Crude market’s health & farewell to the Bay Area

It’s nearly time to say goodbye to the Bay Area head north of the border to British Columbia, Canada but not before some crude market conjecture and savouring the view of Alcatraz Island Prison from Fisherman’s Wharf. A local politician told yours truly it would be an ideal home for speculators, at which point the owner of the cafe ‘with a portfolio’ where we were sitting quipped that politicians could join them too! That’s what one loves about the Bay Area – everyone has a jolly frank opinion.

Unfortunately for debaters on the subject of market speculation, Alcatraz (pictured left) often called “The Rock” and once home to the likes of Al Capone and Machin Gun Kelly was decommissioned in 1963 can no longer be home to either speculators or politicians, though it seems quite a few seagulls kind of like it!

Not blaming speculators or politcians and with market trends remaining largely bullish, selected local commentators here, those back home in the City of London and indeed those the Oilholic is about to meet in Vancouver BC are near unanimous in their belief about holding exposure to oil price sensitivity over the next two quarters via a mixed bag of energy stocks, Russian equities, natural resources linked Forex (especially the Australian and Canadian dollar) and last but not the least an “intelligent play” on the futures market.

Nonetheless the second quarter opened on Monday in negative territory as WTI crude oil slid lower to retest the US$102 per barrel area, while Brent has been under pressure trading just above US$122 per barrel level on the ICE. “The European equity markets are also trading lower as risk appetite has been limited,” notes Myrto Sokou, Sucden Financial Research.

Protecting one’s portfolio from short-dated volatility would be a challenge worth embracing and Société Générale recommends “buying (cheap) short-dated volatility to protect portfolios from escalating political risk in Iran.” (Click on benchmarks graph to enlarge)

Mike Wittner, a veteran oil market commentator at Société Générale, remains bullish along with many of his peers and with some justification. OPEC and Saudi spare capacity is already tight, and will soon become even tighter, due to sanctions on Iran, says Wittner, and the already very bullish scenario would continue to be driven by fundamental.

Analysts point to one or more of the following: 

• Compared to three months ago, fears of a very bearish tail risk have subsided to an extent (e.g. Eurozone, US data) and macro environment is gradually turning supportive.
• Concurrently, risks of a very bullish tail risk remain (e.g. war against Iran or the Straits of Hormuz situation).
• OECD crude oil inventory levels are at five year lows.
• OPEC spare capacity is quite low at 1.9 million barrels per day (bpd), of which 1.6 million bpd is in Saudi Arabia alone.
• Ongoing significant non-OPEC supply disruptions in South Sudan, Syria, and Yemen thought to be in the circa of 0.6 million bpd.
• Broad based appetite for risk assets has been strong.
• Low interest rate and high liquidity environment is bullish.

On the economy front, in its latest quarterly Global Economic Outlook (GEO), Fitch Ratings forecasts the economic growth of major advanced economies to remain weak at 1.1% in 2012, followed by modest acceleration to 1.8% in 2013. While the baseline remains a modest recovery, short-term risks to the global economy have eased over the past few months.

Compared with the previous Fitch GEO in December 2011, the agency has only marginally revised its global GDP forecasts. The agency forecasts global growth, based on market exchange rates, at 2.3% for 2012 and 2.9% in 2013, compared with 2.4% and 3.0% previously.

"Fitch expects the eurozone to have the weakest performance among major advanced economies. Real GDP is projected to contract 0.2% in 2012, and grow by only 1.1% in 2013. Sizeable fiscal austerity measures and the more persistent effect of tighter credit conditions on the broader economy remain key obstacles to growth," says Gergely Kiss, Director in Fitch's Sovereign team.

In contrast to problems in Europe, the recovery in the US has gained momentum over past quarters. Growth is supported by the stronger-than-expected improvement in labour market conditions and indicators pointing to strengthening business and household confidence.

In line with the underlying improvement in fundamentals Fitch has upgraded its 2012 US growth forecast to 2.2% from 1.8%, whilst keeping the 2013 forecast unchanged at 2.6%. For Japan and the UK, Fitch forecasts GDP to increase 1.9% and 0.5% respectively for 2012.

Economic growth of the BRIC countries is expected to remain robust over the forecast horizon, at 6.3% in 2012 and 6.6% in 2013, well above MAE or global growth rates. Nevertheless, Brazil in particular, but also China and India slowed during 2011 and China is expected to slow further this year.

While on the subject of economics, Wittner of Société Générale, regards a shutdown of the Strait of Hormuz as a low-probability but high-impact scenario with Brent potentially spiking to US$150-$200. “In such a scenario, the equity markets would correct sharply. As a rule of thumb, a permanent US$10/barrel increase in the oil price would shave around 0.2% from global GDP growth in the first year after the shock,” he concludes.

That’s all for the moment folks! The Oilholic leaves you with a view of driving on Golden Gate Bridge on a sunny day and downtown San Francisco as he dashes off to catch a flight to Vancouver. Yours truly will be examining Canada’s role as a geopolitically stable non-OPEC supplier of crude while there. Keep reading, keep it ‘crude’!

© Gaurav Sharma 2012. Graph: World crude oil benchmarks © Société Générale. Photo 1: Alcatraz Island. Photo 2: Downtown San Francisco. Photo 3: Driving on the Golden Gate Bridge, California, USA. © Gaurav Sharma.

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.

Examining a crude 2011 & talking Iran vs. 2012

As the Oilholic conjectured at the end of 2010, the year 2011 did indeed see Brent Crude at “around US$105 to US$110 a barrel”. However there was nothing ‘crudely’ predictable about 2011 itself – the oil markets faced stunted global economic growth, prospect of another few quarters of negative growth (which may still transpire) and a Greek crisis morphing into a full blown Eurozone crisis.

The Arab Spring also understandably had massive implications for the instability / risk premium in the price of crude over much of 2011. However, the impact of each country’s regional upheaval on the price was not uniform. The Oilholic summarised it as follows based on the perceived oil endowment (or the lack of it) for each country: Morocco (negligible), Algeria (marginal), Egypt (marginal), Tunisia (negligible), Bahrain (marginal), Iran and Libya (substantial).

Of the latter, when Libya imploded, Europe faced a serious threat of shortage of the country’s light sweet crude. But with Gaddafi gone and things limping back to normal, Libya has awarded crude oil supply contracts in 2012 to Glencore, Gunvor, Trafigura and Vitol. Of these Vitol helped in selling rebel-held crude during the civil war as the Oilholic noted in June.

Meanwhile Iran remains a troubling place and gives us the first debating point of 2012. It saw protests in 2011 but the regime held firm at the time of the Arab spring. However, in wake of its continued nuclear programme, recent sanctions have triggered a new wave of belligerence from the Iranian government including its intention to blockade the Straits of Hormuz. This raises the risk premium again and if, as expected a blanket ban by the EU on Iranian crude imports is announced, the trend for the crude price for Q1 2012 is decidedly bullish.

Société Générale's oil analyst Michael Wittner believes an EU embargo would possibly prompt an IEA strategic release. The price surge – directly related to the Saudi ability to mitigate the Iran effect – would dampen economic and oil demand growth. Market commentators believe an EU embargo is highly likely, especially after it reached an agreement in principle on an embargo on January 4th.

However, a more serious development would be if Iran carries out its threat to shut down the Straits of Hormuz, disrupting 15 million bpd of crude oil flows and we would expect Brent prices to spike into the US$150-200 range albeit for a limited time period according to Wittner.

“A credible threat from missiles, mines, or fast attack boats is all it would take for tanker insurers to stop coverage, which would halt tanker traffic. However, we believe that Iran would not be able to keep the Straits shut for longer than two weeks, due to a US-led military response. The disruption would definitely result in an IEA strategic release. The severe price spike would sharply hurt economic and oil demand growth, and from that standpoint, be self-correcting,” he adds.

Nonetheless, not many in the City see a “high” probability of such a step by Iran. Anyway, enough about Iran; lets resume our look back at 2011 and the release of strategic reserves would be a good joiner back to events of the past year.

Political pressure, which started building from April 2011, onwards saw the IEA ask its members to release an extra 60 million barrels of their oil stockpiles on to the world markets on June 23rd. The previous two occasions were the first gulf war (1991) and the aftermath of Hurricane Katrina (2005). That it happened given the political clamour for it is no surprise and whether or not one questions the wisdom behind the decision, it was a significant event.

For what it was worth, the market trend was already bearish at the time, Libya or no Libya. Concerns triggered by doubts about the US, EU and Chinese economies were aplenty as well as the end of QE2 liquidity injections coupled with high levels of non-commercial net length in the oil markets.

On the corporate front, refineries continued to struggle as expected with many major NOCs either divesting or planning to divest refining and marketing (R&M) assets. US major ConocoPhillips' announcement in July that it will be pursuing the separation of its exploration and production (E&P) and R&M businesses into two separate publicly traded corporations via a tax-free spin-off R&M co. to shareholders did not surprise the Oilholic – in fact it’s a sign of times.

Upstream remains inherently more attractive than the downstream business and the cliché of “high risk, high reward” resonates in the crude world. Continuing with the corporate theme, one has to hand it to ExxonMobil’s inimitable boss – Rex Tillerson – for successfully forging an Arctic tie-up with Rosneft so coveted by beleaguered rival BP.

On August 30th, 2011, beaming alongside Russian Prime Minister Vladimir Putin, Tillerson said the two firms will spend US$3.2 billion on deep sea exploration in the East Prinovozemelsky region of the Kara Sea. Russian portion of the Black Sea has also been thrown in the prospection pie for good measure as has the development of oil fields in Western Siberia.

The US oil giant described the said deal as among the most promising and least explored offshore areas globally “with high potential for liquids and gas.” If hearts at BP sank, so they should, as essentially the deal had components which it so coveted. However, a dispute with local partner TNK-BP first held up a BP-Rosneft tie-up and then finished it off.

One the pipelines front, the TransCanada Keystone XL project continues to be hit by delays and decision is not expected before the US presidential election; but the Oilholic feels the delay is not necessarily a bad thing. (Click here for thoughts)

The Oilholic saw M&A activity in the oil & gas sector over 2011 – especially corporate financed asset acquisitions – marginally exceeding pre-crisis deal valuation levels. Recent research for Infrastructure Journal – suggests the deal valuation figure for acquisition of oil & gas infrastructure assets, using September 30th as a cut-off date, is well above the total valuation for 2008, the year that the global credit squeeze meaningfully constricted capital flows.

Finally, on the subject of the good old oil benchmarks, since Q1 2009, Brent has been trading at premium to the WTI. This divergence has stood in recent weeks as both global benchmarks plummeted in wake of the recent economic malaise. WTI’s discount reached almost US$26 per barrel at one point in 2011.

Furthermore, waterborne crudes have also been following the general direction of Brent’s price. The Louisiana Light Sweet (LLS) increasingly takes its cue from Brent rather than the WTI, and has been for a while. Hence, Brent continues to reflect global conditions better.

Rounding things up, 2011 was a great year in terms of crude reading, travelling and speaking. Starting with the reading bit, 2011 saw the Oilholic read several books, but three particularly stood out; Daniel Yergin’s weighty volume - The Quest, Dan Dicker’s Oil’s Endless Bid and last but not the least Reuters’ in-house Oilholic Tom Bergin’s Spills & Spin.

Switching to crude travels away from London town, the Oilholic blogged from Calgary, Vancouver, Houston, San Francisco, Vienna, Dusseldorf, Bruges, Manama and Doha; the latter being the host city of the 20th World Petroleum Congress. The Congress itself and other signature events in the 2011 oil & gas calendar duly threw up several tangents for discussion.

Most notable among them were the two OPEC summits, the first in June which saw a complete disharmony among the cartel’s members followed by a calmer less acrimonious one in December where a unanimous decision to hold production at 30 million bpd was reached.

On the speaking circuit front, 2011 saw the Oilholic comment on CNBC, Indian and Chinese networks, OPEC webcasts and industry events, most notable among which was the Baker & McKenzie seminar at the World Petroleum Congress which was a memorable experience. That’s all for the moment folks. Here’s to 2012! Keep reading, keep it 'crude'!

© Gaurav Sharma 2012. Photo: Oil rig © Cairn Energy.