Some Crude Chatter from Moody’s & Other Stuff

There’s been some interesting chatter from Moody’s these past seven days on all things crude. Some of these stood out for me. Early last week in a note to clients, the rating agency opined that CNOOC Ltd's Aa3 issuer and senior unsecured ratings would not be immediately affected by the Chinese company's additional equity investment of US$2.47 billion in its 50% joint-venture Bridas Corp.

The investment represents CNOOC's share of funding contributions for Bridas to purchase a remaining 60% interest in Pan American Energy, which is engaged in E&P ops in South America. Bridas plans to fund 70% of its purchase by equity and 30% by debt or additional contributions from shareholders.

CNOOC is funding its equity contribution to Bridas with internal resources on hand. The transaction would give it an additional 429 million BOE of proved reserves and 68,000 bpd daily production in South America, according to Moody’s. Completion of the transaction is expected to take place during H1 2011, that’s of course government and regulatory approvals pending.

However, the crude chatter of the week not just from Moody's, but from the entire market was the agency’s interesting analytical take on oil sands producers’ operating considerations. In a report titled – Analytical Considerations for Oil Sands Producers – the agency notes that while comparing oil sands development and production projects to conventional development and production projects, the former have much larger upfront development costs[1].

Such projects are more likely to incur construction cost overruns, and quite simply take much longer to reach breakeven cash flow. Other features include higher cash operating costs per barrel of oil equivalent, very long reserve life and low maintenance capital expenditures once in production, particularly of mining oil sands operations, the report said.

One might say that parts of the report are predictable but it must be noted that in analysing companies with relatively large oil sands exposure, Moody's balances the negative aspects of the difficult construction period against the anticipated long-term positive contributions from these assets. So well, on balance, I found the principal tenets to be very convincing.

Let us face it, whether peak oil will be here soon or not, “easy oil” (interchangeable with cheap oil) is most certainly gone. Cost overruns are unlikely to deter big oil. So far Shell has invested just under US$10 billion (River Oil Sands), Chevron US$9 billion (Athabasca), ExxonMobil US$5 billion (Kearl Oil sands investment) and BP is said to be catching up via its Sunrise oil sands investment.

Elsewhere, Desire Petroleum’s saga of will they find oil in the Falklands Is. or won't they or worse still when will they give up continues. Its share price saw wild swings and ended in a damp squib (haven’t we heard that before).

On the left, for the umpteenth time, here is Desire’s undesirable share chart (see the day's price nose-dive). To quote The Daily Mail’s inimitable Geoff Foster, “Many professional punters are gluttons for punishment. They continually get suckered into seat-of-your pants oil stocks and more often than not, live to regret it.”

I do not wish to tempt fate, but Desire Petroleum is no Cairn Energy. I do hope for Desire's sake that they do strike black gold in meaningful if not bountiful quantities. However, the market response to a whiff of positive news is nothing short of barmy.

[1] The report is available on Moody's web site.

© Gaurav Sharma 2010. Photo: Oil Sands, Canada © Shell, Graphic: Desire Petroleum Share Chart with stated time frame © Digital Look / BBC

Chinese Tightening, Irish Overhang & ITPOES at it!

It has been an interesting five days over which, most notably, analysts at Goldman Sachs opined on Monday that the Chinese government will in all likelihood employ more tightening measures on the economy but their impact on the burgeoning economy’s oil demand for is likely to be “limited.”

The Goldman guys believe a far greater near term risk will come from the “current exceptional strength in diesel demand, which could push Chinese oil demand to new highs in November and December.” Fair dues I say, but not the best of expressions when talking about Ireland.

As further details about its imminent bailout are awaited not many in the City were keen to commit further funds towards crude futures. However, some city types I know were fairly cool about both the fate of the Irish and the connection of the country's troubles with an equities overhang on either side of the pond.

From Goldman analysts, the Irish and the Chinese to the ITPOES who were at it again last week. ITPOES are of course, the (UK) Industry Taskforce on Peak Oil and Energy Security, who warned the British government again last week that a new "peak oil threat" is likely to be felt in the UK within the next five years.

The ITPOES came into being in 2008 led by none other than the inimitable Sir Richard Branson. Their latest report, which is part rhetoric, part fact, is titled Peak Oil Implications of the Gulf of Mexico Oil Spill and was released on Friday (Available here).

Deepwater drilling, they say, is expected to constitute 29 per cent of new global extraction capacity by 2015, up from only 5 per cent. The result is that any future delays or problems associated with deepwater drilling in wake of the BP Gulf of Mexico accident will have much greater impact on supply than is the case today. Wonder whether that implies the end of "cheap oil" rather than the nearing of "peak oil."

© Gaurav Sharma 2010. Photo: Oil Rig, Santa Barbara Channel, USA © Rich Reid / National Geographic

Of Mid-Nov Price Correction, BP & Lukoil

The price of crude has seen a fair bit of fluctuation week over week and I agree with analysts at Société Générale CIB who noted on Tuesday that "the modest short-term crude price correction has been driven by investor profit-taking, as well as an end to a surge in gasoil cracks, which had temporarily supported crude prices."

Prices actually peaked on Wednesday and Thursday of last week. Since then, the front-month crude prices have eased by US$2-3. At 18:05GMT on Tuesday, WTI forward month contract was trading at US$80.65/bbl and ICE Brent at US$83.60/bbl.

Elsewhere in this crude world, it was revealed on Tuesday that BP’s Rhim field off the coast of Scotland has been shutdown as it is understood that the field turned out to be a joint venture between it and financiers related to Iranian oil. The shutdown was triggered because extraction from the field could be in contravention of existing European Union sanctions against Iran, issued in October.

The company it is now seeking clarification from the UK government on how the sanctions would apply. Elsewhere, S&P Ratings Services affirmed its 'BBB-' long-term corporate credit rating and 'ruAA+' Russia national scale rating for Lukoil last week.

Concurrently, S&P also removed the ratings from CreditWatch, where they were placed on July 29, 2010. S&P credit analyst Andrey Nikolaev said, "The affirmation reflects our improved assessment of Lukoil's liquidity position, which we now assess as 'adequate' after the company successfully issued a $1 billion Eurobond."

S&P also anticipates that Lukoil will extend the terms of its committed credit lines over the next several weeks. "We now estimate Lukoil's ratio of sources to uses of liquidity at about 1.2x, factoring in the committed credit lines with the terms to be extended," Nikolaev added in an investment circular.

S&P views Lukoil's business risk profile as "satisfactory", underpinned by large and profitable upstream and downstream operations, which are largely concentrated in Russia. The ratings agency also views Lukoil's financial risk profile as 'intermediate', based on its modest debt leverage and our perception that it has fairly good access to bank funding and capital markets.

© Gaurav Sharma 2010. Photo: Andrew Rig, North Sea © BP Plc

Talking Refinery Infrastructure on CNBC

This week marked the culmination of almost a month and a half of my research work for Infrastructure Journal on the subject of oil refinery infrastructure and how it is fairing. Putting things into context, like many others in the media I too share an obsession with the price of crude oil and upstream investment. I wanted to redress the balance and analyse investment in the one crucial piece of infrastructure that makes (or cracks) crude into gasoline, i.e. refineries. After all, the consumer gets his/her gasoline at the gas station – not the oil well. The depth of Infrastructure Journal's industry data (wherein a project’s details from inception to financial close are meticulously recorded) and the resources the publication made available to me made this study possible. It was published on Wednesday, following which I went over to discuss my findings with the team of CNBC’s Squawk Box Europe.

I told CNBC (click to watch) that my findings suggest activity in private or public sector finance for oil refinery projects, hitherto a very cyclical and capital-intensive industry currently facing poor margins, is likely to remain muted, a scenario which is not going to materially alter before 2012.

The evidence is clear, integrated oil companies have and will continue to divest in downstream assets particularly refineries because upstream investment culture of high risk, high rewards trumps it.

Growth in finance activity is likely to come from Asia in general and surprise, surprise India and China in particular. It is not that margins are any better in these two countries but given their respective consumers’ need for gasoline and diesel – margins become a lesser concern.

However, in the west, while refiners’ margins remain tight, new and large refinery infrastructure projects would see postponements, if not cancellations. In order to mitigate overcapacity, a number of mainly North American and European refiners or integrated companies will shutdown existing facilities, albeit quite a few of the shutdowns will be temporary.

Geoff Cutmore and Maithreyi Seetharaman probed me over what had materially changed, after all margins have always been tight? Tight yes, but my conjecture is that over the last five years they have taken a plastering. On a 2010 pricing basis, BP Statistical Review of World Energy notes that the 2009 refining average of US$4.00 per barrel fell below the 2008 figure of $6.50 per barrel; a fall of 38.5%. In fact, moving away from the average, on an annualised basis, margins fell in all regions except the US Midwest last year while margins in Singapore were barely positive.

Negative demand has in effect exasperated overcapacity both in Europe and North America. BP notes that global crude runs fell by 1.5 million bpd in 2009 with the only growth coming from India and China where several new refining capacities, either private or publicly financed, were commissioned. Its research further reveals that most of the 2 million bpd increase in global refining capacity in 2009 was also in China and India. Furthermore, global refinery utilisation fell to 81.1% last year; the lowest level since 1994.

In fact does it surprise anyone that non-OECD refinery capacity exceeded that of the OECD for the first time in 2009? It doesn’t surprise me one jot. I see this trend continuing in 2010 and what happens thereafter would depend on how many OECD existing refineries facing temporary shutdown are brought back onstream and/or if an uptick in demand is duly noted by the OECD nations. A hope for positive vibes on both fronts in the short to medium term is well...wishful thinking.

Refineries were once trophy assets for integrated oil companies but in the energy business people tend to have short memories. Alas, as I wrote for Infrastructure Journal (my current employers) and told CNBC Europe (my former employers), now they are the unloved assets of the energy business.

© Gaurav Sharma 2010. Photo 1: Gaurav Sharma on Squawk Box Europe © CNBC, Nov 10, 2010, Photo 2: Oil Refinery Billings, Montana © Gordon Wiltsie / National Geographic Society

Life After the Gulf Spill for Dudley & BP

I had the pleasure of listening to Robert Dudley this morning in what was his first major speech since taking over from Tony Hayward as the group chief executive of BP and there were quite a few noteworthy things to take away from it.

Speaking to delegates at the UK business lobby group CBI’s 2010 annual conference, Dudley said BP had learnt from the Gulf of Mexico tragedy of April 20 and added his own apology for the incident to that of his predecessor and colleagues.

He said that earning and maintaining trust is central to BP’s licence “to operate in society”, as for any business. Crucial to that was re-establishing confidence in BP and its ability to manage risk. “I am determined for BP to succeed in both,” he added emphatically.

Dudley opined that a silver lining of the event is the significant and sustained advance in industry preparedness that will now exist going forward from the learnings and the equipment and techniques invented by necessity under pressure to contain the oil and stop the well.

Not looking too overwhelmed by the task at hand, Dudley also defended BP’s position noting that it found that no single factor caused the tragedy, and that the well design itself, despite what “you have heard”, does not appear to have contributed to the accident. This has been further verified by recent retrieval of equipment.

Predictably there was much talk by Dudley about winning back trust and restoring the oil giant’s reputation. BP new American chief executive said “British Petroleum” was a part of the American community and would not cut and run from the US market. For good measure, he added that there was too much at stake, both for BP and the US.

“The US has major energy needs. BP is the largest producer of oil and gas in the country and a vital contributor to fulfilling them. We also employ 23,000 people directly, have 75,000 pensioners and have ½ million individual shareholders. Our investments indirectly support a further 200,000 jobs in the US. We have paid roughly US$25 billion in taxes, duties and levies in the last several years. These are significant contributions to the US economy,” Dudley explained.

Moving away from defending his own company, Dudley then launched a robust defence of offshore drilling. “The fact is that until this incident, over 5,000 wells had been drilled in over 1,000 feet of water with no serious accident. BP had drilled safely in deep waters of the Gulf of Mexico for 20 years. As business people are telling political leaders all the time, we cannot eliminate risks, but we must manage them,” he concluded.

He also had a pop at the media – noting that while BP’s initial response was less than perfect, for much of the media the Macondo incident seemed like the only story in town. Overall, a solid performance by the new boss of BP in front of what can be safely regarded as a largely sympathetic audience.

© Gaurav Sharma 2010. Photo 1: Aerial of the Helix Q4000 taken shortly before "Static Kill" procedure began at Macondo (MC 252) site in Gulf of Mexico, August 3, 2010. Photo 2: Robert Dudley, Group Chief Executive, BP © BP Plc