Monday, September 05, 2011

Economic malaise & ratings agencies' crude talk

Not the time to say the Oilholic told you so – but the bears never left Crude town. They were merely taking a breather after mauling the oil futures market in the first week of August. It is a no brainer that existing conditions, i.e. fears of recessionary trends in the US, a slowdown in China and Eurozone’s debt fears, are spooking sentiment (again!).

At 14:30 GMT on Monday, ICE Brent crude forward month futures contract was down 1.5% or US$1.63 in intraday trading at US$110.70. Concurrently, WTI futures contract, weighed down more by a perceived American economic malaise, was down 2.8% or US$2.58 trading at US$84.27. Feedback from the city suggests reports of sluggish Chinese service sector growth are as much of a concern as a quarter or two of negativity in the US.

In fact, analysts at Commerzbank believe were it not for market sentiment factoring in possible measures by the US Federal Reserve to stimulate the economy, the WTI could have dipped even further. Additionally, the Libyan instability premium is fast on the verge of being factored out too even though its supply dynamic is far from returning to normalcy.

Société Générale analyst Jesper Dannesboe believes that Brent prices are exposed to a sharp drop down to US$100, or lower, before year-end as oil demand weakens and the market starts pricing in weak 2012 economic and oil demand growth.

“The recent sharp drop in leading indicators in Europe and the US suggest that demand destruction is likely to escalate, thereby resulting in significant drop in global oil demand growth. It is worth remembering that while Chinese demand growth is likely to remain solid, China still only account for about 11-12% of global oil consumption in absolute terms. In other words, the demand outlook in US and Europe remains a key driver of oil consumption, and therefore oil prices,” he wrote in a recent investment note.

All indications are that Société Générale’s Global head of oil research Mike Wittner will review his oil price forecast and will be publishing new lower oil demand and oil price forecast in the investment bank’s Commodity Review slated for publication on Sept 12. However, it is also worth moving away from pricing analysis to discuss what the perceived malaise means for the energy business; both Fitch Ratings and Moody’s have been at it.

In a report published on August 30, Fitch calculates that average oil and gas sector revenue growth will be 6%-7% in 2012, but considers that there is a 20% chance that sector revenue growth may actually be less than zero next year due to slower developed market macroeconomic growth that may also adversely impact oil prices. (Click image to enlarge). Jeffrey Woodruff, London-based Senior Director in Fitch's Energy and Utilities Team, notes, “A US real-GDP growth rate of around 1.8% and an average Brent oil price of US$90 per barrel in 2012 would likely make it a 50/50 chance as to whether or not average oil and gas sector revenue grows or contracts next year."

Fitch believes sector revenue growth in 2011 will average around 20% but is likely to slow to a low double-digit or even high single-digit growth rate thereafter. EBITDA growth tends to broadly follow the trend in revenue growth, but with more volatility. If sector average revenue growth slows to zero in 2012, sector average EBITDA growth is likely to be negative. The cash flow impact from such an event is likely to be modest for investment grade names, but would be more severe for companies with low speculative grade ratings that are more exposed to earnings volatility.

A slowing global economy and particularly weak US economic growth could negatively impact demand for oil for the remainder of 2011 and potentially into 2012. Fitch anticipates the overall rating impact of a slowdown in average sector revenue growth in 2012 will be minimal for investment grade names. However, for non-investment grade companies, it would be an entirely different matter. Fitch believes they would be more affected and the agency could revise rating Outlooks to Negative.

In a report also published on the same day by Moody’s, specifically on downstream, the agency notes that refining and marketing (R&M) sector has reached a peak in its business cycle, with limited prospects for improving from current levels over the next 12-18 months as capacity overtakes demand.

As result, the agency changed its outlook on the R&M sector to stable from positive, because of the considerable risk generated by upcoming capacity additions worldwide. The stable outlook means Moody's expects business conditions in the R&M sector neither to improve nor deteriorate significantly over the next 12-18 months. It last changed the R&M sector's outlook, to positive from stable, on March 31 this year.

Gretchen French, Moody's Vice President and Senior Analyst, expects global demand for gasoline and distillate to grow modestly through 2012, based on the agency’s central scenario of a sluggish global recovery. "However, a capacity glut could suppress margins across the R&M sector as early as 2012 if demand or capacity rationalisation fails to offset anticipated supply increases," she adds.

After all, nearly 2.4 million barrels per day (bpd) of new capacity is scheduled to come online worldwide in 2012. Currently, estimated global demand is only 1.6 million bpd in 2012. Moody’s reckons these concerns, coupled with elevated prices, continued high unemployment in the OECD, softer US or Eurozone economies, and inflation-stemming efforts in China could all dampen demand for refined products. Blimey! Did we leave anything out? The Oilholic bets the bears didn’t either.

On a related note, the latest Iraqi oil exports figures, released by country’s Oil Ministry, make for interesting reading. Data for July suggests total exports came in at 67.2 billion barrels down marginally from 68.2 billion in June. However, as oil prices rose over the corresponding period, revenue actually rose 2% netting the government US$7.31 billion with output currently pegged at around 2.17 bpd.

The total revenue to end-July came in at US$48.6 billion which does suggest that the country is on track to meet its revenue target of US$82.5 billion as stated in its February 2011 budget statement. However, given what is going on in the market at the moment, future crude price could be a concern. It seems the Iraqi budget is predicated at a price of US$76.50 a barrel. So there is nothing to worry about for them, for now!

Finally, here is an interesting CNBC segment on the town of Williston (North Dakota, USA) brought to the Oilholic’s attention, by a colleague who is from around those parts. He calls it Boomtown USA and it may not be that far from the truth!

© Gaurav Sharma 2011. Photo: Oil Refinery - Quebec, Canada © Michael Melford / National Geographic. Graph: Oil & Gas Sector average revenue growth rate © Fitch Ratings, London 2011.

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