Crude market’s health & farewell to the Bay Area

It’s nearly time to say goodbye to the Bay Area head north of the border to British Columbia, Canada but not before some crude market conjecture and savouring the view of Alcatraz Island Prison from Fisherman’s Wharf. A local politician told yours truly it would be an ideal home for speculators, at which point the owner of the cafe ‘with a portfolio’ where we were sitting quipped that politicians could join them too! That’s what one loves about the Bay Area – everyone has a jolly frank opinion.

Unfortunately for debaters on the subject of market speculation, Alcatraz (pictured left) often called “The Rock” and once home to the likes of Al Capone and Machin Gun Kelly was decommissioned in 1963 can no longer be home to either speculators or politicians, though it seems quite a few seagulls kind of like it!

Not blaming speculators or politcians and with market trends remaining largely bullish, selected local commentators here, those back home in the City of London and indeed those the Oilholic is about to meet in Vancouver BC are near unanimous in their belief about holding exposure to oil price sensitivity over the next two quarters via a mixed bag of energy stocks, Russian equities, natural resources linked Forex (especially the Australian and Canadian dollar) and last but not the least an “intelligent play” on the futures market.

Nonetheless the second quarter opened on Monday in negative territory as WTI crude oil slid lower to retest the US$102 per barrel area, while Brent has been under pressure trading just above US$122 per barrel level on the ICE. “The European equity markets are also trading lower as risk appetite has been limited,” notes Myrto Sokou, Sucden Financial Research.

Protecting one’s portfolio from short-dated volatility would be a challenge worth embracing and Société Générale recommends “buying (cheap) short-dated volatility to protect portfolios from escalating political risk in Iran.” (Click on benchmarks graph to enlarge)

Mike Wittner, a veteran oil market commentator at Société Générale, remains bullish along with many of his peers and with some justification. OPEC and Saudi spare capacity is already tight, and will soon become even tighter, due to sanctions on Iran, says Wittner, and the already very bullish scenario would continue to be driven by fundamental.

Analysts point to one or more of the following: 

• Compared to three months ago, fears of a very bearish tail risk have subsided to an extent (e.g. Eurozone, US data) and macro environment is gradually turning supportive.
• Concurrently, risks of a very bullish tail risk remain (e.g. war against Iran or the Straits of Hormuz situation).
• OECD crude oil inventory levels are at five year lows.
• OPEC spare capacity is quite low at 1.9 million barrels per day (bpd), of which 1.6 million bpd is in Saudi Arabia alone.
• Ongoing significant non-OPEC supply disruptions in South Sudan, Syria, and Yemen thought to be in the circa of 0.6 million bpd.
• Broad based appetite for risk assets has been strong.
• Low interest rate and high liquidity environment is bullish.

On the economy front, in its latest quarterly Global Economic Outlook (GEO), Fitch Ratings forecasts the economic growth of major advanced economies to remain weak at 1.1% in 2012, followed by modest acceleration to 1.8% in 2013. While the baseline remains a modest recovery, short-term risks to the global economy have eased over the past few months.

Compared with the previous Fitch GEO in December 2011, the agency has only marginally revised its global GDP forecasts. The agency forecasts global growth, based on market exchange rates, at 2.3% for 2012 and 2.9% in 2013, compared with 2.4% and 3.0% previously.

"Fitch expects the eurozone to have the weakest performance among major advanced economies. Real GDP is projected to contract 0.2% in 2012, and grow by only 1.1% in 2013. Sizeable fiscal austerity measures and the more persistent effect of tighter credit conditions on the broader economy remain key obstacles to growth," says Gergely Kiss, Director in Fitch's Sovereign team.

In contrast to problems in Europe, the recovery in the US has gained momentum over past quarters. Growth is supported by the stronger-than-expected improvement in labour market conditions and indicators pointing to strengthening business and household confidence.

In line with the underlying improvement in fundamentals Fitch has upgraded its 2012 US growth forecast to 2.2% from 1.8%, whilst keeping the 2013 forecast unchanged at 2.6%. For Japan and the UK, Fitch forecasts GDP to increase 1.9% and 0.5% respectively for 2012.

Economic growth of the BRIC countries is expected to remain robust over the forecast horizon, at 6.3% in 2012 and 6.6% in 2013, well above MAE or global growth rates. Nevertheless, Brazil in particular, but also China and India slowed during 2011 and China is expected to slow further this year.

While on the subject of economics, Wittner of Société Générale, regards a shutdown of the Strait of Hormuz as a low-probability but high-impact scenario with Brent potentially spiking to US$150-$200. “In such a scenario, the equity markets would correct sharply. As a rule of thumb, a permanent US$10/barrel increase in the oil price would shave around 0.2% from global GDP growth in the first year after the shock,” he concludes.

That’s all for the moment folks! The Oilholic leaves you with a view of driving on Golden Gate Bridge on a sunny day and downtown San Francisco as he dashes off to catch a flight to Vancouver. Yours truly will be examining Canada’s role as a geopolitically stable non-OPEC supplier of crude while there. Keep reading, keep it ‘crude’!

© Gaurav Sharma 2012. Graph: World crude oil benchmarks © Société Générale. Photo 1: Alcatraz Island. Photo 2: Downtown San Francisco. Photo 3: Driving on the Golden Gate Bridge, California, USA. © Gaurav Sharma.

IEA on demand, Lavrov on Iran plus crude chatter

In its latest monthly report, the IEA confirmed what the Oilholic has been blogging for the past few months on the basis of City feedback – that the likelihood of another global recession will inhibit demand for crude oil this year, a prevalent high oil price might in itself hit demand too and seasonally mild weather already is.

While geopolitical factors such as the Iranian tension and Nigerian strikes have supported bullish trends of late, the IEA notes that Q4 of 2011 saw consumption decline on an annualised basis when compared with the corresponding quarter of 2010. As a consequence, the agency feels inclined to reduce its 2012 demand growth forecast by 220,000 barrels per day (bpd) from its last monthly report to 1.1 million barrels.

"Two inherently destabilising factors are interacting to give an impression of price stability that is more apparent than real. The first is a rising likelihood of sharp economic slowdown, if not outright recession, in 2012. The second factor, which is counteracting bearish pressures, is the physical market tightening evident since mid-2009 and notably since mid-2010," it says in the report.

The IEA also suggests that a one-third downward revision to GDP growth would see this year's oil consumption unchanged at 2011 levels. On the Iranian situation and its threat to disrupt flows in the Strait of Hormuz, through which 20% of global oil output passes, the agency notes, “At least a portion of Iran's 2.5 million bpd crude exports will likely be denied to OECD refiners during second half 2012, although more apocalyptic scenarios for sustained disruption to Strait of Hormuz transits look less likely.”

Meanwhile, Russian foreign minister Sergei Lavrov has weighed in to the Iran debate with his own “chaos theory”. According to the BBC, the minister has warned that a Western military strike against Iran would be "a catastrophe" which would lead to "large flows" of refugees from Iran and would "fan the flames" of sectarian tension in the Middle East. Israeli Defence Minister Ehud Barak earlier said any decision on an Israeli attack on Iran was "very far off".

Meanwhile, one of those companies facing troubles of its own when it comes to procuring light sweet crude for European refiners is Italy’s Eni which saw its long term corporate credit rating lowered by S&P from 'A' from 'A+'. In addition, S&P removed the ratings from CreditWatch, where they were placed with negative implications on December 8, 2011.

Eni’s outlook is negative according to S&P and the downgrade reflects the ratings agency’s view that the Italian oil major’s business risk profile and domestic assets have been impaired by the material exposure of many of its end markets and business units to the deteriorating Italian operating environment. Eni reported consolidated net debt of €28.3 billion as of September 30, 2011. Previously, Moody’s has also reacted to the Italian economy versus Eni situation over Q4 2011.

Elsewhere conflicting reports have emerged about the Obama administration’s decision to deny a permit to Keystone XL project something which the Oilholic has maintained would be a silly move for US interests as Canadians can and will look elsewhere. Some reports said the President has decided to deny a permit to the project while others said a decision was unlikely before late-February. This article from The Montreal Gazette just about sums up Wednesday's conflicting reports.

When the formal rejection by the US state department finally arrived, the President said he had been given insufficient time to review the plans by his Republican opponents. At the end of 2011, Republicans forced a final decision on the plan within 60 days during a legislative standoff.

The Republican Speaker of the US House of Representatives, John Boehner, criticised the Obama administration for its failure over a project that would have created "hundreds of thousands of jobs" while the President responded by starting an online petition so that the general population can express its opposition to the Keystone XL pipeline.

The merits and demerits of the proposal aisde, this whole protracted episode represents the idiocy of American politics. Canadians should now seriously examine alternative export markets; something which they have already hinted at. The Oilholic's timber trade analogy always makes Canadians smile. (Sadly, even Texans agree, though its no laughing matter).

On the crude pricing front, the short term geopolitically influenced bullishness continues to provide resistance to the WTI at the US$100 per barrel level and Brent at US$111. Sucden Financial's Myrto Sokou expects some further consolidation in the oil markets due to the absence of major indicators and mixed signals from the global equity markets, while currency movements might provide some short-term direction. “Investors should remain cautious ahead of any possible news coming out from the Greek debt talks,” Sokou warns.

Finally, global law firm Baker & McKenzie is continuing with its Global Energy Webinar Series 2011-2012 with the latest round – on International Competition Law – to follow on January 25-26 which would be well worth listening in to. Antitrust Rules for Joint Ventures, Strategic Alliances and Other Modes of Cooperation with Competitors would also be under discussion. Thats all for the moment folks. Keep reading, keep it 'crude'!

© Gaurav Sharma 2012. Photo: Oil Refinery, Quebec, Canada © Michael Melford / National Geographic.

Canada, India pitch to world & each other!

One country aims to be a leading producer (Canada) and one is projected to be a leading consumer or at least among them (India), so the Oilholic has clubbed them together for purposes of blogging about what officials from each country said and did here today at the 20th WPC.

Starting with Canada, its ministerial session complete with a RCMP officer on either side of the stage saw Serge DuPont, Deputy Minister, Natural Resources Canada and Cal Dallas, Alberta’s Minister of Intergovernmental, International and Aboriginal Affairs outline their country’s goals for its energy business with the session being moderated by Neil McCrank, Counsel at Borden Ladner Gervais LLP.

The Canadians maintained that in context of developing and investing in the oil sands – of which there is considerable interest here – the country’s energy strategy would be transparent, accountable and responsible both internally and internationally. They also outlined plans to support their industry, akin to many rival oil & gas exporting jurisdictions, via grants – chiefly the provincial government’s energy innovation fund.

This would, according to Deputy Minister DuPont, accompany developing renewable energy sources and a C$2 billion investment in carbon capture and storage. Canada indeed is open for business with foreign direct investment (FDI) welcomed albeit under strict investment guidelines. Proof is in the pudding – not even one top 10 international oil major worth its balance sheet has chosen to ignore projects in the Alberta oil sands.

The Oilholic is reasonably convinced after hearing the ministerial session, that when it comes to environmental concerns versus developing oil & gas projects who would you rather reason with – an open democracy like Canada or Chavez about Venezuela’s heavy oil? In light of recent events, one simply had to raise the Keystone XL question as the Oilholic did with Canadian Association of Petroleum Producers (CAPP) President Dave Collyer on a visit to Calgary earlier this year. After all, one wonders, what is the Canadian patience threshold when it comes to US exports given that new buyers are in town chiefly China, Korea and India.

“Well Canadians are a patient lot. The US remains a major export market for us. The delays associated with the Keystone XL project are frustrating but our medium term belief is that the construction of the pipeline would be approved,” said session moderator and member of the Canadian delegation Neil McCrank of BLG.

He also believes the new buyers in town can be happily accommodated with the oil sands seeing investments from China, South Korea and India (among others). “We acknowledge that there are difficulties in pulling a pipeline from Alberta via British Columbia to the Pacific coast as well – but we are working to resolve these issues as patiently, pragmatically and ethically as only Canadians can!” McCrank concludes.

There is certain truth in that. Despite being an oil producer, Canada does not have a national oil company (NOCs) to trumpet and shows no inclination to shun FDI in Alberta. One of the aforementioned investors, whether ethical or not, is India which has a ‘mere’ 14 NOCs all aching to explore and secure fresh oil reserves to help meet its burgeoning demand for oil.

Of the 14, some four are in the Fortune 500 and operate in 20 international jurisdictions; the loudest of these is ONGC Videsh Limited (or OVL) which among other countries is also looking at Canada as confirmed by both sides. India’s Minister for Petroleum & Natural Gas S. Jaipal Reddy sounded decidedly upbeat at the WPC, telling the world his country’s NOCs would make for robust project partners.

Over a period of the last 12 months, the Oilholic notes that Indian NOCs have invested in admirably strategic terms but overseas forays have also seen them in Syria and Sudan which is politically unpalatable for some but perhaps ‘fair game’ for India in its quest for security of supply. Canada – should Indian NOCs increase their exposure in Alberta – would be interesting from a geopolitical standpoint given China’s overt stance on being a Canadian partner too.

However, the only open quotes in terms of overseas forays from Indian officials came regarding investment in Russia and FSU republics. A high powered Russo-Indian delegation met on the sidelines of the 20th WPC to discuss possible investment by Indian NOCs in the Sakhalin project. Separately, officials from ONGC and GAIL told the Oilholic they were keen in buying a stake in Kazakhstan’s Kashagan oilfield, which is thought to contain between 9 to 16 billion barrels of oil, and join the consortium under the North Caspian Sea Production Sharing Agreement which sees stakes by seven companies – Eni (16.81%), Shell (16.81%), Total (16.81%), ExxonMobil (16.81%), KazMunayGas (16.81%), ConocoPhillips (8.4%) and Inpex (7.56%).

However the rumoured seller – ConocoPhillips – quashed all rumours and instead said it was actually checking out material prospects in Kazakhstan itself. It also detailed its plans for Canada and shale plays. That’s all for the moment folks. Keep reading, keep it ‘crude’!

© Gaurav Sharma 2011. Photo 1: Canadian Ministerial session at the 20th Petroleum Congress (Seated L to R: Neil McCrank, BLG, Cal Dallas, Alberta Goverment, Serge DuPont, Canada's Deputy Minister, Natural Resources. Photo 2: Indian Ministerial session (Seated third from right: India’s Minister for Petroleum & Natural Gas S. Jaipal Reddy) © Gaurav Sharma 2011.

Of Argentina, Petrobras & a few odd pipelines

Last ten days has seen the crude focus shift to Argentina for a multitude of reasons which may be construed as good or bad depending on your point of view. To begin with, BP’s move to sell assets in Argentina has fallen through after its partner withdrew from the deal. BP wanted to sell its 60% stake in Pan American Energy (PAE) to its partner in Argentina, Bridas Energy Holdings, which is subsequently owned by CNOOC, China's largest offshore oil producer.

However, on November 6th CNOOC said it was terminating the deal, signed a year ago as BP was grappling with the fallout from the Gulf of Mexico oil spill. The stake sale was worth an estimated US$7 billion and was one of the largest sales agreed by the firm following the disaster. It is understood that BP will now have to repay its US$3.5 billion deposit on the agreement which had been contingent on regulatory approval.

Barely days later, on November 8th, Spanish giant Repsol’s Argentine subsidiary – YPF Sociedad Anónima – said it had found 927 million barrels of recoverable shale oil in Argentina which could catapult the country to the energy elite league.

In a statement, YPF said the discovery – located in the Vaca Muerta basin of Argentina's Neuquen province – "will transform the energy potential of Argentina and South America, boasting one of the world's most significant accumulations of non-conventional resources".

The discovery is likely to give renewed impetus to the country’s creditors who have been chasing the Argentine government for almost a decade since its default in 2002. Most bondholders took part in debt exchanges in 2005 and 2010, but a brave crew of EM and NML Capital – an affiliate of Elliott management – along with a group of 60,000 individual Italian investors have been bravely holding out and using legal avenues to recoup the US$6 billion-worth of debt plus interest. They may think it’s about time the country paid courtesy of a commodities-led boom.

Regrettably for YPF though, the find came only days after Moody's downgraded Argentine oil & gas companies. These included YPF, Pan American LLC, Petrobras Argentina, Petersen Energia and Petersen Energia Inversora.

According to Moody’s, the ratings downgrade and review for further downgrade were prompted by the new presidential decree requiring oil, gas and mining companies to repatriate 100% of their export proceeds and convert them to Argentine pesos. Previously, oil and gas companies operating in Argentina were permitted to keep up to 70% of their export proceeds offshore.

Neighbouring Brazil’s oil & gas behemoth Petrobras has been busy too. On November 3rd, it announced a new oil discovery in the extreme South Western part of the Walker Ridge concession area, located in the Gulf of Mexico’s ultra-deep waters. The discovery confirms the Lower Tertiary's potential in this area. (see map on the left; click to enlarge)

The discovery – Logan – is approximately 400km southwest of New Orleans, at a water depth of around 2,364 meters (or 7,750 feet). The discovery was made by drilling operations of well WR 969 #1 (or Logan 1), in block WR 969. Further exploration activities will define Logan's recoverable volumes and its commercial potential.

Norway’s Statoil is the consortium's operator, with 35% stake. Petrobras America Inc. (a subsidiary of Petrobras headquartered in Houston, Texas) holds 35% of the stake, while Ecopetrol America and OOGC hold 20% and 10%, respectively.

Petrobras holds other exploratory concession areas in this region, which will be tested later on, growing the Company's operations in the Gulf of Mexico. The Brazilian major is the operator of Cascade (100%) and Chinook (66.7%) oilfields and holds stakes in the Saint Malo (25%), Stones (25%) and Tiber (20%) discoveries, all with significant oil reserves in the Lower Tertiary. Additionally, Petrobras has stakes in the very recent Hadrian South (23.3%), Hadrian North (25%) and Lucius (9.6%) discoveries, all with significant oil reserves and in the Mio-Pliocene.

The company has been pretty busy at home as well, announcing that the first well drilled after the execution of the Transfer of Rights agreement confirmed the extension of the oil reserves located northwest of the Franco area discovery well, in the Santos Basin pre-salt cluster (see map on the left; click to enlarge).

The new well, informally known as Franco NW, is at a water depth of 1860 meters, approximately 188km from the city of Rio de Janeiro and 7.7km northwest of discovery well Franco (or 2-ANP-1-RJS).

The discovery was confirmed by oil samples of good quality (28º API) obtained through cable tests. The well is still in the drilling phase with the aim of reaching the base of the reservoirs containing oil. Once the drilling phase is complete, Petrobras will continue with the investment activities provided in the Mandatory Exploratory Program (or Programa Exploratório Obrigatório, PEO as it’s referred to locally).

From South American discoveries to North American pipelines as it emerged last night that the Obama administration has chickened-out of making a decision on Keystone XL. Faced with the environmental lobby on one side and the Unions craving jobs on the other, the US government has requested further studies on the project which would in theory delay the decision to build the 2700km pipeline well after 2012 presidential election. Frustration across the border in Canada is likely to grow as the Oilholic noted from Calgary earlier this year.

If he rejected the project, Obama could be accused of destroying jobs. If allowed it to go ahead, it could lose him the support of some activists who helped him win the Presidency. So he chose to do what political jellyfish usually do before a crucial vote – nothing.

Additionally, reports surfaced earlier in the week that Houston-based Cardno Entrix – a company involved in the environmental review – had listed developer TransCanada, the pipeline’s sponsor, as a "major client".

A review is now likely to look into this as well as state department emails related to a TransCanada lobbyist who had worked in Secretary of State Hillary Clinton's 2008 presidential campaign. TransCanada says that while it is disappointed with the delay, it continues to “conduct affairs with integrity and in an open and transparent manner.”

Continuing with pipelines, Moody's has assigned a Baa3 rating to Ruby Pipeline's US$1.075 billion senior unsecured notes. The senior unsecured notes have staggered maturities and will be used to refinance US$1.5 billion of project construction loans. The rating outlook is stable.

Stuart Miller, Moody's Vice President and Senior Analyst, said last week that the pipeline is a strategic link that provides diversity of supply to the utilities and industrial markets in Northern California and the Pacific Northwest.

"Hence, the primary drivers for Ruby's Baa3 rating are its initially high leverage tempered by a high level of ship-or-pay firm contracts with counterparties with a weighted average credit rating of Baa1 as well as our expectation that the ratio of debt to EBITDA will rapidly decline to below 4.5x," he concluded.

Ruby's leverage is expected to improve over the next five years as its capital structure includes a five year amortising term loan. Because of the required amortisation, Ruby's leverage, as measured by debt to EBITDA, should decline from approximately 5.2x to less than 4.5x by the end of 2013. Any revenue earned from the 28% un-contracted pipeline capacity would reduce leverage quicker, the agency noted. Finally, Nordstream I gas pipeline came onstream earlier in the week. Here's the WSJ's Oilholic approved take on it.

© Gaurav Sharma 2011. Map 1: Petrobras prospections in Gulf of Mexico © Petrobras 2011. Map 2: Petrobras in Santos Basin, Brazil (Courtesy: Petrobras)

Exploding the resource curse ‘myth’?

The resource curse hypothesis has its detractors and supporters in equal measure. The vanguard of many a commodities bubble – crude oil – often leads the discussion on the subject as the ‘resource’ in question. The title of a book, the first edition of which was published last year, by two academics Pauline Jones Luong and Erika Weinthal – Oil is Not a Curse – simply gives away which side of the argument they are on. Using Former Soviet Union (FSU) nations as case studies, Luong and Weithal opine that resource-rich states are cursed not by their wealth but, rather, by the ownership structure they choose to manage their natural resources with. Furthermore, contrary to popular beliefs, they also stress that weak institutions are not a given in resource-rich nations.

Without a shadow of doubt, such a chain of thought while not unique to the authors is indeed a significant departure from the conventional resource curse literature, especially journalistic writing, which has by and large treated ownership structure as a constant across time and space and has (largely) presumed that resource-rich countries are incapable of either building or sustaining strong institutions – particularly fiscal regimes.

While popular conjecture is based on the usual suspects in the Middle East and Africa, this book of just under 430 pages split by ten chapters, highlights the experiences of the five petroleum-rich FSU states of Azerbaijan, Kazakhstan, the Russian Federation, Turkmenistan, and Uzbekistan to challenge prevalent assumptions about the resource curse. The text is backed-up and contextualised with aid of ample graphs, appendices and tables.

Admittedly, while the arguments offered are very convincing in certain parts of the book, the Oilholic remains sceptical about of the case(s) in point especially those pertaining to Russia and Turkmenistan. However, at the same time the authors’ arguments in context of the other three of the aforementioned jurisdictions – especially Kazakhstan strike a convincing chord.

This FSU’s developmental trajectories since independence certainly demonstrates that ownership structure can vary even across countries that share the same institutional legacy and that this variation helps to explain the divergence in their subsequent fiscal regimes. One of the chapters in the book on foreign private ownership in Kazakhstan is one of the best the Oilholic has read on the topic.

The authors’ concluding chapter makes a reasonably, if not overwhelmingly, persuasive case about why the resource curse hypothesis is a myth. Ultimately, Luong and Weithal believe our take on the subject depends on the broadness of our frame of reference. Warning against faulty generalisations and assumptions over a truncated period of time, they feel that if scope and time frame of the research is broadened – it is not crude oil which is the curse, but Petroleum wealth, which becomes an impediment under certain conditions especially when state-owned and controlled.

The Oilholic really liked the book, albeit with some reservations and is happy to recommend it to those interested in oil, the resource curse hypothesis, current geopolitical debates and energy economics.

© Gaurav Sharma 2011. Photo: Cover of ‘Oil is not a curse' © Cambridge University Press 2010.

Of Mid-Nov Price Correction, BP & Lukoil

The price of crude has seen a fair bit of fluctuation week over week and I agree with analysts at Société Générale CIB who noted on Tuesday that "the modest short-term crude price correction has been driven by investor profit-taking, as well as an end to a surge in gasoil cracks, which had temporarily supported crude prices."

Prices actually peaked on Wednesday and Thursday of last week. Since then, the front-month crude prices have eased by US$2-3. At 18:05GMT on Tuesday, WTI forward month contract was trading at US$80.65/bbl and ICE Brent at US$83.60/bbl.

Elsewhere in this crude world, it was revealed on Tuesday that BP’s Rhim field off the coast of Scotland has been shutdown as it is understood that the field turned out to be a joint venture between it and financiers related to Iranian oil. The shutdown was triggered because extraction from the field could be in contravention of existing European Union sanctions against Iran, issued in October.

The company it is now seeking clarification from the UK government on how the sanctions would apply. Elsewhere, S&P Ratings Services affirmed its 'BBB-' long-term corporate credit rating and 'ruAA+' Russia national scale rating for Lukoil last week.

Concurrently, S&P also removed the ratings from CreditWatch, where they were placed on July 29, 2010. S&P credit analyst Andrey Nikolaev said, "The affirmation reflects our improved assessment of Lukoil's liquidity position, which we now assess as 'adequate' after the company successfully issued a $1 billion Eurobond."

S&P also anticipates that Lukoil will extend the terms of its committed credit lines over the next several weeks. "We now estimate Lukoil's ratio of sources to uses of liquidity at about 1.2x, factoring in the committed credit lines with the terms to be extended," Nikolaev added in an investment circular.

S&P views Lukoil's business risk profile as "satisfactory", underpinned by large and profitable upstream and downstream operations, which are largely concentrated in Russia. The ratings agency also views Lukoil's financial risk profile as 'intermediate', based on its modest debt leverage and our perception that it has fairly good access to bank funding and capital markets.

© Gaurav Sharma 2010. Photo: Andrew Rig, North Sea © BP Plc

Performance of Russian Oil Co’s Remains “Robust”

A recent report by ratings agency Moody’s suggests that Russian integrated oil and gas companies demonstrated financial robustness during the economic downturn, as "certain key features" acted to support their operational and financial profiles.

It notes that negative effects of low oil prices were mitigated by a devaluation in the Rouble and favourable changes to the Russian tax system, which along with cost-containment initiatives and good access to funding boosted the companies' resilience to market turmoil. In fact, the ratings agency said outlook for the sector is stable.

The report titled "Russian Integrated Oil and Gas Companies: 2009-10 Review and 2011 Outlook", further suggests that since late 2009 and all through H1 2010, the operating and financial performance of Russian players gradually improved post-recession, lifted by relativelyhigher oil prices as the global economy recovered.

Moody’s now feels that the operating performance of Russian oil companies is likely to improve in 2010 and in 2011 on the back of stronger oil prices and ongoing cost-cutting and modernisation initiatives. However, the ratings agency does not believe there will be a major upwards trend in profitability in H2 2010 or in 2011, due to the growing tax burden and inflation in non-controllable costs, notably energy and transportation tariffs.

Furthermore, it must be noted that despite overseas overtures, the current reserves and production bases of Russian companies remain concentrated in their own backyard. This, according to the report, "exposes them to geological and geopolitical risk."

Despite the lack of positive ratings momentum, in 2010, Russian players benefited from greater access to bank and bond funding, with lenders offering longer maturities at lower rates. Moody's expects lending conditions to continue to improve in 2011. In addition, overall free cash flow improved in 2010 and will likely remain marginally positive in 2011 as companies ramp-up capital expenditure on projects that were delayed during the downturn.

Continuing with Russia, on October 22 Moody's assigned a provisional rating of (P)Baa2 to the upcoming Eurobond issue by Lukoil via Lukoil International Finance B.V., its indirect and wholly owned subsidiary. The rating is based on an irrevocable and unconditional guarantee from the Russian company and is in line with the company's issuer rating of Baa2. The outlook is stable, according to Moody’s.

The proceeds are largely expected to be used by Lukoil for general corporate purposes, as well as refinancing of existing indebtedness. Moody's believes the Eurobond issue will support Lukoil's liquidity position.

© Gaurav Sharma 2010. Photo: Photo: Oil Drill Pump, Russia © Lukoil

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

Oil Price, Petroaggressors & a Few Books I've Read

Since last week, the wider commodities market has continued to mirror equities. This trend intensified towards the end of last week and shows no sign of abating. Furthermore, it is worth noting that Brent crude is trading at a premium to its American cousin, a gap which widened over USD$2. On Tuesday (August 31) at 13:00 GMT, the Brent forward month futures contract was trading at US$76.10 a barrel (down 1.1%) versus WTI crude at US$73.83 (down 3.1%) in intraday trading.

This of course is ahead of the US energy department’s supplies update, due for publication on Wednesday. The report is widely tipped to show a rise in crude stockpiles and the US market is seen factoring that in. Overall, the average drop in WTI crude for the month of August is around 8.89% as the month draws to a close.

Having duly noted this, I believe that compared to other asset classes, the slant in oil still seems a more attractively priced hedge than say forex or equities. Nonetheless, with there being much talk of a double-dip recession, many commentators have revised their oil price targets for the second half of 2010.

Last month, the talk in the city of London was that crude might cap US$85 a barrel by the end of the year; maybe even US$90 according to Total’s CEO. Crude prices seen in August have tempered market sentiment. Analysts at BofA Merrill Lynch now believe the oil price should average US$78 per barrel over H2 2010 owing to lower global oil demand growth and higher-than-expected non-OPEC supply.

“Following robust increases in oil demand over the past 12 months on a stimulus-driven rebound, we now see some downside risk as slower growth sets in and OECD oil inventories remain high. Beyond 2011, oil markets should remain tight on solid EM fundamentals and potentially a looser monetary policy stance by EM central banks on the back of the recent crisis in Europe. Curves may flatten further as inventories return to normal levels and seasonal hedging activity picks up,” they wrote in an investment note.

Elsewhere, Russia's largest privately held oil company - Lukoil - reported a 16% drop in quarterly profits with net profit coming at US$1.95 billion for the April-June period. Revenues rose 28% to US$25.9 billion on an annualised basis. In statement to the Moscow stock exchange, Lukoil said it is coping with the difficult macroeconomic situation and securing positive cash flow thanks to implementing measures aimed at higher efficiency which were developed at the beginning of the year.

The company largely blamed production costs for a dip in its profits which rose 24% for the first half of 2010. In July, US oil firm ConocoPhillips, which owns a 20% stake in Lukoil, said it would sell its holdings. However, the Russian oil major issued no comment on whether it would buy-out ConocoPhillips’ holdings.

Reading investment notes and following the fortunes of Lukoil aside, I recently stumbled upon a brilliantly coined term – “petroaggressors” – courtesy of author and journalist Robert Slater. After all, little else can be said of Iran, Venezuela, Russia and others who are seeking to alter the energy security hegemony from the developed world in favour of the Third world.

In his latest book – Seizing Power: the global grab for oil wealth – Slater notes that the ranks of petroaggressors are flanked by countries such as India and China who are desperate to secure the supply of crude oil with very few scruples to fuel their respective economic growth.

It is mighty hard to imagine life without oil; such has been the dominance of the internal combustion engine on life in the developed world over the last six decades. Now the developing world is catching-up fast with the burgeoning economies of China and India leading the pack. End result is every economy, regardless of its scale is suddenly worried about its energy security. Slater opines that a grab for this finite hydrocarbon may and in some cases already is turning ugly.

In fact he writes that the West, led by the US (currently the world's largest consumer of crude oil), largely ignored the initial signs regarding supply and demand permutations. As the star of the major oil companies declines, Slater writes that their market share and place is being taken not by something better - but rather by state-run, unproductive and politics-ridden behemoths dubbed as National Oil Companies (NOCs).

If the peak oil hypothesis, ethical concerns, price speculation and crude price volatility were not enough, geopolitics and NOCs run by despots could make this 'crude' world reach a tipping point. Continuing on the subject of books, journalist Katherine Burton's latest work - Hedge Hunters: How Hedge Fund Masters Survived is a thoroughly decent one.

In it, she examines the fortunes of key players in the much maligned, but still surviving hedge fund industry. In the spirit of a true oilholic, I jumped straight to Chapter 9 on the inimitable Boone Pickens, before immersing myself in the rest of her book.

© Gaurav Sharma 2010. Photo: Oil rig © Cairn Energy Plc

Talking Crude: Of Profits, Tax rebates & Asset Sales

Last week was an eventful one in crude terms. Well it’d have to be if Shell and Exxon Mobil declare bumper profits. Both saw their quarterly profits almost double. Beginning with Shell, the Anglo-Dutch firm reported profits of US$4.5 billion on a current cost (of supply) basis, up from US$2.3 billion noted over the corresponding quarter last year.

Excluding one-off items, Shell's profit was $4.2 billion, compared with $3.1 billion last year. Unlike BP, Shell said it would pay a second quarter dividend of $0.42 per share. The oil giant's restructuring plans also appear to be bearing fruit achieving cost savings of $3.5 billion, beating the stated corporate savings target by about 15% and some six months ahead of schedule.

Furthermore, it is thought that as a result of the restructuring, 7,000 employees would leave Shell nearly 18 months ahead of schedule. It also said it expected to sell $7-$8 billion of assets over 2010-11. Concurrently, oil giant Exxon Mobil reported quarterly profits of $7.6 billion, well above the $4.1 billion it posted over the corresponding quarter last year. Revenue for the quarter rose 23% in year over year terms on annualised basis from $72.5 billion to $92.5 billion.

Meanwhile, rival BP reported a record $17 billion second quarter loss which the market half expected. The figure included funds to the tune of $32 billion set aside to cover the costs of the oil spill in the Gulf of Mexico.

Sticking with BP, it has emerged that the beleaguered oil giant included a tax credit claim of almost $10 billion in its Q2 results as it seeks to take the edge off the impact of the Gulf of Mexico oil spill on its corporate finances. Its income statement for the second quarter carries a pre-tax charge of $32.2 billion related to the oil spill and a tax credit of $9.79 billion.

Under domestic tax laws in the US, BP is entitled to deduct a proportion of its losses against US tax. The issue is likely to turn political – especially in an election year, when much more has been made out of far less. However, legally the US government can do precious little to prevent BP from claiming the tax credit.

Crude asset sales seem to be the order of the day. Following on from BP’s sale of assets and Shell’s announcement that it will sell too, news emerged that the Russian government also wants to join the party.

It plans to sell $29 billion worth of assets (not all which are energy sector assets) on the open markets. In the absence of official confirmation, local media speculation suggests minor stakes in Rosneft and Transneft may be put up for sale.

However, speaking to reporters in Moscow on July 29th, the country’s Finance Minister Alexei Kudrin said, "We will sell significant stakes in state companies on the market. We plan to keep controlling stakes. Assets will be valued publicly, in line with market prices and tenders will be open. We are fully ruling out a situation when somebody sells something to someone at an artificially low price."

According to communiqués, the Russian government wanted to rake in $10 billion next year from asset sales. It has also approved a decision to increase mineral extraction taxes on gas producers by 61% from 2011.

Finally from a macro strandpoint, market consensus and comments from BP, Shell and Exxon officials seem to indicate that the top bosses of all three see mixed signals in the global economy. While their earnings figures, excluding BP for obvious reasons, have improved markedly from the quarterly lows of 2009, the overall industry outlook remains uncertain.

© Gaurav Sharma 2010. Photo courtesy © Shell

Russian Production Capped Saudi Output in 2009

Russian production of crude oil overtook that of Saudi Arabia in 2009, thereby making the former the world’s leading oil producer, according to BP’s Statistical Review of World Energy.

Russian crude production rose 1.5% year over year, increasing the country's global oil output share to 12.9%. This compared favourably, for the Russians at least, with Saudi Arabia’s decline in market share to 12% of global output, following an annualised production fall of 10.6%. The difference may be marginal, but it gives the Russians some much needed bragging rights.

Proven oil global reserves rose by 700 million barrels to 1.33 trillion barrels in 2009, the report adds. It also notes that after the global financial crisis, oil consumption dipped 1.7% or 1.2 million barrels per day last year; highest decline since 1982.

It does seem a shade ironic that BP should be bringing this data while the Gulf of Mexico oil spill saga carries on. However, to be fair, they have been publishing this particular data-set for years and are among the most reliable sources of oil industry data.

Following publication of the BP report, the International Energy Agency (IEA) revised its 2010 global oil demand forecast upwards by 60,000 barrels a day to 86.4 million barrels, on the basis of above expectation preliminary economic data from the OECD countries.

The new demand forecast suggests annual demand growth is seen up by 1.7 million barrels or 2% year over year from 2009.

© Gaurav Sharma 2010. Photo Courtesy © Adrian R. Gableson