IOC’s bonds, Dragon's shares & Shell’s spill

The Indian Oil Corporation Ltd (IOC) issued its much talked about bonds to the tune of US$500 million last week, with a 5.625% rate due in 2021 to fund ongoing and future domestic projects. Banking on the premise of burgeoning demand among other metrics, ratings agency Moody’s gave it a Baa3 rating with a stable outlook.

Through its 10 refineries with a combined capacity of 1.2 million barrels a day, IOC is India’s largest downstream company with a near 40% market share. While it is a publicly listed company, the Indian government owns 78.92% of it. From an Indian majority state-owned behemoth to a LSE-listed upstream company 51% owned by the government of the Emirate of Dubai – Dragon Oil – which was brought to the Oilholic’s attention recently.

Dragon’s share price is nowhere near its own 52-week high of 609p, but past few trading sessions following its H1 interim results have seen its price rise nearly 4% or 20p on average to about 490p in a decidedly bearish environment. (For the record, it is not the biggest LSE-listed riser of the day – that accolade goes to Heritage Oil but that’s a story for another day).

Question is do you buy it? Examining past performance seems to suggest so and Dragon has recorded a 25% average (gross) production growth for H1 2011. Furthermore, the upstream co has set itself a rather ambitious production growth target of 20% on an annualised basis for the year.

For 2011-2013, the company seeks to maintain target of average annual production growth in the range of 10% to 15%. Away from production projections and by force of habit the Oilholic always looks at the EPS which is up 125% year over year for the first half of this year. Additionally, it remains a takeover target for the majority owners (among others).

The Dragon’s central plank or prized asset is prospection in the Cheleken, an offshore Turkmen jurisdictional area in the eastern section of the Caspian Sea. This can be further narrowed down to an operational focus on the re-development of two oil-producing fields - Dzheitune (Lam) and Dzhygalybeg (Zhdanov).

On the ground Dragon looks promising; on paper it looks a shade one-dimensional. From an investor’s standpoint, that would make its shares a reasonable medium term investment. The Oilholic is always partial to the idea of going long; hence Dragon’s shares are appealing within reason.

Moving on to an offshore story of a grave kind, Royal Dutch Shell confirmed that a leak in a flow line leading to the Gannet Alpha oil platform, east of Aberdeen, Scotland, found on Wednesday is “under control with leakage considerably reduced.” According to local sources, a Remote-Operated Vehicle (ROV) has been deployed for inspection checks and to monitor the subsea leak.

Admittedly not much is coming out in terms of information, except for Shell’s claims that the oil would disperse naturally and not reach the UK coastline. The Oilholic finds the lack of information to be frustrating and sincerely hopes Shell is not doing a BP style “underestimation”. At this point there is no reason to believe that is the case.

Finally, both WTI and Brent are in the green up 1.83% and 1.31% in intraday at 15:15GMT. The bears are still in Crude town, but quite possibly taking a breather after last week’s mauling, or as Commerzbank analysts note, “Even if the short term trough appears to be reached, weak physical demand should keep oil prices in check.”

Update 16:45 GMT: Latest estimates from Shell’s press office suggest 216 tonnes or 1,300 barrels had been spilled.

Update 10:30 GMT, Aug 16: Shell says additional leakage has been discovered in the flow line beneath Gannet Alpha platform

© Gaurav Sharma 2011. Photo: Dzheitune Lam Platform B © Dragon Oil Plc.

The Bears are back in Crude town!

It seems the Bears are back in Crude town and are hoping to lurk around for a little while yet. So this week begins like last week ended with the TV networks screaming how crude it all is. Well a look at either benchmark reveals a decline of above US$3 per barrel in Monday’s intraday trading alone and both benchmarks if observed over a seven-day period display a dip of 7% and above, more pronounced in the US given the “not so smart” political shenanigans related to the debt ceiling and S&P’s ratings downgrade of the country for the first time in its history.

The Oilholic cannot quite understand why some people are either shocked or displaying a sense of shock over the downgrade because the writing was on the wall for profligate America. As politicians on both sides were more interested in points scoring rather than sorting out the mess, what has unfolded is more sad than shocking. Given the US downgrade and contagion in the EU, short term trends are decidedly bearish for crude markets. However, if it goes beyond the average market scare and develops into a serious recessionary headwind then Brent could finally fall below US$100 per barrel and WTI below US$80.

Given the divergence in both benchmark levels, analysts these days offer different forecasts for both with increased vigour via a single note. For instance, the latest investment note from Bank of America Merrill Lynch (BoAML) sees Brent stabilising at US$80 and WTI at US$60 in the face of mild recessionary headwinds. However, the Oilholic agrees with their assertion there would be a Brent claw-back to prior levels as OPEC turns the taps off.

“In the US, we would see landlocked WTI crude oil prices stabilising at a much lower level, as OPEC supplies are of little relevance to the supply and demand balances for crude oil in the Midwest. With shale output still projected to increase substantially over the next few months, we believe that WTI crude oil prices could briefly drop to US$50/barrel under a recession scenario only to recover back up towards US$60/barrel as shale oil output is scaled back,” BoAML analysts noted further.

Over the short term, what looks bearish (at worst) or mixed (at best) for crude, is evidently bullish for precious metals where gold is the vanguard of the bubble. Does it make sense – no; is it to be expected – yes! Nevertheless, long term supply/demand permutations suggest an uptick in crude prices is more than likely by middle of 2012 if not sooner.

Moody's expects oil prices to remain high through 2012 which will support increasing capital spending by exploration and production (E&P) companies worldwide as they re-invest healthy cash flow streams. About 70% of capital spending will take place outside of North America, with Latin American companies including Brazilian operator Petrobras leading the way, according to a report published July-end.

Additionally, development activity in the 2010 Macondo oil spill-affected Gulf of Mexico – while building some momentum – is still hampered by a slow permit process, says the report.

However, Stuart Miller, vice president at Moody’s notes, "But the industry might approach the top of its cycle during the next year as shorter contracts and lower day rates change the supply/demand balance."

Understandably, high risk, high reward modus operandi of the E&P business will remain more attractive as opposed to the refining and marketing (R&M) end of the crude business as the only way is up given when it comes to long term demand. Even the non demand-driven oil upsides (for example – as seen from Q2 2002 to Q2 2003 and Q3 2007 to Q3 2008) were a shot in the arm of E&P elements of the energy business (as well as paper traders).

Moving on to other chatter, Mercer’s cost of living survey found Luanda, the capital of Angola as the world's most expensive city for expatriates. It topped the survey for the second successive year, followed by Tokyo in Japan and N'Djamena in Chad. New to the top 10 were Singapore, ranked eighth, and Sao Paulo in Brazil, which jumped from 21st to 10th. The Oilholic sees a hint of crudeness in there somewhere.

Meanwhile, the National Iranian Oil Company, which does not get to flex its muscles very often in wake of international sanctions, got to do so last week at the expense of crude-hungry India. The burgeoning Indian economy needs the oil but US sanctions on Iran make it difficult to send international bank payments.

As a result Indian companies have been looking for alternative ways to make payments to Iran after the Reserve Bank of India (RBI) halted a clearing mechanism at the end Q4 2010. In the interim, the cash-strapped oil rich Iranians threw a strop threatening to cut off supplies to India if payments were not made by August 1, 2011.

However, it now emerges that at the eleventh hour both sides agreed to settle the bill as soon as possible. Well when 400,000 barrels per day or 12% of your crude count is at stake – you have to find novel ways to make payments. The “first” part of the outstanding bill we are told would be paid within a few days.

Crudely sticking with India, that same week, the Indian government finally gave a formal “conditional” approval to LSE-listed mining group Vedanta Resources for its takeover of Cairn Energy's India unit. However, approval came with a condition that Cairn India and India's state-owned Oil and Natural Gas Corp (ONGC) share the royalty payment burden of crude production from their Rajasthan fields.

ONGC owns a 30% stake in the block but pays royalties on 100% of the output under a "royalty holiday" scheme dating from the 1990s aimed at promoting private oil exploration.

The sale, held in impasse since August, has been hit by difficulties resulting from differences between Cairn India and ONGC over the royalties issue. Vedanta (so far) has a 28.5% stake in Cairn India. It wants the government to approve the buyout of another 30% stake in Cairn India from Cairn Energy. Cairn Energy currently owns a 52% stake in Cairn India. Given the government’s greenlight, it should all be settled in a matter of months.

© Gaurav Sharma 2011. Photo: Veneco Oil Platform, California © Rich Reid, National Geographic

BP’s profit, Saudi price targets & CNOOC in Canada

Its quarterly results time and there is only one place to start – an assessment of how BP’s finances are coping in wake of Macondo. Its quarterly data suggests the oil major made profits of US$5.3 billion in the three months to June-end. This is down marginally from the US$5.5 billion it made in Q1 2011 and a predictable reversal of the US$17 billion loss over the corresponding quarter last year when the cost of the Gulf of Mexico spill weighed on its books.

Elsewhere in the figures, BP's oil production was down 11% for the quarter on an annualised basis and the company has also sold US$25 billion worth of assets to date, partly to offset costs of the clean-up operation in the Gulf. City analysts told the Oilholic that BP should count itself lucky as the crude price has been largely favourable over the last 12 months.

Moving away from BP, it is worth turning our attention to the perennially crude question, what price of black gold is the Saudi Arabian Government comfortable with? An interesting report published by Riyadh-based Jadwa Investment suggests that the “breakeven” price for oil that matches actual revenues with expenditures is currently around US$84 per barrel for the Kingdom, comfortably below the global price.

The Oilholic agrees with the report’s authors - Brad Bourland and Paul Gamble – that it is bit rich to assume the Saudis crave perennially high oil prices. Au contraire, high oil prices actually hurt Saudi Arabia’s long term future. Bourland and Gamble feel the Kingdom would be more comfortable with prices below US$100 per barrel; actually a range of US$70-90 per barrel is more realistic.

Using either benchmark, prices are comfortably above the range and are likely to stay there for the rest of the year, if that is what the Saudis are comfortable with. Analysts at Société Générale CIB maintain their view for Brent prices to be in the US$110-120 range in H2 2011 on mixed fundamental and non-fundamental drivers. They note that there may be some slight upside to their Brent forecast, and some moderate downside to their WTI forecast. At 8:00 GMT, ICE Brent forward month futures contract was trading at US$118.04 and WTI at US$99.56.

Looking from a long term macroeconomic standpoint, the Jadwa Investment report notes that after the benign decade ahead, unless the current spending and oil trends are changed, Saudi Arabia faces a very different environment. For instance, domestic consumption of oil, now sold locally for an average of around US$10 per barrel, will reach 6.5 million barrels per day in 2030, exceeding oil export volumes. Jadwa Investment does not expect total Saudi oil production to rise above 11.5 million barrels per day by 2030.

Even with a projected slowdown in growth of government spending, the breakeven price for oil will be over a whopping US$320 per barrel in 2030. Furthermore, the Saudi government will be running budget deficits from 2014, which become substantial by the 2020s. By 2030, foreign assets will be drawn down to minimal levels and debt will be rising rapidly.

Before you go “Yikes”, preventing this outcome, according to Bourland and Gamble, requires tough policy reforms in areas such as domestic pricing of energy and taxation, an aggressive commitment to alternative energy sources, especially solar and nuclear power, and increasing the Kingdom’s share of global oil production. By no means a foregone conclusion, but not all that easy either.

Continuing with the Middle East, apart from crushing dissent and chastising the US government for interference, the Syrian government is apparently also open for crude business. In an announcement on July 7th, the creatively named General Establishment for Geology and Mineral Resources (GEGMR) under auspices of the Syrian Petroleum and Mineral Resources Ministry invited IOCs to bid and develop oil shale deposits in the Khanser region in the north. The Ministry says total crude reserves at the site are “estimated” at 39 billion tonnes with the oil content rate valuation at 5 to 11%.

While the tender books, costing US$3,000 each were issued on July 1st, the Ministry declined to answer how many were sold, who took them up and how the bid round is supposed to work in face of international condemnation of what is transpiring within its borders.

Elsewhere, Chinese state behemoth CNOOC’s recent acquisition of a 100% stake in OPTI Canada Inc, a TSX-listed oil sands producer, made the headlines. The aggregate consideration for the transaction is about US$2.1 billion. OPTI owns a 35% working interest in four oil sands projects in Canada – Long Lake, Kinosis, Leismer and Cottonwood.

Kai Hu, Vice President and Senior Analyst at Moody’s, says "CNOOC investment in this transaction is in line with the company's strategy of growing reserves, partly through overseas acquisitions. This investment – as well as its the previous investments in Eagle Ford and Niobrara shale gas projects – indicate its strong interest in gaining experience in unconventional oil and gas reserves.”

As such, Moody’s feels CNOOC Aa3 issuer and senior unsecured ratings will not be immediately affected by its acquisition. It also helps that there are no US-style murmurings of dissent in Canadian political circles.

© Gaurav Sharma 2011. Photo: Pipeline in Alaska © Kenneth Garrett, National Geographic

ConocoPhillips’ move is a sign of crude times

US major ConocoPhillips' announcement last Friday that it will be pursuing the separation of its exploration and production (E&P) and refining and marketing (R&M) businesses into two separate publicly traded corporations via a tax-free spin-off R&M to COP shareholders does not surprise the Oilholic. 

Rather, it is a sign of crude times. Oil majors are increasing turning their focus to the high risk, high reward E&P side of things rather than the R&M business where margins albeit recovering at the moment, continue to be abysmal. Most oil majors  are divesting their refinery assets, and even BP would have done so, regardless of the Macondo tragedy forcing its hand towards divestment. 

ConocoPhillips’ decision should not be interpreted as a move away from R&M – nothing in the oil business is either that simple or linear. However, it certainly tells us where its priorities currently lie and how it feels the integrated model is not the best way forward. This is in line with industry trends as the Oilholic noted last November. 

Meanwhile, following the announcement, ratings agency Moody's says it may review ConocoPhillips' ratings for possible downgrade with approximately US$19.6 billion of rated debt being affected. This includes A1 senior unsecured and other long-term debt ratings of the parent company and its rated subsidiaries. 

Tom Coleman, Moody's Senior Vice-President notes that the distribution to shareholders of the large R&M business could weaken the credit profile of ConocoPhillips and result in a downgrade of its A1 rating. 

"Our review will focus on the company's capital structure following the spin-off, including the potential for debt reduction by ConocoPhillips, along with its financial policies and growth objectives going forward as a stand-alone E&P company," he concludes. 

The wider market is waiting to get a clearer understanding of the oil major’s plans for debt reduction, capital structure and financial policies as an independent E&P. Continuing with corporate deals, BHP Billiton made a strategic swoop for Petrohawk Energy. The cash acquisition, also announced last Friday, to the tune of US$12.1 billion, will give it access to shale oil and gas assets across Texas and Louisiana. BHP’s latest move follows its earlier decision to buy Chesapeake Energy's Arkansas-based gas business for US$4.75 billion. 

Meanwhile, figures released by Brazil’s Petrobras for the month of June indicate that the company’s domestic production rose 3.5% on an annualised basis. The results were boosted by the resumption of production on platforms that had been undergoing scheduled maintenance in the Campos Basin, and startup of a new well connected to platform Jubarte field's P-57 in the Espírito Santo section of the Campos Basin. The Extended Well Test (EWT) in the Campos Basin's Aruanã field also started up in late June.

However, its international output was down 5.6% on an annualised basis due to operating issues and tax payments in Akpo, Nigeria. Petrobras' average oil and natural gas production (both domestic and overseas) amounted to 2,641,508 barrels of oil equivalent per day (boed), 2.13% up on the total figure for May 2011. 

Finally, European woes are weighing on the crude markets. With the NYMEX August crude futures contract due to expire on Wednesday, intraday trading at one point, 1045 GMT to be precise, saw it down 0.31% or 33 cents at US$96.91 a barrel. Concurrently, the September ICE Brent futures contract was down 0.6%, 74 cents at US$116.44 a barrel. 

© Gaurav Sharma 2011. Photo 1: COP Refinery & Oil Platform collage © ConocoPhillips

Crude mood swings, contagion & plenty of chatter

There is a lot going on at the moment for commentators to easily and conveniently adopt a bearish short term stance on the price of crude. Take the dismal US jobs data, Greek crisis, Irish ratings downgrade and fears of contagion to begin with. Combine this with a relatively stronger dollar, end of QE2 liquidity injections, the finances of Chinese local authorities and then some 50-odd Chinese corporates being questioned and finally the US political standoff with all eyes on the Aug 2 deal deadline or the unthinkable.

Additionally, everyone is second guessing what crude price the Saudis would be comfortable with and MENA supply fears are easing. Quite frankly, all of these factors may collectively do more for the cause of those wishing for bearish trends than the IEA’s announcement last month – no not the one about the Golden Age of gas, but the one about it being imperative to raid strategic petroleum reserves in order to ‘curb’ rising prices! The Oilholic remains bullish and is even more convinced that IEA’s move was unwarranted and so are his friends at JP Morgan.

In an investment note, they opined that the effectiveness of IEA’s coordinated release is a matter of some debate and crude prices have rebounded quickly. “But while the US especially has demonstrated a willingness to use oil reserves as a stimulus tool in what has become a rather limited toolbox, a second release will require higher prices and a far more arduous task to achieve unity,” they concluded.

Now, going beyond the short to medium term conjecture, the era of cheap oil, or shall we say cheap energy is fading and fast. An interesting report titled – A new world order: When demand overtakes supply – recently published by Société Générale analysts Véronique Riches-Flores and Loïc de Galzain confirms a chain of thought which is in the mind of many but few seldom talk of. Both analysts in question feel that the last long cycle, which extended from the middle of the 1980s to the middle of the 2000s, was shaped by an environment that strongly favoured the development of supply; the next era will in all likelihood be dictated by demand issues.

Furthermore, they note and the Oilholic quotes: “According to our estimates, energy demand will at least double if not triple over the next two decades. This is significantly more than the IEA is currently projecting, with the difference being mainly attributable to our projections for emerging world energy consumption per capita, which we estimate will considerably rise as these countries develop. Applied to the oil market, these projections mean that today’s proven oil reserves, which are currently expected to meet 45 years of global demand based on the present rate of production, would be exhausted within 15-22 years.”

IEA itself estimates that demand will grow by an average of 1.47 million barrels a day (bpd) in 2012, up from the current 2011 average of 1.2 million bpd. Moving away from crystal ball gazing, Bloomberg’s latest figures confirm that record outflows from commodity ETPs (ETF, ETC and ETN) observed in May slowed abruptly. According to SG Cross Asset Research apart from net inflows into precious metals – the biggest sub-segment measured by assets under management – other categories such as Energy and base metals saw limited net outflows (see table on the left, click to enlarge).

Meanwhile, the London Stock Exchange (LSE) was busy welcoming another new issuer of ETFs – Ossiam – on to its UK markets on Monday. It is already the largest ETF venue in Europe by number of issuers; 20 to be exact. According to a spokesperson there are 481 ETFs listed on the LSE. In H1 2010 there were 369,600 ETF trades worth a combined £19 billion on the Exchange's order book, a 40.3% and 33.5% increase respectively on the same period last year.

Switching to corporates and continuing with the LSE, today Ophir Energy plc was admitted to the Main Market. The company listed on the Premium segment of the Main Market and raised US$375 million at admission and has a market capitalisation of US$1.28 billion.

Ophir is an independent firm with assets in a number of African countries particularly Tanzania and Equatorial Guinea. Since its foundation in 2004, the company has acquired an extensive portfolio of exploration interests consisting of 17 projects in nine jurisdictions in Africa.

The company is one of the top five holders of deepwater exploration acreage in Africa in terms of net area and could be one to watch. So far it has made five discoveries of natural gas off Tanzania and Equatorial Guinea and has recently started drilling in the offshore Kora Prospect in the Senegal Guinea Bissau Common Zone. For the LSE itself, Ophir brings the number of companies with major operations in sub-Saharan Africa listed on its books to 79.

Across the pond, Vanguard Natural Resources (VNR) announced on Monday that it will buy the rest of Encore Energy Partners LP it does not already own for US$545 million, gaining full access to the latter’s oil-heavy reserves. While its shares fell 8% on the news, the Oilholic believes it is a positive statement of intent by VNR in line with moves made by other E&P companies to secure reserves with an eye on bullish demand forecasts over the medium term.

Meanwhile, a horror story with wider implications is unfolding in the US, as ExxonMobil’s Silvertip pipeline leaked oil into the Montana stretch of the Yellowstone River on July 1. The company estimates that almost 42,000 gallons may have leaked and invariably questions were again asked by environmentalists about the wisdom of giving the Keystone XL project the go-ahead. This is not what the US needed when President Obama was making all the right noises – crudely speaking that is.

In March, he expressed a desire to include Canadian and Mexican oil in the US energy mix, in May he said new leases would be sold each year in Alaska's National Petroleum Reserve, and oil and gas fields in the Atlantic Ocean would be evaluated as a high priority. To cap it all, last month, the President reaffirmed that despite the BP oil spill in the Gulf of Mexico in 2010, drilling there remained a core part of the country's future energy supply and new incentives would be offered for on and offshore development. Leases already held but affected by the President's drilling moratorium, imposed in wake of the BP spill, would be eligible for extensions, he added. The ExxonMobil leak may not impact the wider picture but will certainly darken the mood on Capitol Hill.

Russians and Norwegians have no hang-ups about crude prospection in inhospitable climates – i.e. the Arctic. Details are now emerging about an agreement signed by the two countries in June which came into effect on July 7. Under the terms, both countries’ state oil firms – i.e. Russia’s Gazprom and Norway’s Statoil – will divide up their shares of the Barents Sea. USGS estimates from 2008 suggest the Arctic was likely to hold 30% of the world's undiscovered gas and 13% of its oil.

Finally, Sugar Land, Texas-based Industrial Info Resources (IIR) came-up with some interesting findings on the Canadian oil sands. In a report last week, the research firm noted that Canada's Top 10 metals and minerals industry projects are large scale oil sands and metal mining endeavours, with the No. 1 being in Alberta's oil sands.

IIR observed that what was once considered a “large project” was now being dwarfed by “megaprojects”. Not long ago a project valued at CAD$1 billion was considered a mega project; now the norm is more in the region of CAD$5 billion (and above) for a project to earn that accolade. Not to mention the fact that the Canadian dollar has been stronger in relative terms in recent years and not necessarily suffering from a mild case of the Dutch disease like its Australian counterpart. IIR’s findings take the Oilholic nicely back to his visit to Calgary in March, a report he authored for Infrastructure Journal and a conversation he had with veteran legal expert Scott Rusty Miller based in Canada's oil capital. We concurred that while the oil sands developments face myriad challenges they are certainly on the way up. The Canadians are developers with scruples and permit healthy levels of outside scrutiny more than many (or perhaps any) other jurisdictions.

IIR recorded US$176 billion worth of oil sands projects and all of the projected investment capital, except for one project in Utah, is in Alberta. It is becoming more likely than ever that Prime Minister Stephen Harper’s dream of Canada becoming an energy super power will be realised sooner rather than later.

© Gaurav Sharma 2011. Photo 1: Pump Jacks Perryton, Texas © Joel Sartore, National Geographic. Photo 2: Shell Athabasca Oil Sands site work © Royal Dutch Shell. Table: Global Commodity ETPs: Inflows analysis by category © Société Générale July 2011.