Thursday, January 28, 2010

Rig Building Industry Remains in a State of Flux

Post-recession, if one may use the expression, the global rig building industry remains in a state of flux. Often oil market commentators give due attention to global rig counts as a way of gauging the prosperity of oil business. The simple conjecture is that when oil price is high, it makes it worthwhile for oil companies to order jack-ups and semi-submersibles in greater numbers for usage at difficult offshore extraction spots.

The latest overall Baker-Hughes rig count, suggests that in year over year terms, 1282 rigs were in operation in the U.S., 233 fewer than the corresponding week last year. Over a comparable period, Canada saw 495 rigs in operation, up by 69. Internationally, excluding U.S. and Canada, 1024 rigs were in operation, down 54 using December 2009 as a cut-off point.

The stated figures are by no means excellent. However, they are not catastrophic either according to those in the rig building business. The first real rig building boom was seen in the early 1980s. Subsequently, American shipyards as well as their European counterparts lost ground of sorts when demand flattened.

Manufacturing sector analysts partly attribute this to the average age of a jack-up being 20 years, which in truth, most oil firms extend by a further two years. Hence, when the next boom arrived in 2001, Asian players seized the initiative. Of particular significance is the global emergence of two Singapore-based companies – SembCorp and Keppel Offshore & Marine. In between 2002 and 2007, both firms became the world’s leading suppliers of rigs.

As oil prices soared over 2007-08, touching $147 a barrel at one point, both saw their collective order books swell to $8 billion. Apart from being listed companies whose share prices were soaring, direct investment from the Singaporean Government, which has a stake in both, undoubtedly boosted confidence.

Inevitably, the rig count took a beating when the oil price plummeted. Prior to that, Hurricanes Katrina and Rita (2005) took five rigs offline completely and damaged several others. However, that proved to be a different sort of a growth trigger. To begin with, both hurricanes added to order books of rig builders. Furthermore, as the U.S. economy began to take a beating in 2007, drilling companies signed long-term deals to send rigs overseas. It meant the Gulf of Mexico, widely held as the birthplace of offshore drilling, ceased to dictate contract terms benchmarks for drilling equipment.

Emergence of several offshore zones off the coasts of Africa, Middle East, Indian subcontinent and China along with a partial rebound in crude prices has stabilised rig building activity, admittedly at a level below that of fiscal year 2005-06. Rig builders worldwide had 91 major offshore rig manufacturing contracts in 2005-06, up from less than 10 in 2002-03, according to ODS-Petrodata, a research and analysis firm.

Since then, the recession and fluctuation in oil prices has made building trends forecasting extremely tricky. ODS-Petrodata’s latest research reveals that 577 of 751 mobile offshore drilling units were under contract worldwide with global offshore rig fleet utilisation at 76.8%; the highest level since July 2009. Speaking in November 2009, at the IADC Annual General Meeting in Miami, Florida, Tom Kellock, head of consulting and research, ODS-Petrodata, highlighted some of the difficulties faced by forecasters and rig builders alike.

He noted that over 100 jack-ups were idle at the time, i.e. assembled but not online. Another 60 or more were nearing completion and Kellock felt that most but not all will enter the market. Furthermore, ODS-Petrodata had seen a trend of rising gas prices and falling jack-up utilisation from 2002 into 2008.

“No longer do we have the close correlation between gasoline prices and jack-up activity. And the only obvious explanation and the one I would support is that, this is such a mature market, the prospects are just not there anymore. Analysts and even some contractors say, well, when gas prices get back to $5, $6 or $7, (at U.S pumps/per gallon) it’s all going to be OK. I really have difficulty with that,” Kellock told IADC delegates.

“I think industry needs to move on from shallow-water Gulf of Mexico, quite honestly.…This is not where people are going if they have a choice these days to look for oil and gas,” he concluded. Pretty much the same arguments are being put forward to explain the difficulties faced by North Sea as an offshore extraction zone.

Looking ahead, ODS-Petrodata forecasts a supply of 506 jack-ups worldwide by the end of 2015, assuming no additional new-builds or attrition. Its middle of the road forecast, based on gradually increasing oil and gas prices, puts jack-up demand at 334 rigs by end-2015, while the conservative forecast is set at 282 units.

Depending on the type of rigs being ordered, costs could range from US$200 million to $900 million. Hire-purchase and subletting rates of oil rigs, which were seen stabilising in 2008, are likely to remain stable over the next three years before a possible shortage develops. The silver lining is that offshore opportunities in China and India are thought to be growing rapidly. The industry also hopes that Petrobras’ prospecting and subsequent extraction off the coast of Brazil would provide a much needed boost.

While many players fret over pragmatically tight market forecasts, SembCorp and Keppel Offshore & Marine have shown the way by diversifying heavily since 2005. SembCorp builds as well as repairs shipping liners. Keppel has real estate and infrastructure divisions. Both Singaporean firms have expanded overseas and currently operate not just rig-building yards but also ship-repair yards around the world.

© Gaurav Sharma 2010. Photo Courtesy © Cairn Energy Plc

Thursday, January 21, 2010

North Sea’s glory days have long gone

Oil extracted from North Sea once made UK the world’s six-biggest producer of oil and natural gas. However, the tide turned after 1999 when production peaked at 4.5 million barrels per day. Estimates suggest that production is down nearly 40% since then.

At end of 2006 and 2007, UK production had dropped to 2.9 million and 2.8 million barrels per day respectively, indicative of a terminal decline. Geologists are not yet suggesting the North Sea oil has nearly run out. Government and private sector research indicates there is still about 15 to 25 billion barrels beneath the UK Continental Shelf (UKCS). However, all the “easy oil”, to be read as easier to extract, has nearly dwindled.

Most new discoveries contain less than 50 million barrels; minuscule amount by global standards. Harder to extract oil requires additional investment as production becomes more and more capital intensive. Research by Oil and Gas UK (OGUK) suggests that there are already signs of a sharp slowdown in exploration and appraisal drilling activity. In its Economic Report (2009), it noted that the first quarter of 2009 saw a 78% drop in the number of exploration wells drilled.

OGUK expects investment to fall significantly and fears it could even drop below £3 billion in 2010. Historic data suggests investment stood at £4.9 billion in 2007. Furthermore, a fall in the value of the pound sterling against the US dollar and relatively smaller discoveries per exploratory project would imply that 2010 would result in investment of a comparable level yielding less than one third of the oil did in 2001.

OGUK is not shying away from admitting things are not what they used to be. To its credit, the lobby group meaningfully acknowledges UK’s internal “Peak Oil” argument. It believes the surge in oil price during 2007 and 2008 masked a steady decline in the competitiveness of UKCS extraction.

Pure economics also comes into the picture. Quite frankly, despite a decline in relative value of the pound sterling, it is clear that UK oil and gas exploration projects will lose out to other regions around the world which offer more substantial investment opportunities on better terms. For instance, Cairn Energy (LSE: CNE) made its mark in the North Sea, but is banking its future strategy on South Asia (India and Bangladesh), Tunisia and Greenland.

UKCS' decline is unlikely to be stemmed unless the government provides tax breaks to ensure some semblance of competitiveness, according to business lobby groups. Even at the time of the oil price touching dizzy heights of US$147 per barrel many were concerned. I recollect a conversation I had at a House of Commons event early in 2008 with Geoff Runcie, Chief Executive, Aberdeen & Grampian Chamber of Commerce (AGCC) and Howard Archer, chief UK economist, IHS Global Insight.

Runcie believed that despite repeated warnings of escalating oil extraction costs, the UK oil industry had to contend with two major tax increases in recent years. He said that investment in real terms had fallen by £1 billion between the first quarter of 2006 and the first quarter of 2008, despite rising commodity prices.

Archer noted that giving tax breaks to oil companies at a time when crude oil price was at $147 per barrel, household energy prices were rising and oil companies were booking record profits, was politically suicidal for any government. The financial tsunami that followed over 2008-09 and the current precarious state of the UK public purse currently makes allowance for such tax breaks unthinkable.

Furthermore, energy economists believe North Sea investment was hit both ways. High oil price masked under-investment and made tax breaks unpalatable for most of 2007-08. Subsequently, a greater decline in activity was an obvious consequence of a lower oil price which fell to $34 per barrel in December 2008 with no tax break in sight for entirely different reasons.

Despite evidence to the contrary, fall in oil production and two of Scotland’s largest banks being owned by the UK taxpayer, the Scottish National Party (SNP) still bases its case for Scottish Independence on North Sea oil deposits, majority of which lie in what could geographically be described as Scottish waters. The figures may add up today, but do not stand up to scrutiny for much longer. SNP does find common ground with oilmen and lobbyists who wish to see more exploratory activity west of Shetland Islands. Even before significant prospecting, geologists believe it could hold up to 4 billion barrels of oil.

However, commencing projects in the area is not easy. A sea bed with prospective hydrocarbons stored at high pressures, inhospitable climate and a lack of infrastructure temper enthusiasm as easier exploration options are available globally. Total has got one gas project going which was commenced in 2007. It believes the West of Shetland area represents about 17% of UK’s remaining oil and gas resource base and could contribute up to 6% of the country's gas requirements by 2015.

If even a new exploratory zone represents 17% of what is left, one wonders how much actually does remain. Shetland Islands Council EDU sees the inevitable but not immediate decline. West Shetland will not prevent the North Sea’s decline. Furthermore, several government papers between 2003 and 2007 recognise the problem. However, in my opinion none of the papers seem to provide any concrete contingency plans when and if, as expected, UKCS production falls to a third of its 1999 peak level sometime between 2020 and 2030.

Concurrently, Office for National Statistics (ONS) data after the second quarter of 2007 suggests the UK is fast becoming a net importer of crude for the first time in decades. Glory days have long, off-shore industry faces tough challenges, government finances are precarious and no one is in denial. In short, it’s a jolly rotten mess, albeit one which has been in the pipeline for some time.

© Gaurav Sharma 2010. Photo Courtesy © BP Plc, Andrew Rig, N. Sea

Tuesday, January 12, 2010

Ethanol Can’t Solve it All!

When it comes to cutting Greenhouse gas emissions, reasons for being suspicious if not sceptical about the potential of ethanol-based biofuels are gaining traction. The initial promise, some say PR hype, of a clean and green fuel with the potential to solve it all has been dampened by the principal question mark – just how green ethanol fuel really is? The complex answer depends on what technique and which raw material is actually used during the production process.

In this game there are two principal players – Brazil and U.S.A - who between them accounted for some 90% of the world’s ethanol fuel production if 2008 is used as a cut-off point. Minneapolis-based Institute for Agriculture and Trade Policy (IATP) noted in a report in 2008 that only some type of ethanol production processes, which involved low water-absorption intensive techniques over the course of production, were likely to do much good.

This too came from sugarcane produced ethanol made by Brazil. Ethanol produced from corn, i.e. the American way or more specifically the Iowa way, is considered inefficient and expensive. While the Brazilian ethanol fuel industry is over thirty years old, President George W. Bush literally pumped-up a not so dormant U.S. industry in 2007 when he signed legislation requiring a five-fold increase in biofuels production, to 36 billion gallons* by 2022.

Alas when a politician steps in, lobbyists so entrenched in an industry touting its allegedly green credentials cannot be far behind. Woe betide any politician who messes with lobby groups (of all descriptions not just the ‘corny’ ones). By the time Bush signed the legislation, number of U.S. ethanol factories had already tripled over eight years from 50 to 140. The former President was merely following a long drawn out campaign by the American corn ethanol industry that he was doing some good. For them that is, not mother earth.

Research suggests that a typical corn-fed ethanol factory producing 50 million gallons of biofuels a year needs about 500 gallons of water per minute, according to published sources. Most of it goes into boiling and cooling processes. It is a method which in layman terms would be similar to making beer though more water intensive. Experts agree that U.S. ethanol plants have become more efficient over the last five years using nearly half as much water per gallon as they did a decade ago, but the stated figure is the benchmark for better or for worse.

Furthermore, the Brazil Institute of the Woodrow Wilson Center in Washington DC, found in a study that annual yield in litres* per hectare for corn manufactured ethanol was in region of 3100 to 4000 while sugarcane manufactured ethanol yielded double the volume in the circa of 6800 to 8000 litres per hectare.

In face of such overwhelming inefficiencies, the Iowa industry is kept alive largely by generous subsidies and high tariffs which keep out the cheaper and environmentally friendly Brazilian imports, according to FT’s World Trade Editor Alan Beattie. Even then, the Brazil Institute estimates that projected price of ethanol produced in Brazil currently is and remains lower than both the projected prices of unleaded gasoline and of U.S. produced ethanol. In fact, the price differential between Brazilian and U.S. produced ethanol was so great in 2006 that it was still cheaper to import Brazilian ethanol even after the 54 cents per gallon import tariff.

Furthermore, Iowa’s plants have become poster children of the Food Versus Fuel debate. According to a report by the Reuters news agency, while American funding for corn continues, the Inter-American Development Bank (IDB) is rethinking its stance on funding biofuels in general. The UNEP has also conducted detailed research into the subject which makes for interesting reading. However, it curiously notes in its report that the work, “delivers no final word, but a concentration of current knowledge, aimed to support decision making and future scientific work towards a sustainable bio-economy.”

That the American lobbyists are not paying attention or are open to gentle persuasion is a different matter. Ethanol production rose from 440 million gallons in 2002 to 2 billion gallons by 2007 in Iowa alone. That’s not including production facilities in other U.S. states that were brave enough or should I say idiotic enough to allow corn-fed ethanol production facilities to burden their aquifers. In fact, water could be the undoing of ethanol according to IATP. I am not a scientist, but from where I stand even the economics of it is on a shaky footing. Mark Twain aptly observed: "Whiskey is for drinking. Water is for fighting over."

Several ethanol projects within a 30 mile radius of Illinois' Mahomet Aquifer are embroiled in challenges (legal or otherwise) as residents fret over their impact on the region's water supply. Other examples could include cases from Minnesota, Kansas, Nebraska and even Iowa. The recession has had an unwitting effect as well. Most industry observers now feel that despite Government subsidies, only the most efficient U.S. ethanol plants would survive the downturn as the industry has been overbuilt and over-hyped. In the interim, doubts persist whether ethanol, especially the corn-fed variety, is all that green at all. That’s on top of the unwanted side-effect of needless hot air generated by U.S. presidential hopefuls, sitting presidents, politicians and lobbyists of ‘corny’ persuasions.
(* 1 Gallon - U.S. = 3.785 Litres)

© Gaurav Sharma 2010. Photo Courtesy ©

Wednesday, January 06, 2010

London Oil Traders Maybe Humming “Let it Snow”

As some of the heaviest snowfall in history blanketed most of the UK and shows no sign of abating, traders with positions on Brent Crude Oil Futures in London would surely be in the mood for one of Dean Martin’s most famous songs.

On the back of the cold weather, ICE Brent crude oil contract for February delivery was trading at a 14-month high of $80.55 a barrel on the London-based ICE Futures Europe exchange earlier today; the highest this part of the world has seen since October 9, 2008.

Furthermore, it seems the chill and snow is likely to prevail across the British Isles, Scandinavia, much of Europe and parts Eastern United States and East Asia as well for some time yet. Hence, the price spike is likely to go further. A quick call to a contact of mine at Sucden Financial revealed that February ICE Brent crude contract’s discount to the comparable front-month U.S. crude contract was at $1.25 per barrel.

Looking ahead, my contact who wasn’t humming Let it Snow till I put the jingle in his head, said the February versus March Brent spread was at 64 cents. On technicals front, Brent support is at $75 a barrel while resistance is at $82 a barrel. His overall assessment is that the market would more than take a +$80 settlement on the back of a temporary spike provided by the cold weather, given the current “uncertain and fragile” recovery of the global economy.

Most in the City echo the sentiment. Harry Tchilinguirian, head of commodities derivatives research at BNP Paribas, said in a TV interview that the weather has helped to give crude prices a boost. However, he felt the supply situation, especially in the U.S. was more than adequate. Separately, Mike Wittner, Head of oil market research at Société Générale, also expressed a similar opinion.

Both commentators feel that once the snow blasts have disappeared, after having added their couple of dollars worth to the crude price, corrections could be sharp. Nothing lasts forever, until then Let it Snow!

© Gaurav Sharma 2010. Photo Copyright © Gaurav Sharma 2010

Tuesday, January 05, 2010

IEA Belatedly Joins the “Peak Oil” Debate

As 2009 drew to a close, the International Energy Agency (IEA) finally and formally admitted that projections on the timing of oil production reaching its peak were no laughing matter and seriously joined the debate. Previously, the IEA, which advises 28 OECD nations on energy issues, had never really been specific about when it thought conventional sources of oil would peak.

I personally recollect having met someone from the IEA in September 2008 on the back of an OPEC summit that year, who talked at length about the matter in private, but refused to discuss the issue on-record. Over the years, some observers have even alleged that the agency was fudging oil production projections.

This clamour, which had always been lurking in the background, gained traction following a report by Dr. Robert L. Hirsch for the U.S. Department of Energy in which he analysed the possible effects of Peak Oil (Viz. Peaking of world oil production: impacts, mitigation, & risk management). A truncated version of his thoughts was later published by the Atlantic Council of U.S.

Hirsch noted: "The peaking of world oil production presents the U.S. and the world with an unprecedented risk management problem. As peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented. Viable mitigation options exist on both the supply and demand sides, but to have substantial impact, they must be initiated more than a decade in advance of peaking."

In the four years that followed the Hirsch report, many stories in the popular press ran along the lines that all the easy oil and gas in the world had pretty much been found and that tougher times lay ahead. It is an argument which is not hard to dismiss in its entirety. Curiously enough, as an advisory agency to 28 leading economies, the IEA was somehow was not all that keen on discussing it.

All of that was laid to rest over a dramatic few weeks last month. On December 9th, the agency’s eagerly awaited World Energy Outlook 2009 (WEO) noted that conventional oil, from straight-forward to extract sources, is “projected to reach a plateau before” 2030. In the publication, the IEA is seen to have conducted a serious supply-side analysis including the largest oil fields, their rate of production and decline in its research.

Published material suggests that the IEA sees a decline of 7% in year over year terms over the coming years at these extraction site, nearly double the rate of earlier forecasts. Based on the projected rate of decline, the agency estimates that the world would need four new “Saudi Arabias”, a country which has 24% of the world’s proven crude reserves, by 2030 to meet demand. This too is based on the assumption that global demand remains flat at existing levels as does the rate of production decline.

However, quite frankly the agency still prima facie declined to say that the world has currently entered the era of peak oil. Furthermore, in order to perhaps soften its hard assessment, it pointed out that the first half of 2009 saw 10 billion barrels of new oil discoveries; an annual rate previously unheard of! It also said non-conventional sources such as the Athabasca Tar Sands (Canada) should not be discounted either.

Just as sceptics were rounding up on the agency, IEA Chief Economist Dr. Fatih Birol, set out to paint a more pragmatic picture. Having visited some 21 cities in the run-up the WEO’s release, Birol told several media outlets, most notably The Economist and The Guardian newspaper, that the crude production plateau which the agency mentions in the publication, could potentially arrive as early as 2020.

In a much more detailed conversation with The Economist, Birol also made another interesting observation. He said that a worldwide effort to restrict increase in global temperatures to 2 degree centigrade will restrict the increase in global demand for oil to 89 million barrels per day (bpd) in 2030 as opposed to 105 million bpd if no action is taken. That could, in theory, push back peak oil production scenarios as more time would be needed to produce lower-cost oil that remains to be developed.

Watch this space then - for next two decades that is! This argument is far from over. At least the IEA can now dodge accusations that it is not being realistic its assessments and shying away from debate.

© Gaurav Sharma 2010. Photo Courtesy: Martin Rhodes, Essex, England

Monday, January 04, 2010

Fresh Takes on The Resource Curse Hypothesis

The hypothesis that oil damages countries it comes from, in more ways than one, has been with us for some time now. Industry observers and critics perhaps do find common ground in noting that discovery and extraction of crude oil, especially in case of developing economies exporting the stuff, has failed to provide the bonanza and even spread of prosperity that it should for these nations.

On the contrary, oil has stirred up troubles and conflicts. Furthermore, wherever one looks there is a political dimension to the dominance of this single commodity which is limited and will run out in the future, though not as dramatically as sometimes portrayed.

Adding to the debate are fresh thoughts contained in two very interesting books that I have read in recent months. The first is titled Crude World: The Violent Twilight of Oil by Peter Maass. The second is titled False Economy: A Surprising Economic History of the World by Alan Beattie, the fourth chapter of which dwells on the subject (viz. Natural Resources: Why are oil and diamonds more trouble than they are worth? – Pages 95 to 120).

In his book, Maass opines interestingly that the commodity is itself the real villain here. His central argument is that oil has damaged nations it comes from as it artificially strengthens their currencies and makes the rest of the economy uncompetitive. More critically, while wealth creation occurs as a result of oil exports – it does not create what developing economies need most in appreciable numbers – jobs. Furthermore, he offers arguments that oil wealth removes the need for wise spending.

What I liked about this book is that it does not look for fall guys or hammers oil companies, who in the author’s opinion are like any other business seeking the maximum possible returns on investment. Rather, he opines that corruption, greed and strife are also by-products of the oil trade. It is an interesting and unique book though not rich on the economic analysis front.

Along this tangent, the aforementioned chapter in Beattie’s book offers more detailed economic insight. Like Maass, he agrees that it is in the nature of the oil business to benefit fewer workers, as oil and gas extraction is equipment intensive and not labour intensive. Experts believe it is labour intensive mass production industries that do more to lift people out of poverty in the form of job creation with more wages for more people. Hence, oil creates a unique problem for oil-rich developing economies.

Beattie also notes that a significant portion of the return on extraction is used by oil-exporting developing economies to purchase drilling equipment which they cannot manufacture. Throw in the geopolitical permutations and corruption that Peter Maass alludes to, add in the concept of Dutch disease, and we soon arrive at a self-inflicted tragic hotchpotch which may be labelled as a resource fuelled curse that both authors describe in some detail.

No one is discounting the fact that where managed well, oil as a resource has been good for economies exporting it. Norway is often cited as such a nation, but Beattie says it struck oil meaningfully only in the 1970s, by which time it was already a rich economy. Russia is criss-crossing between becoming a meaningful democracy and going down the old Soviet autocratic way. Oil and gas wealth ensures that it may well be, some say already is, heading in the latter direction.

Four of Africa’s longest serving autocrats are from oil exporting nations. More convincing details, especially on Equatorial Guinea, can be found in the work of Dr. Ricardo Soares de Oliveira published in 2007. For lack of a better metaphor, he aptly brands such nations as ‘failed successful states.’

Both these books, especially as they are aimed at a wider readership base rather than academia, rekindle the resource cruse discussion. I particularly like Beattie’s witty observation that oil is bulky, murky and harder to extract, but “like Visa or MasterCard, also widely accepted!”

© Gaurav Sharma 2010. Photo Courtesy Cairn Energy PLC