‘Crude’ sanctions on others always hurt Japan

The Oilholic finds himself in a rain-soaked Tokyo one final time before the big flying bus home! How Asian importing countries cope with sanctions on major oil & gas exporting jurisdictions is an interesting topic in this region reliant on foreign hydrocarbons for obvious reasons.

Mentioning Iran and of late curbs on Russia, deliberations over the past week with market commentators here in Tokyo, as well as Shanghai and Hong Kong, resulted in a consensus of opinion that Japan’s 30-odd oil & gas companies and regional gas-fired utilities feel the pain of such curbs more than corporate citizens of most other Asian importing nations.

The reason is simple enough; of the quartet of major Asian importers – namely China, Japan, India and South Korea – it’s the Japanese who are the most compliant when international pressures surface. Now, whether or not they can afford to is a different matter. According to the EIA and local publications, Japan consumed nearly 4.6 million barrels per day (bpd) in 2013, down from 4.7 million bpd in 2012. 

Going by the IEA’s latest projections, Japan is the third largest petroleum consumer in the world, behind the US and China. Yet domestic reserves are paltry in the region of 45.5 million barrels of oil equivalent, concentrated along the country’s western coastline. Inevitably, Japan imports most of its hydrocarbon requirements as a major industrialised nation.

Given the equation, if sanctions knock out or have the potential to knock out imports from one of its major partners, finding an alternative is neither easy nor simple. Forward planning also gets thrown right out of the window. We’ll discuss the recent Russian conundrum in a moment, but let’s examine the 2012 Iranian sanctions and the Japanese response to them first.

The country, almost immediately complied with requests to import less oil from Iran when European Union and US sanctions escalated in Q1 2012. At the time, Japan accounted for 17% of Iranian exports, above South Korea and India, but below China. The Japanese phased bid to reduce Iranian oil imports was lauded by the West, whereas China largely ignored the call, South Korea asked for more time and the Indians came up with ingenious ways to make remittances to Iran, until curbs on the insurance of tankers carrying Iranian crude began to bite.

Make no mistake, the sanctions on Iran hurt all four back in 2012, but Japan had to contend with the biggest refocusing exercise based on the level and speed of its compliance in moving away from Iranian crude. In the Oilholic’s opinion, for better or worse, that’s the price of being a G7 nation; and “having internationalism factored into the thinking,” adds a contact.

Fast forward to 2014, and the potential for securing of natural gas supplies from Russia to Japan seems to be taking a hit in wake of the Ukraine crisis. At the 21st World Petroleum Congress in June, when the tension had not escalated to the current level, prior to the downing of MH17, policymakers in on both sides were cooing over the potential for cooperation. 

The Institute of Energy Economics, Japan and the Energy Research Institute of the Russian Academy of Sciences even put out a joint white paper at the Congress contemplating a subsea gas pipeline route from Korsakov, Russia, to Kashima, Japan with an onshore Ishikari-Tomakomai section. It was claimed that technical feasibility of the ambitious project, capable of carrying a projected 8 bcm of natural gas to the Pacific Coast of Eastern Japan, had been positive.

Now it’s all gone a bit cold. One can’t directly attribute it to Russia’s face-off with the West, but currently both Japan and Russia describe the project as “just another idea”. This blogger can assure you, people were way more excited about it in June at the WPC than they are at the moment, and one wonders why?

Afterall, post-Fukushima with the rise of natural gas in Japan’s energy mix, however wild a project might be, carries weight rather than being relegated to just an idea. Contrast this with China, which has recently inked a long-term supply contract with the Russians. Quod erat demonstrandum!

With the evening drawing to a close, it’s time to digress a little and disclose the venue of this animated conversation – that’s none other than Tokyo’s iconic Hotel Okura. While a wee tipple is not cheap (average JPY1,700 for a swig of single malt), visiting this modernist institution is something special. 

When Tokyo first hosted the Olympic Games in 1964, the hotel was built in preparation to welcome the world. Since then, Hotel Okura has hosted every serving US President from Richard Nixon onwards.

Author Ian Fleming made James Bond fictitiously check-in to the hotel while in Tokyo in a chapter of "You only live twice". In recent work of fiction, the hotel also makes an appearance in Haruki Murakami’s 1Q84. It’s eclectic lobby, paneling, general sense of tranquility and overall panache of modern Japan is simply splendid (see above left). 

So here’s to 007, Murakami, Queen and Country and all the rest; but also it could be the Oilholic’s last drink at Hotel Okura as we know it. Alas, this grand place is about to fall prey to cultural philistinism in the name of progress as Tokyo prepares to host the Olympic Games once again in 2020. 

Last time around, for the 1964 games, Tokyo got the wretched Nihonbashi Expressway, a ‘clever’ project which included building an expressway over the Nihonbashi bridge, obscuring the magnificent view of Mount Fuji from the bridge and covering-up an ancient river flowering through the heart of Tokyo with steel and much more (see below left)!

Now atop a lot of flattening and rebuilding plans all over town, it seems Hotel Okura’s original main wing has been marked for demolition in August 2015, leaving only the South Tower operational. A proposed spending plan of US$980 million will see the wing open in the spring of 2019, reborn according to an employee as a “mixed-use tower” with 550 guest rooms and 18 stories of office space.

Life it seems will never be the same again for Hotel Okura and its many admirers including the Oilholic, who’d made it his mission not to leave Tokyo without visiting. Glad one got to see it before the demolition men get in. Well that’s all from the Far East folks as its time to bid a sad goodbye to the region!

Tokyo, Hong Kong, Macau and Shanghai, planes, trains, speedboats and automobiles – it was one heck of a crude ride that one will treasure forever. Next stop is London Heathrow, a reminder that all good things must end! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo 1: Tokyo Stock Exchange. Photo 2: Lobby of the Hotel Okura, Tokyo. Photo 3: The Oilholic at Hotel Okura’s Orchid Bar. Photo 4: Nihonbashi Expressway, Tokyo, Japan  © Gaurav Sharma, September, 2014.

Hedge Funds have been ‘contangoed’

Recent events may have pushed the Brent front month futures contract back towards US$108 per barrel; but there's no denying some have been 'contangoed'! Ukrainian tensions and lower Libyan production are hard to ignore, even if the latter is a bit of a given.

Nonetheless, for a change, the direction of both benchmark prices this month indicates that July did belong to the physical traders with papers traders, most notably Hedge Funds, taking a beating.

It's astonishing (or perhaps not) that many paper traders went long on Brent banking on the premise of "the only way is up" as the Iraqi insurgency escalated last month. The only problem was that Iraqi oil was still getting dispatched from its southern oil hub of Basra despite internal chaos. Furthermore, areas under ISIS control hardly included any major Iraqi oil production zone.

After spiking above $115, the Brent price soon plummeted to under $105 as the reality of the physical market began to bite. It seems European refiners were holding back from buying the expensive crude stuff faced with declining margins. In fact, North Sea shipments, which Brent is largely synced with, were at monthly lows. Let alone bothering to pull out a map of Iraqi oilfields, many paper traders didn't even bother with the ancillary warning signs.

As Fitch Ratings noted earlier this month, the European refining margins are likely to remain weak for at least the next one to two years due to overcapacity, demand and supply imbalances, and competition from overseas. Over the first half of 2014, the northwest European refining margin averaged $3.3 per barrel, down from $4 per barrel in 2013 and $6.8 barrel in 2012.

Many European refineries have been loss-making or only slightly profitable, depending on their complexity, location and efficiency. They are hardly the sort of buyers to purchase consignments by the tanker-load during a mini bull run. The weaker margin scenario itself is nothing new, resulting from factors including a stagnating economy and the bias of domestic consumption towards diesel due to EU energy regulations

"This means that surplus gasoline is exported and the diesel fuel deficit is filled by imports, prompting competition with Middle Eastern, Russian and US refineries, which have access to cheaper feedstock and lower energy costs on average. Mediterranean refiners are additionally hurt by the interruption of oil supplies from Libya, but this situation may improve with the resumption of eastern port exports," explains Fitch analyst Dmitry Marinchenko.

Of course tell that to Hedge Funds managers who still went long in June collectively holding just short of 600 million paper barrels on their books banking on backwardation. But thanks to smart, strategic buying by physical traders eyeing cargoes without firm buyers, contango set in hitting the hedge funds with massive losses.

When supply remains adequate (or shall we say perceived to be adequate) and key buyers are not in a mood to buy in the volumes they normally do down to operational constraints, you know you've been 'contangoed' as forward month delivery will come at a sharp discount to later contracts!

Now the retreat is clear as ICE's latest Commitments of Traders report for the week to July 15 saw Hedge Funds and other speculators cut their long bets by around 25%, reducing their net long futures and options positions in Brent to 151,981 from 201,568. If the window of scrutiny is extended to the last week of June, the Oilholic would say that's a reduction of nearly 40%.

As for the European refiners, competition from overseas is likely to remain high, although Fitch reckons margins may start to recover in the medium term as economic growth gradually improves and overall refining capacity in Europe decreases. For instance, a recent Bloomberg survey indicated that of the 104 refining facilities region wide, 10 will shut permanently by 2020 from France to Italy to the Czech Republic. No surprises there as both OPEC and the IEA see European fuel demand as being largely flat.

Speaking of the IEA, the Oilholic got a chance earlier this month to chat with its Chief Economist Dr Fatih Birol. Despite the latest tension, he sees Russian oil & gas as a key component of the global energy mix (Read all about it in The Oilholic's Forbes post.)

Meanwhile, Moody's sees new US sanctions on Russia as credit negative for Rosneft and Novatek. The latest round of curbs will effectively prohibit Rosneft, Novatek, and other sanctioned entities, including several Russian banks and defence companies, from procuring financing and new debt from US investors, companies and banks.

Rosneft and Novatek will in effect be barred from obtaining future loans with a maturity of more than 90 days or new equity, cutting them off from long-term US capital markets. As both companies' trade activities currently remain unaffected, Moody's is not taking ratings action yet. However, the agency says the sanctions will significantly limit both companies' financing options and could put pressure on development projects, such as Novatek's Yamal LNG.

No one is sure what the aftermath of the MH17 tragedy would be, how the Ukrainian crisis would be resolved, and what implications it has for Russian energy companies and their Western partners. All we can do is wait and see. That's all for the moment folks. Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Oil pipeline © Cairn Energy

A Russian deal, an Indian election, Libya & more

While the Europeans are busy squabbling about how to diversify their natural gas supplies and reduce reliance on Russia, the country's President Vladimir Putin hedged his bets earlier this week and reacted smartly by inking a 30-year supply deal with China.

No financial details were revealed and the two sides have been haggling over price for better parts of the last decade. However, yet again the Russian president has proved more astute than the duds in Brussels! Nevertheless, the Oilholic feels Russia would have had to make substantial compromises on price levels. By default, the Ukraine standoff has undoubtedly benefitted China National Petroleum Corp (CNPC), and Gazprom has a new gas hungry export destination.

Still there is some good news for the Europeans. Moody's believes that unlike in 2008-09, when gas prices spiked in the middle of the winter due to the cessation of Russian gas supplies to Europe via Ukraine, any temporary disruption via Ukraine would have only have a muted impact.

"This opinion factors in a combination of (1) lower reliance on Ukraine as a transit route, owing to alternative supply channels such as the Nord Stream pipeline which became operational in 2011; (2) low seasonal demand in Europe as winter has come to an end; and (3) gas inventories at high levels covering a full month of consumption," the ratings agency noted in a recent investment note.

Meanwhile, a political tsunami in India swept the country's Congress party led government out of power putting an end to years of fractious and economic stunting coalition politics in favour of a right-wing nationalist BJP government. The party's leader Narendra Modi delivered a thumping majority, which would give him the mandate to revive the country's economic fortunes without bothering to accommodate silly whims of coalition partners.

Modi was the chief minister of Gujarat, one of the country's most prosperous provinces and home to the largest in the refinery in the world in the shape of Jamnagar. In many analysts' eyes, regardless of his politics, the Prime Minister elect is a business friendly face.

Moody's analyst Vikas Halan expects that the new BJP-led government will increase natural gas prices, which would benefit upstream oil & gas companies and provide greater long term incentives for investment. Gas prices were originally scheduled to almost double in April, but the previous government put that increase on hold because of the elections.

This delay has meant that India's upstream companies have been losing large amounts of revenue, and a timely increase in gas prices would therefore cushion revenues and help revive interest in offshore exploration.

"A strong majority government would also increase the likelihood of structural reform in India's ailing power sector. Closer co-ordination between the central and state governments on clearances for mega projects and land use, two proposals outlined in the BJP's manifesto, would address investment delays," Halan added.

The Oilholic agrees with Moody's interpretation of the impact of BJP's victory, and with majority of the Indian masses who gave the Congress party a right royal kick. However, one is sad to see an end to the political career of Dr Manmohan Singh, a good man surrounded by rotten eggheads.

Over a distinguished career, Singh served as the governor of the Reserve Bank of India, and latterly as the country's finance minister credited with liberalising and opening up of the economy. From winning the Adam Smith Prize as a Cambridge University man, to finding his place in Time magazine's 100 most influential people in the world, Singh – whose signature appears on an older series of Indian banknotes (see right) – has always been, and will always be held in high regard.

Still seeing this sad end to a glittering career, almost makes yours truly wish Dr Singh had never entered the murky world of mainstream Indian politics in the first place. Also proves another point, that almost all political careers end in tears.

Away from Indian politics, Libyan oilfields of El Sharara, El Feel and Wafa, having a potential output level 500,000 barrels per day, are pumping out the crude stuff once again. However, this blogger is nonplussed because (a) not sure how long this will last before the next flare up and (b) unless Ras Lanuf and Sidra ports see a complete normalisation of crude exports, the market would remain sceptical. We're a long way away from the latter.

A day after the Libyan news emerged on May 14, the Brent forward month futures contract for June due for expiry the next day actually extended gains for a second day to settle 95 cents higher at US$110.19 a barrel, its highest settlement since April 24.

The July Brent contract, which became the forward-month contract on May 16, rose 77 cents to settle at US$109.31 a barrel. That's market scepticism for you right there? Let's face it; we have to contend with the Libyan risk remaining priced in for some time yet.

Just before taking your leave, a couple of very interesting articles to flag-up for you all. First off, here is Alan R. Elliott's brilliant piece in the Investor’s Business Daily comparing and contrasting fortunes of the WTI versus the LLS (Louisiana Light Sweet), and the whole waterborne crude pricing contrast Stateside.

Secondly, Claudia Cattaneo, a business columnist at The National Post, writes about UK political figures' recent visit to Canada and notes that if the Americans aren't increasing their take-up of Canada's energy resources, the British 'maybe' coming. Indeed, watch this space. That's all for the moment folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Pipeline, India © Cairn Energy

EU’s Russian gas, who gets what & BP’s Bob

The vexing question for European Union policymakers these days is who has what level of exposure to Russian gas imports should the taps get turned off, a zero storage scenario at importing nations is assumed [hypothesis not a reality] and the Kremlin's disregard for any harm to its coffers is deemed a given [easier said than done].

Depending on whom you speak to, ranging from a European Commission mandarin to a government statistician, the figures would vary marginally but won't be any less worrying for some. The Oilholic goes by what Eurogas, a non-profit lobby group of natural gas wholesalers, retailers and distributors, has on its files.

According to its data, the 28 members of the European Union sourced 24% of their gas from Russia in 2012. Now before you say that's not too bad, yours truly would say that's not bad 'on average' for some! For instance, Estonia, Finland, Lativia and Lithuania got 100% of their gas from Russia, with Bulgaria, Hungary and Slovakia not far behind having imported 80% or more of their requirements at the Kremlin's grace and favour.

On the other hand, Belgium, Croatia, Denmark, Ireland, Netherlands, Portugal, Spain, Sweden and the UK have nothing to worry about as they import nothing or negligible amounts from Russia. Everyone in between the two ends, especially Germany with a 37% exposure, also has a major cause for concern.

And it is why Europe can't speak with one voice over the Ukrainian standoff. In any case, the EU sanctions are laughable and even a further squeeze won't have any short term impact on Russia. A contact at Moody's says the Central Bank of the Russian Federation has more than enough foreign currency reserves to virtually guarantee there is no medium term shortage of foreign currency in the country. Industry estimates, cited by the agency, seem to put the central bank's holdings at just above US$435 billion. EU members should know as they contributed handsomely to Russia's trade surplus!

Meanwhile, BP boss Bob Dudley is making a habit of diving into swirling geopolitical pools. Last November, Dudley joined Iraqi Oil Minister Abdul Kareem al-Luaibi for a controversial visit to the Kirkuk oilfield; the subject of a dispute between Baghdad and Iraqi Kurdistan. While Dudley's boys have a deal with the Iraqi Federal government for the oilfield, the Kurds frown upon it and administer chunks of the field themselves to which BP will no access to.

Now Dudley has waded into the Ukrainian standoff by claiming BP could act as a bridge between Russia and the West. Wow, what did one miss? The whole episode goes something like this. Last week, BP's shareholders quizzed Dudley about the company's exposure to Russia and its near 20% stake in Rosneft, the country's state-owned behemoth.

In response, Dudley quipped: "We will seek to pursue our business activities mindful that the mutual dependency between Russia as an energy supplier and Europe as an energy consumer has been an important source of security and engagement for both parties for many decades. We play an important role as a bridge."

"Neither side can just turn this off…none of us know what can happen in Ukraine," said the man who departed Russia in a huff in 2008 when things at TNK-BP turned sour, but now has a seat on Rosneft's board.

While Dudley's sudden quote on the crisis is surprising, the response of BP's shareholders in recent weeks has been pretty predictable. Russia accounts for over 25% of the company's global output in barrels of oil equivalent per day (boepd) terms. But, in terms of booked boepd reserves, the percentage rises just a shade above 33%.

However, instead of getting spooked folks, look at the big picture – according to the latest financials, in petrodollar terms, BP's Russian exposure is in the same investment circa as Angola and Azerbaijan ($15 billion plus), but well short of anything compared to its investment exposure in the US.

Sticking with the  crudely geopolitical theme, this blogger doesn't always agree with what the Henry Jackson Society (HJS) has to say, but its recent research strikes a poignant chord with what yours truly wrote last week on the Libyan situation.

The society's report titled - Arab Spring: An Assessment Three Years On (click to download here) - noted that despite high hopes for democracy, human rights and long awaited freedoms, the overall situation on the ground is worse off than before the Arab Spring uprisings.

For instance, Libyan oil production has dramatically fallen by 80% as neighbouring Tunisia's economy is now dependent on international aid. Egypt's economy, suffering from a substantial decrease in tourism, has hit its lowest point in decades, while at the same time Yemen's rate of poverty is at an all-time high.

Furthermore, extremist and fundamentalist activity is rising in all surveyed states, with a worrying growth in terror activities across the region. As for democracy, HJS says while Tunisia has been progressing towards reform, Libya's movement towards democracy has failed with militias now effectively controlling the state. Egypt remains politically highly-unstable and polarised, as Yemen's botched attempts at unifying the government has left many political splits and scars.

Moving on to headline crude oil prices, both benchmarks have closed the gap, with the spread in favour of Brent lurking around a $5 per barrel premium. That said, supply-side fundamentals for both benchmarks haven't materially altered; it's the geopolitical froth that's gotten frothier. No exaggeration, but we're possibly looking at a risk premium of at least $10 per barrel, as quite frankly no one knows where the latest Eastern Ukrainian flare-up is going and what might happen next.

Amidst this, the US EIA expects the WTI to average $95.60 per barrel this year, up from its previous forecast of $95.33. The agency also expects Brent to average $104.88, down 4 cents from an earlier forecast. Both averages and the Brent-WTI spread are within the Oilholic's forecast range for 2014. That's all for the moment folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Sullom Voe Terminal, UK © BP

EU’s ‘least worst’ gas supply scenarios & more

The Oilholic spent last Friday evening downing a few drinks with a 'civil servant' of the diplomatic variety who'd returned back from the recently concluded Nuclear Security Summit in The Hague, where the Ukrainian standoff dominated most conversations. But before you get excited, yours truly has no 'Jack Bauer'-level clearance gossip!

However, with 53 nations represented – there were quite a few suits around, and contrary to popular belief, the stiff suits do gossip! Credible intel does appear to suggest that some Europeans did a very fine 'Clinton post-Lewinsky scandal' impression in a geopolitically fresh context which kinda ran like: "We do not have relations with that man Putin." Of course, they were, as Clinton was back in the day, being a little less frugal with the truth.

The Americans already knew that but didn't say so out of diplomatic courtesy, at least not in public. The Oilholic wouldn't have been so courteous, but then yours truly isn't in the diplomatic service. From the Baltics to the Balkans, Russian exports of natural gas dominate the energy spectrum built on hitherto seemingly inextricable relations, whether amicable or not.

Despite promising to diversify their supplies when the Georgian skirmish happened in 2008, not much has changed, as The Oilholic noted earlier this month. As a direct consequence, US sanctions against Russia appear to better structured compared to European ones which look like a rag-bag of measures to accommodate everyone and annoy no one – especially President Putin, who doesn't really care about them in the first place! Most pressing question is – what now for the EU energy equation?

Just as the suits were winding up, Jaroslav Neverovič, Lithuania's energy minister made an impassioned plea to the US to export more gas to Europe as a possible answer. Just as a sub-context, the Baltic States are busy building LNG import terminals. Headline grabbing it may well have been, what Neverovič said, even if realised, would do little to curb European addiction to Russian gas over the medium term.

Supply-side diversity cannot be achieved in an instant, nor can the US solve the problem. If the capacity of all seven US FERC and DOE approved LNG export terminals (so far) is totalled and it is hypothetically (or rather absurdly) assumed that the entire cargo would be dispatched to Europe – the volume would still only replace around 35% of the current level of Russian gas imports to Europe.

But what has changed is that the Baltic nations, as demonstrated by Neverovič, are clearly alarmed; perhaps, more than they were in 2008. The Poles are mighty miffed too and even the Germans are waking up and smelling the coffee. So what's next? American LNG imports will come, while Norway, UK and the Netherlands’ pooled resources could help the trio. 

However, going beyond that, and to quote a brilliant editorial in The Economist, would mean Europeans relying on Algeria, Qatar, Azerbaijan and Kazakhstan which does not seem very savoury. "But the more rogues who sell them gas, the harder it is for any one to hold Europe hostage," it adds! So here's your 'least worst' medium term scenario, preparation for which had to start in 2008 and not in 2014! 

Related to the situation, Fitch Ratings revised the corporate outlooks of nine Russian companies, including those of Gazprom and Lukoil to Negative. As with a situation of this nature there would be losers somewhere and winners elsewhere.

According to the ratings agency, BG, BP, Shell and Total would be among its EMEA rated oil & gas companies that stand to gain from a "potential shift" in EU countries' energy links with Russia over time. On the other hand, Gazprom and Ukraine's Naftogaz – no prizes for guessing – are most likely to find themselves at a competitive disadvantage.

Analysing a scenario where EU countries could be forced to "recast their approach to energy and economic links with Russia over time", as UK Foreign Secretary William Hague has suggested, Fitch said BG, BP,  Shell and Total are well placed.

For instance, BG is participating in three US projects already approved by FERC and DOE to export LNG. BP completed the final investment decision for the Stage 2 development of the Shah Deniz gas field with its local partner State Oil Company of Azerbaijan in December last year. The expansion of the southern corridor gas link to Europe puts these companies in a unique position to diversify EU gas supplies.

Meanwhile, Shell is the first company in the world to develop floating LNG (FLNG) facilities. The technology is an important development for the industry as it reduces both project costs and environmental impact. If Shell is able to replicate the FLNG model it is deploying in Australia to diversify European supplies, it could give the company a competitive advantage over peers.

Finally, Total became the first Western oil major to invest in UK shale prospection after agreeing to take a 40% stake in two licenses that are part of the prospective Bowland Shale in Northern England. The investment could give the company a head start if European shale gas production begins to ramp up in a meaningful way, even though its early days. In fact, its early days in all four cases, and Fitch agreed that supply-side benefits would accrue over time, not overnight.

Going the other way, Gazprom, which supplied around a third of European gas volumes in 2013, faces the prospect of diminishing market share if the EU seeks alternative gas supplies, instead of simply alternative gas routes from Russia around Ukraine. "Europe may finally find the political will to reduce this percentage," Fitch adds.

As for Naftogaz – it's in big trouble alright. Not only could the Ukrainian company face higher prices for gas supplies from Russia accompanied by reduced volumes for internal consumption, the road ahead is anything but certain!

Away from the EU and Ukraine, UK Chancellor of the Exchequer George Osborne dropped a few crude morsels in his annual budget on March 19 to help British consumers and the industry. Fuel duty was frozen again, while passengers on some long-haul flights originating in the UK are set to pay less tax following a revamp of Air Passenger Duty (APD).

Passengers travelling more than 2,000 miles will pay the band B rate, which varies from £67 to £268, Osborne told parliament. The two highest of the four APD tax bands are to be scrapped from 2015, he added. At present, it is cheaper to fly from the UK to the US than the Caribbean, despite often similar distances, a situation Osborne described as "crazy and unjust". So passengers on long-haul flights to destinations such as India and the Caribbean can expect to pay a lower tax rate soon.

Coming on to industry measures, Osborne also put forward a new incentive for onshore prospection, wherein a portion of profit equal to 75% of a company's qualifying onshore capital expenditure will be exempt from supplementary tax charge.

This portion of the profit will then be subject to tax at 30%, while the remaining profit will be subject to a marginal tax rate of 62%, as is usually the case with oil & gas companies operating in the UK. The bold and much needed move went down well in the currently charged geopolitical atmosphere, unless you happen to be opposed to fracking on principle.

Robert Hodges, director of energy tax services at Ernst & Young, said it was welcome news for the shale gas industry which needs to commit significant investment to prove commercial reserves in the UK.

"The Government also announced it will work with industry to ensure that the UK has the right skills and supply chain in place. This is an important commitment, which will be welcomed by industry, to ensure that the UK maximises the benefit from the development of its indigenous oil and gas resources," he added.

As for the North Sea, we saw some moves on ultra high pressure, high temperature (HPHT) fields with Osborne providing an allowance to exempt a portion of a drilling company's profits from the supplementary charge. The amount of profit exempt will equal at least 62.5% of qualifying capex a company incurs on these projects. The Chancellor also said he would launch a review of the tax regime for the entire sector.

Some were pleased, others not so. Maersk Oil and BG, lead operators of the Culzean and Jackdaw fields, are the first to benefit. Both were cock-a-hoop saying it would lead to the direct creation over 700 jobs, with a potential for up to 8,000 more further down the supply chain. However, the International Association of Drilling Contractors (IADC) claims changes over drilling rigs and accommodation vessels would cost firms an estimated £145 million in the coming year. Lobby group Oil & Gas UK also expressed concerns on cost escalation, but welcomed other bits thrown up by Osborne.

Away from it all, there's one tiny non-UK morsel to toss up. According to a recent GlobalData report, it appears that Kenya's first oil & gas licensing round is not expected Q4 2014 at the earliest. The first licensing round was originally scheduled for June last year with an offer of eight blocks up for bidding. Then all went a bit quiet. Now GlobalData says it will happen, but plans have temporarily stalled pending the passage of a new energy bill.

Moving on to the price of the crude stuff, last fortnight was pretty much a case of steady as she goes for Brent, while supply-side issues caused a mini spike with the WTI. And, that can only mean one thing - another narrowing of the Brent-WTI spread to single figures.

Factors in the WTI rear-view mirror included supply shrinkage at Cushing, Oklahoma; down for the eighth successive week last Friday and the lowest in two years, according to the EIA. Libyan, Nigerian supply outages had a bearing on Brent, but it's nothing to write home about this fortnight. Much of the risk is already priced in, especially as Libyan outages are something City traders are getting pretty used to and Nigeria is nothing new. That's all for the moment folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Oil pipeline © Cairn Energy

Turkey's Russian connection: Bazaars to barrels

The Oilholic finds himself in a soggy Istanbul, with Turkey in the middle of election fever and the Black Sea in the grip of a Cold War style stand-off over Ukraine.

Before landing here, yours truly ran in to a Moody's spokesperson at BA's Heathrow T5 lounge. It seems that the ratings agency predictably sees Gazprom and Russia's banking sector taking a hit, if recent notes to subscribers are anything to go by. With 52% of Gazprom's exports to Europe currently routed through Ukraine and the country contributing up to 8% of its revenues, there is trouble ahead. Nonetheless, it can cope pretty well in the face of an escalation.

When it comes to the banking sector, Moody's reckons the aggregated exposure could be as high as US$30 billion. The Kremlin is likely to step in if needs be but it won't be needed as the figure equates to less than 2% of system assets. Interestingly, just before dashing off to our respective flights, our friend from Moody's gently nudged the Oilholic and quipped, "Wait till you get to Istanbul and see NATO member Turkey's exposure to Russia." And so this blogger came, he saw and he wondered!

We'll come to the barrels later, lets start with the bazaars first. Despite the unusually miserable weather, the city is packed with Russian tourists. From the metro to the tourist spots, you cannot escape Russian chatter in the background. "For sale" signs in retail outlets are up in two languages – Turkish and Russian. In expanding its tourism sector and wider economy, Turkey has welcomed Russian tourists and business investments with open arms including a favourable visa regime for over 10 years now.

The results are tangible. With the Turkish Lira in throes of unpredictability, every big ticket item – from designer stuff and marquee labels to high value Turkish handicrafts – is priced by retailers here in euros; with quite a few Russians around with more than a few euros.

Digressing from retail to banks, the exposure of Turkish banking institutions to Russia is harder to quantify as the current macroclimate in the country [not Ukraine & NATO] has conspired to turn the situation fluid. Unfortunately, no one wants to nail a figure on record as forex permutations are making life difficult extremely difficult for the analysts, but off record it is certainly not "as high as Ukraine."

Excluding exposure of Russian banks to Turkish infrastructure project finance exercises, $5 billion to 10 billion is a reasonable conservative guesstimate. From banks, rather crudely to barrels – Russia is Turkey's 6th largest export market. Mostly consumables, textiles and manufactured goods worth $3 billion were exported by Turkey to Russia in 2012.

What came back from Russian shores was $27 billion worth of imports including crude oil, distillates, natural gas and iron and steel that same year. Of the said figure, $17.26 billion were oil & gas imports! Using a dollar valuation at constant exchange rate (which has been anything but constant), we are looking at a 625% jump in Russian "imports" between 2002 and 2012. The said percentage need not be sensationalised as the starting point was a low base, but it gives you an idea of NATO Turkey's exposure to [and reliance on] Russia.

Furthermore, the Bosphorus is a major maritime artery for oil & gas shipments via the Black Sea. Exports from the Russian loading port of Novorossyisk by tankers via the Turkish straits have been rising steadily over the last 10 years. Recognising this, Turkey even has an embassy in Novorossyisk.

Recently, Poland's Prime Minister Donald Tusk, in sync with the Oilholic, was correctly berating Germany for its exposure to Russian gas and why it would give the EU a weaker hand over the Ukrainian tussle.

"Germany's reliance on Russian gas can effectively limit European sovereignty. I have no doubt," Tusk told reporters, ahead of German Chancellor Angela Merkel’s visit to his country. [Ouch!]

Maybe Tusk ought to look at fellow NATO member Turkey too. If the diplomatic row continues to escalate, Turkey would find it very hard to indulge in verbal or economic jousts with Russia. It took a very vocal stand with Syria, but one suspects it may not be the case this time around. Banks, bazaars and barrels could all feel the squeeze – it's what colleagues in the analyst community down here openly acknowledge.

However, you don't need them or the Oilholic. All you need to do is take the tram from Istanbul's Grand Bazaar through to Kabataş, the last stop on the European shore of the Bosphorus, between Beşiktaş and Karaköy. The journey will help you reach the same conclusions unaided by charts, graphs and economic gobbledegook. And here's hoping, the weather is kinder to you than it has been to the Oilholic. That's all for the moment from Istanbul folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo 1: Eminonu Waterfont, Istanbul, Turkey Photo 2: Greek oil tanker Scorpio passes through the Bosphorus, Turkey. ©  Gaurav Sharma, March 2014.

Crude permutations of the Ukrainian stand-off

When the Russo-Georgian skirmish happened in 2008, European policymakers got a stark reminder of how reliant they were on Russian natural gas. Regardless of the geopolitics of that conflict, many leading voices in the European Union, especially in Germany, vowed to reduce their reliance on Russian gas.

The idea was to prevent one of the world's leading exporters of natural gas from using its resource as a bargaining tool should such an episode occur again. Now that it has, as the Ukrainian crisis brings Russia and West into yet another open confrontation, the Oilholic asks what happened to that vow. Not much given the scheme of things! What's worse, the Fukushima meltdown in Japan and a subsequent haphazard dismissal of the nuclear energy avenue by many European jurisdictions actually increased medium-term reliance on mostly Russian gas.

According to GlobalData, Russian gas exports to Europe grew to a record of 15.6 billion cubic feet per day last year. The US, which is not reliant on Russian natural resources, finds itself in a quandary as EU short-termism will almost certainly result in a toning down of a concerted response by the West against Russia in the shape of economic sanctions.

The human and socioeconomic cost of what's happening in Crimea and wider Ukraine is no laughing matter. However, President Vladimir Putin should be allowed a smirk or two at the idiocy and short-sightedness of the EU bigwigs – reliant on him for natural gas but warning him of repercussions! Therefore, sabre rattling by Brussels is bound to have negligible impact.

Meanwhile, Russia's Gazprom has said it will no longer offer Ukraine discounted gas prices because it is over US$1.5 billion in payment arrears which have been accumulating for over 12 months. Additionally, Rosneft could swoop for a Ukrainian refinery, according to some reports. While economic warfare has already begun, this blogger somehow does not see Russians and Ukrainians shooting at each other; Georgia was different.

Having visited both countries in the past, yours truly sees a deep familial and historic bond between the two nations; sadly that's also what makes the situation queasy. The markets are queasy too. Ukraine was hoping for a shale gas revolution and Crimea – currently in the Kremlin's grip – has its own shale bed. In November 2013, Chevron signed a $10 billion shale gas production sharing agreement with the Ukrainian government to develop the western Olesska field. Shell followed suit with a similar agreement.

Matthew Ingham, lead analyst covering North Sea and Western Europe Upstream at GlobalData, says shale gas production was inching closer. "Together with the UK and Poland, Ukraine could see production within the next three to four years."

However, what will happen from here is anyone's guess. A geopolitical bombshell has been dropped into the conundrum of exploratory and commercial risks.

Away from gas markets, the situation's impact on the wider crude oil market could work in many ways. First off, rather perversely, a mobilisation or an actual armed conflict is price positive for regional oil contracts, but not the wider market. A linear supply shortage dynamic applies here.

An economic tit-for-tat between Russia and the EU, accompanied by a conflict on its borders, would hurt wider economic confidence. So a prolonged escalation would be price negative for the Brent contract as economic activity takes a hit. Russia can withstand a dip in price by as much as $20 per barrel; but worries would surface should the $90-resistance be broken. To put things into perspective, around 85% Russia's oil is sold to EU buyers.

Finally, there is the issue of Ukraine as a major transit point for oil & gas, even though it is not a major producer of either. According to JP Morgan Commodities Research over 70% of Russia's oil & gas flow to Europe passes through Ukrainian territory. In short, all parties would take a hit and the risk premium, could just as well turn into a news sensitive risk discount.

Furthermore, in terms of market sentiment, this blogger notes that 90% of the time all of the risk priced and built into the forward month contract never really materialises. So this then begs the question, whose risk is it anyway? The guy at the end of a pipeline waiting for his crude cargo or the paper trader who actually hasn't ever known what a physical barrel is like!

The situation has also made drawing conclusions from ICE's latest Commitments of Traders report a tad meaningless for this week. Speculative long positions by hedge funds and other money managers that the Brent price will rise (in futures and options combined), outnumbered short positions by 139,921 lots in the week ended February 25, prior to the Ukrainian escalation.

For the record, that is the third weekly gain and the most since October 22. Net-long positions rose by 18,214 contracts, or 15%, from the previous period. ICE also said bearish positions by producers, merchants, processors and users of the North Sea crude outnumbered bullish wagers by 266,017 lots, rising 8.2% from the week before.

Away from Ukraine and on to supply diversity, Norway's Statoil has certainly bought cargo from a land far, far away. According to Reuters, Statoil bought 500,000 barrels of Colombian Vasconia medium crude, offered on the open market in February by Canada's Pacific Rubiales.

When a cargo of Columbian crude is sold by a Canadian company to Norwegian one, you get an idea of the global nature of the crude supply chain. That's if you ever needed reminding. The US remains Pacific Rubiales' largest market, but sources say it is increasing its sales to Europe.

Finally, in the humble opinion of yours truly, Vitol CEO Ian Taylor provided the soundbite of the International Petroleum Week held in London last month.

The boss of the world's largest independent oil trading firm headquartered in serene Geneva opined that Dated Brent ought to broaden its horizons as North Sea production declines. The benchmark, which currently includes Brent, Forties, Oseberg and Ekofisk blend crudes, was becoming "less effective" according to Taylor.

"We are extremely concerned about Brent already not becoming a very efficient or effective benchmark. It’s quite a concern when you see that production profile. Maybe the time has come to really broaden out Dated Brent," he said.

Broadening a benchmark that's used to price over half the world's crude could include Algeria's Saharan Blend, CPC Blend from the Caspian Sea, Nigeria's Bonny Light, Qua Iboe and Forcados crudes and North Sea grades DUC and Troll, the Vitol CEO suggested.

Taylor also said Iran wasn't going to be "solved anytime soon" and would stay just about where it is in terms of exports. The Oilholic couldn't agree more. That's all for the moment folks! Keep reading, keep it 'crude'! 

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© Gaurav Sharma 2014. Photo: Pipelines & gas tank, Russian Federation © Rosneft (TNK-BP archives)