Sunday, April 19, 2015

The ostentatious & those 'crude' percentages

The Oilholic finds himself gazing at the bright lights of Las Vegas, Nevada once again after a gap of five years. This gambling hub's uniqueness is often the ostentatious and loud way it goes about itself. The oil market had its own fair share of loud and exaggerated assumptions last week.

Sample these headlines – “Brent spikes to 2015 high”, “Oil markets rally as shale production drops”, “Brent up 10%.” There is some truth in all of this, and the last one is technically correct. Brent did close last Friday up 10.03% relative to the Friday before, while WTI rose 8.41% and OPEC's basket of crude oil(s) rose 10.02% over a comparable period (see graph blow right hand corner).

Bullish yes, bull run nope! This blogger believes market fundamentals haven't materially altered. There is still too much crude oil out there. So what's afoot? Well, given that one is in a leading gambling hub of world, once 'the leading one' by revenue until Macau recently pinched the accolade, it is best to take a cue from punters of a different variety – some of the lot who've been betting on oil markets for decades out of the comfort of Nevada, but never ever turn up at the end of a pipeline to collect black gold.

Their verdict – those betting long are clutching at the straws after enduring a torrid first quarter of the year. Now who can blame the wider trading community for booking a bit of profit? But what's mildly amusing here is how percentages are interpreted by the media 'Las Vegas size', and fanned by traders "clutching at the straws", to quote one of their lot, 'Las Vegas style'.

For the moment, the Oilholic is sticking one's 2015 forecast – i.e. a mid-year equilibrium Brent price of $60 per barrel, followed by a gradual climb upwards to $75 towards the end of the year, if we are lucky and media speculation about the Chinese government buying more crude are borne out in reality. The Oilholic remains sceptical about the latter.

Since one put the forecast out there, many, especially over the last few weeks wrote back wondering if this blogger was being too pessimistic. Far from it, some of the oldest hands in the business known to the Oilholic, including our trader friends here in Las Vegas, actually opine that yours truly is being too optimistic!

The reasons are simple enough – making assumptions about the decline of US shale, as some are doing at the moment is daft! Make no mistake, Bakken is suffering, but Eagle Ford, according to very reliable anecdotal evidence and data from Drillinginfo, is doing pretty well for itself. Furthermore, in the Oilholic’s 10+ years of monitoring the industry, US shale explorers have always proved doubters wrong.

Beyond US shores – both Saudi and Russian production is still marginally above 10 million bpd. Finally, who, alas who, will tell the exaggerators to tackle the real elephant in the room – the actual demand for black gold. While the latter has shifted somewhat based on evidence of improved take-up by refiners as the so called “US driving season” approaches, emerging markets are not importing as much as they did if a quarter-on-quarter annualised conversion is carried out.

Quite frankly, all eyes are now on OPEC. Its own production is at a record high; it believes that US oil production won’t be at the level it is at now by December and its own clout as a swing producer is diminished (though not as severely as some would claim).

Meanwhile, Russian president Vladimir Putin declared the country's financial crisis to be over last week, but it seems Russia’s GDP fell between 2% to 4% over the first quarter of this year. The news caused further rumbles for the rouble which fell by around 4.5% last time one checked. The Oilholic still reckons; Russian production cannot be sustained at its current levels.

That said, giving credit where it is due – Russians have defied broader expectations of a decline so far. To a certain extent, and in a very different setting, Canada too has defied expectations, going by separate research put out by BMO Capital and the Canadian Association of Petroleum Producers. Fewer rigs in Canada have – again inserting the words 'so far' – not resulted in a dramatic reduction in Canadian production.

Finally, here's an interesting report from the Weekend FT (subscription required). It seems BP's activist shareholders have won a victory by persuading most shareholders to back a resolution obliging the oil major to set out the potential cost of climate change to its business. As if that's going to make a difference - somebody tell these activists the oil majors no longer control bulk of the world's oil – most of which is in the hands of National Oil Companies unwilling to give an inch!

That's all for the moment folks from Las Vegas folks, as the Oilholic turns his attention to the technology side of the energy business, with some fascinating insight coming up over the next few days from here. In the interim, keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Paris Casino on the Las Vegas Strip, Nevada, USA © Gaurav Sharma, April 2015. Graph: Oil benchmark prices - latest Friday close © Gaurav Sharma, April 17, 2015.

Thursday, April 16, 2015

Perspectives on a changing energy landscape

That we're in the midst of a profound change in the energy markets in unquestionable. However, fossil fuels still remain the default medium of choice. Within those broader confines, the oil market is seeing a supply-driven correction of the sort that probably occurs once in a few decades.

Meanwhile, peak oil theorists are in retreat following in the footsteps of peak coal theorists last heard of during a bygone era. However, what does it all mean for the wider energy spectrum, where from here and what are the stakes?

Authors and industry experts Daniel Lacalle and Diego Parrilla have attempted to tackle the very questions in their latest work The Energy World is Flat: Opportunities from the end of peak oil (published by Wiley).

In a way, the questions aren’t new, but scenarios and backdrops evolve and of course have evolved to where we currently are. So do the answers, say Lacalle and Parrilla as they analyse the past, scrutinise the present and draw conclusions for future energy market pathways.

In this book of 300 pages, split by 14 interesting chapters, they opine that the energy world is flat principally down to "ten flatteners" along familiar tangents such as geopolitics, reserves and resources, overcapacity, demand displacement and destruction, and of course the economics of the day. 

Invariably, geopolitics forms the apt entry-point for the discussion at hand and the authors duly oblige. As the narrative subtly moves on, related discussions touch on which technologies are driving the current market changes, and how they affect investors. Along the way, there is a much needed discussion about past and current shifts in the energy sphere. You cannot profit in the present, unless you understand the past, being the well rounded message here.

“New frontiers” in the oil and gas business, today’s “unconventional” becoming tomorrow’s “conventional”, and resource projections are all there and duly discussed.

To quote the authors, the world has another 1.5 trillion barrels of proven plus probable reserves that are both technically and economically viable at current prices and available technology, and another 5 trillion-plus barrels that are not under current exploration parameters but might be in the future. Furthermore, what about the potential of methane hydrates?

Politics, of course, is never far from the crude stuff, as Lacalle and Parrilla note delving into OPEC shenanigans and the high stakes game between US shale, Russian and Saudi producers leading to the recent supply glut – a shift with the potential to completely alter economics of the business.

What struck the Oilholic was how in-depth analysis has been packaged by the authors in an engaging, dare one say easy reading style on what remains a complex and controversial discussion. For industry analysts, this blogger including, it’s a brilliant and realistic assessment of the state of affairs and what potential investors should or shouldn’t look at.

The Oilholic would be happy to recommend the book to individual investors, energy economists, academics in the field and of course, those simply curious about the general direction of the energy markets. Policymakers might also find it well worth their while to take notice of what the authors have put forward.

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© Gaurav Sharma 2015. © Photo: Front Cover – The Energy World is Flat: Opportunities from the end of peak oil © Wiley Publishers, Feb, 2015.

Wednesday, April 08, 2015

BG Group’s been ‘Shell-ed’

In case you have been away from this ‘crude' planet and haven’t heard, oil major Royal Dutch Shell has successfully bid for its smaller FTSE 100 rival BG Group in a cash and shares deal valuing the latter at around £47 billion (US$70 billion).

While it’s early days into the current calendar year, the deal, subject to approval by shareholders, could be one of the biggest of 2015 producing a company with a combined value of over £200 billion.

For the Anglo-Dutch oil major, BG Group's acquisition would also add 25% to its proven oil and gas reserves and 20% to production capacity, along with improved access to Australian and Brazilian prospects. BG Group shareholders will own around 19% of the combined group following the deal.

BG Group's new chief executive Helge Lund, who only took up the post last month, will remain with the company while the deal is being worked on. However, he is expected to leave once it is completed walking away with what many in the City reckon to be a £25 million golden goodbye. The Oilholic thinks that’s not too bad a deal for what would come to little over three months of service.

BG Group shareholders, who’ve had to contend with a lacklustre share price for the last 12 months given the company’s poor performance, can also expect a decent windfall should they choose to sell. The bid values BG at around 1,350p per share; a near 50% premium to its closing price of 910.4p on Tuesday. If they decide to hold on to their shares, they’d be likely to receive an improved "Shell of a dividend" from a company that has never failed to pay one since 1945.

Shell chief executive Ben van Beurden said, "Bold, strategic moves shape our industry. BG and Shell are a great fit. This transaction fits with our strategy and our read on the industry landscape around us."

The market gave the news a firm thumbs up. Investec analyst Neill Morton said BG’s long-suffering shareholders have finally received a compelling, NAV-based offer while Shell’s bid was arguably “20 years” in the making.

“We agree that BG’s asset base is better suited to a larger company, but the economics require something approaching Shell’s $90/bl assumption. Consequently, we do not expect a rival bid and are wary of this catalysing a flurry of copycat deals. But we are also mindful that investment bankers can be very persuasive! We suspect Shell aims to re-balance dividends versus buybacks over the long-term. This could imply lower dividend growth,” he added.

As for the ratings agencies, given that the deal completion is scheduled for H1 2016, and quite possibly earlier given limited regulatory hurdles, Fitch Ratings placed Shell's ratings on Rating Watch Negative (RWN) and BG Group's ratings on Rating Watch Positive (RWP).

The agency aims to resolve the Rating Watches on both companies pending the successful completion of the potential transaction and “once there is greater clarity with regard to Shell's post-acquisition strategy and potential synergy effects.” We’re all waiting to hear that, although of course, as Fitch notes – Shell's leverage will increase.

“Our current forecasts suggest that the company's funds from operations (FFO) adjusted net leverage will increase from 1.5x at end-2014 to around 2x in 2015-2017 based on conservative assumptions around the announced $30 billion divestment programme and execution of the announced share buybacks from 2017.”

Moody’s has also affirmed its Aa1 rating for Shell, but quite like its peers changed the company’s outlook to negative in the interim period pending the completion of the takeover. Meanwhile, some City commentators have speculated that Shell's move might trigger a wave of M&A activity in the oil and gas sector.

However, the Oilholic remains sceptical about such a rise in M&A. In fact, one is rather relieved that the Shell and BG Group saga would cool nonsensical chatter about a possible BP and Shell merger (oh well...there's always ExxonMobil).

They’d be the odd buyout or two of smaller AiM-quoted independents, but bulk of the activity is likely to remain limited to asset and acreage purchases. Of course, consolidation within the sector remains a possibility, but we are too early into a cyclical downturn in the oil market for there to be aggressive overtures or panic buying. However, 2016 could be a different matter if, as expected, the oil price stays low.

Moving away from the Shell and BG show, here is one’s take via a Forbes column on how oil markets should price in the Iran factor, following the conclusion of pre-Easter nuclear talks between the Iranians and five permanent members of UN Security Council plus Germany.

Additionally, here’s another one of the Oilholic’s Forbes posts on why a decline in US shale activity is not clear cut. As it transpires, many shale producers are just as adept at coping with a lower oil price as any in the conventional industry. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Vintage Shell petrol pump, San Francisco, USA © Gaurav Sharma

Tuesday, April 07, 2015

Oil storage, Chinese imports & Afren’s CEO

When the oil price is rocky, it seems storage in anticipation of better days is all the rage. Afterall, it does take two to play contango, as the Oilholic recently opined in a Forbes column. But leaving those wanting to play the markets by the side for a moment, wider industry attention is indeed turning to storage like never before.

We are told the US hub of Cushing, Oklahoma has never had it so good were we to rely on Genscape’s solid research on what’s afoot. In trying times, the industry turns to the most economical onshore storage option on the table. For some, actually make that many, Cushing is such a port of call.

As of February-end, Genscape says 63% of Cushing’s storage capacity has already been utilised. Capacity has never exceeded 80%, since Genscape began monitoring storage at Cushing in 2009. So were heading for interesting times indeed!

Meanwhile, the country now firmly established as the world’s top importer of crude oil – i.e. China – might well be forced to import less owing to shortage of storage capacity! Well established contacts in Shanghai have indicated to this blogger that in an era of low prices, Chinese policymakers were strategically stocking up on crude oil.

With Chinese economic data being less than impressive in recent months, it probably explains where a good portion of the 7.1 million barrels per day (bpd) imported by the country in January and February went. However, now that available storage is nearly full, anecdotal evidence suggests Chinese oil imports are going to drop off.

Import volumes for April are not likely to be nearly as strong. As for the rest of the year, the Oilholic expects Chinese imports to stay flat. Furthermore, Barclays analysts believe putting faith in China’s economic growth to support oil prices would be “premature” at best, with the country undergoing structural changes.

On a related note, lower oil prices will also slow the revenue growth of Chinese oilfield services (OFS) companies as their upstream counterparts continue to cut capex. Putting it bluntly, Chenyi Lu, Senior Analyst at Moody’s noted: "In addition to the impact on revenues, Chinese OFS companies will also see their margins weaken over the next two years as their exploration and production customers negotiate lower rates."

Finally, before yours truly takes your leave, it seems the beleaguered London-listed independent upstart Afren has finally named a new CEO following its boardroom debacle. Industry veteran Alan Linn will take-up his post as soon as the company’s “imminent” $300 million bailout is in place. We wish him all the luck, given his task at hand. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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

Friday, March 20, 2015

Oil prices, OPEC shenanigans & the North Sea

It has been a crude fortnight of ups and downs for oil futures benchmarks. Essentially, supply-side fundamentals have not materially altered. There’s still around 1.3 million barrels per day (bpd) of crude oil hitting the markets in excess of what’s required.

Barrels put in storage are at an all time high, thanks either to those forced to store or those playing contango. US inventories also remain at a record high levels. 

However, the biggest story in the oil market, as well as the wider commodities market, is the strength of the US dollar. All things being equal, the dollar’s strength is currently keeping both Brent and WTI front month futures contracts at cyclical lows. The past five trading days saw quite a few spikes and dives but Friday’s close came in broadly near to the previous week’s close (see graph on the left, click to enlarge).

In the Oilholic’s opinion, a sustained period of oil prices below $60 is not ideal for unconventional exploration. Nonetheless, not all, but a sufficiently large plethora of producers just continue to grin and bear it. While that keeps happening, and the dollar remains strong, oil prices will not find support. We could very well be in the $40-60 range until June at the very least. Unless excess supply falls from 1.3 million bpd to around 750,000 bpd, it is hard to see how the oil price will receive support from supply constriction. 

Additionally, Fitch Ratings reckons should Brent continue to lurk around $55, credit ratings of European, Middle Eastern and African oil companies would take a hit. European companies that went into the slump with stretched credit profiles remain particularly vulnerable.

In a note to clients, Fitch said its downgrade of Total to 'AA-' in February was in part due to weaker current prices, and the weaker environment played a major part in the downgrade and subsequent default of Afren.

"Our investigation into the effect on Western European oil companies' credit profiles with Brent at $55 in 2015 shows that ENI (A+/Negative) and BG Group (A-/Negative) were among those most affected. Both outlooks reflect operational concerns, ENI because of weakness in its downstream and gas and power businesses, BG Group due to historical production delays. Weaker oil prices exacerbate these problems," the agency added.

Of course, Fitch recognises the cyclical nature of oil prices, so the readers need not expect wholesale downgrades in response to a price drop. Additionally, Afren remains an exception rather than the norm, as discussed several times over on this blog.

Moving on, the Oilholic has encountered empirical and anecdotal evidence of private equity money at the ready to take advantage of the oil price slump for scooping up US shale prospects eyeing better times in the future. For one’s Forbes report on the subject click here. The Oilholic has also examined the state of affairs in Mexico in another detailed Forbes report published here.

Elsewhere, a statement earlier this week by a Kuwaiti official claiming that there is no appetite for an OPEC meeting before the scheduled date of June 5, pretty much ends all hopes of the likes of Nigeria and Venezuela in calling an emergency meeting. The official also said OPEC had “no choice” but to continue producing at its current levels or risk losing market share.

In any case, the Oilholic believes chatter put out by Nigeria and Venezuela calling for an OPEC meeting in the interest of self-preservation was a non-starter. Given that we’re little over two months away from the next meeting and the fact that it takes 4-6 weeks to get everyone to agree to a meeting date, current soundbites from the ‘cut production’ brigade don’t make sense.

Meanwhile, the UK Treasury finally acknowledged that taxation of North Sea oil and gas exploration needed a radical overhaul. In his final budget, before the Brits see a General Election on May 7, Chancellor George Osborne cut the country’s Petroleum Revenue Tax from its current level of 50% to 35% largely aimed at supporting investment in maturing offshore prospects.

Furthermore, the country’s supplementary rate of taxation, lowered from 32% to 30% in December, was cut further down to 20% and its collection at a lower rate backdated to January. Altogether, the UK’s total tax levy would fall from 60% to 50%.

Osborne’s move was widely welcomed by the industry. Some are fretting that he’s left it too late. Yet others reckon a case of better late than never could go a long way with the North Sea’s glory days well behind it. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Graph: Tracking Friday oil prices close, year to date 2015 © Gaurav Sharma, March 20, 2015.

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