisation in the range of US$10 billion to $30 billion. Then come the 'makers-plus' who also own and lease drill rigs – for example Seadrill, Noble and Transocean with a market cap in a similar sort of a range.

 

And finally there are the big three 'full service' OFS companies Baker Hughes, Halliburton and the world’s largest – Schlumberger. The latter has a market cap of $110 billion plus, last time the Oilholic checked. That’s more than double that of its nearest rival Halliburton. Quite literally, Schlumberger's market cap could give many big oil companies a run for their money. However, if someone told you back in the 1980s that this would be the case in August 2013 – you could be excused for thinking the claimant was on moonshine!

 

The reason for the rise of OFS firms is that their innovation has been accompanied by growing global resource nationalism and maturing wells. The path to prosperity for the services sector began with low margin drilling work in the 1980s and 1990s being outsourced to them by the IOCs. Decades on, the firms continue to benefit from historical partnerships with the oil majors (and minors) aimed at maximising production at mature wells alongside new projects.

 

However, with a rise in resource nationalism, while NOCs often prefer to keep IOCs at arm's length, the same does not apply to OFS firms. Instead, many NOCs choose to project manage exploration sites themselves with the technical know-how from OFS firms. In short, the innovators are currently enjoying, in their own understated way, the best of both worlds! Unconventional prospection from deepwater drilling to the Arctic is an added bonus.

 

If you excluded all of North America, drilling activity is at a three-decade high, according to the IEA and available rig data trends. The Baker Hughes rig count outside North America climbed to 1,333 in June, the highest level in 30 years. Presenting his company’s seventh straight quarterly profit last month, a beaming Paal Kibsgaard, chief executive of Schlumberger, named China, Australia, Saudi Arabia and Iraq among his key markets.

 

Of the four countries named by Kibsgaard, Australia is the only exception where an NOC doesn’t rule the roost, vindicating the Oilholic’s conjecture about the benefits of resource nationalism for OFS firms.

 

Rival Halliburton also flagged up its increased activity and sales in Malaysia, China and Angola and added that it is banking on a second half bounceback in Latin America this year. By contrast, Baker Hughes reported a [45%] fall in second quarter profit, mainly due to weak margins in North America, given the gas glut stateside.

 

Resource nationalism aside, OFS players still continue (and will continue) to maintain healthy partnerships with the IOCs. None of the big three have shown any inclination of owning oil & gas reserves and most of the big players say they never will.

 

Some have small equity stakes here and a performance based contract there. However, this is some way short of ownership. Besides, if there is one thing the OFS players don’t want – it's taking asset risk on their balance sheets in a way the likes of Shell and ExxonMobil do and are pretty good at.

 

Furthermore, the IOCs are major OFS clients. Why would you want to upset your oldest clients, a relationship that is working so well even as the wider industry is undergoing a hegemonic and technical metamorphosis?

 

Success though, does not come cheap especially as it's all about innovation. As a share of annual sales, Schlumberger spent as much on R&D as ExxonMobil, Shell and BP, did using 2010-11 exchange filings. And sometimes, unwittingly, taking the BP 2010 Gulf of Mexico oil spill as an example, the guys in background become an unwanted part of a negative story; Transocean and Halliburton could attest to that. None of this should detract observers from the huge strides made by OFS firms and the ingenuity of the pioneers of directional drilling. And there's more to come!

 

Moving on from the OFS subject, but on a related note, the Oilholic read an interesting Reuters report which suggests oil & gas shareholder activism is coming to the UK market. Many British companies, according to the agency, have ended up with significant assets, including cash, relative to their shrunken stock market value.

 

Some of these have lost favour with mainstream shareholders and are now attracting investors who want to push finance bosses and board members out, access corporate cash and force asset sales. An anonymous investment banker specialising the oil & gas business, told Reuters, rather candidly: "It's a very simple model. You don't have to take a view on the value of the actual assets or know anything about oil and gas. You just know the cash is there for the taking."

 

Finally, linked here is an interesting Bloomberg report on how much the Über-environmentally friendly Al Gore is worth and what he is up to these days. Some say he is 'Romney' rich! 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: Rig in the North Sea © BP