The drivers, the forecasts & the ‘crude’ mood

At times wild swings in the crude market’s mood do not reflect oil supply and demand fundamentals. The fundamentals, barring a geopolitical mishap on a global scale, alter gradually unlike the volatile market sentiment. However, for most parts of Q2 and now Q3 this year, both have seemingly conspired in tandem to take the world’s crude benchmarks for a spike and dive ride.

 

Supply side analysts have had as much food for thought as those geopolitical observers overtly keen to factor in an instability risk premium in the oil price or macroeconomists expressing bearish sentiments courtesy dismal economic data from various crude consuming jurisdictions. For once, no one is wrong.

 

A Brent price nearing US$130 per barrel in mid-March (on the back of Iranian threats to close the Strait of Hormuz) plummeted to under US$90 by late June (following fears of an economic slowdown in China and India affecting consumption patterns). All the while, increasing volumes of Libyan oil was coming back on the crude market and the Saudis, in no mood to compromise at OPEC, were pumping more and more.

 

Then early in July, as the markets were digesting the highest Saudi production rate for nearly three decades, all the talk of Israel attacking Iran resurfaced while EU sanctions against the latter came into place. It also turned out that Chinese demand for the crude stuff was actually up by just under 3% for the first six months of 2012 on an annualised basis. Soon enough, Brent was again above the US$100 threshold (see graph on the right, click to enlarge).

 

Fast forward to the present date and the Syrian situation bears all the hallmarks of spilling over to the wider region. As the West led by the US and UK helps rebels opposed to President Bashar al-Assad, Russia is seen helping the incumbent; not least via a recent announcement concerning exchange of refined oil products from Russia for Syrian crude oil exports desperately needed by the latter.

 

A spread of hostilities to Lebanon, Jordan, Turkey and Iraq could complicate matters with the impact already having been seen in the bombing of Iraq-Turkey oil pipeline. Additionally, anecdotal evidence suggests the Saudis are now turning the taps down a bit in a bid to prop up the oil price and it appears to be working. The Oilholic will be probing this in detail on visit to the Middle East next week.

 

While abysmal economic data from the Old Continent may not provide fuel – no pun intended – to bullish trends, one key component of EU sanctions against Iran most certainly will. A spokesperson told the Oilholic that tankers insured by companies operating in EU jurisdictions will lose their coverage if they continue to carry Iranian oil from July.

 

Since 90% of the world's tanker fleet – including those behemoths called ‘supertankers’ passing through dangerous Gulf of Aden – is insured in Europe, the measure could take out between 0.8 and 1.1 million barrels per day (bpd) of Iranian oil from Q3 onwards according an Istanbul-based contact in the shipping business.

 

In fact OPEC’s output dipped by 70,000 bpd in month over month terms to 31.4 million bpd in July on the back of a 350,000 bpd drop in June over May. No prizes for guessing that of the 420,000 bpd production dip from May to July – 350,000 bpd loss is a direct result of the Iranian squeeze. Although Tehran claims it is a deliberate ploy.

With an average forecast of a rise in consumption by 1 million bpd over 2012 based on statements of various agencies and independent analysts, price spikes are inevitable despite a dire economic climate in Europe or the OECD in general.

 

Cast aside rubbish Iranian rhetoric and throw in momentary geopolitical supply setbacks like the odd Nigerian flare-up, a refinery fire in California or the growing number of attacks on pipeline infrastructure in Columbia. All of these examples have the potential to temporarily upset the apple cart if supply is tight.

 

“Furthermore, traders are wising up to fact that a price nudge upwards these days is contingent upon non-OECD consumption patterns and they hedge their bets accordingly. WTI aside, most global benchmarks look towards the motorist in Shanghai more than his counterpart in San Francisco these days,” says one industry insider of his peers.

 

When the Oilholic last checked at 1215 BST on August 23, the ICE Brent October contract due for expiry on September 13 was trading at US$115.95 while the NYMEX WTI was at US$97.81. It is highly likely that ICE Brent forward futures contracts for the remaining months of the year will end-up closing above US$110 per barrel, and almost certainly in three figures. Nonetheless, prepare for a rocky ride over Q4!

 

Moving away from pricing of the crude stuff, it seems the shutdown of Penglai 19-3 oilfield by the Chinese government in wake of an oil spill last year has hit CNOOC’s output and profits. According to a recent statement issued at Hong Kong Stock Exchange, CNOOC saw its H1 2012 output fall 4.6% on an annualised basis owing to Penglai 19-3 in which it holds 51% of the participating interest for the development and production phase. ConocoPhillips China Inc (COPC) is the junior partner in the venture.

 

This meant H1 2012 net income was down by 19% on an annualised basis from Yuan 39.34 billion to Yuan 31.87 billion (US$5 billion) according to Chief Executive Li Fanrong. CNOOC's US$15.1 billion takeover of Canada’s Nexen, a move which could have massive implications for the North Sea, is awaiting regulatory approval from Ottawa.

 

Away from the “third largest” of the big trio of rapidly expanding Chinese oil companies to a bit of good news, however temporary, for refiners either side of the pond. That’s if you are to believe investment bank UBS and consultancy Wood Mackenzie. UBS believes that for better parts of H1 2012, especially May and June, refining margins were at near “windfall levels” as the price of the crude stuff dipped in double-digit percentiles (25% at one point in the summer) while distillate prices held-up.

 

Wood Mackenzie also adds that given the refiners’ crude raw material was priced lower but petrol, diesel and other distillates remained pricey meant moderately complex refiners in northwest Europe made a profit of US$6.40 per barrel of processed light low sulphur Brent crude in June, compared with the average profit of 10 cents per barrel last year.

 

The June margin for medium, high sulphur Russian Urals crude was a profit of US$13.10 per barrel compared with the 2011 average of US$8.70, the consultancy adds. American refiners had a bit of respite as well over May and June. Having extensively researched refining investment and infrastructure for over two years, the Oilholic is in complete agreement with Société Générale analyst Mike Wittner that such margins are not going to last (see graph above, click to enlarge).

 

To begin with the French investment bank and most in the City expect global refinery runs to drop shortly and sharply to -1.3 million bpd in September versus August and -0.8 million bpd in October versus September. Société Générale also remains neutral on refining margins and expects them to weaken on the US Gulf Coast, Rotterdam and the Mediterranean but strengthen in Singapore. Yours truly will find out more in the Middle East next week. That’s all for the moment from London folks! Keep reading, keep it ‘crude’!

 

© Gaurav Sharma 2012. Photo 1: Russian oil pump jacks © Lukoil. Graph 1: Comparison of world crude oil benchmarks (Source: ICE, NYMEX, SG). Graph 2: World cracking margins (US$/barrel 5 days m.a) © SG Cross Asset Research, August 2012.

The South Sudan question & other crude matters

Where South Sudan fits in the oil world has troubled ‘crudely’ inclined geopolitical analysts for some time now. The country celebrated the first anniversary of its creation on July 9th. But there is little to cheer about yet for South Sudan which inherited over 75% of parent Sudan’s proven oil reserves but is overtly reliant on the latter’s infrastructure to bring it to market. Sources with expertise as well as anyone with a modicum of interest in current events would agree that South Sudan’s outlook is bleak at best and abysmal at worst following decades of conflict. That’s notwithstanding a prolonged border dispute with the North, 170,000-plus refugees and tension over oil revenues which have only just shown signs of easing.

While it is early days, on August 4th a Reuters’ flash stating that the North and South sides had pulled back from the brink of war and finally agreed on oil transit payments was widely welcomed from trading floors to the Office of US Secretary of State Hillary Clinton. And what has emerged so far is a relief for everyone from Elf to Total, from OMV to CNPC; the Chinese being the biggest players in Sudan. Of the seven exploration blocks, CNPC is majorly involved with four in case you didn’t know.

Yet deep down everyone, not least the Oilholic, is pragmatic enough to acknowledge that the time to uncork the champagne is not here yet. This humble blogger was not in the Ethiopian capital of Addis Ababa where the agreement was reached, but courtesy dispatches from kindred souls in diplomatic circles it is known that South Sudan agreed to pay North Sudan just over US$9.05 per barrel for usage of its transport, supply and logistics infrastructure to move the crude stuff to Port Sudan.

However, nearly a fortnight on from the announcement, we still await an announcement about when the South will resume oil exports which were stopped in January. That said North Sudan will receive US$3 billion as compensation for revenue lost in that period.

The agreement is not the end of South Sudan’s problems. Without even having meaningfully exploited its precious resources, the world's newest nation is already a case study for the resource curse hypothesis. With oil production having only begun in 2005 and anti-graft measures either side of the border being ‘less than worse’, it can be safely concluded that South Sudan is more likely to resemble a 1970s Nigeria than a 2012 Botswana.

If the Americans press South Sudan to act on graft they are labelled as arrogant, the South Africans as patronising, the Brits as colonials and so on in populist circles even if the government is partially listening. The Chinese way to calm the situation either side of the disputed border and improving things is by offering to buy the crude stuff at above existing market rates (as they did in February).

Clue – nothing is going to change meaningfully anytime soon. Alas, with a production peak for existing facilities forecast for 2020, a turnaround is needed and fast! At least a plan to move away from overreliance on the North by building a pipeline to Kenya is a positive if it materialises. Happy Belated Birthday South Sudan!

Away from Sudanese problems, but sticking with the African continent – Nigeria has signed an ‘initial’ agreement with USA’s Vulcan Petroleum Resources Ltd.; a Vulcan Capital Management SPV, to build six new oil refineries worth US$4.5 billion. If ‘initial’ becomes ‘final’ and the deal materialises, it would add to the four refineries Nigeria already has increasing refining capacity by 180,000 barrels per day.

For a country which is Africa’s largest oil exporter but a net importer of refined distillates, the Oilholic has always opined that seeing is believing. So we’ll believe when we see and greet the announcement with cautious optimism.

Moving to some corporate news which also has an African flavour, its emerged that Edinburgh-based independent upstart Melrose Resources has announced a merger with Ireland’s Petroceltic. Both companies will now merge operations in North Africa along with Black Sea and the Mediterranean.

The new company will have Petroceltic’s branding and will be headquartered in Ireland. The merger values Melrose at £165 million with Petroceltic shareholders having a 54% stake in the merged company and Melrose shareholders having the rest. Sounds like a sound move!

Finally, a new computer virus is doing the rounds targeting energy infrastructure being dubbed by the security firms as the “Shamoom” attack. A notice from Symantec (available here) describes the virus as “a destructive malware that corrupts files on a compromised computer and overwrites the MBR (Master Boot Record) in an effort to render a computer unusable.”

On Wednesday, Saudi Aramco said it was subject to a virus attack but did not acknowledge whether it was a Shamoom attack. A spokesperson said Aramco had now isolated its computer networks as a precautionary measure while stressing that the attack had no impact on its production. Virulent times in the crude world. That’s all for the moment folks! Keep reading, keep it 'crude'!

© Gaurav Sharma 2012. Photo: Oil worker © Shell

Scrutinising UK’s latest North Sea tax break

The British government announced fresh tax relief measures last week aimed at boosting output in the North Sea. The Oilholic’s first thought, after having scrutinised the small print, is that it’s a positive signal of intent from UK chancellor George Osborne following on from his 2012 union budget. In all fairness he is also looking to put the taxation measures of 2011 budget, which irked the industry, behind him.

From July 25th, new UKCS gas fields with 10-20 billion cubic metres (bcm) in reserves located at depths of less than 30 metres will be exempted from a 32% tax levy on the first £500 million (or US$776 million) of income. Shallow water offshore projects will still pay the 30% Ring Fence Corporation Tax on all income from the field.

UK Treasury figures suggest the measure is expected to cost £20 million per annum in reduced tax receipts, but the government reckons it would generate additional jobs and crucially bolster energy security.

Chancellor Osborne said, "Gas is the single biggest source of energy in the UK. Today the government is signalling its long-term commitment to the role it can play in delivering a stable, secure and lower-carbon energy mix."

A new UK gas strategy is expected this autumn and all indications are that the British will acknowledge the critical role of the gas market in meeting emissions targets alongside a mix of subsidy supported renewable projects. Another passive acknowledgement then that gas, not renewable energy platforms, would be the immediate beneficiary of a post-Fukushima turn-off?

In fact the Oilholic and quite a few others are convinced that gas-fired plants would play a more than complementary role in a future British energy mix. The latest tax relief, aimed at shallow water gas prospection is proof of this.

Derek Henderson, senior partner in the Aberdeen office of Deloitte, also believes the move builds on UK March’s Budget when a number of other reliefs were announced. “This announcement should further support investment, unlock potential gas reserves and increase long term production leading to additional employment and an increase in overall tax revenue,” he said.

“This encouraging action by the Chancellor also provides more evidence of the constructive dialogue that is taking place between industry and the Government. The politicians are demonstrating their commitment to gas, it is now up to the industry to respond with increased activity levels,” Henderson concludes.

Centrica pledged to invest £1.4 billion towards developing its Cygnus gas field with partner GDF Suez barely hours after the announcement of the tax relief. Six days later Prime Minister David Cameron came ‘up North’ to pledge his support to the sector.

“If everything goes well in the oil sector and the renewables sector, is really important, high-quality manufacturing. I think that's something to celebrate and something to stand up for," he said speaking at Burntisland Fabrications in Fife.

The company has just won a contract from Premier Oil to create structures for their platform destined for the Solan oilfield development, west of Shetland. Burntisland Fabrications said the contract will create an additional 350 jobs.

UK’s Department of Energy and Climate Change (DECC) greenlighted Premier Oil’s plans for the Solan oilfield in April. The field could produce up to 40 million barrels of oil, with a projected production commencement rate of 24,000 barrels per day from Q4 2014. Given the amount of activity in the area, looks like a lot work might be coming from developments west of Shetland and it’s great to see the Prime Minister flag it up.

Meanwhile oil giant BP posted a sharp fall in Q2 2012 profits after it had to cut the value of a number of its key assets. The company made a replacement cost profit, outstripping the effect of crude oil price fluctuation, of US$238 million over Q2; versus a profit of US$5.4 billion in the corresponding quarter last year. The cut in valuation was in a number of its refineries and shale play assets.

With the TNK-BP saga continuing, BP’s underlying replacement cost profit for Q2 2012, leaving out asset value reductions, dipped to US$3.7 billion versus US$5.7 billion noted in Q2 2011.

On the crude pricing data front, both benchmarks have not moved much week on week and price sentiment is still bearish ahead of FOMC and ECB meetings. Given that on the macroeconomic front, the global indicators are fairly mixed, Sucden Financial Research analyst Myrto Sokou believes crude oil prices will continue to consolidate within the recent range.

“We saw this today; trading volume remains fairly low as investors would like to remain cautious ahead of the ECB and Fed decisions,” she concluded.

Andrey Dirgin, Head of Research at Forex Club said, “On Tuesday’s trading session, September’s energy futures performed indifferently. Oil contracts didn’t manage to fix on their levels and moved slightly down. The nearest Brent Crude futures contract fell 0.21% to US$104.7.”

Away from pricing and on a closing note, the Oilholic notes another move in the African crude rush. This one’s in Sierra Leone. A fortnight ago, the Sierra Leone government provisionally awarded two offshore exploration blocks – SL 8A-10 and SL 8B-10 – to Barbados registered ODYE Ltd.

The said exploration blocks SL 8A-10 and SL 8B-10 contain 2584 sq.km and 3020 sq.km of prospection area respectively. According to the Petroleum Directorate of Sierra Leone, the exploration blocks consist of early to late Cretaceous oil prone marine source rocks, primarily shale, sand and shale basin floor fans, channelised sand sequences and potentially high porosity sands.

ODYE says it is looking forward to “working with the other participants in these provisionally awarded blocks, Chevron Sahara and Noble Energy” to develop the assets. So the West African gold rush continues. That’s all for the moment folks! Keep reading, keep it ‘crude’!

© Gaurav Sharma 2012. Photo: Andrew Rig, North Sea © BP Plc.

Why CNOOC’s move matters beyond Canada?

China’s CNOOC has made yet another Canadian acquisition; only its latest one announced earlier this week has global implications in the shape of Nexen. On July 23rd Nexen’s board approved CNOOC’s offer to pay US$27.50 per share valuing their company at US$15.1 billion; a near 60% appreciation on valuation at the close of trading on July 20th.

So why does this acquisition matter? After all, it isn’t the first time the Chinese state-owned firm has acquired a Canadian asset. Only last November, CNOOC bought Canadian oil sands firm Opti Canada for C$2.1 billion. In 2005, it acquired a 16.7% share of MEG Energy, another Canadian oil firm.

A CNOOC communiqué suggests it is operating as any oil company would, i.e. by strategically expanding its reserve base. It says the acquisition, which is yet to be cleared by the Canadian government, would boost its oil reserves by 30%.

In a rather 'crude' world, if this Chinese takeover is approved by the Canadians, CNOOC would take control of the UK's largest producing oil field - Buzzard. This would be on top of the Golden Eagle prospection zone about 43 miles offshore from Aberdeen. Unlike oil sands upstarts, Nexen is a major established global operator and has a significant presence in the North Sea. 

Now if you count Sinopec 49% stake in Talisman's business in the British sector of the North Sea together with hypothetical CNOOC access via a takeover of Nexen; it would in theory give the Chinese control of just under 10% of British oil and gas production in the North Sea!

Understandably, there have been murmurings in the Oilholic’s part of the world. However, there are no loud noises as they would run contrary to the British government’s pro-investment stance and in any case they can’t do much about it. By law, the Canadians can block any foreign investments in the country’s firms exceeding C$330 million if the government believes they are not in Canada's best interests. In 2010, the Canadian government prevented BHP Billiton's US$39 billion hostile takeover of fertiliser firm Potash Corp. The LSE-TSX shenanigans of last year are also well documented.

Chinese firms have not felt as welcome in the US, but in Canada their investment is not considered a taboo subject. So how the Harper government responds in this case, which has far reaching implications beyond Canada, remains to be seen.

Meanwhile, contrary to AAR and tycoon Mikhail Fridman’s assertion that there were no takers for BP’s stake in Russia’s TNK-BP, Russian state giant Rosneft has said it is considering buying the stake. A Roseneft statement earlier this week suggested it was interested in a ‘potential acquisition’.

TNK-BP is jointly owned by AAR and BP. Already troubled relations between the two became further fraught after BP sought to form a separate partnership with Rosneft last year.

As AAR has preferred bidder status, this gives it around 90 days during which BP can talk to – but not sign an agreement with – other parties interested in its stake. BP put up its half of the TNK-BP business up for sale in June. AAR has itself declared an interest in buying BP's share.

Finally, the Oilholic is getting in to the Olympics spirit as well! The Chinese, Russians, Americans, Canadians and athletes of some 200-odd countries are now in London town. The Tower Bridge has got its own fancy Olympics rings (see above) and the Olympic Torch passed from the street in front of this blogger’s humble abode on Thursday (see below)!

For those wondering how the torch was being kept powered-up in some really wretched British weather – there is a liquid fuel canister located about halfway up the torch connected via tiny pipe to the top. Through it, the fuel travels up before it is released out at the top of the torch where the pressure in it decreases and this converts the liquid into gas ignited by a spark. Despite exhaustive enquiries, no one would reveal the flow rate which is special to each Olympic torch.

This has been the case since 1972 and London 2012 is no exception to this rule. Quite a few London 2012 Olympic Torches are up for sale on eBay should any of you wish to get your own now that Olympics opening ceremony is done and the cauldron has been lit in the stadium. That’s all for the moment folks! Keep reading, keep it 'crude'!

© Gaurav Sharma 2012. Photo 1: North Sea oil rig © Shell. Photo 2: Tower Bridge London with Olympic rings. Photo 3: London 2012 Olympic Torch passes through London Borough of Barnet, UK.  © Gaurav Sharma 2012.

Crude profit taking & Browne’s Shale hypothesis

Concerns over a conflict in the Middle East involving Iran did ease off last week but apparently not far enough to prevent a further slide in the price of the crude stuff. A relative strengthening of the US dollar was also seen supporting prices to the upside despite Eurozone woes. So Brent resisted a slide below US$107 on Friday while the WTI resisted a slide below US$91 a barrel.

In fact, the WTI August contract reached a high of US$92.94 while Brent touched US$108.18 at one point; the highest for both benchmarks since May 22. This meant that the end of last week saw some good old fashioned profit taking with conditions being perfect for it.

However, on this crude Monday afternoon, we see both benchmarks dipping again. When the Oilholic last checked, Brent was resisting a slide below US$102 per barrel while the WTI was resisting a US$88 level. With the Middle East risk premium easing marginally, City traders have turned their attention to Spain.

Last week the country’s government predicted that the Spanish recession may well extend into next year. Additionally, the regional administration of Valencia asked for federal help from Madrid to balance its books. So what have we learnt over the last seven or eight trading sessions and what has changed? Well not much except that oil price forecasting often resembles an inexact task based on fickle market conjecture.

The bullish sentiments of last week were an aberration prompted by the perceived risk of a conflict in the Middle East which the Iranians would be incredibly barmy to trigger. Add the temporary lowering of oil production courtesy a Norwegian strike and you provide the legs to a perfect short term prancing bull!

Existing economic fundamentals and current supply demand scenarios did not merit last week’s pricing levels either side of the pond. The Oilholic agrees with the EIA’s opinion that the Brent price would indeed range between US$97.50 and US$99.50 a barrel up until the end of 2013. Analysts at investment banks and ratings agencies are also responding.

For instance, Société Générale has downgraded Brent price estimates by 10% over 2012-14, from US$117 a barrel to US$105. The French bank views oil market fundamentals as neutral for the rest of the year. Nonetheless, should the Brent price weaken below US$90, like others in the City, Société Générale says a Saudi response is to be expected.

For what it is worth, at least Brent’s premium to the WTI has been constantly taking a knock. By some traders' accounts, it is presently below US$15 a barrel for the September settlement contract having been at US$26.75 at one point over Q4 2011. As a direct consequence of the linkage between waterborne light sweet crudes, the Louisiana Light Sweet’s premium to the WTI is down as well to around US$16 a barrel according to Bloomberg.

Moving away from pricing, Lord Browne – the former boss of BP and a director of fracking firm Cuadrilla – believes shale prospection would rid the US of oil imports. Speaking in Oxford at the Resource 2012 forum on water, food and energy scarcity, Browne said the US will not need to import any crude within two decades.

He quipped that the amount of shale gas in the US was effectively “infinite". On a sombre note, Browne said, “Shale gas has a very bad reputation, as a result of the weak players cutting corners. Regulation tightening would be welcome."

His Lordship is known to be a member of the “All hail shale” brigade. Back in March he told The Independent newspaper that if fracking took off meaning fully in the UK, it could generate 50,000 British jobs. The country could very well need its own shale drive especially as a government watchdog recently warned of declining oil and gas revenues.

A consultation period is currently underway in London. All UK fracking activity ground to a halt last year, when a couple of minor quakes majorly spooked dwellers of Lancashire where Cuadrilla was test fracking. Given the incident and environmental constrictions, the Oilholic suspects that Lord Browne knows it is too early to get excited about shale from a British perspective. However, Americans see no cause for curbing their enthusiasm. That’s all for the moment folks. Keep reading, keep it ‘crude’!

© Gaurav Sharma 2012. Photo: Oil tankers in English Bay, British Columbia, Canada © Gaurav Sharma 2012.