Keystone XL farce, Jon Stewart & an OFS merger

Despite much being afoot in the crude oil world, there’s only one place to start and that’s the ongoing farce over the Keystone XL pipeline extension project. A continuation of US President Barack Obama’s dithering over approval of the transnational pipeline extension (from Alberta, Canada to Texas) is not a major surprise. However, an unassailable truth flagged up by none other than comedian and political satirist Jon Stewart certainly is! 

It seems many controversial decisions, including Keystone XL’s approval, were delayed by the Obama administration until after the US mid-term elections undoubtedly to calm worried Democrats (who were in for, and eventually did get, an electoral pasting) so that they didn’t have to take a political stand on these issues one way or another. So when Obama delayed approval of Keystone XL (again!) in April this year, that helped the President’s mates both for and against the project. 

Especially, senators Mary Landreiu (D-Louisiana), Mark Begich (D-Alaska), Mark Pryor (D-Arkansas) and Kay Hagan (D-North Carolina) all in red states favouring the project, who then used the delay as a pretext to criticise and "distance themselves" from the president. 

Conversely, blue states Democrats thought they got points for criticising the pipeline extension project to pander to opposing sentiments of their respective electorates. It was supposed to be a win-win situation; except for one thing - they all LOST and Landreiu, who is facing a tough run-off is going to, chuckled Stewart on The Daily Show broadcast for November 6 evening.

This week, the "old" senate rejected approval of Keystone XL, one of its last acts before the new Republican controlled senate convenes. At which point, the "new" senate will approve it and then one assumes the President would veto it. Then Democrat presidential candidate(s), including one Hillary Clinton who is said to be in favour of the pipeline, will take their respective positions either denouncing or praising the decision and so it goes. 

According to the splendid Stewart, it’s a popular tactic known as the “Chickensh*t gambit”. (To view the clip in the US click here, for the UK, click here, for elsewhere not quite sure where!)

Both those for and against the project should despair over the state of affairs. However, on the bright side they’ll be plenty of material for Stewart to bring a bit of laughter into our lives. As for the Canadian side, they are a patient bunch and among their ranks are some who quietly (and somewhat correctly) believe their country's need for the pipeline is diminishing as China's footprint on the global crude oil market grows ever bigger than that of the US. 

Meanwhile, by sheer coincidence barely days after the Oilholic went on Tip TV to discuss the challenging climate for oilfield services (OFS) companies (including why the Kentz takeover in August by SNC-Lavalin would not have happened now at the price it did back then), came the mother of all moves – Halliburton’s for Baker Hughes.

In case you’ve been on another planet and haven’t heard, Halliburton has agreed to buy rival Baker Hughes in a cash and shares deal worth US$34.6 billion. The transaction has been approved by both companies' boards of directors and is expected to close in late 2015, pending regulatory approval. As the oil price has fallen by a third since the summer, demand for OFS has cooled and a coming together of the second and third placed services providers makes sense in a cyclical industry.

Nonetheless, the announcement and speed of agreement took many by surprise. Dave Lesar, CEO of Halliburton, told CNBC's Squawk on the Street program on Tuesday that Baker Hughes brings complimentary product lines to the merger which his company does not have.

“Production chemicals is one, artificial lift is another, so from that standpoint they [Baker Hughes] do have some technology that we do not have. Plus they have some fantastic people in their talented organisation. Combine that with out talent and I think we’re putting together the industry bellwether.”

“Both companies are growing. We’re going to hire 21,000 people just at Halliburton this year, not only blue collar but white collar and professionals. You add that to capability and the growth we’re seeing out at Baker…I think it expands career opportunities.”

Lesar also said he had a top notch team in place to address anti-trust concerns which might involve divestments of up to $7.5 billion. The Halliburton CEO added that the response from big ticket clients, including several National Oil Companies (NOCs), had been great. “Feedback from almost of our customers, including NOCs has been pretty positive, where a stronger, more developed organisation can help them in ways neither Baker nor Halliburton could have done standing on our own.”

“Furthermore, we would not have done this deal if I did not believe that we could get this through the regulatory bodies,” Lesar said. There you have it, and it’d cost $3.5 billion in payments to Baker if he is wrong and regulators block the deal.

The Halliburton CEO largely sidestepped commenting on the Keystone XL farce and the oil price tumble, except adding on the latter point that: “We’re not in the bunker yet!” As OPEC meets on November 27, the market is in a sort of “pause still” mode. Brent is lurking just below $80 level, while the WTI is around the $75 level (see right, click to enlarge).

The Oilholic’s gut instinct, as one told Tip TV, is that OPEC has left it too late to act and should have made a call one way or another via an extraordinary meeting when the Brent fell below $85. So if they cut now, will it have the desired impact?

Meanwhile, Producers for American Crude Oil Exports (PACE), says repealing the ban on US crude oil exports will not only create hundreds of thousands of jobs and grow the economy, it will benefit consumers by “lowering gasoline prices” contrary to opinion expressed in certain quarters. That conclusion, it says, is supported by no less than seven independent economic studies. These include the Brookings Institution, IHS Energy, Dallas Federal Reserve Bank, and the US Government Accountability Office, among others. 

Finally, Fitch Ratings says the 25% drop in the oil price since July is likely to lift economic growth prospects, improve terms of trade, and have a potentially positive credit impact for a number of Asian economies if the lower prices are sustained below $90 level through 2015.

Most major Asian economies - including China, Japan, Korea and Thailand - would see an effective overall income boost from sustained lower oil prices, the agency said. In addition, countries with large oil import needs facing external adjustment pressures such as Indonesia and India are among the best positioned to see a positive impact on sovereign credit profiles, although the broader policy response will matter too, it added. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma, October, 2014. Photo 1: Keystone XL pipeline © CAPP / Fox News as featured on the Daily Show. Photo 2: The Democrat hopefuls and John Stewart on the Daily Show. Photo 3: John Stewart’s “Obama & the Pussycrats”, The Daily Show, November 6, 2014 © Comedy Central / Daily Show November, 2014. © Graph: Oil benchmark prices 5-day assessment October/November 2014 © Gaurav Sharma 2014.

An instructive approach to energy trading tenets

In the challenging world of energy trading, fortune favours the prepared. Whether one is brave enough (or not) comes second and not having a clear strategy would be borderline foolishness.

Given such a backdrop, almost inevitably, there are resources aplenty targeting those who feel the need to be better informed and equipped. Among the latest reference sources, industry veteran and academic Dr Iris Marie Mack’s book Energy Trading and Risk Management published by Wiley is a pretty compelling one.

The Oilholic instantly warmed up to the book barely a chapter in, struck by its practical approach, balanced tone, contextualised narrative and a genuine desire on the author’s part to define terms and methodologies for the benefit of those with a mid-tier investment knowledge base.

Furthermore, the instructive narrative seeks to bring about a holistic understanding of how energy markets work to begin with, leading on to an adequate treatment of risk, speculation and portfolio diversity tenets. The format in which Energy Trading and Risk Management is minutely sub-sectioned point to point is simply splendid. So should you wish to salami slice and pick up bits of the subject, it would serve you just as well as a cover to cover read through.

Conversely, if you are confident enough to skip the basics and go straight through to concepts and formulas, the sequential flow of text in each chapter helps you breeze through basic definitions usually quoted in boxed text on to what you are after.

Accompanying the text are charts, case studies, background briefs, notes on macro drivers and definitions at various points split into ten weighty sub-sectioned chapters in a book of around 270 pages. From contango to the modern portfolio theory, from risk management in the renewables business to mitigation in an ever changing market climate – it’s all there and duly referenced.

While the Oilholic appreciated Dr Mack's work in its entirety, a chapter on exotic energy derivatives (which follows a passage on the plain vanilla variety) stood out for this blogger. One would be happy to recommend this title to energy professionals, fellow energy analysts and those with a desire to pursue energy trading as a career pathway.

It would most definitely appeal to entrants finding their feet in the market as well as established participants wanting to refresh their thinking and methodologies. Ultimately, for every reader this title is bound to morph from being an informative and educational book at the point of first reading, to an invaluable reference source as and when subsequently needed. That makes it worthy of any energy sector professional’s bookshelf.

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© Gaurav Sharma, October, 2014. Photo: Front Cover – Energy Trading and Risk Management © Wiley Publishers, May, 2014.

A crash course in geopolitics

Supply side oil and gas analysts including this blogger, as well as traders of (physical not paper) crude oil contracts feel like tearing their hair when some speculator or the other hits the airwaves citing “risk premium”, “instability premium” or more correctly “geopolitical premium” as the pretext for going long on oil no matter how much of the crude stuff is in the pipeline.

As we are currently witnessing one of those rare moments in the oil market's history when surplus supplies and stunted demand are pretty much neutering the speculators’ geopolitical pretext, you might wonder what the fuss is all about.

Make no mistake; while the selective deployment of geopolitical sentiments in betting on the oil price has always been open to debate, the connection between the oil industry and geopolitics is undeniable. And should you need a crash course, academic Klaus Dodds has the answer.

In his contribution about geopolitics for Oxford University Press’ A Very Short Introduction series, Dodds breezes you through the subject via a concise book of just under 160 pages, split into six chapters.

When covering a subject this vast for a succinct book concept with case studies aplenty, the challenge is often about what to skip, as much as it is about what to include. The author has been brilliant in doing so via a crisp and engaging narrative.

Having enjoyed this book, which is currently in its second edition, the Oilholic would be happy to recommend it to the readers of this blog. As Dodds himself notes: “It’s essential to be geopolitical” and amen to that!

However, be mindful that it is meant to help you understand geopolitics and contextualise geopolitical influences. It is neither a weighty treatise on the subject nor was intended as such. The title itself makes that clear.

Anyone from an analyst to a GCSE student can pick it up and appreciate it as much as those in a hurry to get to grips with the subject or are of a curious disposition. Should you happen to be in this broad readership profile, one suggests you go for it, and better still keep it handy, given the times we live in!

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© Gaurav Sharma, October, 2014. Photo: Front Cover – Geopolitics: A Very Short Introduction © Oxford University Press, June 2014.

Crude prices, rouble’s rumble & EU politics

Both crude oil benchmarks are more or less staying within their ranges seen in recent weeks. That would be US$80-85 per barrel for Brent and $76-80 per barrel for WTI. ‘Short’ is still the call. 

While Russia is coping with the current oil price decline, the country’s treasury is clearly not enjoying it. However, given the wider scenario in wake of Western sanctions, the Russian rouble’s decline actually provides momentary respite on the ‘crude’ front and its subsequent free float some much needed positivity.

The currency’s fall this year against the US dollar exasperated as sanctions began to bite. While that increases the bill for imports, Russian oil producers (and exporters) actually benefit from it. There is a very important domestic factor in the oil exporters’ favour – the effective tax rate paid by them as oil prices decline falls in line with the price itself, and vice versa. While a declining rouble hurts other parts of the economy reliant on imports, it partially helps offset weaker oil prices for producers.

According to calculations by Fitch Ratings, if the rouble stabilises near about its current level and the oil prices hold steady around $85 per barrel next year, an average Russian producer should report 2015 rouble operating profits broadly in line with 2013, when oil prices averaged $109. 

“In this scenario Russian oil companies' financial leverage may edge up, especially for those producers that relied most heavily on international finance, because their hard currency-denominated debts will rise in value. Given that Fitch-rated oil companies, such as LUKOIL, GazpromNeft and Tatneft, all have relatively low leverage for their current ratings, this should not trigger rating actions,” says Dmitry Marinchenko, an Associate Director at the ratings agency.

The primary worry for Russia at the moment would be a decline in prices below $85 (as is the case at the moment) which would certainly hurt profits, as would a sudden recovery for the rouble while oil prices continue to tumble. Fitch reckons most Russian oil companies have solid liquidity and would comfortably survive without new borrowing for at least the next couple of years.

“However, they may need to reconsider their financing model should access to international debt markets remain blocked for a long time, because of sanctions and overall uncertainty over the Ukrainian crisis. Nevertheless, their fundamentals remain strong, and we expect them to maintain flat oil production and generate stable cash flows for at least the next three to four years, even with lower oil prices,” Marinchenko adds.

There is one caveat though. All market commentary in this regard, including Fitch’s aforementioned calculation, is based on the assumption that the Kremlin won’t alter the existing tax framework in an attempt to increase oil revenue takings. Anecdotal evidence the Oilholic has doesn’t point to anything of the sort. In fact, most Russian analysts this blogger knows expect broader taxation parameters to remain the same.

If deliberations over the summer at the 21st World Petroleum Congress in Moscow were anything to go by, the country was actually attempting to make its tax regime even more competitive. A lot has happened since then, not just in terms of the oil price decline but also with relation to the intensification of sanctions. Perhaps with near coincidental symmetry, both the rouble and oil prices have plummeted by 30% since the first quarter of this year, though the free float attempt has helped the currency.

The Oilholic feels the Kremlin is inclined to leave more cash with oil companies in a bid to prop up production. With none of the major producers blinking (as one noted in a recent Forbes column), the Russians didn’t either pumping over 10 million barrels per day in September. That’s their highest production level since the collapse of the Soviet Union.

For the moment, the Central Bank of Russia has moved to widen the rouble's exchange-rate corridor and limit its daily interventions to a maximum of $350 million. This followed last week's 150 basis points increase in its benchmark interest rate to 9.5%. The central bank’s idea is to ease short-term pressure on dollar reserves and counteract the negative fiscal impact of lower oil prices. Given the situation is pretty fluid and there are other factors to be taken into account, let’s see how all of this plays over the first quarter of 2015.

Meanwhile, the Russians aren’t the only ones grappling with geopolitics and domestic political impediments. We’re in the season of silly politics in wider Europe as well. The European Union’s efforts to wean itself of Russian gas remain more about bravado than any actual achievement in this regard. As one blogged earlier, getting a real-terms cut in Russian imports to the EU over the next decade is not going to be easy.

Furthermore, energy policy in several jurisdictions is all over the place from nuclear energy bans to shale exploration moratoriums, or in the UK’s case a daft proposal for an energy price freeze by the leader of the opposition Labour party Ed Miliband to counter his unpopularity. All of this at a time when Europe will need to invest US$2.2 trillion in electricity infrastructure alone by 2035, according to Colette Lewiner, an industry veteran and energy sector advisor to the Chairman of Capgemini.

“Short of nationalisation where the state would bear the brunt of gas market volatility, a price freeze would not work. In order to mitigate effects of the freeze, companies could cut infrastructural investment which the UK can ill afford or they’ll raise revenue by other means including above average prices rises ahead of a freeze,” she told this blogger in a Forbes interview.

No wonder UK Prime Minister David Cameron is concerned as Miliband's proposal has the potential to derail much needed investment. In a speech to the 2014 CBI annual conference (see right) that was heavy on infrastructure investment and the country’s ongoing tussle with EU rules, Cameron did take time out to remind the audience about keeping the climate conducive for inward investment, especially foreign direct investment, in the UK’s energy sector.

“To keep encouraging inward investment, you need consistency and predictability. That is particularly important in energy,” he said to an audience that seemed to agree.

Investment towards infrastructure and promoting a better investment climate usually goes down well with the business lobby group. However, in the current confusing climate with barely six months to go before the Brits go to the polls, keeping the wider market calm when an opponent with barmy policies, could potentially unseat you is not easy.

The Oilholic feels the PM’s pain, but is resigned to acceptance of the country’s silly election season, and yet sillier policy ideas. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo 1: Red Square, Moscow, Russia. Photo 2: UK Prime Minister David Cameron addresses the 2014 CBI Annual Conference, November 2014 © Gaurav Sharma.

Crude price, some results & the odd downgrade

We are well into the quarterly results season with oil and gas companies counting costs of the recent oil price slump on their profit margins among other things. The price itself is a good starting point. 

The Oilholic’s latest 5-day price assessment saw Brent nearly flat above US$86 per barrel at the conclusion of the weekly cycle using each Friday this month as a cut-off point (see left, click on graph to enlarge). 

Concurrently, the WTI stayed above $81 per barrel. It is worth observing the level of both futures benchmarks in tandem with how the OPEC basket of crude oils fared over the period. Discounting kicked-off by OPEC heavyweight Saudi Arabia earlier in the month, saw Iran and Kuwait follow suit. Subsequently, the OPEC basket shed over $6 between October 10 and October 24. If Saudi motives for acting as they are at the moment pique your interest, then here is one’s take in a Forbes article. Simply put, it’s an instinct called self-preservation! 

Recent trading sessions seem to indicate that the price is stabilising where it is rather than climbing back to previous levels. As the Western Hemisphere winter approaches, the December ICE Brent contract is likely to finish higher, and first contract for 2015 will take the cue from it. This year's average price might well be above or just around $100, but betting on a return to three figures early on into next year seems unwise for the moment.

Reverting back to corporate performance, the majors have started admitting the impact of lower oil prices. However, some are facing quite a unique set of circumstances to exasperate negative effects of oil price fluctuations.

For instance, Total tragically and unexpectedly lost its CEO Christophe de Margerie in plane crash last week. BP now has Russian operational woes to add to the ongoing legal and financial fallout of the Gulf of Mexico oil spill. Meanwhile, BG Group has faced persistent operational problems in Egypt but is counting on the appointment of Statoil’s boss as its CEO to turn things around.

On a related note, oilfield services (OFS) companies are putting on a bullish face. The three majors – Baker Hughes, Halliburton and Schlumberger – have all issued upbeat forecasts for 2015, predicated on continued investment by clients including National Oil Companies (NOCs).

In a way it makes sense as drilling projects are about the long-term not the here and now. The only caveat is, falling oil prices postpone (if not terminate) the embarkation of exploration forays into unconventional plays. So while the order books of the trio maybe sound, smaller OFS firms have a lot of strategic thinking to do.

Nonetheless, we ought to pay heed to what the big three are saying, notes Neill Morton, analyst at Investec. “They have unparalleled global operations and unrivalled technological prowess. If nothing else, they dwarf their European peers in terms of market value. As a result, they have crucial insight into industry activity levels. They are the ‘canaries in the coal mine’ for the entire industry. And what they say is worth noting.”

Fair enough, as the three and Schlumberger, in particular, view the supply and demand situation as “relatively well balanced”. The Oilholic couldn’t agree more, hence the current correction in oil prices! The ratings agencies have been busy too over the corporate results season, largely rating and berating companies from sanctions hit Russia.

On October 21, Moody's issued negative outlooks and selected ratings downgrade for several Russian oil, gas and utility infrastructure companies. These include Transneft and Atomenergoprom, who were downgraded to Baa2 from Baa1 and to Baa3 from Baa2 respectively. The agency also downgraded the senior unsecured rating of the outstanding $1.05 billion loan participation notes issued by TransCapitalInvest Limited, Transneft's special purpose vehicle, to Baa2 from Baa1. All were given a negative outlook.

Additionally, Moody's changed the outlooks to negative from stable and affirmed the corporate family ratings and probability of default ratings of RusHydro and Inter RAO Rosseti at Ba1 CFR and Ba1-PD PDR, and RusHydro's senior unsecured rating of its Rouble 20 billion ($500 million) loan participation notes at Ba1. Outlook for Lukoil was also changed to negative from stable.

On October 22, Moody's outlooks for Tatneft and Svyazinvestneftekhim (SINEK) were changed to negative. The actions followed weakening of Russia's credit profile, as reflected by Moody's downgrade of the country’s government bond rating to Baa2 from Baa1 a few days earlier on October 17.

Meanwhile, Fitch Ratings said the liquidity and cash flow of Gazprom (which it rates at BBB/Negative) remains strong. The company’s liquidity at end-June 2014 was a record RUB969 billion, including RUB26 billion in short-term investments. Gazprom also reported strong positive free cash flows over this period.

“We view the record cash pile as a response to the US and EU sanctions announced in March 2014, which have effectively kept Gazprom, a key Russian corporate borrower, away from the international debt capital markets since the spring. We also note that Gazprom currently has arguably the best access to available sources of funding among Russian corporate,” Fitch said in a note to subscribers.

By mid-2015, Gazprom needs to repay or refinance RUB295 billion and then another RUB264 billion by mid-2016. Its subsidiary Gazprom Neft (rated BBB/Negative by Fitch) is prohibited from raising new equity or debt in the West owing to US and EU sanctions, in addition to obtaining any services or equipment that relate to exploration and production from the Arctic shelf or shale oil deposits.

On the other hand, a recent long term deal with the Chinese should keep it going. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma, October, 2014. Graph: Brent, WTI and OPEC Basket prices for October 2014 © Gaurav Sharma, October, 2014.