Preparing for an oil slump away from US pumps

The Oilholic is delighted to be back in lovely San Francisco, California, some 5350 miles west of London town. And what a 'crude' contrast it has been between two visits - when yours truly was last here little less than two years ago, the oil price was in three figures and our American cousins were (again!) bemoaning oil prices at the pump, not all that unaware about even higher prices we pay in Europe.

Not so anymore – for we’re back to under $3 per gallon (that’s 3.785 litres to Europeans). Back in January, CNBC even reported some pumps selling at rock bottom prices of as little as 46 cents per gallon in eastern US; though its doubtful you’ll find that price anywhere in California. 

Nonetheless, the Bay Area’s drivers are smiling a lot more and driving a lot more, though not necessarily honking a lot less in downtown San Francisco. By and large, you might say its happy days all around; that’s unless you run into an oil and gas industry contact. Most traders here are pretty prepared for first annual decline in global oil production since 2009, underpinned by lower US oil production this year.

Ratings agency Moody’s predicts a peak-to-trough decline in US production of at least 1.3 million barrels per day (bpd) that is about to unfold. On a related note, Genscape expects North American inventories to remain at historically high levels for 2016, and production to fall by -581,000 bpd in 2016, and -317,000 bpd in 2017, as surging blended Canadian production is expected to grow at +84,000 bpd year-over-year in 2016.

Most reckon the biggest US shale declines will occur in the Bakken followed by the Eagle Ford, with Permian showing some resilience. Genscape adds that heavy upgrader turnarounds in Spring 2016 will impact near-term US imports from Canada.

All things being even, and despite doubts about China’s take-up of black gold, most Bay Area contacts agree with the Oilholic that we are likely to end 2016 somewhere in the region of $50 per barrel or just under.

As for wider domino effects, job losses within the industry are matter of public record, as are final investment decision delays, capital and operating expenditure cuts that the Oilholic has been written about on more than one occasion in recent times. Here in the Bay Area, it seems technology firms conjuring up back office to E&P software solutions for the oil and gas business are also feeling the pinch.

Chris Wimmer, Vice President and Senior Credit Officer at Moody's, also reckons the effects of persistently low crude oil prices and slowing demand in the commodities sectors are rippling through industrial end markets, weakening growth expectations for the North American manufacturing sector.

Industry conditions are unfavourable for almost half of the 15 manufacturing segments that Moody's rates, with companies exposed to the energy and natural resource sectors at the greatest risk for weakening credit metrics.

As a result, Moody's has lowered its expectations for median industry earnings growth to a decline of 2%-4% in 2016, from its previous forecast for flat to 1% growth this year. "This prolonged period of low oil prices initially affected companies in the oil & gas and mining sectors, but is spreading to peripheral end markets," Wimmer said.

"Slackening demand and cancelled or deferred orders in the commodities sectors will constrain growth for a growing number of end markets as the fallout from commodities weakness and lackluster economic growth expands."

Everyone from Caterpillar to Dover Corp has already warned of lower profits owing to weak equipment sales to customers in the agriculture, mining, and oil and gas end markets. The likelihood of deteriorating performance will continue to increase until the supply and demand of crude oil balance and macroeconomic weakness subsides, Wimmer concluded.

Finally, as the Oilholic prepares to head home, not a single US analyst one has interacted with seems surprised by a Bloomberg report out today confirming the inevitable – that China will surpass the US as the top crude oil importer this year. As domestic shale production sees the US import less, China’s oil imports are seen rising from an average of 6.7 million bpd in 2015 to 7.5 million bpd this year.

And just before one takes your leave, Brent might well be sliding below $40 again but all the talk here of a $20 per barrel oil price seems to have subsided. Well it’s the end of circling the planet over an amazing 20 days! Next stop London Heathrow and back to the grind. That's all from San Francisco folks. Keep reading, keep it ‘crude’! 

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© Gaurav Sharma 2016. Photo I: Vintage Tram in Downtown San Francisco. Photo II: Gas prices in Fremont. Photo III: Golden Gate Bridge, San Francisco, California, USA © Gaurav Sharma, March 2016.

Crude viewpoints from the Bay Area

The Oilholic finds himself in the San Francisco Bay Area yet again for the briefest of visits. By force of habit, one couldn't help doing a bit of tanker spotting from a vantage point some 21 floors above on a gloriously sunny day. More importantly, it's always a pleasure to discuss the stock market prices of companies behind what these metallic behemoths at sea are carrying.

The trading community appears to be in bullish mood close the midway point of 2014. Yours truly spoke to seven traders based here, most of whom had a buy recommendation on the big four services companies, which is not entirely unexpected. Five also had a buy recommendation on EOG Resources, a company the Oilholic admits has largely gone under his radar and Enterprise Products Partners, which hasn't.

 

The former, according IHS Energy data, saw a 40% rise in value to just under US$46 billion in 2013, making the company the largest market capitalisation gainer for upstream E&P companies last year. Now that is something. It is blatantly obvious that the liquids boom in North America is beginning to drive investment back into all segments of the oil & gas sector.

 

"Stock market is rewarding those with sensible exposure to unconventional plays. Hell if it goes on the way it has, I might even recommend Canadian E&P firms more frequently, Keystone XL or not," quips one trader. (Not to detract from the subject at hand, but most said even if Keystone XL doesn't get the go ahead from the Obama administration, future isn't so bleak for Canadian E&P; music to the ears of Chinese and Korean businessmen in town.)

Midstream companies are in many cases offering good returns akin to their friends in the services sector, given their connect to the shale plays. Okay now before you all get hot under the collar, we're merely talking returns and relative stock valuation here and not size. And for those of you who are firm believers of the 'size does matter' hypothesis, latest available IHS Energy data does confirm that the 16 largest IOCs it monitors posted a combined market capitalisation of $1.7 trillion at the end of 2013, a little over 10% above their value the year before.

Yet, oil majors continue to divest, especially on the refining & marketing (R&M) side of the business and occasionally conventional E&P assets where plays don't gel well with their wider objectives. Only last week, BP sold its interests in four oilfields on the Alaska North Slope for an undisclosed sum to Hilcorp.

The sale included BP's interests in the Endicott and Northstar oilfields and a 50% interest in each of the Liberty and the Milne Point fields. Ancillary pipeline infrastructure was also passed on. The fields accounted for around 19,700 barrels of oil equivalent per day (boepd). Putting things into context, that's less than 15% of the company's total net production on the North Slope alone and near negligible in a global context.

BP said the deal does not affect its position as operator and co-owner of Prudhoe Bay nor its other interests in Alaska. But for Hilcorp, which would become the operator of Endicott, Northstar and Milne Point and their associated pipelines and infrastructure pending regulatory approval, it is a sound strategic acquisition.

Going back to the core discussion, smart thinking could, as the Bay Area traders opine, see all sides (small, midcap and IOCs) benefit over what is likely to be seminal decade for the North American oil & gas business between now and 2024-25.

As Daniel Trapp, senior energy analyst at IHS and principal author of the analysis firm's Energy 50 report, noted earlier this year in a note to clients: "While economic and geopolitical uncertainty will certainly continue driving energy company values, it is clear that a thought out and well-executed strategy positively affects value.

"This was particularly true with companies that refocused on North America in 2013, notably Occidental, which saw its value expand 24%, and ConocoPhillips, which grew 23% in value."

There seem to be good vibes about the performance of North American refiners. As promised to the readers, yours truly wanted to know what people here felt. Ratings agency Moody's said earlier this month that North American refiners could retain their advantage over competitors elsewhere in the globe, with cheaper feedstock, natural gas prices, and lower costs contributing to 10% or higher EBITDA growth through mid to late 2015.

Those with investments and stock exposure in US refiners reckon the Moody's forecast is about right and could be beaten by a few of the players. A few said Phillips 66 would be the one to watch out for. Question is – what will these companies do with their investment dollars going forward in light higher profits, as the case for pumping in more capex into existing infrastructure is not clear cut, despite the need for Gulf Coast upgrades.

Additionally, most anecdotal evidence here in California suggests tightening emissions law in the state is price negative in particular for Tesoro and Valero, but Phillips 66 could take a hit too. In essence, not much has changed in terms of the legal parameters; only their impact assessment in 2014-15 is yet to reach investors' mailboxes.

On a related note, here is an interesting piece from Lior Cohen of the Motley Fool, examining the impact of the shrinking Brent-WTI spread on refiners. Valero and Marathon's first quarter performance could be negatively impacted as the spread narrows, the author reckons.

Overall, in the Oilholic's opinion what appears to be an abundance of low-cost feedstock from inexpensive domestic crude oil supply will continue to benefit US refiners. While North American refiners should be content with abundance, Europeans are getting pretty discontent about their reliance on Russian gas.

Despite obvious attempts by the European Union to belatedly wean itself off Russian gas, Fitch Ratings reckons the 28 member nations group would be pretty hard pressed to replace it. In fact, an importation ban on Russian gas to the EU would cause substantial disruption to Europe's economy and industry, according to the agency.

Painting a rather bleak picture, Fitch noted in a recent report that the immediate aftermath of such a move would see the region suffer from gas shortages and high prices due to its limited ability to reduce demand, source alternative supplies and transport gas to the most affected countries.

A surge in gas prices after a ban would probably also have knock-on effects on electricity, coal and oil prices. Industry would bear the brunt of supply shortages as household demand would be given priority. A lengthy ban on Russian gas – described as "a low-probability, but high-impact scenario" would see gas-intensive sectors such as steel and chemicals being heavily hit.

This would accelerate the closure or mothballing of capacity that is suffering from low profitability due to competition from low-cost energy jurisdictions such as the US or Middle East.

In 2013, Russia supplied 145 bcm of gas to Europe, and the latter would have great difficulty in sourcing alternative supplies. "Increased European gas production and North African piped gas could offset a small proportion of this. Tapping into the global LNG market would yield limited volumes as Europe's Russian gas demand equates to nearly half of the world's LNG production, which is already mostly tied to long-term supply contracts. Hence, gas and other energy prices could surge," the agency noted.

In theory, Europe has plenty of unused LNG regasification capacity, which could help replace some Russian supplies. But the majority of plants are located in Southern Europe and the UK, far away from the Central and Eastern European countries that are most reliant on Russian gas. So there you have it, and it should help dissect some of the political hot air. That's all for the moment from San Francisco folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo 1: San Francisco skyline from 4th Street with an oil tanker heading to Oakland in the background. Photo 2: Port of San Francisco, California, USA © Gaurav Sharma April, 2014.

A Californian emission law, refiners & Muir woods

When in town, spending a few hours watching shipping lanes in the San Francisco bay area is an old pastime of the Oilholic’s, especially when it comes to spotting oil tankers which bring in some of the crude stuff to the area's refiners.

This morning, while sitting on Pier 39, yours truly spotted three pass by along with a few loaded containers - all following a well practised drill moving along a designated route under the Golden Gate Bridge, past Alcatraz Island before turning away left. Away from eye-view and the rather tranquil shipping lanes, there is local trouble at the mill for the already beleaguered refiners who have to contend with overcapacity and stunted margins.

It comes in the shape of a gradual but steady implementation of California's (relatively) new environmental regulations by 2020. This piece of regulation is known as California's Global Warming Solutions Act a.k.a. the AB 32, the central objective of which is to reduce Californian greenhouse gas emissions to 1990 levels by 2020.

According to the California Air Resources Board, in 2013 it will begin enforcing a state-wide cap on greenhouse gas emissions. The cap-and-trade programme coupled with the Low Carbon Fuel Standard would give California some of the most stringent air quality and emissions laws in the USA, although a spokesperson refused to describe it as such.

Ratings agency Moody’s believes refining and marketing (R&M) companies Tesoro, Alon USA, Phillips 66 and Valero are particularly exposed to the gradual implementation of the new environmental rules.

"California's increasingly stringent environmental regulations will challenge refiners over the next decade, increasing operating costs and negatively impacting refined product demand. These new rules will reduce cash flow that could be used for debt repayment or strategic growth and could discourage refiners from investing in California," says Gretchen French, a senior analyst and Vice President at Moody’s.

Among the majors, Chevron which has a significant refinery capacity in California, is likely to feel the impact most among its peers. Nonetheless as ratings agencies generally tend to rate integrated oil & gas companies higher than R&M only companies, Chevron should have no immediate concerns. The company's long-term debt is rated by Moody’s Aa1 with a stable outlook according to a communiqué dated March 27th.

The agency believes Chevron's ratings reflect its significant scale and globally integrated operations, its diversified upstream reserves and production portfolio, and a strong financial profile, which is underpinned by strong cash flow coverage metrics, low financial leverage, robust capital returns, and a conservative approach to shareholder rewards.

Furthermore, Chevron's strong liquidity profile is characterised by free cash flow generation, ongoing asset sales proceeds, and a large cash position. Chevron's liquidity is further supported by US$6 billion of unused committed credit facilities due in December 2016. Moody's does not expect the new rules to affect the ratings for Tesoro, Alon, Phillips 66 or Valero either over the near to medium term, but the new standards could limit credit accretion.

"Well diversified companies with high financial flexibility and strong liquidity will shoulder the new burdens and weaker demand most easily. Refiners with efficient cost structures and high distillate yields will retain the greatest advantage," French says.

Additionally, a pool of commentators here in the Bay Area seem to suggest that most players – especially Tesoro and Valero – have had a fair bit of time to indulge in regulatory risk mitigation. This piece of legislation was to be expected as California has admirably been a state keen on conservation, forestry and the environment.

The “Father of the US National Parks” – John Muir – an author, naturist and an early advocate of preservation of wilderness in the USA did most of his life’s important work here in California’s Sierra Nevada mountain range. In 1908, Muir who also founded one the country’s most important conservation organisation – the Sierra Club – had a national park named after him. This amazing redwood forest - the Muir Woods National Monument near San Francisco - now provides joy to countless visitors among whom the Oilholic was one this afternoon.

More than six miles of trails are open for visitors to experience an easy walk on the valley floor through the primeval redwood forest. Though the forest is naturally quiet, the Oilholic is in agreement with the US National Park Service, that people are key to preserving the ancient tranquillity of an old-growth forest in our noisy, modern world. That’s all for the moment folks! Keep reading, keep it ‘crude’!

© Gaurav Sharma 2012. Photo 1: Oil Tanker in the San Francisco Bay Area shipping lane. Photo 2: Valero Pump. Photo 3: Collage of Muir Woods National Monument, California, USA © Gaurav Sharma.

Valero, BP, Crude price & the week that was!

The seven days that have passed have been ‘crudely’ interesting to say the least. First off, early May saw one of the biggest market sell-offs in recent memory as commodities of all descriptions did a mini battle with price volatility. Brent crude for its part fell nearly 6% before recovering and stabilising above US$110 per barrel.

Macroeconomic factors aside many in the City believe the ongoing conflict in Libya no longer appears to be a key driver of oil prices as the loss of Libyan oil exports were fully discounted by the market some time ago. The profit takers agree! Société Générale CIB analysts noted in a report to clients that they estimate:

“the fair value for the Brent price would be about US$100 if no MENA risk premium were included. It is difficult to see the MENA risk premium rising much further near-term unless significant unrest emerges in countries with substantial oil exports such as Algeria and Saudi Arabia.”

That is not happening and Syria is of peripheral importance from near term instability premium perspective. Société Générale CIB analysts further note that the Brent crude oil price may correct lower over coming weeks as speculative traders may be tempted to take some profit on long positions as:

• recent significant events in the Middle East & North Africa (MENA) have been limited to countries with little oil exports


• tentative signs of demand destruction in the US, and


• growing concerns of a bumpy or hard landing in China.

Moving away from the crude price, heads of the big five oil firms Shell, Exxon, Conoco, BP America and Chevron and some Democrats on the Senate finance committee squared up to each other on May 6^th over the age-old issue of tax subsidies for oil companies. The latter want the tax subsidies removed, but big oil contests that they are benefitting from the subsidies like any other US business does and furthermore they are heavily taxed already.

That same day BP’s shares rallied in the UK following news that an arbitral panel has issued a consent order permitting BP and the AAR consortium to assign an Arctic opportunity to TNK-BP, subject to consent from Russian state-controlled firm Rosneft. The long drawn out saga may finally be reaching a favourable conclusion for BP.

Also last week ratings agency Moody’s changed US refiner Valero Energy's rating outlook to stable from negative and at the same time affirmed Valero's existing Baa2 senior unsecured note ratings. It said the stabilisation in the rating outlook reflects the expectation that Valero's cash flow will remain strong over the short term due to rising industrial activity pushing modest growth in demand for distillates and the expectation of supportive light/heavy spreads.

The stable outlook also reflects the assumption that Valero will maintain investment grade leverage metrics over the next 12-18 months as it continues to pursue organic growth and acquisition opportunities.

Additionally Moody's expects Valero's earnings to remain highly cyclical, and noted that the 2010 sale of the company's secularly weaker US East Coast refining assets, willingness and financial capacity to idle underperforming assets, as well as its recent cost reduction efforts should enhance the company's ability to withstand the inherent cyclicality of the sector. Moody's also expects that Valero will remain acquisitive. In March of this year, Valero announced the purchase of Chevron's Pembroke refinery in the UK for US $1.7 billion.

Rounding off - the Oilholic turned 33 years young today, last seven of which have been a ‘crude’ affair ;-) Thanks for all the birthday messages!

© Gaurav Sharma 2011. Photo: Alaska Pipeline with Brooks Range in background © Michael S. Quinton / National Geographic

Libya & OPEC’s “Will they, Won’t they” Routine

As the situation in Libya worsens, depending on differing points of view of Gaddafi goons and rebel fighters, OPEC’s routine of sending conflicting messages does not harm the price of crude – something which I don’t think the cartel minds all that much over the short term. In fact the OPEC basket price of crude seems to be following Brent’s price more closely than ever.

In a nutshell according to various newswires, Gaddafi militia and rebel fighters are toughing it out near oil terminals over 500km east of the capital Tripoli. Heaviest of the skirmishes have been outside (& within) the oil town Ras Lanuf, with both sides claiming a position of strength. A rebel spokesperson even gave out a statesman like statement, telling the BBC they would “honour” oil contracts.

However, anyone looking towards OPEC to calm the markets got a ‘crude’ response and mixed signals in keeping with the cartel's well practised drill of letting the wider world indulge in a guessing game of whether a production increase was on cards or not. The Saudis sought to calm, the Venezuelans and Iranians tried to confuse and the rest were quite simply confused themselves.

Moving away to a corporate story, pre-tax profits announced last week by UK independent upstart Tullow Oil have jumped 361% to US$152 million with a 19% rise in revenues to US$1 billion in the year to 31 December. In a statement to investors, its chief executive Aidan Heavey said the outlook was "very positive". I’d say its much more than that sir!

Finally, one of UK’s signature refineries – Pembroke – would now be a proud member of San Antonio, Texas-based refining major Valero Energy Corp. That’s after its current owner Chevron announced on March 11 that Valero had agreed to pay US$730 million for the refinery and US$1 billion for the assets. Ratings agency Moody's views Valero's acquisition of Pembroke and associated marketing and logistics assets as credit neutral. It may well be noted that it took Chevron nearly a year to...ahem....get rid of it (??)

© Gaurav Sharma 2011. Photo © Gaurav Sharma 2009