Eurozone crisis vs. a US$100/barrel price floor

In the middle of a Eurozone crisis rapidly evolving into a farcical stalemate over Greece’s prospects, on May 13 Saudi Arabia’s oil minister Ali al-Naimi told a Reuters journalist at an event in Adelaide that he sees US$100 per barrel as a “great price” for crude oil. In wake of the comment, widely reported around the world, barely six days later came confirmation that Saudi production had risen from 9.853 million barrels  per day (bpd) in February to 9.923 bpd in March with the kingdom overtaking Russia as the world's largest oil producer for the first time in six years.

In context, International Energy Forum says Russia's output in March dropped to 9.920 million bpd from 9.943 million bpd in February. The Saudis exported 7.704 million bpd in March versus 7.485 million bpd in February but no official figure was forthcoming from the Russians. What al-Naimi says and how much the Saudis export matters in the best of circumstances but more so in the run-up to a July 1 ban by the European Union of imports of Iranian crude and market theories about how it could strain supplies.

Market sources suggest the Saudis have pumped around 10 million bpd for better parts of the year and claim to have 2.5 million bpd of spare capacity. In fact, in November 2011 production marginally capped the 10 million bpd figure at one coming in at 10.047 million bpd, according to official figures. The day al-Naimi said what price he was comfortable with ICE Brent crude was comfortably above US$110 per barrel. At 10:00 GMT today, Brent is resisting US$106 and WTI US$91. With good measure, OPEC’s basket price stood at US$103.49 last evening and Dubai OQD’s forward month (July) post settlement price for today is at US$103.65.

With exception of the NYMEX Light Sweet Crude Oil futures contract, the benchmark prices are just above the level described by al-Naimi as great and well above the breakeven price budgeted by Saudi Arabia for its fiscal balance and domestic expenditure as the Oilholic discussed in July.

Greece or no Greece, most in the City remain convinced that the only way is up. Société Générale CIB’s short term forecast (vs. forward prices) suggests Brent, Dubai and even WTI would remain comfortably above US$100 mark. The current problem, says Sucden Financial analyst Myrto Sokou, is one of nervousness down to mixed oil fundamentals, weak US economic data and of course the on-going uncertainty about the future of Eurozone with Greece remaining the main issue until the next election on June 17.

“WTI crude oil breached the US$90 per barrel level earlier this week and tested a low at US$89.28 per barrel but rebounded on Thursday, climbing above US$91 per barrel. Brent oil also retreated sharply to test a low at US$105 per barrel area but easily recovered and corrected higher toward US$107 per barrel. We continue to expect particularly high volatile conditions across the oil market, despite that oil prices still lingering in oversold territory,” she adds.

Not only the Oilholic, but this has left the inimitable T. Boone Pickens, founder of BP Capital Partners, scratching his head too. Speaking last week on CNBC’s US Squawk Box, the industry veteran said, “I see all the fundamentals which suggest that the price goes up. I am long (a little bit) on oil but not much…I do see a really tight market coming up. Now 91 million bpd is what the long term demand is globally and I don’t think it would be easy for the industry to fulfil that demand.”

Pickens believes supply is likely to be short over the long term and the only way to kill demand would be price. Away from pricing, there are a few noteworthy corporate stories on a closing note, starting with Cairn Energy whose board sustained a two-thirds vote against a report of the committee that sets salaries and bonuses for most of its senior staff at its AGM last week.

Earlier this year, shareholders were awarded a windfall dividend in the region of £2 billion following Cairn's hugely successful Indian venture and its subsequent sale. However, following shareholder revolt a plan to reward the chairman, Sir Bill Gammell, with a bonus of over £3 million has been withdrawn. The move does not affect awards for the past year. Wonder if the Greenland adventure, which has yielded little so far, caused them to be so miffed or is it part of a wider trend of shareholder activism?

Meanwhile the FT reports that UK defence contractor Qinetiq is to supply Royal Dutch Shell with fracking monitors. Rounding things up, BP announced a US$400 million spending plan on Wednesday to install pollution controls at its Whiting, Indiana refinery, to allow it to process heavy crude oil from Canada, in a deal with US authorities.

Finally, more than half (58%) of oil & gas sector respondents to a new survey of large global companies – Cross-border M&A: Perspectives on a changing world – conducted by the Economist Intelligent Unit on behalf of Clifford Chance, indicates that the focus of their M&A strategy is on emerging/high-growth economies as opposed to domestic (14%) and global developed markets (29%). The research surveyed nearly 400 companies with annual revenues in excess of US$1 billion from across a range of regions and industry sectors, including the oil & gas sector. That’s all for the moment folks! Keep reading, keep it ‘crude’!

© Gaurav Sharma 2012. Photo: Oil worker in Oman © Royal Dutch Shell.

EU’s Iran ban, upcoming Indian adventure & Cairn

Earlier on Monday and in line with market expectations, the European Union agreed to impose an embargo on the import of Iranian crude oil. The EU, which accounts for 20% of Iran’s crude exports, now prohibits the import, purchase and transport of Iranian crude oil and petroleum products as well as related finance and insurance. All existing contracts will have to be phased out by July 1st, 2012.

In response, Iran declared the ban as "unfair" and "doomed to fail", said it will not force it to change course on its controversial nuclear programme and renewed threats to blockade the Strait of Hormuz. Going into further details, EU Investment in as well as the export of key equipment and technology for Iran's petrochemical sector is also banned.

A strongly worded joint statement by British Prime Minister David Cameron, French President Nicolas Sarkozy and German Chancellor Angela Merkel says, “Until Iran comes to the table, we will be united behind strong measures to undermine the regime’s ability to fund its nuclear programme, and to demonstrate the cost of a path that threatens the peace and security of us all.”

That’s all fine and yes it will hurt Iran but unless major Asian importing nations such as China, India and Japan decide to ban Iranian imports as well, EU’s ban would not have the desired impact. Of these, China alone imports as much Iranian oil as the EU, Japan accounts for 17% of the country’s exports, followed by India (16%) and South Korea (9%).

So until the major Asian economies join in the embargo, both EU and Iran will end up hurting themselves. As a Sucden Financial note concludes, “Unless a deal can be agreed unilaterally, it is likely that the weak European economies could suffer from firmer crude prices whilst relatively robust Asian economies might benefit from preferential crude trade agreements.”

China is unwilling to follow suit while it is thought that Japan and South Korea are seeking supply assurances from other sources before reacting. India’s response had been lukewarm in the run-up the EU’s decision. Now that the decision has been made, it will be interesting to note how the Indian government responds. The Oilholic is heading to India this week (and for better parts of the next) and will try to sniff out the public and government mood.

Meanwhile, Fitch Ratings has said the EU embargo will increase geopolitical risk in the Middle East region supporting high oil prices. The agency considers blocking the Strait of Hormuz - the world's most important oil chokepoint - to be a low-probability scenario and believes any obstruction to trade routes would have a short duration if it did actually transpire.

Arkadiusz Wicik, Director in Fitch's European Energy, Utilities and Regulation team and an old contact of the Oilholic’s, feels that the EU ban on Iranian oil is largely credit neutral for EU integrated oil and gas companies. "The cash flow impact of the ban may be negative for refining operations, but should be positive or neutral for upstream operations," he says.

The most likely scenario is that the EU embargo will result in higher oil prices. However, prices may not necessarily increase markedly from current levels as some of the risks related to the EU ban on Iranian oil appear factored in already.

A new Fitch report further notes the ban is likely to have a moderately negative impact on EU refiners as high oil prices may further erode demand for refined products in Europe. This would worsen the already weak supply-demand balance in European refining. The embargo may also change oil price spreads in Europe as Iranian crude imports would likely be replaced with alternative crude, which may be priced at a lower discount to Brent than Iranian crude oil.

EU refiners' security of oil supply is unlikely to be substantially affected by an Iran ban. There are alternative suppliers, such as Saudi Arabia (which has said it is able and willing to increase oil production to meet additional demand), Russia and Iraq. Libyan oil production is also recovering. Iranian oil accounted for just 5.7% of total oil imports to the EU in 2010, and 4.4% in Q111. Furthermore, the sanctions will be implemented gradually by July 1st, 2012, which should give companies that use Iranian crude oil time to find alternative suppliers, the report notes.

Southern European countries - Italy, Spain and Greece - are the largest importers of Iranian crude oil in the EU. A rise in oil prices could be further bad news for these countries, which already face a weak economic outlook in 2012.

“The impact of the new US sanctions signed into law late last year against Iran is difficult to predict at this stage. It is not certain whether Asian countries, which are by far the largest importers of Iranian crude, accounting for about 70% of total Iranian oil imports, will substantially reduce supplies from Iran in 2012 and replace them with other OPEC sources as a result of the new US sanctions,” the Fitch report notes further.

The agency’s report does make one very important observation – one that has been doing the rounds in the City ever since news of the ban first emerged – that’s if Asian reduction is substantial, in combination with the EU ban, it could considerably lower OPEC's spare production capacity. In such a scenario, the global oil market would have less flexibility in the event of large unexpected supply interruptions elsewhere, potentially sending oil prices much higher than current levels.

Moving away from the Iranian situation, Cairn Energy has sold a 30% stake in one of its Greenland exploration licences to Norway’s Statoil. The UK independent upstart spent nearly £400 million in exploration costs last year with little to show for it as no commercially exploitable oil or gas discovery was recorded. While the percentage of the stake has been revealed, neither Cairn nor Statoil are saying how much was paid for the stake. Nonetheless, whatever the amount, it would help Cairn mitigate exploration costs and risks as it appears to be in Greenland for the long haul.

Elsewhere, there is positive and negative news on refineries front. Starting with the bad news, shares in Petroplus – Europe’s largest independent refiner – were suspended from trading on the Swiss SIX stock exchange on Monday at the company’s request. As fears rise about Petroplus defaulting on its debt following an S&P downgrade last month and yet another one on January 17th, looks like the refiner is in a fight for its commercial life.

Lenders suspended nearly US$1 billion in credit lines last month which prevented Petroplus from sourcing crude oil for its five refineries. However, it had still managed to keep refineries at Coryton (Essex, UK) and Ingolstadt (Germany) running at reduced capacity. Late on Monday, Bloomberg reported that delivery lorries did not leave the Coryton facility and concerns are rising for the facility’s 1000-odd workforce. PwC, which has been appointed as the administrator of Petroplus' UK business, said on Tuesday that it aims to continue to operate the Coryton facility without disruption. The Oilholic hopes for the best but fears the worst.

Switching to the positive news in the refineries business, China National Petroleum Corp, Qatar Petroleum and Royal Dutch Shell agreed plans on January 20th for a US$12.6 billion refinery and petrochemical complex in eastern China. Quite clearly, hounded by overcapacity and poor margins in Europe, the future of the refineries business increasingly lies in the Far East on the basis of consumption patterns. That’s all for the moment folks. Keep reading, keep it ‘crude’!

© Gaurav Sharma 2012. Photo: Oil tanker © Michael S. Quinton / National Geographic.

Cairn Energy "Smells" Black Gold in Greenland

Barely a week after announcing the proposed sale of a 51% stake in its Indian unit to Vedanta in order to concentrate on its Greenland operations, Cairn Energy claims to have discovered gas in the self-governing Danish protectorate. It is usually a sign that the crude stuff may follow. In a statement, the company said its personnel had observed "early indications of a working hydrocarbon system" off Greenland’s coast at its Baffin Bay T8-1 prospection well. Apart from the T8-1 site, the energy company said plans to drill at least two other wells over the course summer were also on track.

Cairn chief executive Sir Bill Gammell says he is looking forward to assessing results of the remainder of the 2010 drilling programme. So does rest of the market; except for Greenpeace who have promptly dispatched a protest ship to the region.

The company's planned drilling target depth is in the region of 4,000 metres (or above) and energy sector analysts are not yet jumping with joy. Perhaps a knee-jerk reaction to Cairn’s announcement has been tempered by the fact that Scandinavian, British and American teams have all attempted drilling off the coast of Greenland in the past, i.e. in 1970-75 and then again in 2000. Neither of the drives resulted in success.

Still the Greenland Bureau of Minerals and Petroleum, which has made developing oil activities one of its most important priorities aimed at creating enough revenues to replace the subsidy the protectorate receives from Denmark, would be hoping Cairn is lucky in striking black gold this time.

Meanwhile, the forward month crude oil futures contract dipped below US$72 a barrel in intraday trading across the pond as the wider commodities market mirrored equties trading; a trend noted over the last six trading sessions. I quite agree with Phil Flynn, analyst at PFG Best, who wrote in an investment note that: "Just when it seems oil is going to rally on strong economic optimism; it gets crushed with the realty of gluttonous supply."

London Brent crude was just about maintaining resistance above US$72 down 89 cents or 1.2% at US$72.55 around 14:45 BST. However, weaker economic data on either side of the Atlantic and fears of a double dip recession, most recently stoked by Bank of England’s MPC member Martin Weale have certainly not helped.

©Gaurav Sharma 2010. Photo: Oil tanker ©Michael S. Quinton/National Geographic Society

Cairn Energy: Choosing Greenland over India?

It seems Cairn Energy has shifted its attention from India to Greenland. What else can be said of the Edinburgh-based independent upstream upstart’s announcement of plans to sell a 51% stake in its Indian operations to mining group Vedanta for up to US$8.5 billion?

After a week of nudges and winks, Cairn confirmed rumours of the sale doing the rounds in the city of London. The company’s Indian operations have a market capitalisation of just over US$14 billion which makes Cairn India, the country’s fourth largest oil company.

Apart from seeking a "substantial return of cash" to shareholders, it is now clear that Cairn hopes to pursue its drilling ambitions in Greenland with some vigour. In a media statement, Cairn’s chief executive Sir Bill Gammell said, “I am delighted to announce the proposed disposal of a significant shareholding in Cairn India in line with our objective of adding and realising value for shareholders.”

To fathom what the announcement means for Cairn energy is easy. In fact, market analysts I have spoken to reckon the sale would generate more than adequate capital for Cairn's Greenland prospection in the medium term. This makes Cairn pretty cash rich and the market wonders what the inimitable Bill Gammell has up his sleeve. That it could bag another similarly scaled production asset akin to its fields in India’s Rajasthan state is doubtful.

Working out what the deal means for Vedanta is trickier. Its chief executive Anil Agarwal gave a rather simplistic explanation. In a statement he said, “The proposed acquisition significantly enhances Vedanta's position as a natural resources champion in India. Cairn India's Rajasthan asset is world class in terms of scale and cost, delivering strong and growing cash flow.”

Hence, simply put Vedanta has stated its intentions of venturing beyond metals and make a headline grabbing foray into the oil and gas sector. The market would be watching how the two aspects of the business gel under the Vedanta umbrella, but there are precedents of success – most notably at BHP Billiton.

In a related development, Cairn energy was featured in Deloitte’s half-yearly assessment of UK independent oil and gas companies. At the end of H1 2010, according to Deloitte the top five UK independent oil companies by market capitalisation were - Tullow Oil, Cairn Energy, Premier Oil, SOCO International and Heritage Oil in that order. The top three have maintained their respective positions from December 2009 while SOCO International entered the top five with a 31% increase in market capitalisation.

Overall, the first half of the year was broadly positive for the UK independents, with market capitalisation of the majority of companies in the league table increasing by 4.6% over the 6 month period to 30 June 2010. It stood at £26.482 billion as of end-June. (Click box on the left for the entire list)

On the oil price front, the crude stuff plummeted nearly 7% over the course of the week ended Fri 13th on either side of the pond. The price resistance is presently above US$75 a barrel and I expect it to remain there despite some pretty disappointing economic data doing the rounds these days. Looking further ahead, analysts at Société Générale’s Cross Asset Research team forecast NYMEX WTI to average US$80 in Q3 2010 (revised down by $10) and $85 in Q4 2010 (revised down by $5).

Looking further ahead, an investment note states that they expect NYMEX WTI of US$92.30 in 2011 (revised down by $8.70). NYMEX WTI is forecast at US$88.30/$87.50 in Q1 2011/Q2 2011, increasing to $95/$98.30 in Q3 2011/Q4 2011. On a monthly average basis, Société Générale expects NYMEX WTI of US$87.50 in December 2010 and $100 in December 2011.

In truth, fear of a double dip recession persists in wider market, especially in the US, EU and UK. However, many crude traders are quietly confident that in such an event, India and China’s crude oil consumption will help maintain the oil price at US$70 plus levels.

© Gaurav Sharma 2010. Photo courtesy © Cairn Energy Plc. Chart Courtesy © Deloitte LLP