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

Crude Sort of a Month (So far)

We are nearing the end of September and crude oil just cannot shake off the linkage with perceived (rather than prevalent) risks to the health of the global economy. In fact, for lack of a better phrase - the “on” or “off” risk has been causing price fluctuation for some eight weeks now.

My contacts in the City also voice concerns about the next round of G20 opting for further regulation on commodities trading. Although it is the kind of rhetoric they have indeed heard time and again over the decades; it irks their collective psyche.

Overall, most expect crude oil prices to remain in the range of $73 to $85 until at least Q1 2011. Analysts at Société Générale CIB actually have a much wider ranged forecast to the tune of US$70 to US$85. In the oil business its best to avoid generalisations especially when it comes to forecasts, but a return to a US$100 plus price is not forecast by much of the wider market before Q1 2012 at the earliest.

Furthermore, crude stocks haven’t altered all that much. Société Générale CIB’s Global Head of Oil Research Mike Wittner notes in a recent investment note that:

“Despite 12 months of global economic recovery, stocks are little changed from a year ago, and are still at the top of their five-year range. OECD combined crude and product inventories remain stubbornly high at over 61 days forward cover. In other words, the increase in crude and product consumption over recent quarters has been matched by an increase in supply of about the same magnitude.”

In fact the big story, which Wittner also alludes to in his note, is the surprisingly large increase in supply from non-OPEC exporters while the cartel’s output itself has been stable. Looking ahead to the OPEC summit on Oct 14, which I will be attending in Vienna, the cartel is widely tipped to hold production levels steady at 29.0 million barrels per day.

Elsewhere in this crude world, Moody’s outlined potential Deepwater Horizon disaster liabilities for Transocean in an interesting report published on Monday. The report notes that Transocean’s credit risk has increased due to the disaster, although it is hard to quantify by how much.

While much depends on unknown variables, Transocean's stake is likely to be limited to 10% of the total liabilities, which could reach as much as US$60 billion, Moody's said. The recent downgrade of Transocean's long-term credit rating to Baa3 from Baa2 reflects that.

Kenneth Austin, Vice President & Senior Credit Officer at Moody's, feels that Transocean has sufficient cash, free cash flow and credit arrangements to address a US$6 billion responsibility without losing its investment-grade rating. “But any damages beyond that could force the company to consider ways to raise additional capital," he added.

For now, Transocean's indemnification agreement with BP - the largest partner and operator of the Deepwater Horizon rig and Macondo well - leaves BP responsible for the damages, unless the oil giant challenges the agreement in court, the report said.

Finally, the wider market has got word on what is being touted as the mother of all energy stock floatation’s and the largest share issue in corporate history – i.e. Petrobras’ attempt to raise something in the region of US$64.5 to US$74.7 billion. News emerged on Thursday that the final valuation was US$70 billion.

Following my earlier query, a company spokeswoman told me that Petrobras issued 2.4 billion common shares priced at BRL 29.65 (US$17.12) each and 1.87 billion preferred shares at BRL26.30 (US$15.25) each. The capital from the much delayed IPO will finance development of offshore drilling in the country’s territorial waters. The Brazilian government also gets its fair “share” in return for giving Petrobras access to up to 5 billion barrels of oil.

© Gaurav Sharma 2010. Photo: Oil Drill Pump, North Dakota, USA © Phil Schermeister / National Geographic Society

From a Sobering August to Sept's Crude Forecast!

August has been a sobering month of sorts for the crude market. Overall, the average drop in WTI crude for the month was well above 8% and the premium between Brent crude and WTI crude futures contracts averaged about US$2. The market perhaps needed a tempering of expectations; poor economic data and fears of a double-dip recession did just that.

Even healthy US jobs data released last week could not stem the decline; though prices did recover by about 2% towards the end of last week. On Friday, the crude contract for October delivery lost 0.6% or US$0.41 to $74.60 a barrel on NYMEX. This is by no means a full blown slump (yet!) given that last week’s US EIA report was bearish for crude. It suggests that stocks built-up by 3.4 million barrels, a figure which was above market consensus but less than that published by the API. This is reflected in the current level of crude oil prices.

Looking specifically at ICE Brent crude oil futures, technical analysts remain mildly bullish in general predicting a pause and then a recovery over the next three weeks. In an investment note discussing the ICE Brent crude oil contract for October delivery, Société Générale CIB commodities technical analyst Stephanie Aymés notes that at first the market should drift lower but US$74.40/73.90 will hold and the recovery will resume to 77.20 and 77.70/78.00 or even 78.80 (Click chart above).

On the NYMEX WTI forward month futures contract, Aymés also sees a recovery. “73.40 more importantly 72.60 will hold, a further recovery will develop to 75.55/90 and 76.45 or even 77.05/77.25,” she notes. By and large, technical charts from Société Générale or elsewhere are not terribly exciting at the moment with the price still generally trading pretty much within the US$70-80 range.

Elsewhere in the crude world, here is a brilliant article from BBC reporter Konstantin Rozhnov on how Russia’s recently announced privatisation drive is sparking fears of a return to the Yeltsin era sale of assets.

On a crudely related note, after a series of delays, Brazil’s Petrobras finally unveiled its plans to sell up to US$64.5 billion of new common and preference stock in one of the largest public share offerings in the world.

A company spokeswoman said on Friday that the price of new shares would be announced on September 23rd. The IPO could well be expanded from US$64.5 billion to US$74.7 billion subject to demand; though initially Petrobras would issue 2.17 billion common shares and 1.58 billion preferred shares. The share capital will finance development of offshore drilling in the country’s territorial waters.

Lastly, the US Navy and BP said late on Sunday that the Macondo well which spilled over 200 million gallons of oil into the Gulf of Mexico poses no further risk to the environment. Admiral Thad Allen, a US official leading the government’s efforts, made the announcement after engineers replaced a damaged valve on the sea bed.

Concurrently, The Sunday Times reported that BP had raised the target for its asset sales from US$30 billion to US$ 40 billion to cover the rising clean-up cost of the Gulf of Mexico oil spill. The paper, citing unnamed sources, also claimed that BP was revisiting the idea of selling a stake in its Alaskan assets.

© Gaurav Sharma 2010. Graphics © SGCIB / CQG Inc. Photo: Alaska, US © Kenneth Garrett / National Geographic Society

Rig Building Industry Remains in a State of Flux

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

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

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

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

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

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

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

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

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

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

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

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

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

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

© Gaurav Sharma 2010. Photo Courtesy © Cairn Energy Plc