Oil oversupply has triggered risk premium fatigue

The Oilholic reckons it will take at least another six months in the New Year to ease the current oil oversupply glut. More so, as OPEC is highly likely to maintain its current production level, according to initial conjecture here in Vienna, Austria with the latest oil ministers’ summit currently underway.

That would probably take us to somewhere around June 2016, when we’ll see excess supply falling to somewhere in the region of 1 million barrels per day (bpd). Be that as it may, even such a decline might not be enough to bring the so-called risk or geopolitical premium into play. 

Last week, offered a clear case in point when the Turkish Air Force brought down a Russian fighter jet. Both countries are significant players in the oil and gas world – Turkey, is a custodian of the key shipping artery of the Bosphorus, and Russia, is the world’s leading oil and gas producer.

Yet, an oil futures "rally" in wake of the incident barely lasted two sessions and a few dollars, before oversupply sentiment returned to dictate market direction as per the current norm. Furthermore, both Brent and WTI futures are going sideways in the $40-45 per barrel range, as has been the case of late.

Flashpoints in the oil and gas world haven’t disappeared. Nigeria, Libya, West’s relations with Russia and Iraq are broadly where they were, if not worse. In fact, situation in the wider Middle East is pretty dire. Yet, the risk premium - so prevalent in the oil trade - is more or less nonexistent in a market struggling to park its barrels.

That will remain the case until excess supply falls to around 700,000 to 800,000 bpd. Even beyond the first half of 2016, few expect a dramatic uptick in oil prices, using Brent as a global proxy benchmark. At Fitch Ratings’ recent London Energy Seminar, this blogger found himself in the company of several experts who agreed that $60-level is unlikely to be capped before the end of 2016.

Alex Griffiths, Head of Natural Resources and Commodities at Fitch Ratings, Tim Barker, Head of Credit Research at Old Mutual Global Investors, Julian Mylchreest, Global Head of Energy at Bank of America Merrill Lynch, and Mutlu Guner, Executive Director at Morgan Stanley, all agreed there is little around to instil confidence in favour of a fast uptick above $60 being on cards within 12 months time. 

Moving away from the oil price, Genscape Oil Editor David Arno’s thoughts on the impact of Keystone XL’s rejections by the Obama administration, chimed with yours truly. Rail freight companies would undoubtedly be the biggest beneficiaries. In his blog post following the decision last month, Arno also felt denial of the pipeline provides rail shippers with “at least a year and a half more of comfort that Canadian rail opportunities will be needed.”

Finally, a couple of notes from Moody’s are worth flagging. The agency recently changed Kinder Morgan's outlook to negative from stable. Senior Vice-President Terry Marshall said the negative outlook reflects Kinder Morgan's increased business risk profile and additional pressure on its already high leverage that will result from its agreement to increase ownership in Natural Gas Pipeline Company, a distressed company. 

On November 30, Kinder Morgan announced an agreement to increase its ownership in NGPL of America to 50% from 20% for approximately $136 million. Brookfield Infrastructure Partners will own the remaining 50%. Proportionate consolidation of NGPL's debt will add about $1.5 billion to KMI's consolidated debt. NGPL's trailing twelve month September 30, 2015 EBITDA was $273 million (gross).

Moving on to state-owned crude giants, Moody's also said China National Petroleum Corporation's (CNPC) proposal to sell some of its pipeline assets is credit positive, as profits and proceeds from the sale will partially offset negative impact from low crude oil and gas prices and help preserve its financial profile during the current industry downturn.

However, Moody’s said the sale has no immediate impact on its ratings and outlook as the benefits “are marginal, given CNPC's extremely large revenue and asset size.” Nonetheless, the ratings agency expects sale proceeds to help CNPC fund the gap between its capital expenditure and operating cash flow and therefore lower its reliance on additional debt to fund its growth.

Finally, the rating agency also downgraded Pemex’s global foreign currency and local currency ratings to Baa1 from A3. Simultaneously, Moody's lowered Pemex's baseline credit assessment (BCA), which reflects its standalone credit strength, to ba3 from ba1.

The actions were prompted by Moody's view that the company's current weak credit metrics will "deteriorate further in the near to medium term. The outlook on all ratings was changed to negative." That’s all for the moment folks from Vienna folks, as the Oilholic finds his bearings at yet another OPEC summit. Plenty more from here shortly! In the interim, keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: OPEC Signage © Gaurav Sharma / Oilholics Synonymous Report.

Going sideways: Brent & WTI lurk above $40

The market’s huffed and puffed, issues and influences have come and gone but both oil benchmarks – Brent and WTI have done little to escape their current ranges by more than $2 per barrel.

What’s more, if you outstrip the week’s volatility, on a five-day week-on-week basis to Friday, November 20, Brent ended a mere ten cents lower while WTI rose 67 cents. In fact we've been going sideways for over a month now (see graph, above left, click to enlarge).

Expect more of this for some time yet, as oversupply - the overriding market sentiment that has prevailed for much of 2015 - dominates market chatter and will continue to do so for at least another two quarters. With as much as 1.3 to 1.5 million barrels per day (bpd) of surplus crude oil regularly hitting the market, there’s little around by way of market influence to dilute the impact of oversupply.

The OPEC ministers’ meeting, due early December, is the next major event on the horizon, but the Oilholic does not expect the producers’ collective to announce a production cut. Since, all players are entrenched in their positions in a bid to keep hold of market share, it would be mighty hard to get all 12 players to agree to a production cut, more so as the impact of such a cut remains highly questionable in terms of lending meaningful (and sustainable) support to prices.

Away from the direction of the oil price, yet on a related note, Fitch Ratings unsurprisingly expects the macro environment for EMEA oil and gas majors to remain challenging in 2016. “Crude prices are unlikely to recover (soon), while refining margins will moderate from the record 2015 levels. However, cost deflation should become more pronounced and help to cushion the majors' profits,” the agency noted.

While the sector outlook is viewed by Fitch as “generally negative”, the rating outlook is "stable"  as the agency does not expect sector-wide negative rating actions. “Credit metrics of most players will remain stretched in 2016, but this cyclicality is a known feature of companies in this industry, and we will only take negative action where we expect the current downturn to permanently impair companies' credit profiles,” it added. 

That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Chart: Oil benchmark prices Jan to YTD 2015 © Gaurav Sharma / Oilholics Synonymous Report, November 2015.

Upstream woes denting midstream prospects

In wake of weak oil prices, the upstream side of this ‘crude’ world is going through the worst cyclical downturn in years. The Oilholic’s most conservative of estimates sees the situation staying the way it is, if not worsening, for at least another 15 months.

In fact, one feels fresh investment towards exploration and production (E&P) could remain depressed for as much as 18 to 24 months. Both Fitch Ratings and Moody’s have negative outlooks on the upstream industry, as 2015 looks set to end as the year with the lowest average Brent price since 2005.

National Oil Companies (NOCs), bleeding cash reserves in order to stay in the game and put rivals out of it, are maximising existing onstream capabilities. Meanwhile, International Oil Companies (IOCs) looking to cut costs, are delaying final investment decisions on E&P projects at the moment.

As one wrote on Forbes, Big Oil is gearing up for a $60 breakeven oil price for the next three years and capital expenditure cuts of 10%-15% in 2016 with far reaching consequences. Of course, the pain will extend well beyond the obvious linear connection with oilfield services (OFS) and drilling companies.

Global midstream growth is getting hammered by E&P cuts too, according anecdotal evidence from reliable contacts at advisory firms either side of the pond. Most point to a Moody’s subscriber note issued on November 6, that set out the ratings agency’s stable outlook on the US midstream sector, but also suggested that industry EBITDA [Earnings before interest, taxes, depreciation, and amortisation] growth will struggle to cap 5% in 2016.

Andrew Brooks, Senior Analyst at Moody’s, noted: "For the past five years, the midstream industry has rapidly ramped up investment in infrastructure projects to serve the E&P industry's extensive investment in US oil and gas shale resource plays. 

"But now deep cuts in the E&P sector and continued low oil and natural gas prices will limit midstream spending through at least early 2017."

There was a sense in Houston, Texas, US when the Oilholic last went calling in February and again in May this year that midstream companies have already built much, if not most, of the infrastructure required for US shale production. Therefore it is only logical for ratings agencies and analysts to suggest incremental EBITDA growth will slow as fewer new shale and tight oil assets go into service. 

Only thing in midstream players' favour over the next, or quite possibly two, lean fiscal year(s) is the linkage they provide between producers and downstream markets. In Moody’s view this need would mitigate some of the risk of slower growth, even if gathering and processing margins remain at cyclical lows.

"And the midstream sector should be more insulated from contract renegotiation risk with upstream operators having less flexibility to force price concessions on midstream services companies than they have had with OFS firms and drillers," Brooks concluded.

So all things considered, midstream is perhaps not as deeply impacted as E&P, OFS segments of the oil and gas business, but suffering it most certainly is. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Pipeline signage, Fairfax, Virginia, USA © O. Louis Mazzatenta / National Geographic

Keystone XL farce and rail freighters' smiles

The Obama administration’s long anticipated rejection of the Keystone XL project – an extension [from Hardisty, Alberta to Port Arthur, Texas] to the already existing transnational pipeline between Canada and the US – on 5 November hardly came as a surprise to the oil and gas industry. But is it finally the end of the saga? Not quite, only for the Obama White House staff. 

Once a new US president is in, the project sponsors can, should they choose to do so (and is quite likely they will), launch a fresh application with amendments and new proposals. Quite frankly, the development might be new but the talking points aren’t.

The saga has dragged on and on for seven years and descended into a farce that even provided material for comedian Jon Stewart on more than one occasion (click here). However jokes apart whatever side of the argument you are, that the whole thing got dragged into the quagmire of US politics in the way that it did, is no laughing matter.

This blogger has always maintained that the project's rejection is not some sort of a fatal blow to Canada’s oil and gas industry, but rather an inconvenience and one that has arrived at a time of wider difficulties in the market. Several analysts in Canadian financial circles concur and rail freight companies probably cheered the rejection, despite their own problems with safety related issues and incidents when it comes to moving crude oil.

Of course, moving crude by rail to the Gulf Coast costs almost double per barrel in the region of $7.00 to $11, but for some it won't be a choice. Moving crude by rail is also probably twice as much environmentally unfriendly, something few of the pipeline extension's naysayers appear to be touching on.

There will need to be some medium term adjustments. As the Oilholic noted in 2013, TransCanada is already forging ahead with a West to East pipeline corridor aimed at bringing domestic crude in meaningful volumes from Alberta to Quebec and New Brunswick by 2017 and 2018 respectively. Additionally, considerable amount of lobbying is afoot in terms of looking towards Eastern markets, especially China (despite the recent oil price decline), via British Columbia’s coastline. 

As for the near term, Moody’s expects currently available pipeline and rail transportation to meet anticipated production growth through to the fourth quarter of 2017.

“Post 2017, we expect that as oil egress from Canada becomes constrained, additional rail capacity will fill the void until one of the three proposed major domestic pipelines – Trans Canada's Energy East, Kinder Morgan's Trans Mountain expansion or Enbridge's Northern Gateway – is approved and built,” said Moody’s analyst Terry Marshall. 

There already exists about 550,000 barrels per day (bpd) of unused rail capacity in Western Canada at present, according to the Canadian Association of Petroleum Producers' (CAPP) data. That’s over and above the approximate 200,000 bpd of capacity that will be used to ship oil in 2015, and few, including Moody’s analysts, are in any doubt that moving crude by rail will rise in all likelihood.

Rail freighters' joy is also likely to be further prolonged by the current political climate in Canada. With the oil and gas industry friendly Stephen Harper administration having been voted out after nine years in office, it is all but guaranteed the new Liberal Party Government's pre-election promise to “rework the domestic pipeline approval process” will go ahead.

Not quite clear on the minutiae and what this would entail until details are published and then put to the Canadian parliament later down the year. However, having seen plenty of such overtures in numerous jurisdictions, the Oilholic feels an increase in cost and timescale of the regulatory process is highly likely, alongside the escalating cost of environmental compliance in Canada. 

All of this comes at a time when Canadian oil exploration and production companies could well have done without it. A tough few years are on the horizon. That’s all for the moment folks! Keep reading, keep it ‘crude’! 

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© Gaurav Sharma 2015. Photo: Railway oil tankers outside of Calgary, Alberta, Canada © Gaurav Sharma, March 2011.

The enduring legend of El Dorado

Having spent much of one’s career dabbling in the commodities sphere in general and the crude oil market in particular, the Oilholic, while not claiming to have any doctorate in gold matters, is nonetheless fascinated by the unique appeal of the shiny yellow metal passed down the ages, stretching from ancient to the modern world. 

Gold, one humbly suggests is the ultimate fool’s commodity. Excepting industrial use, it is bought and sold for one purpose alone – selling for more than the purchase price coupled with a lust in many, perhaps all, cultures for wanting more of the stuff. This lust triggered the desire to colonise others and several gold rushes in the history of mankind. While California’s Gold Rush of the late 1840s is the stuff of legends, human history is littered with other gold rushes.

However one enduring legend, born here in Colombia, transcends all others and epitomises this lust – that’s the myth (or is it) of El Dorado. The Oilholic, out of morbid curiosity and certainly not wanting to miss out on Bogota’s splendid Museo del Oro, decided to dedicate his entire last day in South America towards probing the local legend that’s all too international. Scholars in the Colombian capital say that while toughing it out with the Incas in the 1530s, the Spanish Empire and its conquistadors started hearing tales about a tribe of natives high in the Andes Mountains where gold was much in abundance.

When the tales reached Spanish royalty, conquistador Gonzalo Jiménez de Quesada was dispatched to lead an expeditionary force into the Colombian highlands. Upon gaining their first territorial victory in 1537, among the first pieces of local intelligence to reach the ears of Jimenez de Quesada’s soldiers was an ever more detailed narrative about that "Land of Gold."

Conquered Musica Indians told the Spanish that on the shores of Laguna de Guatavita or Lake Guatavita (35 miles northwest of modern Bogota) once lived a chieftain who periodically covered himself in gold dust during religious ceremonies and festivities, and then dived from a raft into the lake shedding the riches, as depicted here in an ancient artwork on display at the Museo del Oro (see left). On each occasion, natives then threw gold, emeralds and precious jewels into the lake to appease a mythical god that lived underwater.

Jiménez de Quesada’s men were told the ceremonies ended by turn of the 15th century, when the chieftain was killed and his subjects conquered by another Musica tribe some 50 years before their arrival. Part convinced by the tale, seeing locals displaying a liking for gold trinkets, and the promise of untold riches, the Spanish named the late Musica chieftain “El Dorado” or “The Golden One” and set about finding the lake.

With their conquest of the Colombian highlands complete, the Spanish finally located Lake Guatavita having dedicated lives, limbs and their local loot to the cause. The Spanish Crown ordered the lake to be drained by “all resourceful means”. Given the year was 1545, with all the resources of the time, Jiménez de Quesada’s men could only lower the water level to dabble at the edges of the lake.

A few hundred pieces of gold were indeed found, but Colombian and Spanish historical archives suggest there was no mass discovery. Furthermore, even if all of the gold was in deeper waters of Lake Guatavita – it was beyond human reach at the time. After the death of Jiménez de Quesada in 1579, businessman Antonio de Sepúlveda took on the mantle of draining Lake Guatavita.

In their previous attempt, Spanish soldiers could only muster three metres worth of drainage, but de Sepúlveda’s men managed 20 metres. At a great cost and further loss of lives, they found more gold but nothing on the scale the Spanish crown was hoping. 

Meanwhile, the legend of El Dorado and riches of the “new world” reached other European colonial powers. The English, Dutch and Portuguese all vowed to beat the Spanish to it. Better still all three, and even the Spanish at a later stage, concurred from the lack of success at Lake Guatavita that the promised gold paradise must be “somewhere else in Northern half of South America”, as it was the part of the continent they had encountered natives with a penchant for gold, and a breathtaking array of ornaments.

The legend of El Dorado got the era’s poster child in the form of adventurer Sir Walter Raleigh; trusted lieutenant of Queen Elizabeth I of England and purveyor of tobacco, another commodity unknown to his homeland before he introduced it from one of his many travels. 

Like his colonial peers, Sir Walter failed in his attempts to find the Land of Gold (that he often confusingly labelled "City of Gold") first in 1595 and then 1617, which in his opinion was somewhere in modern Guiana. Instead, he lost both his son (Watt Rayleigh in battle) and his head, having miffed King James I for starting a skirmish with the Spanish against the English monarch’s wishes.

Yet Sir Walter’s conjecture about the existence of the Land of Gold in a widely circulated book, described as, and subsequently proven to be inflated nonsense, only fuelled the legend further. And so went the idiocy associated with it driven by lust. Countless more lives, limbs and ironically gold from colonial powers' treasuries were lost across South and Central America in the quest for El Dorado for another 300 years! Published in 1849, Edgar Allan Poe’s poem – Eldorado – just about summed it up:

“Gaily bedight, a gallant knight, in sunshine and in shadow,
Had journeyed long, singing a song, in search of Eldorado.

But he grew old, this knight so bold, and o'er his heart a shadow,
Fell as he found, no spot of ground, that looked like Eldorado.

And as his strength, failed him at length, he met a pilgrim shadow
"Shadow," said he, "Where can it be - this land of Eldorado?"

"Over the Mountains of the Moon, down the Valley of the Shadow,
Ride, boldly ride, the shade replied – "If you seek for Eldorado!" 

The last such recorded attempt, a source of much disdain in Bogota, was in 1898 when British expatriate Hartley Knowles’ company – Contractors Ltd – drained the Lake Guatavita so low that only mud and slime was left rendering it impossible to explore when sludgy. Subsequently, the mud baked in Colombian sunshine all that was left was nature’s version of concrete.

Having wasted millions and destroyed the area, all the nutcases could find were a few trinkets that fetched £500 at a Sotheby’s auction back then, and can be seen today at the British Museum! A much more impressive collection, should gold be your thing, can be found at the Museo del Oro (see examples on the right). 

Thankfully, Lake Guatavita was declared a protected area in 1965. Nature and rainfall restored some of its lost beauty in subsequent decades, after years of greed and pillaging ruined it. Private salvage, let alone draining the Lake, are now illegal and punishable by a custodial sentence, one is informed.

And well, no gold discovery on the scale of 15th Century projections put forward by Sir Walter and others was ever made. Yet the El Dorado legend and mankind’s attraction for the shiny yellow metal remains undiminished. Each time another asset class feels the squeeze or a currency gets shorted, headlines about “investors plying into gold” emerge with every price decline or uptick duly reported.

From Hollywood blockbusters to the Indian Wedding Season, star-crossed lovers’ offerings to central bank vault deposits, gold and its lure is all around us. Mankind it seems has never stopped looking for El Dorado in some way, shape or form!

On that note, the Oilholic must board flight AA1122 from his El Dorado; Bogota’s international airport in the small hours of the morning. That’s all from South America folks. It’s been a fascinating few weeks in this vibrant continent. Next stop Dallas, and then on to London Heathrow. Adiós América del Sur; adios Colombia! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo I: Museo del Oro, Bogota, Colombia, Photo II: El Dorado legend gold sculpture at Museo del Oro, Bogota. Photo III: Ancient gold ornaments at Museo del Oro. Photo IV: El Dorado International Airport, Bogota, Colombia © Gaurav Sharma, October 2015.