Crude take: $60 Brent price is (still) about right

Does the Iranian nuclear settlement make a $60 per barrel Brent price seem too optimistic as a median level for the current year - that's the question on most oil market observers' minds. Even before delving into City chatter, the Oilholic believes the answer to that question in a word is ‘no’.

For starters, the settlement which had been on the cards, has already been priced in to a certain extent despite an element of unpredictability. Secondly, as yours truly noted in a Forbes column - it will take better parts of 12 months for Iran to add anywhere near 400,000 barrels per day (bpd), and some 18 months to ramp up production to 500,000 bpd.

Following news of the agreement, Fitch Ratings noted that details of the condition of Iran's production infrastructure might well be sketchy, but with limited levels of investment, it is likely that only a portion of previous capacity can be brought back onstream without further material reinvestment. 

“We would expect to see some increases in production throughout the course of 2016 but that this would be much less than half of the full 1.4 million bpd that was lost,” said Alex Griffiths, Managing Director at the ratings agency.

“It will require significant investment and expertise - for which Iran is likely to want to partner with international oil companies. These projects typically take many months to agree, as oil companies and governments manoeuvre for the best terms, and often years to implement.”

Thirdly, it is also questionable whether Tehran actually wants to take the self-defeating step of ‘flooding’ the market even if it could. The 40 million or so barrels said to be held in storage by the country are likely to be released gradually to get the maximum value for Tehran’s holdings. Fourthly, the market is betting on an uptick in demand from Asia despite China's recent woes. The potential uptick wont send oil producers' pulses racing but would provide some pricing comfort to the upside.

Finally, IEA and others, while not forecasting a massive decline, are factoring in lower non-OPEC oil production over the fourth quarter of this year. Collectively, all of this is likely to provide support to the upside. The Oilholic’s forward projection is that Brent could flirt with $70 on the right side of Christmas, but the median for 2015 is now likely to come in somewhere between $60-$62.5. 

Yet many don’t agree, despite the oil price returning to largely where it was actually within the same session's trading itself on day of the Iran announcement. For instance, analysts at Bank of America Merrill Lynch still feel Iran could potentially raise production back up by 700,000 bpd over the next 12 months, adding downside pressure on forward oil prices of $5-$10 per barrel. 

On the other hand, analysts at Barclays don't quite view it that way and the Oilholic concurs. Like Fitch, the bank’s team neither see a huge short-term uptick in production volumes nor the oil price moving “markedly lower” from here as a result of the Iranian agreement.

“We believe that the market will begin to adjust, whether through higher demand, or lower non-OPEC supply in the next couple years but only once Iran’s contribution and timing are made clear. For now, OPEC is already producing well above the demand for its crude, and this makes it worse,” Barclays analysts wrote to their clients. 

“We do not expect the Saudis to do anything markedly different. Rather, they will take a wait and see approach.”

One thing is for sure, lower oil prices early on in the third quarter would have as detrimental an effect on the quarterly median, as early January prices did on the first quarter median (see above right, click to enlarge). End result is quite likely to ensure the year-end average would be in the lower $60s. That's all for the moment folks! Keep reading, keep it 'crude'!

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Hallelujah, it’s Bearish Brent!

Mercury is not rising (at least where this blogger is), it’s not half past 10 (more like half past four), and it’s certainly not for the first time in history, but Hallelujah it’s Bearish Brent!

Sorry, a rather crude attempt to re-jingle that ‘80s hit song, but on a more serious note there is a bit of a commotion in the oil markets with bears roaming the streets. As the readers of this blog would testify, the Oilholic has short called Brent for a while now. Being precise, the said period covers most of the past six and current Brent front-month contracts.

Aggressive yelling of the word 'risk' proved this supply-side scribe wrong for June, but one has been on the money most of the time since the summer. July’s high of US$115.71 per barrel was daft with speculators using the initial flare-up in Iraq as a pretext to perk things up.

The Oilholic said it would not last, based on personal surmising, feedback from physical traders and their solver models. And to the cost of many speculators it didn’t. As one wrote in a Forbes post earlier this week, if an ongoing war (in the Middle East of all places) can’t prop up a benchmark perceived to be a common proxy for oil prices on the world market, then what can?

Rather controversially, and as explained before, the Oilholic maintains that Brent is suffering from risk fatigue in the face of lacklustre demand and erratic macroeconomic data. In Thursday’s trade, it has all come to down to one heck of a bear maul. Many in the City are now wondering whether a $90 per barrel floor might be breached for Brent; it already has in the WTI’s case and on more than one occasion in intraday trading.

All of this comes on the back of Saudi Arabia formally announcing it is reducing its selling price for oil in a move to protect its share in this buyers’ market. The price of OPEC basket of twelve crudes stood at $92.31 dollars a barrel on Wednesday, compared with $94.17 the previous day, according to its calculations.

With roughly 11 days worth of trading left on the November Brent front-month contract, perceived oversupply lends support to the bears. Nonetheless, a bit of caution is advised. While going short on Brent would be the correct call at the moment, Northern Hemisphere winter is drawing closer as is the OPEC meeting next month. So the Oilholic sees a partial price uptick on cards especially if OPEC initiates a production cut.

The dip in price ought to trouble sanction hit Russia too. According to an AFP report, Herman Gref, head of Sberbank, Russia’s largest bank, said the country could repeat the fate of the Soviet Union if it doesn't reform its economic policies and avoid the "incompetent" leadership that led to the end of communism.

Speaking at the annual “Russia Calling” investment forum in Moscow, Gref said Russia imports too much, is too reliant on oil and gas exports and half of its economy is monopolised. The dynamic needs to change, according to Russia’s most senior banker, and one employed by a state-owned bank.

Away from Russia, here is the Oilholic's latest Forbes post on the prospects of shale exploration beyond North America. It seems initial hullabaloo and overexcitement has finally been replaced by sense of realism. That said, China, UK and Argentina remain investors’ best hope.

On a closing note, while major investment banks maybe in retreat from the commodities market and bears are engulfing it for the time being, FinEx group, an integrated asset management, private equity and hedge fund business, has decided to enter the rocky cauldron.

Its specialist boutique business – FinEx Commodity Partners – will be led by Simon Smith, former Managing Director and Head of OTC Commodity Solutions at Jefferies Bache. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo: Disused gas station, Preston, Connecticut, USA © Todd Gipstein / National Geographic.

The Kurdish question & a ‘Dudley’ sin?

The autonomous region of Kurdistan within Iraq's borders is drawing 'crude' headlines yet again. It's that old row about who controls what and gives rights for E&P activity in the region – the Federal administration in Baghdad or the provincial administration in Erbil?

 

The historical context is provided by Gulf War I, when allied forces imposed a no-fly zone, and the Kurds subsequently pushed Saddam Hussein's forces back outside the provincial border. That was 1991, this is 2013 – a lot has changed for Iraq, but one thing hasn't – Iraqi Kurdistan is as autonomous today, as it was back then.

 

In fact, it is more prosperous and an oasis of calm compared to the rest of the Federal state. One simple measure is that the rest of Iraq ravaged by sectarian conflict and Gulf War II still only provides its citizens with about an average of 6 to 7 hours of electricity per day. The average resident of Erbil gets 22 hours and sees infrastructural spending all around, driven by targeted revenue from oil and gas licensing and exports.

Since 2006, the Kurdistan Regional Government (KRG) has been granting rights for exploration within its borders to firms from Norway to the US, with much gusto and on better terms, many say, than the Federal administration in Baghdad. The Iraqi government in turn says KRG has no right to do so.

 

Mutual consternation came to a head in January when BP and Baghdad reached an agreement to revitalise the northern Kirkuk oilfield. Since jurisdictional mandate over the oilfield and the city is hotly contested by both sides, KRG declared the deal to be illegal on grounds that it was not consulted.

 

Firing a return salvo, Iraqi Oil Minister Abdul Kareem al-Luaibi called the production and export of oil from Kurdistan to be an act of "smuggling" and threatened to cut the region's [17%] spending allocation from the federal budget as well as take legal action against Western firms digging up Kurdistan, beginning with London-listed Genel Energy (the first such firm to export from the region).

Neither Genel Energy nor the administration paid heed to that threat. Baghdad and BP did likewise with KRG's moans over Kirkuk. Then the US State Department issued an advisory to all American oil firms operating in Kurdistan that they could be liable for legal damages from Baghdad. Doubtless, the rather handsomely rewarded legal eagles at their end advised them not to worry too much.

An "as-you-were" lull lasted for roughly 10 months, when last week in an extraordinary development, Bob Dudley, CEO of BP, joined al-Luaibi and officials from the Iraqi state-run North Oil Company to pay a controversial visit to the Kirkuk oilfield in a show of support. Why Dudley took the decision to go himself instead of sending a deputy is puzzling and paradoxically a bit obvious as well.

 

In making an appearance himself, Dudley wanted to show how important the Kirkuk deal is. Yet a deputy of his would have drawn a similar two-fingered gesture from KRG, as his visit did. Playing it cool, a source at BP said its only intention is to revive production at Kirkuk, an oilfield which at the turn of millennium saw an output of 900,000 barrels per day (bpd), but can barely manage less than a third of it today.

 

BP has the technical know-how to improve the field's output, but how it will extricate itself from the quagmire of the area's politics is anybody's guess. An Abu Dhabi based source says both sides are entrenched at Kirkuk. BP will have access to the Federally-administered side of the Kirkuk field, namely the Baba and Avana geological formations. But one formation – Khurmala – is inside the Kurdish provincial borders and being is developed by the KAR group.

 

Furthermore, there is another twist in the linear fight between Baghdad and Erbil – Kirkuk's governor Najimeldin Kareem, a man of Kurdish origin, has backed the Federal deal with BP. Dudley left the oilfield without saying anything concrete on record, leaving it to the Iraqis to do most of the talking.

 

The Iraqi Oil Ministry chose to describe Kareem's backing "as securing the complete support from the local government of Kirkuk" in order to commence developing Kirkuk. Hmm…but whose Kirkuk is it anyway? The primary beneficiary of Kurdish oil exports is Turkey; the closest market where the aforementioned Genel Energy delivers most of its output to.

 

Where the tussle will lead to is unpredictable – but it hasn't deterred either BP from signing up a deal with Baghdad or the likes of ExxonMobil, Chevron and Total with Erbil. This brings us back to why Dudley went himself – well, when his peers such as Rex Tillerson, ExxonMobil's boss, have showed-up in Erbil, there was perhaps little choice left. If the regional politics goes out of control, the bosses of oil firms would have only themselves to blame for getting so close to the Iraqi wrangles most say they are least interested in.

 

At the centre of it all is the thirst for black gold. KRG is providing generous production sharing and contract conditions within its autonomous borders, while Baghdad has quite possibly given equally generous terms to BP for Kirkuk. The oil major has already announced a US$100 million investment in the oilfield.

 

Giving KRG the last word in the verbal melee – in September 2012, even before the recent salvos had been fired in earnest and the CEOs had come calling, Ashti Hawrami, Minister for Natural Resources of KRG, said something rather blunt on BBC’s Hard Talk programme which explains it all: "To put it politely, if I have million barrels of oil to produce in two years time, the market needs it, Iraq needs it and at the end of the day we are going to win that battle."

 

There are 50 plus firms already helping him achieve that objective. With geological surveys projecting that Kurdistan potentially has 45 billion barrels of the crude stuff, many of these firms are working with the KRG contrary to advice given by their own governments.

 

And as if to rub it in further into his Federal counterpart, Hawrami quipped, "Kurdistan's investment and spending plans are more structured…Why is Baghdad buying F-16s when Iraqis have little more than 4 hours of electricity per day on average [much worse than the inhabitants of Iraqi Kurdistan]." OUCH!

 

Moving away from Iraqi politics, Brent's $106 per barrel floor has not only been breached, but was smashed big time last week. As noted, hedge funds are indeed feeling the pinch, for instance high-flier Andy Hall's $4 billion baby – Astenbeck Capital Management.

 

According to Reuters, Astenbeck is down 5% as of Oct-end, largely due to the slump in Brent prices. Even though Hall's team have diversified into palladium, platinum and soft commodities, it'd be remarkable if the fund is able to avoid its first annual loss in six years. However, one shouldn't be too hard on Astenbeck as the average energy fund on Chicago's Hedge Fund Research Index, is down 4.45%. That's all for the moment folks! Keep reading, keep it 'crude'!

 

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© Gaurav Sharma 2013. Photo: Exploration site in Kurdistan © Genel Energy plc

OPEC & the downward bias in Black Gold’s value

The OPEC ministers have packed-up and left with no real surprises as the cartel maintained its daily output at 30 million barrels per day (bpd). But in the absence of any real surprises from OPEC, the downward bias in the direction of leading oil futures benchmarks is getting stronger, given the perceived oversupply and a flat, if not dicey, macroeconomic climate. The Brent forward month futures contract plummeted to nearly US$100, seeing a near 2.5% dip from last week (click on graph to enlarge). Given that the trading community had already factored in the outcome of the 163rd OPEC meeting even before it concluded, most appear to be waiting to see whether the US Federal Reserve continues with its monetary stimulus programme. Even if it does so, given the macroeconomic permutations, it is not worth holding your breath for a ‘crude’ bounceback.

 

Far from cutting production, there seem to be murmurs and concern in the hawkish camps of Iran and Venezuela about constantly improving production levels in Iraq. Abdul Kareem al-Luaibi, Iraq’s oil minister, confirmed at a media scrum in Vienna that the country plans to start production at two of its largest oilfields within “a matter of weeks.”

 

Production commencement at Majnoon (which is imminent) and Gharraf (due in July), followed by a third facility at West Qurna-2 (due by December if not earlier) would lift Iraqi capacity by 400,000 bpd according to al-Luaibi. The country’s current output is about 3.125 million bpd. The additional capacity would bolster its second position, behind Saudi Arabia, in the OPEC output league table.

 

The Iraqis have a monetary incentive to produce more of the crude stuff. Sadly for OPEC, it will come at a time the cartel does not need it. Instead of adherence, there will be further flouting of the recently agreed upon quota by some members. Iraq is not yet even included in the quota (and may not be until late into 2014).

 

Non-OPEC supply is seeing the ranks of the usual suspects Russia and Norway, joined ever more meaningfully by Brazil, Kazakhstan, Canada and not to mention (and how can you not mention) – the US, courtesy of its shale supplies and more efficient extraction techniques at Texan conventional plays. So a downward bias will prevail – for now.

 

In fact, Morgan Stanley did not even wait for the OPEC meeting to end before downgrading oil services firms, mostly European ones, based on the conjecture that IOCs as well as NOCs (several of whom hail from OPEC jurisdictions) would allocate relatively lower capex towards E&P.

 

Robert Pulleyn, analyst at Morgan Stanley, wrote and the Oilholic quotes: “With oil prices the key determinant of industry operating cash flow, and given our expectation for an increasingly range bound price environment, we expect industry-operating-cash-flow growth to fall from 14% compound annual growth rate (since 2003) to about 3% in the future. We expect capex growth to fall to around 5% a year to 2020, compared to 18% compound annual growth rate since 2003.”

 

Of the five it downgraded on Thursday – viz. Vallourec, SBM Offshore, CGG Veritas, TGS-NOPEC and Subsea 7 – only the latter avoided a dip in share price following the news. However, Morgan Stanley upgraded John Wood Group, saying it is better positioned to withstand a lower growth outlook for industry spending.

 

As for the price of the crude stuff itself, many analysts didn’t wait for OPEC either with Commerzbank, Société Générale and Bank of America Merrill Lynch (BoAML) all sounding bearish on Brent. BoAML cut its Brent crude price forecasts to $103 per barrel from $111 for the second half of 2013, citing lower global oil demand, rising supplies and higher inventories. The bank expects the general weakness to persist next year and reduced its 2014 average Brent price outlook from $112 to $105 per barrel. So there you have it and that’s all from Vienna folks!

 

Since it’s time to say Auf Wiedersehen, the Oilholic leaves you with a view of the city’s Irrgarten and Labyrinth at the Schönbrunn Palace grounds (see right). Once intended for the amusement of Austro-Hungarian royalty and their guests, this amazing maze is now for the public’s amusement.

 

While visitors to this wonderful place are getting lost in a maze for fun, OPEC ministers going round in circles over a key appointment to the post of Secretary General is hardly entertaining. At such a challenging time for it, the 12-member oil exporters’ club could do with a bit of unity. Yet it cannot even unite behind a single candidate for the post – something which has been dragging on for a year – as rivals Iran and Saudi Arabia continue to hold out for their chosen candidate for the post. Furthermore, it’s taken an ugly sectarian tone along Shia and Sunni lines.

 

Worryingly, this time around, neither the Saudis nor the Iraqis are in any mood for a compromise as the rest of the 10 members wander around in a maze feeling dazed about shale, internal rivalries, self interest and plain old fashioned market anxieties. The Oilholic maintains it’s premature to suggest that a rise in unconventional production is making OPEC irrelevant, but its members are unwittingly trying really hard to do just that! Keep reading, keep it ‘crude’!

 

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© Gaurav Sharma 2013. Graph: World crude oil futures benchmarks to May 25, 2013 © Société Générale. Photo: Irrgarten & Labyrinth, Schönbrunn Palace, Vienna, Austria © Gaurav Sharma 2013.

Crude thoughts, an event, few articles & a lecture!

Brent’s decline continues with the forward month futures contract now well and truly below the US$110 per barrel level. In fact, when the Oilholic last checked, a price of US$108.41 was flashing on the ticker. Given that over the past seven days – OPEC, EIA and IEA – have all come out with bearish reports, the current price level should hardly be a surprise.

 

Additionally, both OPEC and IEA appear to be in broad agreement that overall concerns about economic growth in the US and the Eurozone will continue to persist over the short term at the very least. As if that wasn’t enough, the US dollar has reached a seven-month high against a basket of currencies, not least the pound sterling!

 

At such points in recent trading history, geopolitics always lends support to the oil price. Yet further evidence is emerging about the oil & gas community largely regarding the risk premium to be neutral, a theme which this blogger has consistently stressed on since September last year. Many delegates at the recently concluded International Petroleum Week (IP Week) in London, a signature European event, expressed pretty much the same sentiments.

 

Rather than relying on the Oilholic’s anecdotal evidence, here’s an observation from Société Générale analyst Michael Wittner who wrote in an investment note that, “On the geopolitical front, there seemed to be a sort of fatigue (at the IP Week), if not boredom, with the various issues and countries. In addition to Syria and Iran, there was talk about risks in Iraq and Nigeria, and even Chinese-Japanese tensions. Given recent events in Algeria, Egypt, and Mali, we were surprised at how little concern there was about North Africa.”

 

“All agreed that the geopolitical elephant in the room was still Iran, but even here, the fatigue was evident. People were well aware of Israel’s late spring/early summer “deadline”, but they were not excited about it. Some pointed to higher Saudi spare capacity (after recent cuts) and much higher pipeline capacity that could be used to avoid the Straits of Hormuz. Others simply thought that, posturing aside, there was little real appetite for a war against Iran, and that an Iranian bomb was inevitable,” he wrote further. Need we say more?

 

So in summation – tepid crude demand plus fatigued risk premium equals to no short term hope for the bulls! But at least there’s hope for the Brent-WTI spread to narrow, with the former falling and the latter rising on the back of the supply glut at Cushing, Oklahoma showing signs of abating.

 

Away from pricing matters, given that yours truly has been travelling a lot within good old England these past few weeks, there has also been plenty of time to do some reading up on trains! Four interesting articles came up while the Oilholic was experiencing the joys (or otherwise) of British railways.

 

First off, the Wall Street Journal’s Jerry A. Dicolo screams: “Brent barrels to prominence: European oil benchmark poised to overtake WTI as a global gauge.” The Oilholic has some news for the WSJ – Er…Brent is not ‘poised’ to overtake WTI as a global gauge, it has already overtaken it in terms of market sentiment! This blog first mulled the subject as far back as May 2010! Since then, even the EIA has decided to adopt Brent as a benchmark that’s more reflective of global conditions.

 

The second interesting piece of reading material yours truly encountered was a republished Bloomberg wire copy that carried feedback from an Indian refiner. In it, he suggested that the country’s refiners may be forced to halt purchases of Iranian crude as local insurers refuse to cover the risks for any Indian refinery using the Islamic Republic’s oil.

 

Bloomberg cites a certain P.P. Upadhya, Managing Director of the Mangalore Refinery in Southern India as having said, “There’s a problem with getting insurance for refineries processing Iranian oil. If there’s no clarity very soon, we all have to stop buying from Iran or risk operating the refineries without insurance.” Looks like the squeeze on Iran is going into overdrive!

 

Moving on to the third article, here is The Economist's sound take on the late Hugo Chavez’s rotten economic legacy. And finally, a Reuters’ exclusive would have you believe we Brits are planning to bid for US gas to be imported to our shores.

 

An abundance of gas, courtesy of the country’s shale bonanza has certainly lent credence to the US’ gas exporting potential. One would think if the US were to export gas, it would one fine day make its way to the UK. However, a “source” spoken to by Reuters seems to suggest that day is not that far away.

 

Speaking of shale, the Oilholic had the pleasure of listening to a brilliant lecture on the subject from Prof. Paul Stevens, the veteran energy economist and Chatham House fellow. Delivering the Institution of Engineering and Technology’s Clerk Maxwell Lecture for 2013, Prof. Stevens set about exploding the myth of a shale gas revolution taking place in Europe anytime soon.

 

He joked that North Dakota might become the next member of OPEC, but one thing is for certain Poland and other European shale enthusiasts are not getting there any time soon. Apart from the usual concerns, often mulled over by the Oilholic, such as jurisdictional prospection moratoriums and population density, pipeline access, environmental regulations etc. being very different between the US and Europe, the good professor pointed out a very crucial point.

 

“Shale rock formation in Europe is very different from what it is in North America. When ExxonMobil was disappointed in Poland, it was not for want of trying. Rather US technology was found lacking when it came to Polish geology. There is no one size fits all! The American shale revolution got where it is today through massive investment and commitment towards research and development (and over two decades of perseverance). I don’t see that level of commitment in Europe,” he said.

 

Speaking to the Oilholic, following his lecture, Prof. Stevens said the export of US gas to the UK was plausible, but that Asia was a much more natural export market for the Americans. “Plus, let’s not forget that the moment US exports start to rise meaningfully, there is always a chance the likes of Congressman Ed Markey might take a nationalistic tone and try to stunt them,” he added.

 

Quite true, after all we got a glimpse of Markey’s intellect via his ‘Bolshoi’ Petroleum remark! 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. Sullom Voe Terminal, UK © BP Plc