Oil markets & producers on a tricky skating rink

So we had a crude oil price plunge early January, followed by a spike that promptly "un-spiked", only to rise from the ashes and subsequently go down the path of decline again. Expect further slippage, more so as the last week of profit taking takes place before the March futures contracts close, which in ICE Brent’s case would be February 13.

Amid the ups and downs of the last six weeks, headline writers were left tearing their hair on a daily basis switching from "Brent extends rally" to "Oil slides despite OPEC talk of a floor" to "Falling Premiums" to "Crude oil getting hammered" and back to "Oil jumps". All the while commentators queued up with some predicting a return to a US$100 per barrel Brent price "soon", alongside those sounding warnings about a drop to $10.

The actual market reality is both here and nowhere, as we enter a period of constant slides and spikes between $40 and $60. There are those who say the current oil price level cannot be sustained and supply-side analysts, including the Oilholic, who say the current oil production levels cannot be sustained. Both parties are correct – a price spike and a supply correction will happen in tandem, but not overnight.

It will take at least until the summer for sentiments about lower production levels to feed through, if not longer. More so, as many are gearing up to produce more with less, for example in Western Canada where fewer wells would be dug this year, but the production tally would be higher than the previous year. Taking a macro viewpoint, all the chatter of bull runs, bear attacks and subsequent rallies is just that – chatter. Market fundamentals have not materially altered.

Despite the latest Baker Hughes data showing fewer operational rigs compared to this point last year, the glut persists and there is some way to go before it alters. Roughly around 5% of current global oil production is taking place at a loss. Yet producers are biting the bullet wary of losing market share. It'll take a lot longer than a few weeks of negative rig data in the new year, before someone eventually blinks and makes a substantial impact on production levels. The Oilholic reckons it will be around June.

Until then, expect the market to continue skating in the $40 to $60 rink. In fact, there is some justification in OPEC Secretary General Abdalla Salem El-Badri’s claim that oil prices have bottomed out. While we could have a momentary dip below $40, something which the Western Canadian Select has already faced. However, by and large benchmark prices have indeed found resistance above $40. 

Having said so, the careful thing to do between now and (at least) June would be to not get carried away by useless chatter. When Brent shed 11.44% in the first five trading days of January, only to more than recover the lost ground by the end of the month (see chart on the right, click to enlarge), some called it a mini-bull run.

Percentages are always relative and often misleading in the volatile times we see at the moment, as one noted in a recent Tip TV broadcast. So mini-bull run claims were laughable. As for the eventual supply correction, capex reduction is already afoot. BP, Shell, BG Group and several other large and small companies have announced spending cuts. A recent Genscape study of 95 US exploration and production (E&P) companies noted a cumulative capex decline of 27%, from $44.5 billion last year to a projected $32.5 billion this year.

Meanwhile, Igor Sechin, the boss of Russia’s Rosneft has denied the country would be the first to blink and lower production in a high stakes game. Quite the contrary, Sechin compared the US shale boom to the dotcom bubble and rambled about the American position not being backed up by crude reserves.

He also accused OPEC along familiar lines of conspiring with Western nations, especially the US, to hurt Russia. Moving away from silly conspiracy theories, Sechin does have a point – the impact of a lower oil price on shale is hard to predict and is currently being put to test. We’ll know more over the next two to three quarters.

However, comparing the shale bonanza to the dotcom bubble suggests wilful ignorance of a few basic facts. Unlike the dotcom bubble, where a plethora of so-called technology firms put forward their highly leveraged, unproven, profit lacking ventures pitched to investors by Wall Street as the next big thing, independent shale oil upstarts have a ready, proven product to sell in barrels.

Of course, operational constraints and high levels of leveraging remain burdensome in a bearish oil market. While that might cause difficulties for fringe shale players, established ones will carry on regardless and find ways to mitigate exposure to volatility.

In case of the dotcom bubble, where some had nothing of proven tangible value to sell, independents tipped over like dominos when the bubble burst, apart from those who had a plan. For instance, the likes of Amazon or eBay have survived and thrived to see their stock price recover well above the dotcom boom levels.

Finally, in case of US shale players, ingenuity of the wildcatters catapulted them to where they are with a readily marketable product to sell. There is anecdotal evidence of that same ingenuity kicking in tandem with extraction process advancements thereby making E&P activity viable even at a $40 Brent price for many if not all.

So it's not quite like Pets.com if you know what the Oilholic means. Sechin’s point might be valid but its elucidation is daft. Furthermore, US shale players might have troubling days ahead, but trouble is something the Russian oil producers can see quite clearly on their horizon too. Additionally, shale plays have technological cooperation aimed at lowering costs on their side. Sanctions mean sharing of international technology to sustain or boost production as well as lower costs is off limits for the moment for Russia.

On a closing note, its being hotly disputed these days whether and by how much lower oil prices boost global economic activity, as one noted in a recent World Finance journal video broadcast. Entering the debate this week, Moody’s said lower oil prices might well give the US economy a boost in the next two years, but will fail to lift global growth significantly as headwinds from the Eurozone, China, Brazil and Japan would dent economic activity.

Despite lower oil prices, the agency has maintained its GDP growth forecast for the G20 countries at just under 3% in both 2015 and 2016, broadly unchanged from 2014. Moody's outlook is based on the assumption that Brent will average $55 in 2015, rising to $65 on average in 2016. 

It assumes that oil prices will stay near current levels in 2015 because demand and supply conditions are "unlikely to change markedly" in the near future, as The Oilholic has been banging on many a blog post including this one. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Danger of slipping sign. Graph: Oil Benchmark Prices, January 2015 © Gaurav Sharma

Why Dated Brent is no ‘Libor scandal in waiting’

The Oilholic was asked at a recent industry event whether he thought or had heard any anecdotal evidence about Brent being 'crooked' and susceptible to what we saw with financial benchmarks like Libor. Perhaps much to the annoyance of conspiracy theorists, the answer is no! A probe by the European Commission (EC), which included raids on the London offices of several oil companies and Platts last year, and an ongoing CFTC investigation into trading houses stateside, seems to have triggered the recent wave of questions.

Doubts in the minds of regulators and the public are understandable and very valid, but that an offence on an industry-wide scale can be proved beyond reasonable doubt is another matter. The UK's Office of Fair Trading has already investigated and cleared all parties raided by the EC. Furthermore, it stood by its findings as news of the EC raids surfaced.

As far as price assessment mechanisms go, only Platts' Market on Close (MoC) has faced allegations. It is cooperating with the EC and nothing has emerged so far. Competing methods, for instance ones used by Argus Media, another price reporting agency (PRA), were neither part of the investigation nor have been since.

Let's set all of this aside and start with the basics. A monthly cash-settled future is calculated on the difference between the daily assessment price for Dated Brent (the price assigned on a date when North Sea crude will be loaded onto a tanker) and the ICE daily settlement price for Brent 1st Line Future. Unless loaded as cargo, a North Sea oil barrel – or any barrel for that matter – retains the wider trading metaphor of a paper barrel.

Now as far as the Dated Brent component goes, agreed the PRAs are relying on market sources to give them information about bids, offers and supply-side deals. However, the diversity of sources should mitigate any attempt to manipulate prices by a group of individuals submitting false information. In the case of Libor, the BBA, a single body used to collate the information. In Brent's case, there is more than one PRA. None of these act as some sort of a centralised monopolistic data aggregation body. For what it's worth, anybody with even a minute knowledge of oil & gas markets would know the fierce competition between the two main PRAs.

Don't get the Oilholic wrong – collusion is possible in theory whereby traders gang-up and provide the PRAs with false pre-agreed information to skewer the objectivity of the assessment. However, the supply-side dynamic can wobble on the back of a variety of factors ranging from rig maintenance to an accident, a geopolitical event to actions of other market participants. So how many or how few would be required to fix prices and which PRA would be targeted, when and by how much and so on, and so on!

Then hypothetically let's assume all the price-fixers and factors align, given the size of the market – even if rigging did happen – it'd be localised and cannot be anything on the global scale of fixing that we have seen with the Libor revelations to date. Take it all in, and the allegations look silly at best because the 'collusion dynamic', should there be such a thing, cannot possibly be akin to what went on with Libor.

The EC wants to regulate PRAs via a proposed mandatory code and there is nothing wrong with the idea on the face of it. However, one flaw is that in a global market, buyers and sellers are under no obligation to reveal the price to the PRAs. Many already don't in an ultracompetitive crude world where cents per barrel make a difference depending on the size of the cargo.

If the EC compels traders to reveal information, trading would move elsewhere. Dubai for once would welcome them with open arms and other benchmarks would replace European ones. Anyway, enough said and the last bit is not farfetched! Finally, if fixing on the scale of the Libor scandal is discovered in oil markets and the Oilholic is proved wrong, this blogger would be the first to put his hand up!

Coming on to the current Brent forward month futures price, the last 5-day assessment provided plenty of food for thought. Supply disruptions in Libya (down by 100,000 bpd) and Angola (force majeure by BP potentially impacting 180,000 bpd) kept the contract steady either side of US$109 per barrel level, despite tepid US economic data. That said, stateside the WTI remained stubbornly in three figures on the back of supply side issues at Cushing, Oklahoma. The Oilholic reckons that's the fifth successive week of gains.

Meanwhile, the ICE's latest Commitment of Traders report for the week to February 11 notes that hedge funds and other money managers raised their net long position by 29.6% to 109,223; the highest level since the last week of 2013. The Brent price rose by around $4 a barrel over the stated period. By contrast, the previous week's net long position of 84,276 was the lowest since November 2012.

Away from pricing issues to its impact,  Fitch Ratings said in a recent report that production shortfalls and strategy changes to appease equity holders were a greater threat to the ratings of major Western European oil companies than a prolonged downturn in crude prices.

The ratings agency's stress test of the sector indicated that a Brent price of $55 per barrel would put pressure on credit quality, but compensating movements in cost bases and capex would give most companies a fighting chance at preserving rating levels.

Alex Griffiths, head of natural resources and commodities at Fitch, said, "With equity markets increasingly focussed on returns, bond yields near historical lows and oil prices forecast to soften, the chances of companies increasing leverage to benefit equity holders have risen. The European companies that have reported so far this year have generally resisted this pressure – but it may increase as the year goes on."

Separately, the agency also noted that a fall of the rouble would benefit Russian miners more than oil exporters. For both sectors, the currency's limited decline will strengthen earnings and support their credit profile, but ratings upgrades are unlikely without indications that the currency has settled at a new lower level.

To give the readers some context, the rouble has depreciated by 8% against the US dollar since the first trading day of the year and is down 17% from the end of 2012.

Depreciation of a local currency is generally good news for a country's exporters, but the effect on Russian oil exporters is less pronounced due to taxation and hence is less likely to result in positive rating actions in the future, Fitch said.

From Russia to the US, where there are widespread reports of a flood of public comments arriving at door of the State Department with public consultation on Keystone XL underway in full swing. See here's what yours truly does not get – you can have your comments included in the wider narrative, but are not obliged to give your details even under a confidentiality clause. This begs the question – how do you differentiate the genuine input, both for and against the project, from a bunch of spammers on either side?

Meanwhile, the Department of Energy has approved Sempra Energy's proposal to export LNG to the wider market including export destinations that do not have free trade agreement countries with the US. The company, which has already signed Mitsubishi and Mitsui of Japan and GDF Suez of France, could now spread its net further afield from its proposed export hub in Louisiana.

Elsewhere, Total says its capex budget is $26 billion for 2014, and $24 billion for 2015, down from $28 billion in 2013. No major surprises there, and to quote an analyst at SocGen, the French oil major "is sticking to its guns with more downstream restructuring being a dead certainty."

After accusations of not being too ambitious in its divestment programme, Shell said it could sell-off of its Anasuria, Nelson and Sean platforms in the British sector of the North Sea. The three platforms collectively account for 2% of UK production. Cairn Energy has had a fair few problems of late, but actress Sienna Miller and model Kate Moss weren't among them. That's until they took issue with one of the company's oil rigs blotting the sea off their party resort of Ibiza, Spain, according to this BBC report.

Finally, the pace of reforms and general positivity in the Mexican oil and gas sector is rubbing off on PEMEX. Last week, Moody's placed its Baa1 foreign currency and global local currency ratings on review for an upgrade.

In a note to clients, Tom Coleman, senior vice president at Moody's, wrote: "Mexico's energy reform holds out prospects for the most far ranging changes we have seen to date, benefiting both Mexico's and PEMEX's growth profiles in the medium-to-longer term."

And just before yours truly takes your leave, OPEC says world oil demand will increase by 1.09 million bpd, or 1.2%, to 90.98 million bpd from 89.89 million bpd in 2013. That's an upward revision of 1.05 million bpd in 2014. Non-OPEC supply should more than cover it methinks. That's all for the moment folks! Keep reading, keep it 'crude'!

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To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2014. Photo 1: Oil tankers in English Bay, British Columbia, Canada © Gaurav Sharma, April 2012. Photo 2: Oil exploration site © Lukoil.

Crude reality: Time to short as bulls go lethargic?

Most of the Oilholic's contacts in City trading circles had been maintaining in recent months that a US$106 per barrel price would be the psychological floor to the year-end, barring bearish trends induced by a wider and unforeseen macroeconomic tsunami.

To be quite honest, the global economy is probably where it has been for a while – in a bit of a lull. So even though things are neither materially better nor all that worse, the level was still breached this Monday morning. Methinks there is going to be further selling and yet more shorting either side of the Atlantic.

Our old friends the hedge funds – held responsible by many for the assetization of black gold – certainly seem to think so. That's if you believe data published by ICE Futures Europe. It indicates speculative bets that the Brent price will rise (in futures and options combined), outnumbered short positions by 119,451 lots in the week ended October 29.

The London-based exchange says that's a reduction of 21% (or 30,710 contracts) from the previous week and the biggest drop since the week ended June 25. Concurrently, bearish positions on Brent outnumbered bullish wagers by 321,470; a 3.2% decrease in net-short positions from October 22. So there you have it!

On a related note, albeit for different reasons, the WTI also closed at its lowest since June 26. In fact the forward month futures contract for December shed as much as 55 cents to $94.06 at one point in intraday trading on Monday.

The Oilholic believes the prices aren’t plummeting; rather they are hitting a much more realistic level. Such a sentiment was echoed by two new supply-side contacts this blogger had the pleasure of running into at the UK business lobby group CBI's 2013 annual conference.

As 2014 is nearly upon us, Steven Wood, managing director (corporate finance) at Moody's, says oil prices should stay robust through next year. His and Moody's quantification of robustness for Brent, factoring in Chinese demand and tensions in the Middle East, stands at around $95 per barrel, and West Texas Intermediate "for slightly less, in the next one to two years."

"And with the worst behind the US natural gas industry, prices for benchmark Henry Hub will average about $3.75 per thousand cubic feet next year," he adds.

Additionally, the good folks at Moody's reckon the E&P sector's fortunes will continue to rise over the next year, with big capital spending budgets keeping fundamentals strong (also for the oilfield service and drilling sector).

One minor footnote though, even if it is still some way off – what if international sanctions on Iran get eased should relations between the Islamic Republic and the West improve? We could then see the Iran add over 750,000 barrels per day to the global oil output pool. Undoubtedly, this would be bearish for oil markets, especially so for Brent. The recent dialogue between both sides has made contemplating the possibility possible!

Away from price-related issues, if you needed any further proof of renewed vigour in North Sea E&P activity, then Norway's Statoil has announced it will go ahead with a decision to build a new platform at its Snorre field to extract another 300 million barrels of the crude stuff at an expense of £4.2 billion. This would, according to the Norwegian media, extend the project's lifetime to 2040.

Statoil will take a final decision on engineering aspects in the first quarter of 2015 with the platform scheduled to come onstream in the fourth quarter of 2021. The Norwegian firm owns 33.3% of the exploration project licence. Other shareholders include Petoro (30%), ExxonMobil (17.4%), Idemitsu Petroleum (9.6%), RWE (8.6%) and Core Energy (1.1%). That’s all for the moment folks! Keep reading, keep it ‘crude’!

To follow The Oilholic on Twitter click here.

To email: gaurav.sharma@oilholicssynonymous.com

 

© Gaurav Sharma 2013. Photo: North Sea oil rig © Cairn Energy plc