Monday, August 08, 2011

The Bears are back in Crude town!

It seems the Bears are back in Crude town and are hoping to lurk around for a little while yet. So this week begins like last week ended with the TV networks screaming how crude it all is. Well a look at either benchmark reveals a decline of above US$3 per barrel in Monday’s intraday trading alone and both benchmarks if observed over a seven-day period display a dip of 7% and above, more pronounced in the US given the “not so smart” political shenanigans related to the debt ceiling and S&P’s ratings downgrade of the country for the first time in its history.

The Oilholic cannot quite understand why some people are either shocked or displaying a sense of shock over the downgrade because the writing was on the wall for profligate America. As politicians on both sides were more interested in points scoring rather than sorting out the mess, what has unfolded is more sad than shocking. Given the US downgrade and contagion in the EU, short term trends are decidedly bearish for crude markets. However, if it goes beyond the average market scare and develops into a serious recessionary headwind then Brent could finally fall below US$100 per barrel and WTI below US$80.

Given the divergence in both benchmark levels, analysts these days offer different forecasts for both with increased vigour via a single note. For instance, the latest investment note from Bank of America Merrill Lynch (BoAML) sees Brent stabilising at US$80 and WTI at US$60 in the face of mild recessionary headwinds. However, the Oilholic agrees with their assertion there would be a Brent claw-back to prior levels as OPEC turns the taps off.

“In the US, we would see landlocked WTI crude oil prices stabilising at a much lower level, as OPEC supplies are of little relevance to the supply and demand balances for crude oil in the Midwest. With shale output still projected to increase substantially over the next few months, we believe that WTI crude oil prices could briefly drop to US$50/barrel under a recession scenario only to recover back up towards US$60/barrel as shale oil output is scaled back,” BoAML analysts noted further.

Over the short term, what looks bearish (at worst) or mixed (at best) for crude, is evidently bullish for precious metals where gold is the vanguard of the bubble. Does it make sense – no; is it to be expected – yes! Nevertheless, long term supply/demand permutations suggest an uptick in crude prices is more than likely by middle of 2012 if not sooner.

Moody's expects oil prices to remain high through 2012 which will support increasing capital spending by exploration and production (E&P) companies worldwide as they re-invest healthy cash flow streams. About 70% of capital spending will take place outside of North America, with Latin American companies including Brazilian operator Petrobras leading the way, according to a report published July-end.

Additionally, development activity in the 2010 Macondo oil spill-affected Gulf of Mexico – while building some momentum – is still hampered by a slow permit process, says the report.

However, Stuart Miller, vice president at Moody’s notes, "But the industry might approach the top of its cycle during the next year as shorter contracts and lower day rates change the supply/demand balance."

Understandably, high risk, high reward modus operandi of the E&P business will remain more attractive as opposed to the refining and marketing (R&M) end of the crude business as the only way is up given when it comes to long term demand. Even the non demand-driven oil upsides (for example – as seen from Q2 2002 to Q2 2003 and Q3 2007 to Q3 2008) were a shot in the arm of E&P elements of the energy business (as well as paper traders).

Moving on to other chatter, Mercer’s cost of living survey found Luanda, the capital of Angola as the world's most expensive city for expatriates. It topped the survey for the second successive year, followed by Tokyo in Japan and N'Djamena in Chad. New to the top 10 were Singapore, ranked eighth, and Sao Paulo in Brazil, which jumped from 21st to 10th. The Oilholic sees a hint of crudeness in there somewhere.

Meanwhile, the National Iranian Oil Company, which does not get to flex its muscles very often in wake of international sanctions, got to do so last week at the expense of crude-hungry India. The burgeoning Indian economy needs the oil but US sanctions on Iran make it difficult to send international bank payments.

As a result Indian companies have been looking for alternative ways to make payments to Iran after the Reserve Bank of India (RBI) halted a clearing mechanism at the end Q4 2010. In the interim, the cash-strapped oil rich Iranians threw a strop threatening to cut off supplies to India if payments were not made by August 1, 2011.

However, it now emerges that at the eleventh hour both sides agreed to settle the bill as soon as possible. Well when 400,000 barrels per day or 12% of your crude count is at stake – you have to find novel ways to make payments. The “first” part of the outstanding bill we are told would be paid within a few days.

Crudely sticking with India, that same week, the Indian government finally gave a formal “conditional” approval to LSE-listed mining group Vedanta Resources for its takeover of Cairn Energy's India unit. However, approval came with a condition that Cairn India and India's state-owned Oil and Natural Gas Corp (ONGC) share the royalty payment burden of crude production from their Rajasthan fields.

ONGC owns a 30% stake in the block but pays royalties on 100% of the output under a "royalty holiday" scheme dating from the 1990s aimed at promoting private oil exploration.

The sale, held in impasse since August, has been hit by difficulties resulting from differences between Cairn India and ONGC over the royalties issue. Vedanta (so far) has a 28.5% stake in Cairn India. It wants the government to approve the buyout of another 30% stake in Cairn India from Cairn Energy. Cairn Energy currently owns a 52% stake in Cairn India. Given the government’s greenlight, it should all be settled in a matter of months.

© Gaurav Sharma 2011. Photo: Veneco Oil Platform, California © Rich Reid, National Geographic

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