Crude markets & the Eurozone mess

The Eurozone sad show continues alternating from a Greek tragedy to an Italian fiasco and woes continue to hit market sentiment; contagion is now – not entirely unexpectedly – seen spreading to Italy with the country’s benchmark debt notes rates rising above the 7% mark at one point deemed ‘unsustainable’ by most economists. Inevitably, both crude benchmarks took a plastering in intraday trading earlier in the week with WTI plummeting below US$96 and Brent sliding below US$113. Let’s face it; the prospect of having to bailout Italy – the Eurozone’s third largest economy – is unpalatable.

The US EIA weekly report which indicated a draw of 1.37 million barrels of crude oil, against a forecast of a 400,000 build provided respite, and things have become calmer over the last 24 hours. Jack Pollard, analyst at Sucden Financial Research, noted on Thursday that crude prices gathered some modest upside momentum to recover some of Wednesday’s losses as equities pared losses and Italian debt yields come off their record highs.

“One important factor for crude remains the Iranian situation with Western diplomats adopting a decidedly more hard-line approach to their rhetoric. For example, the French Foreign Minister has said the country is prepared to implement ‘unprecedented sanctions’ on Iran whilst William Hague, British Foreign Secretary, has said ‘no option is off the table’. Should the geopolitical situation deteriorate, the potential for supply disruptions from OPEC’s second largest producer could provide some support to crude prices,” Pollard notes.

From a Brent standpoint, barring a massive deterioration of the Iranian scenario, the ICE Brent forward curve should flatten in the next few months, mainly down to incremental supply of light sweet crude from Libya, end of refinery maintenance periods in Europe and inventories not being tight.

In an investment note to clients, on October 20th, Société Générale CIB analyst Rémy Penin recommended selling the ICE Brent Jan-12 contract and simultaneously buying the Mar-12 contract with an indicative bid @ +US$1.5/barrel. (Stop-loss level: if spread between Jan-12 and Mar-12 contracts rises to +US$2.5/barrel. Take-profit level: if spread drops to 0.)

The Oilholic finds himself in agreement with Penin even though geopolitical risks starting with Iran, followed by perennial tensions in Nigeria, and production cuts in Iran and Yemen persist. But don’t they always? Many analysts, for instance at Commerzbank, said in notes to clients issued on Tuesday that the geopolitical climate justifies a certain risk premium in the crude price.

But Penin notes, rather dryly, if the Oilholic may add: “All these factors have always been like a Damocles sword over oil markets. And current disruptions in Nigeria, Yemen and Iraq are already factored in current prices. If tensions ease, the still strong backwardation should as well.”

Additionally, on November 1st, his colleagues across the pond noted that over the past 20 years, when the NYMEX WTI forward curve has flipped from contango into backwardation, it has provided a strong buy signal. Société Générale CIB, along with three others (and counting) City trading houses recommend buying WTI on dips, as the Oilholic is reliably informed, for the conjecture is not without basis.

There is a caveat though. Société Générale CIB veteran analyst Mike Wittner notes that it is important to take into account the fact that crude oil stocks at Cushing, Oklahoma, consist not only of sweet WTI-quality grades but also of sour grades. “Most market participants, including us, do not know the exact breakdown between sour and sweet crudes at Cushing, but the recent move into backwardation suggests that there is little sweet WTI-quality crude left,” he adds.

Société Générale CIB analysts believe market participants who are reluctant to go outright long WTI in the current highly uncertain macroeconomic environment may wish to consider using the WTI sweet spot signal to go long WTI against Brent. Any widening of the forward-month Brent-WTI spread towards US$20 represents a trading opportunity, as the spread should narrow to at least US$15 and possibly to as low as US$10 before year-end, on the apparent shortage of WTI and increasing supply of Atlantic Basin waterborne sweet crude.

© Gaurav Sharma 2011. Photo: Trans Alaska Pipeline © Michael S. Quinton / National Geographic

Sucden to Soc Gen: The fortnight’s crude chatter

The last two weeks have been tumultuous for the oil market to say the least. This morning, the ICE Brent crude forward month futures price successfully resisted the US$100 level, while WTI’s resistance to US$80 level has long since crumbled. Obviously, the price of crude cannot divorce itself from the global macroeconomic picture which looks pretty grim as it stands, with equity markets plummeting to fresh new lows.

Bearish sentiments will persist as long as there is uncertainty or rather the "Greek tragedy" is playing in the Eurozone. Additionally, there is a lack of consensus about Greece among EU ministers and their next meeting - slated for Oct 13th - has been cancelled even though attempts are afoot to allay fear about a Greek default which hasn’t yet happened on paper.

Sucden Financial Research’s Myrto Sokou notes that following these fragile economic conditions across the Eurozone and weak global equity markets, the energy market is under quite a bit of pressure.

“The stronger US dollar weighs further to the market, while investors remain cautious and are prompted to some profit-taking to lock-in recent gains. We know that there is so much uncertainty and nervous trading across the markets at the moment, as the situation in the Eurozone looks daunting, “ready for an explosion”. So, we expect crude oil prices to remain on a downside momentum for the short-term, with WTI crude oil retesting the US$70-$75 range, while Brent consolidating around the US$98-$100 per barrel,” Sokou adds.

Many in the City opine that some commodities are currently trading below long term total costs, with crude oil being among them. However, in the short-run, operating costs (the short run marginal costs) are more important because they determine when producers might cut supply. Analysts at Société Générale believe costs should not restrict prices from dropping, complementing their current bearish view on the cyclical commodities.

In a note to clients on Sep 29th, they noted that the highest costs of production are associated with the Canadian oil sands projects, which remain the most expensive source of significant new supply in the medium to long term (US$90 represents the full-cycle production costs).

“However global oil supply is also influenced by political factors. It should also be noted that while key Middle East countries have very low long term production costs, social costs also need to be added to these costs. These costs, in total, influence production decisions; consequently, this may cause OPEC countries cutting production first when, in fact textbook economics says they should be the last to do so,” they noted further.

Furthermore, as the Oilholic observed in July – citing a Jadwa Investment report – it is commonly accepted by Société Générale and others in the wider market that Saudi Arabia needs US$90-$100 prices to meet its national budget; and this is particularly true now because of large spending plans put in place earlier this year to pre-empt and counter public discontent as the Arab Spring unfolded.

Therefore, in a declining market, Société Générale expects long-dated crude prices to show resilience around that level but prices are still significantly higher than the short-run marginal costs so their analysts see room for further declines.

Concurrently, in its September monthly oil market report, the International Energy Agency (IEA) cut its forecast for global oil demand by 200,000 barrels per day (bpd) to 89.3 million bpd in 2011, and by 400,000 bpd to 90.7 million bpd in 2012. Factoring in the current macroeconomic malaise and its impact on demand as we’ve commenced the final quarter of 2011, the Oilholic does not need a crystal ball to figure out that IOCs will be in choppy waters for H1 2012 with slower than expected earnings growth.

In fact ratings agency Moody’s changed its outlook for the integrated oil & gas sector from positive to stable in an announcement last week. Francois Lauras, Vice President & Senior Credit Officer - Corporate Finance Group at Moody’s feels that the weakening global macroeconomic conditions will lead to slower growth in oil consumption and an easing in current market tightness over the coming quarters, as Libyan production gradually comes back onto the market.

The Oilholic is particularly keen to stress Mr. Lauras’ latter assertion about Libya and that he is not alone in thinking that earnings growth is likely to slow across the sector in 2012. Moody’s notes that as crude oil prices ease and pressure persists on refining margins and downstream activities slower earnings are all but inevitable. This lends credence to the opinions of those who advocate against the integrated model. After all, dipping prices are not likely to be enjoyed by IOCs in general but among them integrated and R&M players are likely to enjoy the current unwanted screening of the Eurozone “Greek tragedy” the least.

© Gaurav Sharma 2011. Photo: Alaska Pipeline, Brooks Range, USA © Michael S. Quinton / National Geographic

Penglai 19-3, Syrian oil & the latest price forecast

Starting with the latter point first, Société Générale’s latest commodities review for Q4 2011 throws up some crude points for discussion. In the review, the French investment bank’s analysts hold a largely bearish stance over the price of crude for the remainder of 2011; even for the forecasts where the possibility of a recession has not been factored in.

Société Générale’s global head of oil research Mike Wittner notes that oil markets have not yet priced in a weaker economic and oil demand growth environment. “As such, our view is that crude oil prices are due for a significant decline, which will ratchet the oil complex down into a lower trading range that will last through 2012,” he adds.

He notes that the crude price drop “should” begin within the next 30-45 days, for a variety of reasons. “Current bullish supply disruptions in Nigeria and the UK are temporary, and peak Atlantic hurricane season typically ends in mid-October. As these bullish factors fade, a bearish driver will begin to emerge,” Wittner adds.

As the Oilholic noted last week, this driver is the new Libyan government’s move toward a modest resumption of crude production by end-September. Couple this with weak economic data and Société Générale is not alone in bearish price forecasts. It projects ICE Brent crude to average US$98 in both Q4 2011 and Q1 2012 (each revised downward by US$15). Brent forecast for 2012 is US$100 (also down US$15).

Concurrently, NYMEX WTI crude is expected to average US$73 in both Q4 2011 and Q1 2012 (down US$28). Société Générale’s WTI projection for 2012 is US$80 (down US$23). The reason for the larger revisions to WTI is that the bank expects current price disconnect with waterborne crudes, such as LLS and Brent, to continue.

As widely expected, and in line with weaker economic growth, Société Générale also lowered its forecasts for global oil demand growth to 1.0 million barrels per day (bpd) in both 2011 and 2012 (revised downward by 0.4 million bpd and 0.5 million bpd, respectively). Additionally, it is now looking increasingly like that growth in non-OPEC supply and OPEC NGLs will be enough to meet demand, so OPEC will not need to increase crude output above the current 30.0 million bpd at its next meeting in December.

Moving away from pricing, the row over whether or not banning or restricting the import of Syrian crude oil is an effective enough tool to force President Bashar al-Assad to give up violent ways continues. While clamour had been growing for the past four weeks, it gained momentum when the EU has stepped up sanctions on Syria by banning imports of its oil, as protests against the rule of President Assad were brutally crushed last week. On the other side of the argument, Russia condemned the EU’s move as ‘ineffective.’

Quite frankly, in a crude hungry world, there is nothing to stop the Syrians from seeking alternative markets. Nonetheless, the Oilholic feels it is prudent to point out that EU member nations are buyers of 95% of Syrian crude. So a sudden ban could be a blow to Assad, albeit a temporary one. From a risk premium standpoint, Syrian contribution to global markets is not meaningful enough to impact crude prices.

Elsewhere, the State Oceanic Administration of China ordered ConocoPhillips China Inc (COPC) to stop all operations at the Penglai 19-3 oil field in the Bohai Bay off North-eastern China last week because of its dissatisfaction with COPC's progress in cleaning up an oil spill.

The field is operated under a Production Sharing Contract wherein COPC is the operator and responsible for the management of daily operations while CNOOC holds 51% of the participating interest for the development and production phase. However, ratings agency Moody’s thinks suspension of Penglai 19-3 work has no ratings impact on CNOOC itself.

"CNOOC expects the suspension of all operations at Penglai 19-3 will reduce the company's net production volume by 62,000 barrels per day, or approximately 6.7% of its average daily production in H1 2011. Although the reduction is sizable, the impact is mitigated by the higher-than-expected oil prices realised by CNOOC year-to-date, and which provide it with strong operational cash flow and a strong liquidity buffer," says Kai Hu, a Moody's Vice President and Lead Analyst for CNOOC.

Even after the volume reduction and a moderate retreat of crude oil prices to around US$90 is factored in, Moody’s estimates that CNOOC will still generate positive free cash flow in 2011 and 2012, on the assumption that there is no material change in its announced capex and investment plan, and that it will maintain prudent discipline in reserve acquisitions and development.

"CNOOC has maintained a solid liquidity profile, which is supported by a total of Rmb 88.37 billion in cash and short-term investments as of June 30, 2010, and compared with Rmb 40.66 billion in total reported debt (including Rmb 21.99 billion in short-term debt)," Hu concludes.

© Gaurav Sharma 2011. Photo: Alaska Pipeline, Brooks Range, USA © Michael S. Quinton/National Geographic

BP’s profit, Saudi price targets & CNOOC in Canada

Its quarterly results time and there is only one place to start – an assessment of how BP’s finances are coping in wake of Macondo. Its quarterly data suggests the oil major made profits of US$5.3 billion in the three months to June-end. This is down marginally from the US$5.5 billion it made in Q1 2011 and a predictable reversal of the US$17 billion loss over the corresponding quarter last year when the cost of the Gulf of Mexico spill weighed on its books.

Elsewhere in the figures, BP's oil production was down 11% for the quarter on an annualised basis and the company has also sold US$25 billion worth of assets to date, partly to offset costs of the clean-up operation in the Gulf. City analysts told the Oilholic that BP should count itself lucky as the crude price has been largely favourable over the last 12 months.

Moving away from BP, it is worth turning our attention to the perennially crude question, what price of black gold is the Saudi Arabian Government comfortable with? An interesting report published by Riyadh-based Jadwa Investment suggests that the “breakeven” price for oil that matches actual revenues with expenditures is currently around US$84 per barrel for the Kingdom, comfortably below the global price.

The Oilholic agrees with the report’s authors - Brad Bourland and Paul Gamble – that it is bit rich to assume the Saudis crave perennially high oil prices. Au contraire, high oil prices actually hurt Saudi Arabia’s long term future. Bourland and Gamble feel the Kingdom would be more comfortable with prices below US$100 per barrel; actually a range of US$70-90 per barrel is more realistic.

Using either benchmark, prices are comfortably above the range and are likely to stay there for the rest of the year, if that is what the Saudis are comfortable with. Analysts at Société Générale CIB maintain their view for Brent prices to be in the US$110-120 range in H2 2011 on mixed fundamental and non-fundamental drivers. They note that there may be some slight upside to their Brent forecast, and some moderate downside to their WTI forecast. At 8:00 GMT, ICE Brent forward month futures contract was trading at US$118.04 and WTI at US$99.56.

Looking from a long term macroeconomic standpoint, the Jadwa Investment report notes that after the benign decade ahead, unless the current spending and oil trends are changed, Saudi Arabia faces a very different environment. For instance, domestic consumption of oil, now sold locally for an average of around US$10 per barrel, will reach 6.5 million barrels per day in 2030, exceeding oil export volumes. Jadwa Investment does not expect total Saudi oil production to rise above 11.5 million barrels per day by 2030.

Even with a projected slowdown in growth of government spending, the breakeven price for oil will be over a whopping US$320 per barrel in 2030. Furthermore, the Saudi government will be running budget deficits from 2014, which become substantial by the 2020s. By 2030, foreign assets will be drawn down to minimal levels and debt will be rising rapidly.

Before you go “Yikes”, preventing this outcome, according to Bourland and Gamble, requires tough policy reforms in areas such as domestic pricing of energy and taxation, an aggressive commitment to alternative energy sources, especially solar and nuclear power, and increasing the Kingdom’s share of global oil production. By no means a foregone conclusion, but not all that easy either.

Continuing with the Middle East, apart from crushing dissent and chastising the US government for interference, the Syrian government is apparently also open for crude business. In an announcement on July 7th, the creatively named General Establishment for Geology and Mineral Resources (GEGMR) under auspices of the Syrian Petroleum and Mineral Resources Ministry invited IOCs to bid and develop oil shale deposits in the Khanser region in the north. The Ministry says total crude reserves at the site are “estimated” at 39 billion tonnes with the oil content rate valuation at 5 to 11%.

While the tender books, costing US$3,000 each were issued on July 1st, the Ministry declined to answer how many were sold, who took them up and how the bid round is supposed to work in face of international condemnation of what is transpiring within its borders.

Elsewhere, Chinese state behemoth CNOOC’s recent acquisition of a 100% stake in OPTI Canada Inc, a TSX-listed oil sands producer, made the headlines. The aggregate consideration for the transaction is about US$2.1 billion. OPTI owns a 35% working interest in four oil sands projects in Canada – Long Lake, Kinosis, Leismer and Cottonwood.

Kai Hu, Vice President and Senior Analyst at Moody’s, says "CNOOC investment in this transaction is in line with the company's strategy of growing reserves, partly through overseas acquisitions. This investment – as well as its the previous investments in Eagle Ford and Niobrara shale gas projects – indicate its strong interest in gaining experience in unconventional oil and gas reserves.”

As such, Moody’s feels CNOOC Aa3 issuer and senior unsecured ratings will not be immediately affected by its acquisition. It also helps that there are no US-style murmurings of dissent in Canadian political circles.

© Gaurav Sharma 2011. Photo: Pipeline in Alaska © Kenneth Garrett, National Geographic

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

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

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

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

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

Crude Year 2011 Begins With a Bang

I must say the New Year has commenced with a flurry of crude news. Traders and oil men had barely resumed work for the first trading day of 2011 that the IEA declared rising oil prices to be a risk to economic recovery. In a publication on Jan 5th, the agency said oil import costs for OECD countries had risen 30% in the past year to US$790 billion which is equal to a loss of income of 0.5% of OECD gross domestic product (GDP).

Speaking to the BBC’s world service, IEA’s Fatih Birol said, "There is definitely a risk of major negative implications for the global economy." I agree and accept this, but truth be told we are some way away from a US$150-plus per barrel high. This morning though, the Brent forward month futures contract was flirting with the US$100 mark. The cold weather we have had either side of the pond does generally tend to support crude prices.

Analysts at SocGen believe the Alaska pipeline shutdown, following a leak, provided only limited support to WTI. Last weekend, a minor leak was discovered at Pump Station 1 on the Trans-Alaska Pipeline System (TAPS) causing a shutdown on the pipeline and prompting Alaska North Slope (ANS) production to be cut from 630,000 bpd to just 37,000 bpd. The pipeline, which carries almost 12% of US crude output, should be restarted "soon", according to its operator Alyeska which is 47% owned by BP, while ConocoPhillips and ExxonMobile have 28% and 20% stakes respectively.

Continuing with forecasts, a new report from ratings agency Moody’s notes that oil prices should stay "moderately high" in 2011, boosting energy companies that produce crude and natural gas liquids, but weak natural gas prices will continue to dog the energy sector this year. More importantly, rather than the volatility of recent years, Moody's expects a continuation of many of the business conditions seen in 2010, despite the Macondo incident.

Steven Wood, managing director of Moody's Oil and Gas/Chemicals group believes that certain business conditions will tighten during the year, and pressures could emerge beyond the near term. Moody's price assumptions – which are not forecasts, but guidelines that the agency uses in its evaluations of credit conditions – call for moderately high crude prices of US$80 per barrel for 2011, along with natural gas prices of US$4.50 per million Btus.

Elsewhere, a US government commission opined in a report that 'bad management' led to BP disaster. Across the pond in London, a parliamentary committee of British MPs raised "serious doubts" about the UK's ability to combat offshore oil spills from deep sea rigs. However, they stopped short of a calling for a moratorium on deep sea drilling noting that it would undermine British energy security.

© Gaurav Sharma 2011. Photo: Veneco Oil Platform, California © Rich Reid / National Geographic

Black Gold @ US$90-plus! No, Surely? Is it?

“You can’t be serious,” was often the trademark thunder of American tennis legend John McEnroe when an umpiring decision went against him. In a different context some commodities analysts might be thundering exactly the same or maybe not. In any case, deep down Mr. McEnroe knew the umpire was being serious.

On a not so sunny Tuesday afternoon in London, ICE Futures Europe recorded Brent crude oil spot price per barrel at US$91.32. This morning the forward month Brent futures contract was trading around US$90.80 to US$91.00. While perhaps this does not beggar belief, it certainly is a bit strange shall we say. I mean just days ago there was the Irish overhang and rebalancing in China and all the rest of it – yet here we are. Société Générale’s Global Heal of Oil research Mike Wittner believes the fundamental goalposts may have shifted a bit.

In a recent note to clients, he opines that underpinned by QE2, the expected environment of low interest rates and high liquidity next year should encourage investors to move into risky assets, including oil. “With downward pressure on the US dollar and upward pressure on inflation expectations, the impact should therefore be bullish for crude oil prices,” he adds.

The global oil demand growth for this year has been revised up sharply to 2.4 Mb/d from 1.8 Mb/d previously by SGCIB, mainly due to an unexpected surge in Q3 2010 OECD demand. The demand growth for next year has also been increased, to 1.6 Mb/d from 1.4 Mb/d previously (although still, as expected, driven entirely by emerging markets).

What about the price? Wittner says (note the last bit), “For 2011, we forecast front-month ICE Brent crude oil near US$93/bbl, revised up by $8 from $85 previously. With continued low refinery utilisation rates, margins are still expected to be mediocre next year, broadly similar to this year. The oil complex in 2011 should again be mainly led by crude, not products.”

YooHoo – see that – “mainly led by crude, not products.” Furthermore, SGCIB believes crude price should average US$95 in H2 2011, in a $90-100 range. Well there you have it and it is a solid argument that low interest rates and high liquidity environment is bullish for oil.

Elsewhere, a report published this morning on Asian refining by ratings agency Moody’s backs up the findings of my report on refinery infrastructure for Infrastructure Journal. While refinery assets are rather unloved elsewhere owing to poor margins, both the ratings agency and the Oilholic believe Asia is a different story[1].

Renee Lam, Moody's Vice President and Senior Analyst, notes: “Continued demand growth in China and India in the short to medium term will be positive for players in the region serving the intra-Asia markets. Given the stabilization of refining margins over the next 12 to 18 months, a further significant deterioration of credit metrics for the sector is not expected.”

While Moody's does not foresee a significant restoration of companies' balance-sheet strength in the near term, they are still performing (and investing in infrastructure) better than their western, especially US counterparts.

[1] Oil Refinery Infra Outlook 2011: An Unloved Energy Asset By Gaurav Sharma, Infrastructure Journal, Nov 10, 2010 (Blog regarding some of the basic findings and my discussion on CNBC Europe about it available here.)

© Gaurav Sharma 2010. Graphic: ICE Brent Futures chart as downloaded at stated time © Digital Look / BBC, Photo: Oil Refinery © Shell

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

Cairn Energy: Choosing Greenland over India?

It seems Cairn Energy has shifted its attention from India to Greenland. What else can be said of the Edinburgh-based independent upstream upstart’s announcement of plans to sell a 51% stake in its Indian operations to mining group Vedanta for up to US$8.5 billion?

After a week of nudges and winks, Cairn confirmed rumours of the sale doing the rounds in the city of London. The company’s Indian operations have a market capitalisation of just over US$14 billion which makes Cairn India, the country’s fourth largest oil company.

Apart from seeking a "substantial return of cash" to shareholders, it is now clear that Cairn hopes to pursue its drilling ambitions in Greenland with some vigour. In a media statement, Cairn’s chief executive Sir Bill Gammell said, “I am delighted to announce the proposed disposal of a significant shareholding in Cairn India in line with our objective of adding and realising value for shareholders.”

To fathom what the announcement means for Cairn energy is easy. In fact, market analysts I have spoken to reckon the sale would generate more than adequate capital for Cairn's Greenland prospection in the medium term. This makes Cairn pretty cash rich and the market wonders what the inimitable Bill Gammell has up his sleeve. That it could bag another similarly scaled production asset akin to its fields in India’s Rajasthan state is doubtful.

Working out what the deal means for Vedanta is trickier. Its chief executive Anil Agarwal gave a rather simplistic explanation. In a statement he said, “The proposed acquisition significantly enhances Vedanta's position as a natural resources champion in India. Cairn India's Rajasthan asset is world class in terms of scale and cost, delivering strong and growing cash flow.”

Hence, simply put Vedanta has stated its intentions of venturing beyond metals and make a headline grabbing foray into the oil and gas sector. The market would be watching how the two aspects of the business gel under the Vedanta umbrella, but there are precedents of success – most notably at BHP Billiton.

In a related development, Cairn energy was featured in Deloitte’s half-yearly assessment of UK independent oil and gas companies. At the end of H1 2010, according to Deloitte the top five UK independent oil companies by market capitalisation were - Tullow Oil, Cairn Energy, Premier Oil, SOCO International and Heritage Oil in that order. The top three have maintained their respective positions from December 2009 while SOCO International entered the top five with a 31% increase in market capitalisation.

Overall, the first half of the year was broadly positive for the UK independents, with market capitalisation of the majority of companies in the league table increasing by 4.6% over the 6 month period to 30 June 2010. It stood at £26.482 billion as of end-June. (Click box on the left for the entire list)

On the oil price front, the crude stuff plummeted nearly 7% over the course of the week ended Fri 13th on either side of the pond. The price resistance is presently above US$75 a barrel and I expect it to remain there despite some pretty disappointing economic data doing the rounds these days. Looking further ahead, analysts at Société Générale’s Cross Asset Research team forecast NYMEX WTI to average US$80 in Q3 2010 (revised down by $10) and $85 in Q4 2010 (revised down by $5).

Looking further ahead, an investment note states that they expect NYMEX WTI of US$92.30 in 2011 (revised down by $8.70). NYMEX WTI is forecast at US$88.30/$87.50 in Q1 2011/Q2 2011, increasing to $95/$98.30 in Q3 2011/Q4 2011. On a monthly average basis, Société Générale expects NYMEX WTI of US$87.50 in December 2010 and $100 in December 2011.

In truth, fear of a double dip recession persists in wider market, especially in the US, EU and UK. However, many crude traders are quietly confident that in such an event, India and China’s crude oil consumption will help maintain the oil price at US$70 plus levels.

© Gaurav Sharma 2010. Photo courtesy © Cairn Energy Plc. Chart Courtesy © Deloitte LLP