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.

Monday, March 09, 2015

Viewing US oil output through Drillinginfo’s lens

Perceptions about massive a decline in US oil production currently being put forward with such fervour and the ground reality of an actual one taking place are miles apart; or should we say barrels apart. 

Assuming that a decline in production stateside would start eroding the oil supply glut thereby lending slow but sure support to the oil price is fine. But declarations on the airwaves by some commentators that a North American decline is already here, imminent or not that far off, sound too simplistic at best and daft at worst.

The Oilholic agrees that Baker Hughes rig count, which this blog and countless global commentators rely upon as a harbinger of activity in the sector, has shown a continual decline in operational rigs over recent weeks and months. However, that does not paint a complete picture.

Empirical and anecdotal data from Canada demonstrates that Western Canadians are aiming to do more with less. According to research conducted by the Canadian Association of Petroleum Producers (CAPP), fewer wells would be dug this year but production will actually rise on an annualised basis over 2015. That’s despite the fact that the Western Canadian Select fell to US$31 per barrel at one point.

There’s a similar story to be told in the US of A, and digital disruptors at Drillinginfo are doing a mighty fine job of narrating it. The Austin, Texas headquartered energy data analytics and SaaS-based decision support technology provider opines that much of the current conversation obsessively intertwines the oil price dip with a decline in activity, bypassing efficiencies of scale and operations achieved by US shale explorers.

“Our conjecture is that an evident investment decline does not imply that production is nose-diving in tandem. Quite the contrary, our research suggests exploration and production firms are 25% more efficient than they were three years ago,” says Tom Morgan, Analyst and Corporate Counsel at Drillinginfo.

It’s not that Drillinginfo is not recording dip in rig counts and new drilling projects coming onstream via its own DI Index. Towards the end of February, its US rig count stood at 1433, while new US oil production dipped 9% on the month before to 525 million barrels per day (bpd). However, if what’s quoted here sounds better than what you’ve heard elsewhere then it most probably is for one simple reason.

“What we put forward is in real-time. Two years ago, we started handing out GPS trackers to operators to latch on to their rigs. It was not easy convincing an old fashioned industry to immediately warm up to what we were attempting to do. It was a long drawn out process but we converted many people around to our viewpoint.

“At present, over 80% of rigs in continental US are reported on daily via Drillinginfo installed GPS units. In return, the participants get free access to our collated data. At this moment in time, not only can I point out each of these rigs via a heat signature (see image from January above left, click to enlarge), but also pinpoint the coordinates for you to locate one, drive there and verify yourself. I’d say our data is 99% accurate based on back testing and reconciling trends with our archives,” Morgan adds.

Drillinginfo also examines the actual spud of a well that's been drilled but not yet completed, as well as permit applications. “The thought process in case of the latter is that if you have applied for a permit to drill, then you are more than likely [if not a 100%] sure of going ahead with it.”

Drillinginfo saw a 24% decline in US permit application between January and February. This shows that investment is slowing down, yet at the same time operational wells are generally on song. With the end of first quarter of this year in sight, the US is still the world’s leading producer in barrels of oil equivalent terms.

Oil production continues to rise, albeit not in incremental volumes noted over the first and second quarters of last year prior to the slump. US producers, or shall we say those producers who can, are strategically lowering operations in less bankable or logistically less connected shale plays, while perking up production elsewhere.

For instance, while the collated production level at Bakken shale plays in North Dakota is declining, production at Eagle Ford shale in Texas has risen to 159,000 bpd; a good 26,000 bpd above levels seen towards the end of last year.  In terms of the type of wells, Drillinginfo sees older vertical wells bear the brunt of the slump, while production at onstream horizontal wells is either holding firm or actually rising a notch or two.

“No one is pretending that market volatility and the oil price slump isn’t worrying. What we are encountering is that shale players are trying to achieve profitability at a price level we could not imagine ten, five or even three years ago because technology has advanced and efficiencies have improved like never before,” Morgan adds.

While pretty reliable, feed-through of information via the Baker Hughes rig count is not real-time but looking backwards based on a telephone and electronic submission format. By that argument, the Oilholic finds what Drillinginfo has to say to be an eye-opener in the current climate, particularly in an American context. 

However, company man Morgan, who has known Drillinginfo's co-founder and CEO Allen Gilmer since both their freshmen years at Rice University back in the 1980s, has a more polished description.

“Today we talk of heat map of rigs, real-time data, rig movement monitoring, type and location of rigs going offline, and much more. I’d say we’re bringing agility via a digital medium to participants in a very traditional business.”

That agility and sense of perspective is something the industry does indeed crave, especially in the current climate. The Oilholic would say what Genscape is bringing to storage monitoring; Drillinginfo is bringing to upstream data analytics. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Graphic: Map of new US wells drilled in January 2015, and those drilled within the last six months © Drillinginfo, 2015

Tuesday, February 24, 2015

Summing up the ‘crude’ mood in Houston

The Oilholic finds the mood in Houston to be rather dark on his latest visit, and the weather here seems to be reflecting it. Oil price remains shaky, local refineries are battling strikes and shutdowns.

Meanwhile, as expected the Obama Administration has vetoed the Keystone XL pipeline project as the farcically prolonged tussle about an extension that’s meant to bring Canadian crude to Texan refineries continues.

Unsurprisingly, Texas is mirroring the globally evident trend of oil and gas sector job cuts, and costs of redundancies are more visible in an oil hub like Houston.

However, local commentators say the city (and by extension the state) has seen slumps in the global oil markets before, will see it again and remains capable enough to weather this latest one.

Dr Vincent Kaminski, an industry veteran and prominent academic at Rice University, says there’s no panic in the ranks even if the euphoria of a $100 per barrel price has long gone. “The word ‘caution’ is being branded about. No one can predict how long this period of lower oil prices is going to last. There is consensus that the price will bounce back, though not to the highs of 2013-14 unless there is a geopolitical development of a magnitude that would neutralise the impact of oversupply. Right now, there isn’t an obvious one.”

Kaminski feels what’s critical here is the management of this period of depressed prices, especially on the human capital front. Anecdotal evidence and published data suggests companies that are firing are not hiring with the same pace for the moment.

Deborah Byers, Managing Partner of global advisory firm EY’s Houston Office, says managing human resources is critical in the current climate. “My fear is that not everybody will get it right. Letting people go in a tough climate is a reactionary move; re-hiring talent when the market bounces back isn’t. A lot people in Houston have reacted very quickly. I agree that the supply glut has infused a bit of disciple in the sector, but it’s a nuanced situation to 2008-09.

“What we are seeing is a profound structural change leading to a transition towards a different type of market. In wake of the global financial crisis, we had a lack of demand scenario; what’s afoot now is a story of oversupply. That said, over the long-term the current situation would turn out to be a good story.”

Louis J. Davis, Chair of international law firm Baker & McKenzie’s North America Oil & Gas Practice, says the speed of the oil price decline caught many in Houston by surprise. “Some clients foresaw it, but not with the speed with which the decline hit home. Companies in the exploration and production (E&P) business are going to hold back on activity, lay down rigs and wait for a level of stability in the global markets. That’s unless they have existing well commitments.

“Nobody wants to drill uneconomic wells; including those who are hedged. It’s about keeping reserves up; and hedges are going to periodically roll-off within a 3 to 12 month window. By then, if a broader recovery, or at least a level of stability within a price bracket that's considered viable, is not achieved you'll find a lot of worried people.”

Furthermore, as Davis points out, even for those who are neatly hedged, their borrowing base is going to drop because they are not going to replenish their reserves by drilling additional wells. The Baker & McKenzie veteran says quite a few of his clients are in fine fettle but cautious.

“Many see opportunities when the market goes through a cyclical correction, and that hasn’t changed. There is a lot of money out there to buy promising assets at better prices. That said, interaction with people I’ve known for 40 years, as well as anecdotal evidence from a recent NAPE expo suggests the M&A deal flow is very slow right now. 

“Some deals that have been signed up are not closing, and no one is in a rush to close. Some are even taking the pain of letting their holding deposit slip. Yet, I’d say the present situation is troubling, but not an unseen one for Houston. We've been here before.”

Kaminski, Byers and Davis are united in their opinion that Houston’s economy is way more diversified than it was in the 1980s. As Kaminski points out – the city’s thriving Medical Center, adjacent to Rice University, employs more people than back office and ancillary staff at oil and gas companies.

Services, higher education, real estate and technology sectors are other major contributors to metropolitan and regional growth. There is evidence that the real estate market is slowing down in wake of oil and gas sector downturn. However, this is also not uniform across the greater Houston area; there are discrepancies from area to area.

Finally, Byers says corporate leaders within the sector always pause and reflect at such junctures. “For me personally, this is my fourth cyclical downturn – 1986, 1999, 2008-09 and now 2014-15. Couple of CEOs I’ve known and worked with for decades, say we’ve seen this before and we know what levers to pull. The question is how long will the duration of the downturn be and how long do we need to pull those levers before we switch back to an offensive mode.”

That’s a billion dollar question indeed; one that's guaranteed to be asked several times over the course of this year. That’s all for from Houston folks. Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photos: Glimpses of downtown Houston, Texas, USA © Gaurav Sharma, 2015

Monday, February 23, 2015

When BP met…er…nobody!

It’s good to be back in Houston, Texas although the Oilholic could have done without the very British weather we’re having here. Before getting down to cruder brass tacks and gaining market insight in wake of the oil price slump, one decided to probe the ongoing chatter about BP being sized up suitors.

To being with, this blogger does not believe ExxonMobil is going to takeover BP, has said so quite openly on broadcasting outlets back in England. That sentiment is shared by a plethora of senior commentators the Oilholic has met here in Houston over the past 48 hours. Both financial and legal advisers along with industry insiders remain unconvinced. Hell, even BP employees don’t buy the slant.

For starters if you are ExxonMobil, why would you want a company that has quite a lot of baggage no matter how attractive a proposition it is in terms of market valuation. Let us face it BP’s valuation is pretty low, but a damn sight better than 280p circa it was fetching in the immediate aftermath of the Gulf of Mexico oil spill.

However, the valuation is where it is for a reason. BP has scored a few legal victories, but the protracted tussle in US courtrooms resulting from the spill's fallout will continue for sometime yet. Secondly, its 19% stake in Russia’s Rosneft, while widely deemed as a positive move in Houston back in 2012, isn’t look all too attractive right now. BP’s latest financial data bears testimony to that.

Now if you were Rex Tillerson that’s not the most attractive partner out there to put it mildly, say Houston contacts who’ve advised the inimitable ExxonMobil boss on the company's previous forays. There are also regulatory hurdles. A hypothetical ExxonMobil takeover would create an oil and gas major with a cumulative revenue base that’d beat the GDP of a basket of mid-tier economies (using World Bank’s data on economic performance).

Finally, you can’t put monetary value on reputational risk. BP’s brand is considerably less toxic with boss Bob Dudley & co working real hard to mend it. Yet, the toxicity would take a while yet to dissipate. It’s not easy to forget the events of April 2010. Any suitor for BP, not just ExxonMobil, would be only too aware of that.

Another strange theory doing the rounds is that Shell might make an approach. This has been visited several times over the years, not least directly by BP’s former boss Lord Browne. The reason it hasn’t taken off is because the Dutch half of Royal Dutch Shell does not want its influence diluted further, which is guaranteed to happen were Shell and BP to merge.

Moving away from the improbable and the lousy, to something more credible - a theory doing the rounds that BP might find a credible white knight in the shape of Chevron. Such a tangent does make ears prick in Houston and gets the odd nod for experts who have seen many a merger and the odd mega merger. 

The only problem is that in more ways than one, Chevron and BP’s North American ventures overlap which isn’t a problem to such an extent in the case of ExxonMobil and Shell. So a BP and Cheveron merger does stack up in theory. However, there would plenty of regulatory hurdles and both parties would need to divest substantially for the merger to be approved by regulators in more than one jurisdiction.

While everything is possible on the BP front, nothing is worth getting excited about. In the interim, an odd investment banker (or two or possibly more) in New York or London will keep pedalling BP’s vulnerability.  But consider this, were a suitor or suitors turn up for BP, it wont hurt your prospects if you happen to be a BP shareholder!

That’s all for the moment folks from Houston, where there are a few strikes, some trepidation and a whole lot of realism in the air! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo 1: Logo of BP © BP Plc. Photo 2: ExxonMobil office signage, Downtown Houston, USA © Gaurav Sharma.

Sunday, February 22, 2015

A seminal moment has arrived for Pemex

For 76 years, Mexico’s state-owned oil and gas company Petroleos Mexicanos (or Pemex) has had a near monopoly over the country’s oil production. However, 2015 would be its 77th and final monopolistic one as Mexico prepares to open up oil exploration and production to foreign and domestic private sector participants.

Declining production levels for the last 10 years seem to have forced the government’s hand to invigorate the sector and shake-up Pemex. Mexico currently produces around 2.5 million barrels per day (bpd), nearly a million less than it did in 2004 when production peaked.

Unlike his predecessors who promised much but delivered little, President Enrique Peña Nieto changed Mexico’s constitution to facilitate private investment in a bid to revive Pemex’s fortune, given that it provides nearly a third of Mexico’s tax revenues. However, desperate to keep the public opinion onside, Peña Nieto vowed that “Pemex itself would never be privatised.”

Some still say the reforms did not go far enough. Yet by Mexican standards, it’ll be one heck of shake-up for a state-owned oil and gas company which has never competed itself to bid for overseas exploration rights (unlike many other state-owned behemoths especially from China and India).  

Pemex will have a new board of directors, procedural overhauls, process streamlining (at least on paper) and for the first time in its history face competition from private sector participants. If all that wasn’t enough, Pemex will allow its petrol stations and forecourts to compete with each other on price at the pump for the first time ever.

However, nothing is ever plain sailing in Mexico. The general public has largely embraced the change so far but some union leaders who carry considerable clout haven’t and are peddling alarmist ideas about an American takeover of Mexico’s precious resource. A negative vote in a referendum on further changes could bring things to a grinding halt. 

While the oil price decline is worrying, commentators say market volatility is not enough to derail things as one noted earlier. As for Pemex, Moody’s seems to suggest it is on the right track. On Friday, it affirmed the ratings of the state-firm and its subsidiaries, including Pemex's A3 and (P)A3 global long-term ratings with a “stable” outlook.

Moody’s notes that despite significant changes arising from the new energy law, Pemex will remain closely linked to the government of Mexico, which will continue to provide strong support, given the company's importance to the government's budget, to the oil sector and to the country's exports.

In the short to medium term, Moody's does not expect any material reduction in Pemex's tax burden and its debt amount is likely to rise to fund higher capital expenditures. “However, its managerial and budgetary autonomy will increase, improving its efficiency,” says Moody’s analyst Nymia Thamara Cortes de Almeida.

While Moody’s reckons Pemex will be able to maintain its production level around 2.5 million bpd level for three years at the very least, the government thinks it’ll be able to do so for the next 15 years! Suitably modest as usual! 

In the so-called “Round Zero” allocation last year, Pemex was still given rights to 83% of all proven and probable reserves in Mexico. But in “Round One”, scheduled to end by September 2015, Peña Nieto administration will put tender 169 blocks covering 28,500 square kilometres open to private participation in (or without) cooperation with Pemex.

A major test will come if an oil major gets drilling without Pemex and it’s not inconceivable given the pace with which things are moving here. The government is seeking oil and gas foreign direct investment in the range of US$50 to 60 billion by 2018.

Over the course of three days, the Oilholic has spoken on and off record to several market participants. Mood here is upbeat to begin with and several commentators also said Pemex had given them direct feedback about wanting to put its house in order. It's early days so lets see how this plays out.

The biggest question in a bearish market, is whether investors, especially foreign investors and IOCs would buy the idea of entering the Mexican oil and gas sector.

The Oilholic intends to explore this in greater detail from Houston and London over the coming weeks and months. However, one thinks it won’t be easy convincing the private sector especially when it comes to bidding for subsequent exploration rights offers. The initial and most lucrative exploration rights were given to Pemex. The next round puts forward exploration rights to areas where there is only a 50% chance of finding and tapping out the crude stuff in an economically viable fashion. In the following round, the probability percentage falls to 10%, and the ultimate round would see potential suitors vie for untested prospects.

If the Oilholic were a bidder, this doesn’t really fill one with confidence from the outset. It’ll all depend on the terms on offer and the jury is still out on that one. One thing is for sure, with Mexico’s proven oil reserves standing falling from 5th to 18th in the global league table, no one is opening that premium tequila bottle just yet. Much will depend on Pemex's capacity to finally embrace change. That’s all from Mexico City folks as an amazing but short trip comes to an end! Next stop, Houston Texas! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo 1: Pemex Petrol Station in Mexico City, Mexico, May 2015. Photo 2: Pemex Signage © Gaurav Sharma.

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