ConocoPhillips’ move is a sign of crude times

US major ConocoPhillips' announcement last Friday that it will be pursuing the separation of its exploration and production (E&P) and refining and marketing (R&M) businesses into two separate publicly traded corporations via a tax-free spin-off R&M to COP shareholders does not surprise the Oilholic. 

Rather, it is a sign of crude times. Oil majors are increasing turning their focus to the high risk, high reward E&P side of things rather than the R&M business where margins albeit recovering at the moment, continue to be abysmal. Most oil majors  are divesting their refinery assets, and even BP would have done so, regardless of the Macondo tragedy forcing its hand towards divestment. 

ConocoPhillips’ decision should not be interpreted as a move away from R&M – nothing in the oil business is either that simple or linear. However, it certainly tells us where its priorities currently lie and how it feels the integrated model is not the best way forward. This is in line with industry trends as the Oilholic noted last November. 

Meanwhile, following the announcement, ratings agency Moody's says it may review ConocoPhillips' ratings for possible downgrade with approximately US$19.6 billion of rated debt being affected. This includes A1 senior unsecured and other long-term debt ratings of the parent company and its rated subsidiaries. 

Tom Coleman, Moody's Senior Vice-President notes that the distribution to shareholders of the large R&M business could weaken the credit profile of ConocoPhillips and result in a downgrade of its A1 rating. 

"Our review will focus on the company's capital structure following the spin-off, including the potential for debt reduction by ConocoPhillips, along with its financial policies and growth objectives going forward as a stand-alone E&P company," he concludes. 

The wider market is waiting to get a clearer understanding of the oil major’s plans for debt reduction, capital structure and financial policies as an independent E&P. Continuing with corporate deals, BHP Billiton made a strategic swoop for Petrohawk Energy. The cash acquisition, also announced last Friday, to the tune of US$12.1 billion, will give it access to shale oil and gas assets across Texas and Louisiana. BHP’s latest move follows its earlier decision to buy Chesapeake Energy's Arkansas-based gas business for US$4.75 billion. 

Meanwhile, figures released by Brazil’s Petrobras for the month of June indicate that the company’s domestic production rose 3.5% on an annualised basis. The results were boosted by the resumption of production on platforms that had been undergoing scheduled maintenance in the Campos Basin, and startup of a new well connected to platform Jubarte field's P-57 in the Espírito Santo section of the Campos Basin. The Extended Well Test (EWT) in the Campos Basin's Aruanã field also started up in late June.

However, its international output was down 5.6% on an annualised basis due to operating issues and tax payments in Akpo, Nigeria. Petrobras' average oil and natural gas production (both domestic and overseas) amounted to 2,641,508 barrels of oil equivalent per day (boed), 2.13% up on the total figure for May 2011. 

Finally, European woes are weighing on the crude markets. With the NYMEX August crude futures contract due to expire on Wednesday, intraday trading at one point, 1045 GMT to be precise, saw it down 0.31% or 33 cents at US$96.91 a barrel. Concurrently, the September ICE Brent futures contract was down 0.6%, 74 cents at US$116.44 a barrel. 

© Gaurav Sharma 2011. Photo 1: COP Refinery & Oil Platform collage © ConocoPhillips

Notes on a ‘Crude’ fortnight !

It has been a crude ol’ fortnight and there are loads of things to talk about. But first some “fused” thoughts from the Société Générale press boozer in London yesterday. There was consensus among crude commentators at the French investment bank most of whom asked that with commodities prices having been at or near record levels earlier this year, and subsequently subsiding only modestly, can anyone realistically say scribes or paranoid Western commentators are overstating the significance of China's presence in the global commodities markets? Nope! 

Additionally, should the existing commodities market conditions represent a bubble (of sorts); a deceleration in China could ultimately cause it to burst, they added. Most, but not all, also agreed with the Oilholic that IEA’s move to tap members’ strategic petroleum reserves (SPRs) may push Brent below US$100, but not US$90. At the moment it is doing neither. Finally, it is not yet time to hail shale beyond North America. Population concentration, politics and planning laws in Europe would make Poland a hell of a lot more difficult to tap than some American jurisdictions.

From an informal press party to a plethora of formal events at City law firms; of which there have been quite a few over the Q2 2011. Two of the better ones the Oilholic was invited to last quarter happened to be at Fulbright & Jaworski (May 10) and Clyde & Co (May 19).

The Fulbright event made Iraq and its “re-emergence” as an oil market as its central focus. Partners at the law firm, some of whom were in town from Houston, noted that since 2009 three petroleum licensing rounds have been held in Iraq with deals signed to cover of 51 billion barrels of reserves. There was enthusiastic chatter about the country’s ambitious plans to increase production from approximately 2.4 million barrels per day (bpd) to 12 million bpd by 2017. The Oilholic was also duly given a copy of the Legal guide to doing business in Iraq which regrettably he has so far not found the time to read.

Moving on, the Clyde & Co. event focussed on legal implications one year on from the BP Deepwater Horizon rig explosion. While much of the discussion was along predictable tangents, David Leckie and Georgina Crowhurst of Clyde & Co. drew an interesting comparison between the Piper Alpha tragedy of 1988 in the North Sea and the aftermath of the Gulf of Mexico spill. Agreed that regulatory regimes across the globe are fundamentally different, but observe this – Piper Alpha saw no corporate criminal prosecutions, no individual prosecutions and no top level political criticism. Deepwater Horizon will see FBI criminal and civil investigation, possible individual liability and we all remember President Obama’s “I am furious” remark. Shows how far we have come!

Continuing with Deepwater Horizon fiasco, met Tom Bergin last evening, a former broker turned Reuters oil & gas correspondent and a familiar face in crude circles. His book on BP – the aptly titled Spills and Spin: The Inside Story of BP – is due to be released on July 7th. Admittedly, books on the subject and on BP are aplenty since the infamous mishap of April 20th, 2010 and business book critics call them a cottage industry. However, the Oilholic is really keen to read Bergin’s work as he believes that akin to Bethany “Is Enron Overpriced?” McLean and Peter Elkind’s book on the Enron scandal which was outstanding (and surrounded by a cacophony of average “accounts”); this title could be the real deal  on BP and the spill.

Bergin knows his game, waited to present his thoughts and research in the fullness of time instead of a hurriedly scrambled “make a quick buck” work, has followed the oil major in question and the wider market for a while and has unique access to those close to the incident. Watch this space for a review!

Now, on to pricing and industry outlooks – nothing has happened since the Oilholic’s last blog on June 23rd that merits a crude change of conjecture. IEA’s move to tap in to members’ SPRs will not push Brent’s forward month futures contract below US$90 over the medium term. Feel free to send hate mail if it does! Analysts at ratings agency Moody's believe that (i) ongoing unrest in parts of the Middle East and North Africa (MENA); (ii) protracted supply disruptions in Libya; and (iii) lingering questions about OPEC supply are likely to keep crude at premium prices over the next 12-18 months.

In the past week, the press has received some ballpark figures from the agency. The release of 60 million barrels will take place in this month – but this will not be a straight cut case of two million bpd; the actual release will be much slower. The breakdown, as per IEA communiqués, will be -

• USA: 30 million barrels (or 50% of the quota comprising largely of light sweet with delivery of their lot to be complete by the end of August), 
• Europe: 18 million barrels (30%)
• Asia: 12 million barrels (20%)

Finally, the British Bankers Association (BBA) conference last week also touched on crude matters. Gerard Lyons, Chief Economist & Group head of Global Research at Standard Chartered opined that Western economies are two years into a recovery and that growth prospects are far better in the East than in the West. Hence, he also expects energy prices to firm up next year.

Douglas Flint, Group Chairman of HSBC Holdings noted that China is now a major destination for Middle Eastern exports (to be read oil and gas, as there is little else). So we’re back where we started this post – in the East that is!

© Gaurav Sharma 2011. Photo: Pipeline in Alaska © Michael S. Quinton, National Geographic

Well ‘Why-EA’? Agency wilts as politicians win!

Earlier this afternoon, for only the third time in its history, the IEA asked its members to release an extra 60 million barrels of their oil stockpiles on to the world markets.

The previous two occasions were the first gulf war (1991) and the aftermath of Hurricane Katrina (2005). That it has happened given the political clamour for it is no surprise and whether or not one questions the wisdom behind the decision, it is a significant event.

The impact of the move designed to stem the rise of crude prices was felt immediately. At 17:15GMT ICE Brent forward month futures contract was trading at US$108.45 down 4.99% or US$5.74 in intraday trading while the WTI contract fell 3.64% or US$3.51 to US$91.46.

Nearly half of the 60 million barrels would be released from the US government’s Strategic Petroleum Reserve (SPR). In relative terms, UK’s contribution would be three million barrels – which tells you which nation the IEA was mostly looking to. The agency’s executive director Nobuo Tanaka feels the move will contribute to “well-supplied markets” and ensure a soft landing for the world economy.

This begs the question if the market is “well-supplied” especially with overcapacity at Cushing (Stateside) why now? Why here? For starters, and as the Oilholic blogged earlier, some politicians like Senator Jeff Bingaman – a Democrat from New Mexico and chairman of the US Senate energy committee – have been clamouring for his country’s SPR to be raided to relieve price pressures since April.

OPEC’s shenanigans earlier this month gave them further ammunition amid concerns that the summer or “driving season” rise in US demand would cause prices to rise further still. That is despite the fact that the American market remains well supplied and largely unaffected by 132 million barrels of Libyan light sweet crude oil which the IEA reckons have disappeared from the market (until the end of May since the hostilities began).

Nonetheless, all this mega event does is add to the market fear and confirm that a perceptively short term problem is worsening! Long term hope remains that the Libyan supply gap would be plugged. Releasing portions of the SPRs would not alleviate market concerns and could even be a disincentive for the Saudis to pump more oil – although they made it blatantly obvious after the OPEC meeting deadlock on June 8 that they will up production. Now how they will react is anybody's guess?

Jason Schenker, President and Chief Economist of Prestige Economics, feels that while the decision is price bearish for crude oil in the immediate term, these measures are being implemented with the intent to stave off significantly higher prices in the near and medium term.

In a note to clients, Schenker notes: “The fact that the IEA had to go to these lengths in the second year of an expanding business cycle says something very bullish about crude oil prices in the medium and long term. The global economy is up against a wall in terms of receiving additional oil supplies to meet demand. Additional demand or supply disruption would have a massively bullish impact on prices. After all, releasing emergency inventories is a last resort.”

But must we resort to last resorts, just yet? While Sen. Bingaman would be happy, most in the market are worried. Some moan that Venezuelan and Iranian intransigence in Vienna brought this about. For what it is worth, the market trend was already bearish, 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.

Some for instance like Phil Flynn, analyst at PFG Best, think the IEA’s move was “the final nail in the coffin for the embattled oil markets.” Let’s see what the agency itself makes of its move 30 days from now when it reassesses the situation.

Those interested in the intricacies of this event would perhaps also like to know how the sale takes place but we only have the US example to go by. Last time it happened – under the Bush administration on September 6, 2005 – of the 30 million barrels made available, only 11 million were actually sold to five bidders by the US energy department. Nine of a total of 14 bidders were rejected, with deliveries commencing in the third week of the month. What the take-up would be in all IEA jurisdictions this time around remains to be seen.

Medium term price sentiments according to the Oilholic’s feedback have not materially altered and so they shouldn’t either. An average of five City forecasts sees Brent at US$113.50 in Q3 2011, US$112.50 in Q4 11 and US$115 in Q1 2012. Finally, most city forecasters, and to cite one, remain “marginally” bullish for 2012 though no one, this blogger including, sees a US$150 price over 2012.

Finally to all of the Oilholic's American readers concerned about the rising price of gas, spare a thought for some of us across the pond. OPEC’s research suggests (click graph above) that much higher taxes in most national jurisdictions in this part of the world means we pay way more than you guys. That is not changing any time soon. Releases of SPRs woould not meaningfully ease price pressures at the pump for us.

© Gaurav Sharma 2011. Photo: Gas Station, Sunnyvale, California, USA © Gaurav Sharma, April 2011. Graphics: Who gets what from a litre of Oil? © OPEC Secretariat, Vienna 2010.

Crude 7 days & wayward Hayward’s comeback?

It is not often that we talk about Jean-Claude Trichet – the inimitable and outgoing European Central Bank president here, but last week he said something rather interesting at a London School of Economics event which deserves a mention in light of the unfolding Greek tragedy (part II) and before we talk crude pricing.

Trichet said the ECB needs to ensure that oil (and commodity) price increases witnessed in recent months do not trigger inflationary problems. Greece aside, Trichet opined that the Euro zone recovery was on a good footing even though unemployment (currently at a ten year high) was “far too high.”

While he did not directly refer to the deterioration in Greece’s fiscal situation, it may yet have massive implications for the Euro zone. Its impact on crude prices will be one of confidence, rather than one of consumption pattern metrics. Greece, relative to other European players, is neither a major economy and nor a major crude consuming nation. Market therefore will be factoring in the knock-on effect were it to default.

Quite frankly, the Oilholic agrees with Fitch Ratings that if commercial lenders roll over their loans to Greece, it will deem the country to be in “default". Standard & Poor's has already issued a similar warning while Moody’s says there is a 50% chance of Greece missing a repayment within three to five years.

With confidence not all that high and the OPEC meeting shenanigans from a fortnight now consigned to the history books, the crude price took a dip with the ICE Brent forward month futures contract at US$112.54 last time I checked. Nonetheless, oil market fundamentals for the rest of 2010 and 2011 are forecasted to be reasonably bullish.

Analysts at Société Générale feel many of the prevalent downside risks are non-fundamental. These include macro concerns about the US, Europe (as noted above) and China; the end of QE2 liquidity injections; concerns about demand destruction; uncertainty about Saudi price targets; fading fears of further MENA supply disruptions; and still-high levels of non-commercial net length in the oil markets.

In an investment note to clients, Mike Wittner, the French investment bank’s veteran oil market analyst wrote: “Based on these offsetting factors, our forecast for ICE Brent crude is neutral compared to current prices. We forecast Brent at US$114 in Q3 11 (upward revision of $3) and US$113 in Q4 11 (+$6). Our forecast for 2012 is for Brent at US$115 (+$5). Compared to the forward curve, we are neutral for the rest of 2011 and slightly bullish for 2012.”

Meanwhile the IEA noted that a Saudi push to replace “lost” Libyan barrels would need to be competitively priced to bring relief. Market conjecture and vibes from Riyadh suggest that while the Saudis may well wish to up production and cool the crude price, they are not trying to drive prices sharply lower.

The problem is a “sweet” one. The oil market for the rest of 2011, in the agency’s opinion, looks potentially short of sweet crude, should the Libyan crisis continue to keep those supplies restrained. Only “competitively priced OPEC barrels” whatever the source might be could bring welcome relief, it concludes.

Now on to corporate matters, the most geopolitically notable one among them is a deal signed by ConocoPhillips last Thursday, with the government of Bangladesh to explore parts of the Bay of Bengal for oil and gas. This is further proof, if one needed any, that the oil majors are venturing beyond the traditional prospection zones and those considered “non-traditional” thus far aren’t any longer.

The two zones, mentioned in the deal, are about 175 miles offshore from the Bangladeshi port of Chittagong at a depth of 5,000 feet covering an area of approximately 1.27 million acres. According to a ConocoPhillips' corporate announcement exploration efforts will begin “as soon as possible.”

In other matters, the man who founded Cairn Energy in 1980 – Sir Bill Gammell is to step down as the independent oil upstart’s chief executive to become its non-executive chairman under a board reshuffle. He will replace current chairman Norman Murray, while the company’s legal and commercial director Simon Thomson will take over the role of chief executive.

However, Sir Bill would continue as chairman of Cairn India and retain responsibility for the sale of Cairn Energy's Indian assets to Vedanta in a deal worth nearly US$10 billion. The deal has been awaiting clearance for the last 10 months from the Indian government which owns most of ONGC, which in turn has a 30% stake in Cairn India's major oil field in Rajasthan.

It was agreed in 1995, that ONGC would pay all the royalties on any finds in the desert. But that was before oil had been found and the government is now trying to change the terms of that arrangement with some typical Indian-style bickering.

Elsewhere, after becoming a publicly-listed company last month, Glencore – the world's largest commodities trader – reported a net profit for the first three months of the year to the tune of US$1.3 billion up 47% on an annualised basis. Concurrently, in its first public results, the trader said revenue was up 39% to US$44.2 billion.

Glencore's directors and employees still hold about 80% of the company and the figures should make them happier and wealthier still. Glencore leads the trading stakes with Vitol and Gennady Timchenko’s Gunvor second and third respectively.

Finally, the so-called most hated man in America – Tony Hayward – commenced a rather spectacular comeback last week flanked by some influential friends. Together with financier Nathaniel Rothschild, investors Tom Daniel and Julian Metherel, Hayward has floated Vallares, an oil and gas investment vehicle which raised £1.35 billion (US$2.18 billion) through an IPO recently.

This is well above market expectations according to most in the City and all four have nailed their colours to the mast by putting in £100 million of their own money. Some 133 million ordinary shares nominated at £10 each were offered and taken-up rather enthusiastically. Rumour has it that hedge funds, selected Middle Eastern sovereign wealth funds and institutional investors (favouring long-only positions) are among the major buyers.

Vallares’ focus will be on upstream oil and gas assets away from "tired, second-hand assets" in the North Sea or in politically unstable areas such as Venezuela or central Asia. The Oilholic thinks this is way more than an act of hubris. However, the investment vehicle’s success will not particularly reverse Hayward’s deeply stained reputation. A failure well be the end. Only time will tell but the front man has brought some powerful friends along on the “comeback” trail. They are likely to keep a more watchful eye over Hayward and perhaps prevent him from going wayward.

© Gaurav Sharma 2011. Photo: Fairfax, Virginia, USA © O. Louis Mazzatenta, National Geographic

Buzz at Central Bank of Oil Before 1600 CET

Ahead of the OPEC decision, prices for the forward month ICE Brent and NYMEX WTI futures contracts have fallen by US$2-3 on average over two weeks if the last fortnight is taken into consideration. That is largely down to the fact that traders have begun to factor in a possible increase in OPEC crude production quotas in the run up to the meeting here in Vienna today.

For the purposes of a price check, at 11:00am CET, ICE Brent is trading at US$116.26 down 0.5% or 16 cents, while WTI is down 99 cents or 1% at US$98.46. Additionally, the OPEC basket of twelve crudes stood at US$110.66 on Tuesday, compared with US$110.99 the previous day according to OPEC Secretariat calculations this morning.

Mike Wittner of Société Générale notes that if an increase in OPEC quota is made from a starting point of actual production, rather than the previous quota, it is that much more real, that much more serious, and potentially that much more bearish, at least in the short term.

“In contrast, if OPEC were to increase quotas by 1.5 million b/d, but versus previous quotas and not actual production, all they would be doing would be legitimising recent/current overproduction versus the old quota,” he adds.

Most analysts including Wittner and those present here believe a physical increase would be coming our way. Speaking of analysts, it is always a pleasure meeting Jason Schenker, President & Chief Economist of Prestige Economics at these OPEC meetings. He’s to be credited for describing OPEC as the Central Bank of Oil. The Oilholic heartily agrees and could not have put it better. Schenker believes OPEC is looking at the medium term picture and not just the next few months.

“As anticipated if there is a production hike today, the thinking at the “Central Bank of Oil” would be that it could carry them across to the end of Q4 2011 perhaps without facing or acting upon further calls for alterations of production quotas,” he says.

On a somewhat 'crude' but unrelated footnote, hearing about my recent visit to Alberta, Canada, Jason agrees there are a whole lot of crude opportunities for Canadians to be excited about. It would not be easy and it is certainly not cheap. But then cheap oil has long gone – this not so cheap resource is in a safe neutral country. Furthermore, one must never say never, but Canadians are not exactly queuing up to join OPEC any time soon (or ever).

Finally on a totally unrelated footnote, one can see the “Made in UK” label at OPEC HQ – it’s the paper cups near the water dispenser - not something extracted from the North Sea.

© Gaurav Sharma 2011. Photo: Oil well in Oman © Royal Dutch Shell

Arriving at the not so ‘Ordinary’ OPEC meeting

The Oilholic probably has to go back to Q1 2008 when an OPEC meeting last generated as much interest as the soon to be held 159th Ordinary meeting of the cartel here in Vienna. Interest of this magnitude usually gains traction when the cartel contemplates an alteration of production quotas. Initial signals are that come 1600 CET tomorrow, we could see a rise in the OPEC member nations’ quotas by 0.5 to 1.5 million b/d.

Such talk has intensified in the three weeks leading up to the meeting. OPEC’s May crude oil production report notes that the cartel’s total crude output was 28.99 million b/d. If Iraq, which is not subject to OPEC quotas at present, is excluded, then the production came in at 26.33 million b/d, or 1.5 million b/d higher than the quota of 24.8 million b/d as set in Q4 2008.

This begs the question, what would the increase be like in real terms – i.e. would it be an increase in paper targets (to which methinks not a lot of attention would or should be paid by the markets) or would it be an increase over the already existing, but not officially acknowledged physical production levels. If it is the latter, then that would be something and Société Générale's Mike Wittner reckons it would be a physical increment rather than a paper one.

Furthermore, in a note to clients, Wittner observes: “Before analysing what OPEC is thinking about, why it will probably increase quotas, and what the dangers are of doing so, it is very important to note the latest signal regarding the meeting. Early Monday evening (EST), it was reported that the Saudi-owned al-Hayat newspaper, based in London, quoted an unnamed source as saying that if OPEC decides to lift its output by more than 1 million b/d, Saudi Arabia’s production will reach about 10 million b/d during the summer period, when its domestic demand increases. This compares to around 8.9 - 9.0 million b/d in May, according to preliminary wire service estimates, with an increase of 0.2 - 0.3 million b/d expected in June, according to various sources."

The initial feelers here seem to be following the norm. The Saudis for instance, according to various media reports, would increase production anyway even if an increase is not announced. Approach of the others is more nuanced while some would suggest there are bigger factors at play rather than a straight cut decision on production.

Earlier today, following a meeting at 1600 CET, a ministerial monitoring sub-committee comprising of ministers from Algeria, Kuwait and Nigeria overseen by the OPEC secretariat proposed a 1 million b/d increment to the existing quotas. This could be a harbinger of what may follow tomorrow. However, few here expect anything other than stiff resistance to an increase in quotas by Iran and Venezuela.

Both countries have provided interesting sideshows. Iran's President Mahmoud Ahmadinejad sacked his oil minister and seized control of his ministry ahead of the meeting. He then appointed his close ally Mohammad Aliabadi as caretaker oil minister after parliament and Iran's constitutional watchdog said the president had no right to head the ministry.

Oilholic regrets that he knows little about the right honourable Aliabadi who has precious little experience of oily matters. Guess being greasily close to Ahmadinejad is a resume builder in that part of the world. Additionally, Venezuela is to complain about US sanctions on PDVSA.

Meanwhile, crude oil futures rose slightly either side of the pond following concerns that OPEC’s spare capacity will tighten pending on what happens tomorrow. OPEC had 5.94 million b/d in spare capacity in May, down 2.7 per cent from April, based on Bloomberg estimates. Spare capacity was 6.31 million barrels a day in March, the highest level since May 2009.

The official line from OPEC as of this evening is – “We’ll pump more if needs be.” But do we? Tracking arrivals of OPEC ministers in Austria one by one since 09:00 CET not one has said much about what may happen on this occasion. Based on past experience that is always a sign that something will happen.

© Gaurav Sharma 2011. Photo: Empty OPEC Press conference table © Gaurav Sharma 2011

IEA, OPEC & a few more bits on BP

It has been a month of quite a few interesting reports and comments, but first and as usual - a word on pricing. Both Brent crude oil and WTI futures have partially retreated from the highs seen last month, especially in case of the latter. That’s despite the Libyan situation showing no signs of a resolution and its oil minister Shukri Ghanem either having defected or running a secret mission for Col. Gaddafi depending on which news source you rely on! (Graph 1: Historical average annual oil prices. Click on graph to enlarge.)

Either way, the 159th OPEC meeting in Vienna which the Oilholic will be attending in a few weeks promises to be an interesting one; we’re not just talking production quotas here. Iranian President Mahmoud Ahmadinejad is also expected to be in Austrian capital – so it should be fun. The market undoubtedly still craves and will continue to crave the quality of crude that Libya exports but other factors are now at play; despite whatever Gaddafi may or may not be playing at.

Contextualising the Libyan situation, Société Générale CIB analyst Jesper Dannesboe notes that Cushing (Oklahoma), the physical delivery point for WTI crude oil, has recently been oversupplied resulting in contango at the very front end of the WTI forward curve.

“This situation is likely to persist until at least mid-2012 as higher supply to Cushing from Canadian oil sands and from North Dakota should result in high Cushing stocks as new pipelines from Cushing to the coast will not be ready until late 2012 at the earliest. This makes it attractive to put on WTI time spreads further out the forward curve at backwardation as they should over time roll into contango,” he wrote in a note to clients.

Dannesboe also observes that while the entire Brent crude oil forward price curve is currently in backwardation (i.e. near-dated prices higher than further-dated prices) out to about 2017, the front-end of the WTI crude oil forward price curve has remained in contango.

The Brent forward curve flipped from contango to backwardation in late February as a result of the unrest in the Middle East & North Africa (MENA). However, contango at the front-end of the WTI forward curve has persisted because WTI's physical delivery point, Cushing (US midcontinent), has remained oversupplied despite a generally tight global market for sweet crude as a result of the loss of Libyan exports, he concludes.

Meanwhile, ahead of the OPEC meeting, the International Energy Agency (IEA) called for “action” from oil producers that will help avoid the negative global economic consequences which a further sharp market tightening could cause. Its governing board meeting last Thursday expressed “serious concern” that there are growing signs the rise in oil prices since September is affecting the economic recovery. As ever, the IEA said it stood ready to work with producers as well as non-member consumers.

The Oilholic also recently had the pleasure of reading a Fitch Ratings report, authored earlier this month in wake of the Libyan situation, which notes that the airline sector is by far the most vulnerable to rising oil and gas prices of all corporate sectors in the EMEA region given the heavy weight of fuel costs in operating cost structures (20%-30%), execution risks from companies' use of hedging instruments to mitigate their fuel exposure and fierce industry competition. (Graph 2: Price movement - Jet fuel vs. Brent oil. Click on graph to enlarge)

Erwin van Lumich, a Managing Director in Fitch's corporate departments, said, "The gap between the jet fuel price curve and the Brent curve narrowed to approximately 13% during 2010, with airlines in emerging markets generally most exposed to fuel price fluctuations due to a lack of market development for fuel hedging."

It gives food for thought that a temporary impact of the Icelandic volcanic ash can send jitters down the spine of airline investors but the jet fuel pricing spread, airlines’ hedging techniques (or the lack of it) and how it might impact operating margins is mostly raised at their AGMs. Where there are losers, there are bound to be winners but Fitch notes that the ratings of companies in the extractive industries are not expected to benefit from the price increases as the agency uses a mid-cycle pricing approach to avoid cyclical price changes having an impact on ratings. At this stage, Fitch does not anticipate a revision to its mid-cycle price deck to an extent that it would result in rating changes.

Finally, a couple of things about BP. To begin with, BP’s share swap deal with Rosneft failing to meet the May 16th deadline does not imply by default that that deal would not happen. In wake of the objection of AAR – its TNK-BP joint venture partner – there are still issues to be resolved and they will be in the fullness of time contrary to reports on the deal’s demise. A source close to the negotiations (at AAR not Rosneft) says talks are continuing.

Continuing with BP, it finally got recognition that blame for the Macondo incident is not exclusively its. Mitsui (which holds 10% of the well’s licence) and Anadarko (25%) had both blamed accident on BP’s negligence, refusing to pay or bear costs. However, Mitsui finally agreed to settle claims relating to the disaster with BP. It now agrees with BP that it was the result of oversights and mistakes by multiple parties. Undoubtedly, the pressure will now be on Anadarko to settle with BP.

According to US government figures, BP has paid out US$20.8 billion. It has invoiced Mitsui for approximately US$2.0 billion with the Japanese company expected to pay half of that at the present moment in time. A US trial on limitation of liabilities is expected to rule on the issue of gross negligence by parties concerned sometime over Q1 2012. Watch this space!

© Gaurav Sharma 2011. Graphics © Fitch Ratings, May 2011

Valero, BP, Crude price & the week that was!

The seven days that have passed have been ‘crudely’ interesting to say the least. First off, early May saw one of the biggest market sell-offs in recent memory as commodities of all descriptions did a mini battle with price volatility. Brent crude for its part fell nearly 6% before recovering and stabilising above US$110 per barrel.

Macroeconomic factors aside many in the City believe the ongoing conflict in Libya no longer appears to be a key driver of oil prices as the loss of Libyan oil exports were fully discounted by the market some time ago. The profit takers agree! Société Générale CIB analysts noted in a report to clients that they estimate:

“the fair value for the Brent price would be about US$100 if no MENA risk premium were included. It is difficult to see the MENA risk premium rising much further near-term unless significant unrest emerges in countries with substantial oil exports such as Algeria and Saudi Arabia.”

That is not happening and Syria is of peripheral importance from near term instability premium perspective. Société Générale CIB analysts further note that the Brent crude oil price may correct lower over coming weeks as speculative traders may be tempted to take some profit on long positions as:

• recent significant events in the Middle East & North Africa (MENA) have been limited to countries with little oil exports


• tentative signs of demand destruction in the US, and


• growing concerns of a bumpy or hard landing in China.

Moving away from the crude price, heads of the big five oil firms Shell, Exxon, Conoco, BP America and Chevron and some Democrats on the Senate finance committee squared up to each other on May 6^th over the age-old issue of tax subsidies for oil companies. The latter want the tax subsidies removed, but big oil contests that they are benefitting from the subsidies like any other US business does and furthermore they are heavily taxed already.

That same day BP’s shares rallied in the UK following news that an arbitral panel has issued a consent order permitting BP and the AAR consortium to assign an Arctic opportunity to TNK-BP, subject to consent from Russian state-controlled firm Rosneft. The long drawn out saga may finally be reaching a favourable conclusion for BP.

Also last week ratings agency Moody’s changed US refiner Valero Energy's rating outlook to stable from negative and at the same time affirmed Valero's existing Baa2 senior unsecured note ratings. It said the stabilisation in the rating outlook reflects the expectation that Valero's cash flow will remain strong over the short term due to rising industrial activity pushing modest growth in demand for distillates and the expectation of supportive light/heavy spreads.

The stable outlook also reflects the assumption that Valero will maintain investment grade leverage metrics over the next 12-18 months as it continues to pursue organic growth and acquisition opportunities.

Additionally Moody's expects Valero's earnings to remain highly cyclical, and noted that the 2010 sale of the company's secularly weaker US East Coast refining assets, willingness and financial capacity to idle underperforming assets, as well as its recent cost reduction efforts should enhance the company's ability to withstand the inherent cyclicality of the sector. Moody's also expects that Valero will remain acquisitive. In March of this year, Valero announced the purchase of Chevron's Pembroke refinery in the UK for US $1.7 billion.

Rounding off - the Oilholic turned 33 years young today, last seven of which have been a ‘crude’ affair ;-) Thanks for all the birthday messages!

© Gaurav Sharma 2011. Photo: Alaska Pipeline with Brooks Range in background © Michael S. Quinton / National Geographic

Oh the market ‘insouciance’ outside is frightful!

It is no longer strange to see Americans and Canadians complain about the rising price of gasoline. After all, it’s the price at the pump which hurts us all – something which has seen a steady rise.

A short-term respite is quite frankly not in sight; more so for Europeans but complaints from North American consumers and change in consumption patterns (in relative terms) have grown in the last five years. Although some in the English town of Bradford, who pay more for their petrol/per litre than North Americans, got a temporary one-off respite according to the BBC, after the station staff put a decimal point in the wrong place. The story is hilarious, aptly timed for April Fools Day and one for the little guy troubled by rising inflation in UK.

US President Obama finally pointed to Canada, Mexico as reliable sources of crude oil and said they could play their part in his consuming nation’s bid to slash imports from unfriendly governments. Both countries rank higher than Saudi Arabia in terms of crude exports to the US, so very welcome quotes – but as with all else about him – a bit late.

The short-term problem – and a global one it is too – is the widening of premium between easier to refine sweet crude oil and sour crude which is the opposite. Anecdotal evidence, either side of the Atlantic is that refiners (either European or European subsidiaries of overseas owners), are paying record physical premiums to secure supplies of sweet crude in wake of the Libyan stand-off.

The quality of Libyan sweet crude is excellent and as a short-term problem starts resembling a longer termed stand-off, the market is getting spooked as no one can make up their minds about who is in charge of the country. That’s despite the on / off media reports of oil being loaded on to tankers both on the rebels’ side and Gaddafi’s side.

End result - Brent Crude forward month futures (May) contract, more reflective of global conditions, has spiked to a 30-month high. Oilholic believes this is no ordinary or linear spike resulting from a geopolitical bias/risk premium to the upside. Rather it is clearly reflective of the rise in price differentials between sweet and sour crude in wake of Libya and hence impacts Brent as a benchmark to a greater extent than the WTI.

As early as a fortnight ago, the IEA rightly warned that we are underestimating the impact of the temporary (or otherwise) loss of Libyan sweet crude on traded paper barrels. In its monthly report for March, it noted, "Market insouciance may change abruptly as April approaches, when global crude demand is expected to increase by around 1 million barrels a day as Atlantic Basin refinery maintenance ends."

Sweet crude varieties are trading at a premium of US$2.80 to US$4.10 per barrel above sour varieties, according to the Oilholic’s sources. This is the highest for some time. Try as they might, Saudis won’t materially alter this; the premium has solid foundations!

Finally before I leave Canada for San Francisco, here is a brilliant editorial in The Economist about European nations trying to forget embarrassing ties in the Middle East and a BBC report on Transocean’s 'crude' announcement of bonuses related to their "best year of safety."

© Gaurav Sharma 2011. Photo: Gas Station, Houston, Texas, USA © Gaurav Sharma, March 2011

Glimpses of Fort Calgary, 1914 & all that!

The Oilholic paid a visit to Fort Calgary in between meetings; not far from Downtown Calgary (towards the east end of the city). There is no better place to soak in the city’s rich heritage. Founded in 1875, the then North West Mounted Police (NWMP) built this outpost at the convergence point of Bow and Elbow Rivers. In all fairness, say local historians, they laid the foundations of the modern city of Calgary.

For oilholics the world over, the 'crude' bits are very crucial and merit a detailed look. First gas and (as was often the case with hydrocarbon prospecting) then oil was found in May, 1914, just south of Calgary. After the first discovery, there was a long wait of some 33 years before the next meaningful discovery was made.

The rest, as they say, is all history and I am reading up on it thanks to some wonderful books obtained from stores recommended by Rusty Miller, Ogilvy Renault LLP’s managing partner here. He also spared time from his busy schedule to give me some valuable insight on intricacies of the energy business in this part of the world.

Uploaded above are some 'crude' snaps from the Fort, captioned as appropriate. If you happen to be in town – please do visit. For some strange reason, and locals scratch their heads too, this wonderful place does not receive any Federal funding! Even provincial support needs to be applied for and is not a given thing by any means according to an official. Local energy companies have been good though and long may that continue.

Finally, a few crude words on the price and differentials between both benchmarks – WTI & Brent. This weekend, using the Brent forward month (May) futures contract as a benchmark – the crude price is at its highest since August 2008. With the May contract at US$117.36 per barrel, that is an annualised price appreciation of nearly 24% and by my estimation – a week-over-week appreciation of nearly 2.4% plus. Price differential between Brent and WTI also averaged US$10 and shows no sign of narrowing!

The Libyan situation also shows no signs of a resolution. Both in Alberta and Texas – the overwhelming sentiment is that Libya is fast resembling a stand-off and that adds to the upside bias reflected in the risk premium. It seems that for the short term, the market will have to make do without Libyan crude.

Problem is if it becomes a medium term supply concern. Surely, a high price should please Texans and Albertans – but "only to a point" notes one. That tipping point could hurt both the global economy and the profit margins of those in the business.

© Gaurav Sharma 2011. Photos: (Top) Fort Calgary, (Clockwise) Signage charting the first discovery of oil on the exterior of the fort, Turner Valley & Leduc crudes on display, Model of an old Gas station (Click on images to enlarge) © Gaurav Sharma, March 2011

First thoughts from Houston…mine & others'

It is good to be back in the city that made the oil trade a business! With both ICE Brent and West Texas Intermediate forward month futures contract benchmarks above US$100 per barrel, Houston should be a happy place on this beautiful Thursday morning. Following a breakfast meeting with some ‘crude’ contacts, the viewpoints to emerge were more nuanced than I’d thought and some were in line with my chain of thoughts.

But first things first, last I checked WTI forward month futures contract was at US$106.35/b and ICE Brent at US$115.60/b. An energy partner at a law firm, a commodities trader, an industry veteran and an oil executive were all in agreement that geopolitical bias for crude prices – well – is almost always to the upside. Recent events in the Middle East and whats going on Libya in particular is having more of an impact on the Brent spread, as it is more reflective of global conditions. WTI is more reflective of conditions in the US mid-west and as such many here believe even US$100-plus does not reflect market demand vs. supply fundamentals.

Only medium term concern here, moving away from the geopolitical bias, is the perceived bottleneck associated with pipeline capacity (from Alberta, Canada) to Cushing and then southwards. This is unlikely to be relieved until 2013 (TCPL Keystone XL) or 2014 (Enbridge) and lets not forget the associated politics of it all.

The Libya situation, most experts here say, may create a short-term spike for both crude benchmarks, more so in Brent’s case – but it is not going to be 2008 all over again – in the words of four experienced Texans and the pragmatic SocGen analyst Mike Wittner.

Furthermore, market commentators here believe that over the next three quarters both speculative activity and investor capital flow in to the crude market (or shall we say the paper crude market) will be highly tactical as the current geopolitical risk premium (hopefully) eases gradually.

As expected, local feedback suggests utilisation rates of refineries and LNG terminals locally is still low. While I attach a caveat that four experts do not speak for the whole state, the belief here in Texas is that refining margins, which have been pathetic for the past six quarters may show some recovery towards the end of 2011.

© Gaurav Sharma 2011. Photo: Pump Jacks, Perryton, Texas © Joel Sartore/National Geographic

Market Chatter on ‘Crude’ effects of Instability

As allied forces start bombing Libya and the full damage – both physical and reputational – to the nuclear generated power industry in wake of the earthquake in Japan is known, it is time to move beyond ranting about how much instability premium is actually there in the price of crude oil to what its impact may be. Using the Brent forward month futures contract as a benchmark, conservative estimates put the premium at US$10 but yet looser ones put it at US$20 per barrel at the very least.

It is also getting a bit repetitive to suggest that fundamentals do not support such a high price of crude, even if the geopolitics is taken out of it. Thing is even profit taking at some point is not likely to cool the hot prices in the short term and the market has already started chatting about the impact. The tragic earthquake in Japan has added another dimension. Until nuclear power generation gets back on track in Japan, in order to meet their power demand the Japanese will increase the use of hydrocarbons as they have no other choice.

Regarding the latter point, Ratings agency Moody's says that displaced demand from Japan's nuclear shutdown will shift to Asia-Pacific thermal-energy producers such as Australia's upstream Woodside Petroleum (Moody’s rating Baa1 negative), Indonesia's thermal-coal miner Adaro (Ba1 stable), Korea's refiner SK Innovation (Baa3 Stable), and Thailand's petrochemical firm PTT Chemical (Baa3 review for upgrade).

Renee Lam, a Moody's vice president in Hong Kong, says, "These firms and others in the region can capitalise on near- and longer-term displaced demand as Japan must now rely more on non-nuclear fuel." Lam also expects global crude prices to remain high, despite a near-term drop from dislocation in Japan.

She further notes, "Refinery shutdowns in Japan, accounting for 9% of Asian capacity and 2% of global capacity, have pushed up Asian refining margins. Strong margins benefiting non-Japanese, regional refineries should continue at least in the near term. We expect strong results for our rated refiners in the first half of this year."

Additionally, Fitch Ratings says airlines and European Gas-Fired Utilities Unprepared for Current Oil Spike and that the substantial increase in oil prices in a short time frame has caught many corporate energy consumers off guard, as they are not properly hedged to cope with such high oil price levels. In a scenario of sustained high oil prices, corporate issuers that are heavily exposed to oil-related commodities feedstock are likely to face a direct impact on their earnings.

In the agency’s view, management teams may be reluctant to hedge the oil price at these high levels, in anticipation of a softening in the oil price once geopolitical tensions subside. Fitch also considers it possible that banks might be less keen to finance oil option contracts at such high levels, as they do not want to take the risk of a continued rally in the price of crude.

As oil price volatility remained fairly low in 2010, airlines seem to have been hedging less and are now more vulnerable to the current spike. In the current high oil price environment, an increasing number of airlines are taking a wait-and-see approach in anticipation of a softening of the oil price and perhaps due to higher hedging costs. In Fitch's view, sustained oil prices well in excess of US$100 per barrel could negatively affect the operating performance and creditworthiness of high intensity corporate energy consumers and may also hamper the global economic recovery.

Analysts at SocGen CIB note that the forward curve for Brent is currently in backwardation (nearby premium, forward discount) for the next 5 years, reflecting concerns over growing physical tightness in the crude markets. Especially, in light of the NATO/allied forces bombardment of Gaddafi forces last night, the market is pricing in an extended Libyan shutdown of crude exports. About 1 million barrels per day of crude oil production has been cut and Libya’s major exporting ports are now closed.

As Nymex WTI-ICE Brent spreads have been less weak, SocGen analysts note that the front month spread has traded around -US$9.75/b on Tuesday vs -US$15/b one week ago. They opine that the recent strength of the WTI / Brent spreads has not really been due to the decreasing risk-premium of Brent, but more to very strong inflows of money on WTI-linked instruments.

In a note to clients last week, they note and I quote: “Indeed, the last CFTC COT report shows that the net position of the non-leveraged investments on WTI hit a new record high. This is so large that even the swap dealers now have a negative net position on WTI futures.”

I feel it is prudent to mention (again!!!) that this blogger, all main ratings agencies and a substantial chunk of commentators in the City believe that a large portion of the current oil price spike has been driven by speculative activity rather than supply fundamentals. Oil supply has remained more or less balanced as most other oil producing nations have raised their production levels in order to keep overall production largely unaffected – so far that is!

Finally, here’s an interesting segment of CNBC's Mad Money programme, where Jim Cramer talks oil n’ gas in the US state of North Dakota. It’s relatively small from a global standpoint, but could be important from an American one.

© Gaurav Sharma 2011. Photo: Oil Drill Pump, North Dakota © Phil Schermeister, National Geographic Society

Libya & OPEC’s “Will they, Won’t they” Routine

As the situation in Libya worsens, depending on differing points of view of Gaddafi goons and rebel fighters, OPEC’s routine of sending conflicting messages does not harm the price of crude – something which I don’t think the cartel minds all that much over the short term. In fact the OPEC basket price of crude seems to be following Brent’s price more closely than ever.

In a nutshell according to various newswires, Gaddafi militia and rebel fighters are toughing it out near oil terminals over 500km east of the capital Tripoli. Heaviest of the skirmishes have been outside (& within) the oil town Ras Lanuf, with both sides claiming a position of strength. A rebel spokesperson even gave out a statesman like statement, telling the BBC they would “honour” oil contracts.

However, anyone looking towards OPEC to calm the markets got a ‘crude’ response and mixed signals in keeping with the cartel's well practised drill of letting the wider world indulge in a guessing game of whether a production increase was on cards or not. The Saudis sought to calm, the Venezuelans and Iranians tried to confuse and the rest were quite simply confused themselves.

Moving away to a corporate story, pre-tax profits announced last week by UK independent upstart Tullow Oil have jumped 361% to US$152 million with a 19% rise in revenues to US$1 billion in the year to 31 December. In a statement to investors, its chief executive Aidan Heavey said the outlook was "very positive". I’d say its much more than that sir!

Finally, one of UK’s signature refineries – Pembroke – would now be a proud member of San Antonio, Texas-based refining major Valero Energy Corp. That’s after its current owner Chevron announced on March 11 that Valero had agreed to pay US$730 million for the refinery and US$1 billion for the assets. Ratings agency Moody's views Valero's acquisition of Pembroke and associated marketing and logistics assets as credit neutral. It may well be noted that it took Chevron nearly a year to...ahem....get rid of it (??)

© Gaurav Sharma 2011. Photo © Gaurav Sharma 2009

In the Realm of Crude “What Ifs”

Last time I checked the ICE Brent forward month futures contract was trading at US$110.46 per barrel up US$4.68 or 4.43% in intraday trading (click on chart to enlarge). It is my considered belief, since fundamentals do not support such a high price at this moment in time that there is at least US$10 worth of instability premium factored in to the price.

Given the number of “what if” analysts doing the rounds of the TV stations today, it is worth noting with the Libyan situation that not only are supply concerns propping up the price but the type of crude that the country supplies is also having an impact. I feel it is the latter point which is reflected more in the crude price than supply disruption. Light sweet crude is the most cost effective variety to refine and while Libyan crude is not as good as American light sweet crude, it is still of a very good quality relative to its OPEC peers.

Now, if exporters such as Saudi Arabia talk of making up the short supply, not all of the Libyan export shortfall can be compensated for with a type of crude the country exports. This is what the speculators are factoring in, though it is worth stating the obvious that Libya is the world 12th largest exporter of crude.

Furthermore, the age-old “what if” question is also hounding trading sentiment, i.e. “What if the house of Saud collapses and there is a supply disruption to the Saudi output?” The question is not new and has been around for decades. Problem is that a lot of the “what ifs” in Middle East and North Africa have turned to reality in recent weeks. If the House of Saud were to fall, it will be a geopolitical impact on crude markets of a magnitude that we have not seen since the Arab oil embargo.

Elsewhere at the International Petroleum Week, advisory firm Deloitte revealed its second full year ranking of UK upstream independent oil companies by market capitalisation. The top three are Tullow, Cairn and Premier Oil in that order, a result similar to end-2009. Tullow’s strength in Ghana helped it to maintain top spot in the sector. Its £11 billion market capitalisation is more than twice the valuation of its closest rival Cairn Energy, which in turn is more than twice the size of third placed Premier Oil. (Click on table below to enlarge)

Cairn continues to excite after agreeing to sell its Indian interests to Vedanta last year and concentrating on Arctic exploration. However, its drilling off the coast of Greenland has yet to yield anything ‘crudely’ meaningful. Another noteworthy point is the entry of Rockhopper Exploration, which is prospecting for crude off the coast of the Falkland Islands, into the top ten at 9th (up from 26th at end-2009).

“We have seen a great deal of volatility in the ranking showing the transformational growth achievable through exploration success. Overall, 2010 was a year of recovery for the UK upstream independent oil and gas sector, with rising oil prices and greater access to capital improving investor sentiment in the sector,” says Ian Sperling-Tyler, associate partner of energy transaction services at Deloitte.

“The improved environment was reflected in a 28% increase in the market capitalisation of the 25 biggest companies in the sector from £25.3 billion to £32.2 billion. In contrast, the FTSE 100 posted a 9% gain,” he adds.

Moving away from UK independent upstarts to a British major’s deal with an Indian behemoth. Following the BP/Reliance Industries Limited (RIL) announcement about a joint venture, ratings agency Moody's has changed the outlook of the Baa2 local currency issuer rating of RIL from stable to positive. RIL's foreign currency issuer and debt ratings remain unchanged at Baa2 with a stable outlook, as these are constrained by India's sovereign foreign currency ceiling of Baa2.

The rating action follows the company's recent announcement of a transformational partnership agreement with BP that will see the British major take a 30% stake in RIL's 23 Indian oil and gas blocks, including the substantial KG D6 gas field, for an initial consideration of US$ 7.2 billion plus further performance related payments of up to US$ 1.8 billion.

Philipp Lotter, a Senior Vice President at Moody's in Singapore believes the partnership agreement has generally positive credit implications for RIL, both operationally and financially. "The decision to bring on board BP in support of India's domestic gas market development will benefit RIL from BP's deep-water drilling expertise, as well as allow it to share risks and costs of future exploration and infrastructure projects, thus significantly de-risking its upstream exposure," he adds.

However, according to Moody's it is worth noting that the outlook could revert back to stable, if RIL undertakes transformational debt-funded acquisitions, or allocates material liquidity to finance growth that entails higher business risk. A deterioration of retained cash flow to debt below 30% is also likely to reverse any upward rating pressure.

© Gaurav Sharma 2011. Graphics 1: Brent crude oil chart © Digital Look/BBC Feb 23, 2011, Graphics 2: Leading UK independent oil companies © Deloitte LLP

Shell Divests, BP Invests and Libya Implodes!

Earlier on Monday, oil giant Shell announced its intentions to sell most of its African downstream businesses to Swiss group Vitol and Helios Investment Partners for US$1 billion adding that it will create two new joint ventures under the proposed deal.

The first of these JVs will own and operate Shell's existing oil products, distribution and retailing businesses in 14 African countries, most notably in Egypt, Morocco, Kenya, Uganda and Madagascar.

The second JV will own and operate Shell's existing lubricants blending plants in seven countries. The move is in line with Shell’s policy of divesting its non-core assets. It sold US$7 billion of non-core assets in 2010. While Shell was divesting in Africa, BP was investing in India via a strategic oil & gas partnership with Reliance Industries.

Both companies will form a 50:50 joint venture for sourcing and marketing hydrocarbons in India. The agreement will give BP a 30% stake in 23 oil and gas blocks owned by Reliance including 19 off the east coast of India. Market feedback suggests the deal is heavily weighted towards gas rather than the crude stuff.

In return for the stake, BP will invest US$7.2 billion in the venture and a further US$1.8 billion in future performance-related investments. The combined capital costs are slated to be in the region of US$20 billon with local media already branding it as the largest foreign direct investment deal in India by a foreign company.

Switching focus to the Middle Eastern unrest, what is happening from Morocco to Bahrain is having a massive bearing on the instability premium factoring in to the price of crude. However, the impact of each country’s regional upheaval on the crude price is not uniform. I summarise it as follows based on the perceived oil endowment (or the lack of it) for each country:

• Morocco (negligible)
• Algeria (marginal)
• Egypt (marginal)
• Iran (difficult to gauge at the moment)
• Tunisia (negligible)
• Bahrain (marginal)
• Libya (substantial)

Of these, it is obvious to the wider market that what is happening in Libya is one of concern. More so as the unrest has become unruly and the future may well be uncertain as the OPEC member country accounts for around 2% of the daily global crude production.

Italian and French oil companies with historic ties to the region are among those most vulnerable, though having said so BP also has substantial assets there. Austria’s OMV and Norway’s Statoil are other notable operators in Libya. A bigger worry could be if Iran erupts in a similar unruly way. Given the international sanctions against Iran, oil majors are not as involved there as they are in Libya. However, the question Iran’s crude oil endowment and its impact on the oil markets is an entirely different matter.

Finally, the ICE Brent crude forward month futures contract stood at US$108.25 per barrel, up 5.6% in intraday trading last time checked. I feel there is at least US$10 worth of instability premium in there, although one city source reckons it could be as high as US$15. The "What if" side analysts (as I call them) are having a field day - having already moved their focus from Iran to Saudi Arabia.

© Gaurav Sharma 2011. Photo: Vintage Shell gasoline pump, Ghirardelli Square, San Francisco, California, USA © Gaurav Sharma, March 2010

Of PetroChina, Gazprom and Hackers!

But first...Brent remains well into US$100+ per barrel territory while WTI remains in sub-US$90 region. Let’s face it the Nymex WTI-ICE Brent spreads remain extremely weak and it is becoming a recurring theme. The front-month spread even capped -US$16 per barrel mark (US$16.29 to be exact) on Feb 11; the date of expiry of the Brent forward month futures contract.

Moving away from pricing, it emerged last week that Russia’s Gazprom reported a fall in profits from RUR173.5 billion to RUR160.5 billion; an annualised dip of 9% for the quarter from July to Sept 2010 period. The cost of purchasing oil and gas jumped 29% according to the state owned firm while operational costs rose 12%. Dip in profit even prompted Russian PM Putin to “ask” them to raise their game.

Elsewhere, the “All Hail Shale” brigade had to contend with PetroChina – the Chinese state-controlled energy firm – acquiring a 50% stake in a Canadian Shale Gas project run by Encana. The stake cost is pegged at a cool US$5.4 billion. PetroChina already has majority stakes in two oil projects in Canada with Encana. There doesn’t appear to be much of a ruckus about the Chinese shopping in Canada. I guess Canadians are less uptight about Chinese investment in perceived strategic energy assets than the Americans.

Finally, computer security firm McAfee claimed in a report published on February 10th that hackers have attacked networks of a number of oil and gas firms for a good few years now. The full report is available for downloading here and it makes for interesting reading. However, I am not entirely surprised by the revelations.

In a nutshell, McAfee claims that in a series of co-ordinated attempts at least a dozen multinational oil, gas and energy companies were targeted – named by it as Night Dragon attacks – which began in November 2009. Five firms have now confirmed the attacks, it adds.

© Gaurav Sharma 2011. Photo: Oil tanker © Michael S. Quinton/National Geographic Society

BP's loss, Brent’s Gain & Worries over Suez Traffic

To begin with, Brent’s strength relative to its American counterpart index continues, as the ICE Brent forward month futures contract climbed to US$101.01, last time I checked today. There are pressures to the upside bolstering the price rise, but impact of the Egyptian political crisis on traffic through the Suez Canal is not as clear cut as many popular media commentators make it out to be.

According to wires and international broadcasters, the Suez Canal is still functioning as normal and continues to be heavily guarded by the Egyptian forces. So while the potential of traffic disruption is there, I am not so sure how it can manifest itself so soon in a meaningful way. There are other factors behind, as I noted yesterday, in Brent’s strength.

Elsewhere, if you haven’t heard BP has reported an annual loss of US$4.9 billion for 2010, it’s first, though unsurprising annual loss since 1992. This compares rather unfavourably with a profit of US$13.9 billion the oil major recorded in 2009. The Gulf of Mexico oil spill has blown a Macondo sized whole in its books, though the company said it would restore its dividend payment to shareholders hitherto suspended in wake of the Gulf spill.

Another key announcement was BP’s decision to sell two US oil refineries in Texas and California thereby halving its refining capacity in the US. The sale includes the Texas City refinery, where 15 workers were killed in an explosion in 2005 – the site of BP’s last disaster in the States prior to Macondo.

The announcement vindicates my analysis for Infrastructure Journal back in November. BP is not alone; the oil majors no longer regard refining as central to their business. There’s a part of me that thinks BP would have sold its refinery assets, even if the Gulf of Mexico tragedy had not happened. The incident only brought the sale forward.

© Gaurav Sharma 2011. Photo: Macondo containment, Gulf of Mexico, USA © BP Plc

ETFs, Brent's Strength & ExxonMobil's Russian Deal

There seem to be more backers of the theory that Brent is winning the crude battle of the indices. I certainly believe Brent provides a much better picture of the global oil markets over WTI. Back in May 2010, I blogged that David Peniket, President and COO of Intercontinental Exchange (ICE) Futures Europe, gave Brent his backing. SocGen joined the ever-growing chorus last week. In a note to clients, the French banking major noted that Brent is a much better barometer of the global oil markets, where both crude and product demand have been strong.

Regarding premium between Brent and WTI, SocGen analysts note: “First, preliminary Euroilstock data showed a 4.2 Mb crude stockdraw in December. When this month-on-month per cent change is applied to the end-November OECD Europe crude stock figures from the IEA, the result in end-December European crude stocks that are below average; this is in sharp contrast to the near-record high stocks at Cushing.”

Additionally, oil field technical problems have caused some supply losses in the North Sea and planned pipeline maintenance at the Gullfaks field, in Norway, was also announced last weekend. Moving away from the North Sea, news has emerged that Roseneft and ExxonMobil have penned a deal for oil and gas exploration in the Black Sea, though intricacies and value of the deal is as yet unknown.

Finally, SocGen’s Mutual Fund & ETF report published last week makes for interesting reading; a sort of a continuation of trends noted by the wider market in general. It notes that the commodity rally was supported by US$23 billion inflows in 2010 (click on graphics to enlarge). Over the past 6 months, the rally in commodity prices has been significant (CRB index +27%) and directly associated with the expected pick-up in demand, but reallocation to protect against inflation has clearly played a role as well.

However, SocGen observed that Precious metals, and not energy, dominated commodity inflows. Precious metals were by far the largest category in commodity ETPs (including ETFs, ETCs and ETNs) accounting for 76% of US$157 billion assets under management and they continue to attract most of the inflows.

© Gaurav Sharma 2011. Graphics © SGCIB Cross Asset Research, Jan 19, 2011

Of IEA, OPEC and the Hoo-Hah over BP & Rosneft

Both the IEA and OPEC are now more upbeat about the global economic recovery over 2011, which could mean only one thing – an upward revision of global crude oil demand. Starting with the IEA, the agency says it now expects global crude demand to rise by 1.4 million barrels a day in year over year terms over 2011 to 89.1 million barrels per day; a revision of 360,000 barrels per day compared to its last forecast.

OPEC also revised its global oil demand forecast putting demand growth at 1.2 million barrels a day for the year; an upward revision of 50,000 barrels per day from its last estimate. In its monthly report, the cartel also noted that demand for its own crude is expected to average 29.4 million barrels of oil per day in 2011; an upward revision of 200,000 barrels over the previous forecast.

Both OPEC and IEA expect the increase in crude oil demand to be driven entirely by emerging markets, while OECD demand is projected to reverse to its "underlying, structural decline in 2011," according to the latter. Their respective response to the forecasts is one of understandable contrasts.

Nobuo Tanaka, head of the IEA, said a subsequent "alarming" rise in the oil price would be damaging. "We are concerned about the speed of the rising oil price, which can harm the growth of economies. If the current price continues, it will have a negative impact," he added. However, OPEC remains unmoved, as the forward month futures spread between Brent and WTI crude continues to widen to US$5-plus in favour of the latter. Both benchmarks lurk close to the US$100-mark.

OPEC’s position unsurprisingly is that the market remains well supplied. Cartel members UAE, Iran, Venezuela and Algeria say they are not concerned about a US$100 per barrel price. In fact, Venezuela's Energy Minister, Rafael Ramirez, described the price of $100 as "fair value" while speaking to the Reuters news agency. There are no prizes for guessing that an emergency meeting of the cartel to raise production is highly unlikely!

Now to the BP-Rosneft tie-up which sent the markets into a tizzy. In a nutshell, news of BP’s acquisition of a 9.5% stake in Rosneft which in turn would bag a 5% stake in BP was good, but it did not quite merit the response it got. Markets cheered it; environmentalists jeered it (given the open invitation to dig in the Arctic).

Rest of the narrative is a bit barmy. First of all, agreed it is a solid deal but given the involvement of a company 75% owned by the Russian government – I am unsure how it would be instrumental or for that matter detrimental to the UK’s petroleum security. Surely, the jury should still be out on that one. Secondly, this in no way implies that BP has turned its back on the US market in light of recent events as some market commentators have opined.

Finally, it is more of a marriage of convenience rather than a historic deal. Rosneft needed technical expertise and does not care much for political rhetoric in western markets about digging deeper and deeper for crude. BP needs access to resources. Both parties should be happy and it is rumoured in the Russian press that TNK-BP would also like a slice of the potentially lucrative Arctic ice cake. Away from the main event, the sideshow was just as engaging.

Curiously city sources revealed that BP did not use its preferred broker JPMorgan Cazenove, but rather opted to go with London-based Lambert Energy Advisory. It did amuse some in the City. All I can say is good luck to Philip Lambert. Finally, talking of the little guys in this crude world – have you heard of AIM-listed Matra Petroleum?

Last I checked, this independent upstart expects to be producing a rather modest 600-700 barrels per day by H1 2011 and its share price is around 3.52p. So assuming, Brent caps US$100-plus by end of H1 2011 and Matra delivers – the share price could treble in theory. I am not making a recommendation – let’s call it an observation!

© Gaurav Sharma 2011. Photo © Adrian R. Gableson