Wednesday, March 21, 2012

The fortnight’s ‘crude’ conjecture & UK’s budget

It’s been an interesting few weeks with varying takes on the ‘crude’ state of affairs, but first the UK’s union budget and its impact on the North Sea. Delivering his 2012 budget in the British House of Commons on Wednesday, Chancellor of the exchequer George Osborne announced plans for a major package on tax changes to boost oil and gas extraction in the North Sea, along with a £3 billion new field allowance West of Shetland.

The Chancellor also said a new gas strategy designed to secure investment in the sector will be announced in the autumn. Of the two, the tax incentives announcement allowing British companies operating in the North Sea to enter into contracts with the UK Government aimed at offering long term certainty on future decommissioning cost tax relief was perhaps a more significant announcement from the Chancellor in the Oilholic’s humble opinion given the acrimony caused by last year's tax rises. Most in the City are united in their belief that this will go some way towards restoring trust which had been shaken by last year’s oil tax increase.

Osborne said the government "will end the uncertainty over decommissioning tax relief that has hung over the industry for years by entering into a contractual approach”, adding that he wanted to ensure the UK "extracts the greatest possible amount of oil and gas from our reserves in the North Sea".

Roman Webber, UK head of oil & gas tax at Deloitte, believes the announcement will remove a major fiscal risk for UK North Sea investors and release significant funds for investment if companies can move to post-tax decommissioning guarantees.

“In the longer term this measure should also increase the tax take for the Government. Whilst much work remains to be done to work out the detail and legislation is not expected until 2013, this is a very positive development. Deloitte Petroleum Services Group estimates that the UK North Sea decommissioning costs for the remainder of the life of the UK North Sea will be around £27 to 30 billion (US$44 to $48 billion),” he concludes.

Away from the UK budget and on to market conjecture, Mark Brown of Fitch Ratings hypothesises that Abu Dhabi will become the oil producing member of the Gulf Cooperation Council that is best insulated from a closure of the Strait of Hormuz, once the Habshan-Fujairah pipeline is fully operational later this year.

In January, the UAE's energy minister said that the pipeline, designed to transport 1.5 million barrels per day (bpd), should hopefully be operational within six months. “As we have previously said, a prolonged closure of the Strait is a low probability. As well as the practical challenge of physically blocking it, we think Iran would only choose to close an international shipping lane that is the world's most important oil chokepoint as a last resort, given the potential for international retaliation. Iran also exports oil via the Strait,” Brown says.

However, if the Strait was blocked in the second half of this year, when the Habshan-Fujairah pipeline could be operational, it would potentially give Abu Dhabi the best safety net. “It would enable Abu Dhabi, which has the world's second largest per capita reserves of hydrocarbons, to continue to export up to around two-thirds of its oil output, or around three-quarters of its current net oil exports, by bypassing the Strait and delivering oil to the Gulf of Oman,” he concludes.

Fitch also believes Saudi Arabia currently has the advantage that it already enjoys pipeline access to the Red Sea via the East-West pipeline. The country could export more than half its output through this pipeline, which has a maximum capacity of 5 million bpd and currently transports around 1.8 million bpd.

However, even at maximum capacity, with 2011 output running at 9.3 million bpd and no decline so far this year due to the tensions over Iran, a higher proportion of Saudi oil output and exports would be stuck inside the country if they could not be shipped out of the Persian Gulf than would be the case for Abu Dhabi once the Habshan-Fujairah pipeline is operational.

Switching tack to an unrelated comment from Moody’s, the ratings agency believes that as a result of financial flexibility built up over the past two years, rated Russian integrated oil & gas companies will be able to accommodate volatility in oil prices and other emerging challenges in 2012 within their current rating categories.

In a note to clients, Victoria Maisuradze, an Associate Managing Director in Moody's Corporate Finance Group, writes: "In 2011, rated Russian players continued to demonstrate strong operating and financial results, underpinned by elevated oil prices. Indeed, operating profits are likely to remain stable in 2012 as an increased tax and tariff burden will offset the benefits of high crude oil prices."

Speaking of prices, WTI-Brent price differential did narrow down to under US$18 over the course of the last fortnight. Brent is resisting a price level of US$123, while WTI is resisting a price level of US$106 and market trends remain moderately bullish with Greece having been “sorted”, US data being encouraging and geopolitical factors nudging the forward month futures price upwards.

Following minor bearish trends, crude oil prices were again correcting higher on Wednesday, tracking a broader rally in risk assets as the dollar eases back from yesterday’s gains. Specifically, front-month WTI is trading around the US$106.50 mark ahead of US data, notes Jack Pollard of Sucden Financial research.

“Bears will happily refer to repeated Saudi claims of increased production, though the threat in the Straits of Hormuz as well as the reduction in Saudi spare capacity (amid broad based geopolitical volatility) will remain the bulls’ best bet,” concludes Pollard.

This brings the Oilholic to a superb editorial in The Economist. The inimitable publication, of which yours truly has been a loyal reader for the past 14 years, debates in a recent edition whether another oil shock maybe on the cards. It comes-up with its own unique equation, in an American context: "Politician + pump prices + poll = panic"

From a global standpoint, The Economist notes that Iranian threats are only one of many scares facing oil markets drawing an analogy with a horror flick:

“When things get too quiet in horror films it is a sure sign that something nasty is just around the corner. Stability in oil prices (earlier in the year) may have been the forerunner of something unpleasant too…But as in any scary movie, the obvious suspect is not always to blame…Many analysts reckon that Iran would not close the strait because of the damage it would do to its own oil exports and vital imports. And anyway such a move would almost certainly lead to military retaliation.” (Oil Markets: High Drama, The Economist, February 25, 2012)

Well said sir! In fact many in the City agree and do believe Sudan, Nigeria and maintenance issues in the North Sea are as much to blame for the price rise. That’s all for the moment folks! Keep reading, keep it ‘crude’!

© Gaurav Sharma 2012. Photo: North Sea Oil Rig © Cairn Energy

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