Oil storage, Chinese imports & Afren’s CEO

When the oil price is rocky, it seems storage in anticipation of better days is all the rage. Afterall, it does take two to play contango, as the Oilholic recently opined in a Forbes column. But leaving those wanting to play the markets by the side for a moment, wider industry attention is indeed turning to storage like never before.

We are told the US hub of Cushing, Oklahoma has never had it so good were we to rely on Genscape’s solid research on what’s afoot. In trying times, the industry turns to the most economical onshore storage option on the table. For some, actually make that many, Cushing is such a port of call.

As of February-end, Genscape says 63% of Cushing’s storage capacity has already been utilised. Capacity has never exceeded 80%, since Genscape began monitoring storage at Cushing in 2009. So were heading for interesting times indeed!

Meanwhile, the country now firmly established as the world’s top importer of crude oil – i.e. China – might well be forced to import less owing to shortage of storage capacity! Well established contacts in Shanghai have indicated to this blogger that in an era of low prices, Chinese policymakers were strategically stocking up on crude oil.

With Chinese economic data being less than impressive in recent months, it probably explains where a good portion of the 7.1 million barrels per day (bpd) imported by the country in January and February went. However, now that available storage is nearly full, anecdotal evidence suggests Chinese oil imports are going to drop off.

Import volumes for April are not likely to be nearly as strong. As for the rest of the year, the Oilholic expects Chinese imports to stay flat. Furthermore, Barclays analysts believe putting faith in China’s economic growth to support oil prices would be “premature” at best, with the country undergoing structural changes.

On a related note, lower oil prices will also slow the revenue growth of Chinese oilfield services (OFS) companies as their upstream counterparts continue to cut capex. Putting it bluntly, Chenyi Lu, Senior Analyst at Moody’s noted: "In addition to the impact on revenues, Chinese OFS companies will also see their margins weaken over the next two years as their exploration and production customers negotiate lower rates."

Finally, before yours truly takes your leave, it seems the beleaguered London-listed independent upstart Afren has finally named a new CEO following its boardroom debacle. Industry veteran Alan Linn will take-up his post as soon as the company’s “imminent” $300 million bailout is in place. We wish him all the luck, given his task at hand. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Oil pipeline, Fairfax, Virginia, USA © O. Louis Mazzatenta / National Geographic

Oil prices, OPEC shenanigans & the North Sea

It has been a crude fortnight of ups and downs for oil futures benchmarks. Essentially, supply-side fundamentals have not materially altered. There’s still around 1.3 million barrels per day (bpd) of crude oil hitting the markets in excess of what’s required.

Barrels put in storage are at an all time high, thanks either to those forced to store or those playing contango. US inventories also remain at a record high levels. 

However, the biggest story in the oil market, as well as the wider commodities market, is the strength of the US dollar. All things being equal, the dollar’s strength is currently keeping both Brent and WTI front month futures contracts at cyclical lows. The past five trading days saw quite a few spikes and dives but Friday’s close came in broadly near to the previous week’s close (see graph on the left, click to enlarge).

In the Oilholic’s opinion, a sustained period of oil prices below $60 is not ideal for unconventional exploration. Nonetheless, not all, but a sufficiently large plethora of producers just continue to grin and bear it. While that keeps happening, and the dollar remains strong, oil prices will not find support. We could very well be in the $40-60 range until June at the very least. Unless excess supply falls from 1.3 million bpd to around 750,000 bpd, it is hard to see how the oil price will receive support from supply constriction. 

Additionally, Fitch Ratings reckons should Brent continue to lurk around $55, credit ratings of European, Middle Eastern and African oil companies would take a hit. European companies that went into the slump with stretched credit profiles remain particularly vulnerable.

In a note to clients, Fitch said its downgrade of Total to 'AA-' in February was in part due to weaker current prices, and the weaker environment played a major part in the downgrade and subsequent default of Afren.

"Our investigation into the effect on Western European oil companies' credit profiles with Brent at $55 in 2015 shows that ENI (A+/Negative) and BG Group (A-/Negative) were among those most affected. Both outlooks reflect operational concerns, ENI because of weakness in its downstream and gas and power businesses, BG Group due to historical production delays. Weaker oil prices exacerbate these problems," the agency added.

Of course, Fitch recognises the cyclical nature of oil prices, so the readers need not expect wholesale downgrades in response to a price drop. Additionally, Afren remains an exception rather than the norm, as discussed several times over on this blog.

Moving on, the Oilholic has encountered empirical and anecdotal evidence of private equity money at the ready to take advantage of the oil price slump for scooping up US shale prospects eyeing better times in the future. For one’s Forbes report on the subject click here. The Oilholic has also examined the state of affairs in Mexico in another detailed Forbes report published here.

Elsewhere, a statement earlier this week by a Kuwaiti official claiming that there is no appetite for an OPEC meeting before the scheduled date of June 5, pretty much ends all hopes of the likes of Nigeria and Venezuela in calling an emergency meeting. The official also said OPEC had “no choice” but to continue producing at its current levels or risk losing market share.

In any case, the Oilholic believes chatter put out by Nigeria and Venezuela calling for an OPEC meeting in the interest of self-preservation was a non-starter. Given that we’re little over two months away from the next meeting and the fact that it takes 4-6 weeks to get everyone to agree to a meeting date, current soundbites from the ‘cut production’ brigade don’t make sense.

Meanwhile, the UK Treasury finally acknowledged that taxation of North Sea oil and gas exploration needed a radical overhaul. In his final budget, before the Brits see a General Election on May 7, Chancellor George Osborne cut the country’s Petroleum Revenue Tax from its current level of 50% to 35% largely aimed at supporting investment in maturing offshore prospects.

Furthermore, the country’s supplementary rate of taxation, lowered from 32% to 30% in December, was cut further down to 20% and its collection at a lower rate backdated to January. Altogether, the UK’s total tax levy would fall from 60% to 50%.

Osborne’s move was widely welcomed by the industry. Some are fretting that he’s left it too late. Yet others reckon a case of better late than never could go a long way with the North Sea’s glory days well behind it. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Graph: Tracking Friday oil prices close, year to date 2015 © Gaurav Sharma, March 20, 2015.

Viewing US oil output through Drillinginfo’s lens

Perceptions about massive a decline in US oil production currently being put forward with such fervour and the ground reality of an actual one taking place are miles apart; or should we say barrels apart. 

Assuming that a decline in production stateside would start eroding the oil supply glut thereby lending slow but sure support to the oil price is fine. But declarations on the airwaves by some commentators that a North American decline is already here, imminent or not that far off, sound too simplistic at best and daft at worst.

The Oilholic agrees that Baker Hughes rig count, which this blog and countless global commentators rely upon as a harbinger of activity in the sector, has shown a continual decline in operational rigs over recent weeks and months. However, that does not paint a complete picture.

Empirical and anecdotal data from Canada demonstrates that Western Canadians are aiming to do more with less. According to research conducted by the Canadian Association of Petroleum Producers (CAPP), fewer wells would be dug this year but production will actually rise on an annualised basis over 2015. That’s despite the fact that the Western Canadian Select fell to US$31 per barrel at one point.

There’s a similar story to be told in the US of A, and digital disruptors at Drillinginfo are doing a mighty fine job of narrating it. The Austin, Texas headquartered energy data analytics and SaaS-based decision support technology provider opines that much of the current conversation obsessively intertwines the oil price dip with a decline in activity, bypassing efficiencies of scale and operations achieved by US shale explorers.

“Our conjecture is that an evident investment decline does not imply that production is nose-diving in tandem. Quite the contrary, our research suggests exploration and production firms are 25% more efficient than they were three years ago,” says Tom Morgan, Analyst and Corporate Counsel at Drillinginfo.

It’s not that Drillinginfo is not recording dip in rig counts and new drilling projects coming onstream via its own DI Index. Towards the end of February, its US rig count stood at 1433, while new US oil production dipped 9% on the month before to 525 million barrels per day (bpd). However, if what’s quoted here sounds better than what you’ve heard elsewhere then it most probably is for one simple reason.

“What we put forward is in real-time. Two years ago, we started handing out GPS trackers to operators to latch on to their rigs. It was not easy convincing an old fashioned industry to immediately warm up to what we were attempting to do. It was a long drawn out process but we converted many people around to our viewpoint.

“At present, over 80% of rigs in continental US are reported on daily via Drillinginfo installed GPS units. In return, the participants get free access to our collated data. At this moment in time, not only can I point out each of these rigs via a heat signature (see image from January above left, click to enlarge), but also pinpoint the coordinates for you to locate one, drive there and verify yourself. I’d say our data is 99% accurate based on back testing and reconciling trends with our archives,” Morgan adds.

Drillinginfo also examines the actual spud of a well that's been drilled but not yet completed, as well as permit applications. “The thought process in case of the latter is that if you have applied for a permit to drill, then you are more than likely [if not a 100%] sure of going ahead with it.”

Drillinginfo saw a 24% decline in US permit application between January and February. This shows that investment is slowing down, yet at the same time operational wells are generally on song. With the end of first quarter of this year in sight, the US is still the world’s leading producer in barrels of oil equivalent terms.

Oil production continues to rise, albeit not in incremental volumes noted over the first and second quarters of last year prior to the slump. US producers, or shall we say those producers who can, are strategically lowering operations in less bankable or logistically less connected shale plays, while perking up production elsewhere.

For instance, while the collated production level at Bakken shale plays in North Dakota is declining, production at Eagle Ford shale in Texas has risen to 159,000 bpd; a good 26,000 bpd above levels seen towards the end of last year.  In terms of the type of wells, Drillinginfo sees older vertical wells bear the brunt of the slump, while production at onstream horizontal wells is either holding firm or actually rising a notch or two.

“No one is pretending that market volatility and the oil price slump isn’t worrying. What we are encountering is that shale players are trying to achieve profitability at a price level we could not imagine ten, five or even three years ago because technology has advanced and efficiencies have improved like never before,” Morgan adds.

While pretty reliable, feed-through of information via the Baker Hughes rig count is not real-time but looking backwards based on a telephone and electronic submission format. By that argument, the Oilholic finds what Drillinginfo has to say to be an eye-opener in the current climate, particularly in an American context. 

However, company man Morgan, who has known Drillinginfo's co-founder and CEO Allen Gilmer since both their freshmen years at Rice University back in the 1980s, has a more polished description.

“Today we talk of heat map of rigs, real-time data, rig movement monitoring, type and location of rigs going offline, and much more. I’d say we’re bringing agility via a digital medium to participants in a very traditional business.”

That agility and sense of perspective is something the industry does indeed crave, especially in the current climate. The Oilholic would say what Genscape is bringing to storage monitoring; Drillinginfo is bringing to upstream data analytics. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Graphic: Map of new US wells drilled in January 2015, and those drilled within the last six months © Drillinginfo, 2015

Summing up the ‘crude’ mood in Houston

The Oilholic finds the mood in Houston to be rather dark on his latest visit, and the weather here seems to be reflecting it. Oil price remains shaky, local refineries are battling strikes and shutdowns.

Meanwhile, as expected the Obama Administration has vetoed the Keystone XL pipeline project as the farcically prolonged tussle about an extension that’s meant to bring Canadian crude to Texan refineries continues.

Unsurprisingly, Texas is mirroring the globally evident trend of oil and gas sector job cuts, and costs of redundancies are more visible in an oil hub like Houston.

However, local commentators say the city (and by extension the state) has seen slumps in the global oil markets before, will see it again and remains capable enough to weather this latest one.

Dr Vincent Kaminski, an industry veteran and prominent academic at Rice University, says there’s no panic in the ranks even if the euphoria of a $100 per barrel price has long gone. “The word ‘caution’ is being branded about. No one can predict how long this period of lower oil prices is going to last. There is consensus that the price will bounce back, though not to the highs of 2013-14 unless there is a geopolitical development of a magnitude that would neutralise the impact of oversupply. Right now, there isn’t an obvious one.”

Kaminski feels what’s critical here is the management of this period of depressed prices, especially on the human capital front. Anecdotal evidence and published data suggests companies that are firing are not hiring with the same pace for the moment.

Deborah Byers, Managing Partner of global advisory firm EY’s Houston Office, says managing human resources is critical in the current climate. “My fear is that not everybody will get it right. Letting people go in a tough climate is a reactionary move; re-hiring talent when the market bounces back isn’t. A lot people in Houston have reacted very quickly. I agree that the supply glut has infused a bit of disciple in the sector, but it’s a nuanced situation to 2008-09.

“What we are seeing is a profound structural change leading to a transition towards a different type of market. In wake of the global financial crisis, we had a lack of demand scenario; what’s afoot now is a story of oversupply. That said, over the long-term the current situation would turn out to be a good story.”

Louis J. Davis, Chair of international law firm Baker & McKenzie’s North America Oil & Gas Practice, says the speed of the oil price decline caught many in Houston by surprise. “Some clients foresaw it, but not with the speed with which the decline hit home. Companies in the exploration and production (E&P) business are going to hold back on activity, lay down rigs and wait for a level of stability in the global markets. That’s unless they have existing well commitments.

“Nobody wants to drill uneconomic wells; including those who are hedged. It’s about keeping reserves up; and hedges are going to periodically roll-off within a 3 to 12 month window. By then, if a broader recovery, or at least a level of stability within a price bracket that's considered viable, is not achieved you'll find a lot of worried people.”

Furthermore, as Davis points out, even for those who are neatly hedged, their borrowing base is going to drop because they are not going to replenish their reserves by drilling additional wells. The Baker & McKenzie veteran says quite a few of his clients are in fine fettle but cautious.

“Many see opportunities when the market goes through a cyclical correction, and that hasn’t changed. There is a lot of money out there to buy promising assets at better prices. That said, interaction with people I’ve known for 40 years, as well as anecdotal evidence from a recent NAPE expo suggests the M&A deal flow is very slow right now. 

“Some deals that have been signed up are not closing, and no one is in a rush to close. Some are even taking the pain of letting their holding deposit slip. Yet, I’d say the present situation is troubling, but not an unseen one for Houston. We've been here before.”

Kaminski, Byers and Davis are united in their opinion that Houston’s economy is way more diversified than it was in the 1980s. As Kaminski points out – the city’s thriving Medical Center, adjacent to Rice University, employs more people than back office and ancillary staff at oil and gas companies.

Services, higher education, real estate and technology sectors are other major contributors to metropolitan and regional growth. There is evidence that the real estate market is slowing down in wake of oil and gas sector downturn. However, this is also not uniform across the greater Houston area; there are discrepancies from area to area.

Finally, Byers says corporate leaders within the sector always pause and reflect at such junctures. “For me personally, this is my fourth cyclical downturn – 1986, 1999, 2008-09 and now 2014-15. Couple of CEOs I’ve known and worked with for decades, say we’ve seen this before and we know what levers to pull. The question is how long will the duration of the downturn be and how long do we need to pull those levers before we switch back to an offensive mode.”

That’s a billion dollar question indeed; one that's guaranteed to be asked several times over the course of this year. That’s all for from Houston folks. Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photos: Glimpses of downtown Houston, Texas, USA © Gaurav Sharma, 2015

When BP met…er…nobody!

It’s good to be back in Houston, Texas although the Oilholic could have done without the very British weather we’re having here. Before getting down to cruder brass tacks and gaining market insight in wake of the oil price slump, one decided to probe the ongoing chatter about BP being sized up suitors.

To being with, this blogger does not believe ExxonMobil is going to takeover BP, has said so quite openly on broadcasting outlets back in England. That sentiment is shared by a plethora of senior commentators the Oilholic has met here in Houston over the past 48 hours. Both financial and legal advisers along with industry insiders remain unconvinced. Hell, even BP employees don’t buy the slant.

For starters if you are ExxonMobil, why would you want a company that has quite a lot of baggage no matter how attractive a proposition it is in terms of market valuation. Let us face it BP’s valuation is pretty low, but a damn sight better than 280p circa it was fetching in the immediate aftermath of the Gulf of Mexico oil spill.

However, the valuation is where it is for a reason. BP has scored a few legal victories, but the protracted tussle in US courtrooms resulting from the spill's fallout will continue for sometime yet. Secondly, its 19% stake in Russia’s Rosneft, while widely deemed as a positive move in Houston back in 2012, isn’t look all too attractive right now. BP’s latest financial data bears testimony to that.

Now if you were Rex Tillerson that’s not the most attractive partner out there to put it mildly, say Houston contacts who’ve advised the inimitable ExxonMobil boss on the company's previous forays. There are also regulatory hurdles. A hypothetical ExxonMobil takeover would create an oil and gas major with a cumulative revenue base that’d beat the GDP of a basket of mid-tier economies (using World Bank’s data on economic performance).

Finally, you can’t put monetary value on reputational risk. BP’s brand is considerably less toxic with boss Bob Dudley & co working real hard to mend it. Yet, the toxicity would take a while yet to dissipate. It’s not easy to forget the events of April 2010. Any suitor for BP, not just ExxonMobil, would be only too aware of that.

Another strange theory doing the rounds is that Shell might make an approach. This has been visited several times over the years, not least directly by BP’s former boss Lord Browne. The reason it hasn’t taken off is because the Dutch half of Royal Dutch Shell does not want its influence diluted further, which is guaranteed to happen were Shell and BP to merge.

Moving away from the improbable and the lousy, to something more credible - a theory doing the rounds that BP might find a credible white knight in the shape of Chevron. Such a tangent does make ears prick in Houston and gets the odd nod for experts who have seen many a merger and the odd mega merger. 

The only problem is that in more ways than one, Chevron and BP’s North American ventures overlap which isn’t a problem to such an extent in the case of ExxonMobil and Shell. So a BP and Cheveron merger does stack up in theory. However, there would plenty of regulatory hurdles and both parties would need to divest substantially for the merger to be approved by regulators in more than one jurisdiction.

While everything is possible on the BP front, nothing is worth getting excited about. In the interim, an odd investment banker (or two or possibly more) in New York or London will keep pedalling BP’s vulnerability.  But consider this, were a suitor or suitors turn up for BP, it wont hurt your prospects if you happen to be a BP shareholder!

That’s all for the moment folks from Houston, where there are a few strikes, some trepidation and a whole lot of realism in the air! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo 1: Logo of BP © BP Plc. Photo 2: ExxonMobil office signage, Downtown Houston, USA © Gaurav Sharma.

A seminal moment has arrived for Pemex

For 76 years, Mexico’s state-owned oil and gas company Petroleos Mexicanos (or Pemex) has had a near monopoly over the country’s oil production. However, 2015 would be its 77th and final monopolistic one as Mexico prepares to open up oil exploration and production to foreign and domestic private sector participants.

Declining production levels for the last 10 years seem to have forced the government’s hand to invigorate the sector and shake-up Pemex. Mexico currently produces around 2.5 million barrels per day (bpd), nearly a million less than it did in 2004 when production peaked.

Unlike his predecessors who promised much but delivered little, President Enrique Peña Nieto changed Mexico’s constitution to facilitate private investment in a bid to revive Pemex’s fortune, given that it provides nearly a third of Mexico’s tax revenues. However, desperate to keep the public opinion onside, Peña Nieto vowed that “Pemex itself would never be privatised.”

Some still say the reforms did not go far enough. Yet by Mexican standards, it’ll be one heck of shake-up for a state-owned oil and gas company which has never competed itself to bid for overseas exploration rights (unlike many other state-owned behemoths especially from China and India).  

Pemex will have a new board of directors, procedural overhauls, process streamlining (at least on paper) and for the first time in its history face competition from private sector participants. If all that wasn’t enough, Pemex will allow its petrol stations and forecourts to compete with each other on price at the pump for the first time ever.

However, nothing is ever plain sailing in Mexico. The general public has largely embraced the change so far but some union leaders who carry considerable clout haven’t and are peddling alarmist ideas about an American takeover of Mexico’s precious resource. A negative vote in a referendum on further changes could bring things to a grinding halt. 

While the oil price decline is worrying, commentators say market volatility is not enough to derail things as one noted earlier. As for Pemex, Moody’s seems to suggest it is on the right track. On Friday, it affirmed the ratings of the state-firm and its subsidiaries, including Pemex's A3 and (P)A3 global long-term ratings with a “stable” outlook.

Moody’s notes that despite significant changes arising from the new energy law, Pemex will remain closely linked to the government of Mexico, which will continue to provide strong support, given the company's importance to the government's budget, to the oil sector and to the country's exports.

In the short to medium term, Moody's does not expect any material reduction in Pemex's tax burden and its debt amount is likely to rise to fund higher capital expenditures. “However, its managerial and budgetary autonomy will increase, improving its efficiency,” says Moody’s analyst Nymia Thamara Cortes de Almeida.

While Moody’s reckons Pemex will be able to maintain its production level around 2.5 million bpd level for three years at the very least, the government thinks it’ll be able to do so for the next 15 years! Suitably modest as usual! 

In the so-called “Round Zero” allocation last year, Pemex was still given rights to 83% of all proven and probable reserves in Mexico. But in “Round One”, scheduled to end by September 2015, Peña Nieto administration will put tender 169 blocks covering 28,500 square kilometres open to private participation in (or without) cooperation with Pemex.

A major test will come if an oil major gets drilling without Pemex and it’s not inconceivable given the pace with which things are moving here. The government is seeking oil and gas foreign direct investment in the range of US$50 to 60 billion by 2018.

Over the course of three days, the Oilholic has spoken on and off record to several market participants. Mood here is upbeat to begin with and several commentators also said Pemex had given them direct feedback about wanting to put its house in order. It's early days so lets see how this plays out.

The biggest question in a bearish market, is whether investors, especially foreign investors and IOCs would buy the idea of entering the Mexican oil and gas sector.

The Oilholic intends to explore this in greater detail from Houston and London over the coming weeks and months. However, one thinks it won’t be easy convincing the private sector especially when it comes to bidding for subsequent exploration rights offers. The initial and most lucrative exploration rights were given to Pemex. The next round puts forward exploration rights to areas where there is only a 50% chance of finding and tapping out the crude stuff in an economically viable fashion. In the following round, the probability percentage falls to 10%, and the ultimate round would see potential suitors vie for untested prospects.

If the Oilholic were a bidder, this doesn’t really fill one with confidence from the outset. It’ll all depend on the terms on offer and the jury is still out on that one. One thing is for sure, with Mexico’s proven oil reserves standing falling from 5th to 18th in the global league table, no one is opening that premium tequila bottle just yet. Much will depend on Pemex's capacity to finally embrace change. That’s all from Mexico City folks as an amazing but short trip comes to an end! Next stop, Houston Texas! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo 1: Pemex Petrol Station in Mexico City, Mexico, May 2015. Photo 2: Pemex Signage © Gaurav Sharma.

Oil price vs. investment: A view from Mexico City

The Oilholic has temporarily swapped London for the quaint charms of Mexico City in order to get a perspective on the current oil market melee and its impact on sector investment here.

On the face of it, there’s no panic in policymakers’ ranks and commentators of all description agree that as a major oil producer Mexico could well do without an oil price decline. President Enrique Peña Nieto’s bid to boost economic activity via oil and gas sector reform legislation announced last year remains on track. It has taken 76-years for Mexico to get where it did last year and people are in a buoyant mood.

In fact, Peña Nieto surprised global markets and Mexicans in equal measure by biffing through his pre-election promise of sector reform in a short space of 18 months. In précis, via the said reform package, Sener (Ministry of Energy) gave state-owned Petroleos Mexicanos (or Pemex) 83% of Mexico’s proven and probable hydrocarbon reserves and 21% of the prospective resources. However, new private sector participants, while expected to explore the remaining 17%, would have access to 79% of prospective reserves in the next round. Many prospects are promising according to seismic data and market evidence. 

The move carries massive changes for Pemex, something which the Oilholic will discuss in greater detail shortly. On paper, we’re still in nascent stages of what the government says it is trying to achieve. So does the current volatility constitute a proverbial spanner in the work? No, say most commentators yours truly has spoken to since arrival.

Benjamín Torres-Barrón, Baker & McKenzie's Energy, Mining & Infrastructure Practice Group leader in Mexico, whom the Oilholic first met at the 20th World Petroleum Congress in Doha back in 2011, says the oil and gas sector is better placed than it has ever been in recent years. 

“Timing of the oil price decline could be described as unfortunate. You could say that we’ve waited 76-years for change and when that change arrives, this happens. However, my argument is that there is never a good or bad time for legislative reform; it’s about seizing opportunities. Imagine if we were stuck in the same place as we were in 2011 [with the Felipe Calderón administration promising much with little to show for it] and the oil price nosedived as it has; you would have found the domestic market in a terrible state. Declining production and archaic legislation would have been a double blow.

"Right now Mexico is sending a positive message albeit in a tough climate. A drive has been set in motion and the dampening effect of oil market volatility on the capacity for reform would be negligible," he adds.

Most of Baker & McKenzie's corporate clients are not necessarily put off by the oil price dip. “Current investment is not about the here and now, but rather about the future. Those waiting for market access could [and should] have a broad range of potential concerns from security to politics, corruption to red tape, but not a single client has told us we’re no longer interested in participation singularly on the basis of oil price fluctuations.”

Torres-Barrón’s colleague Carlos Linares-Garcia, the international law firm’s Principal Economist attached to its Latin America Transfer Pricing practice, underscores why Mexico must carry on regardless.

“Royalties and tax takings from private investors might well be lower in the current climate. Stated production level of 2.5 million barrels per day (bpd) still makes Mexico the world’s sixth-largest oil producer. Yet, people long for the days in the not so distant past when production stood at 3.4 million bpd [3.6 mbpd in boepd] in 2004.” 

The subsequent decline made Pemex a familiar figure of farce as far as bloated state entities go and criticism followed in editorials ranging from local media to The Economist. “There is a determination to shake off that image. In my direct interactions with Pemex since August, I’ve noticed a clear recognition of the challenges and a desire for change. Pemex wants things to change, as much as people in legislative circles and the wider public,” Linares Garcia adds.

In fact, most energy sector reforms in any jurisdiction (e.g. shale exploration framework amendments in various EU markets), is accompanied by protests and rabble-rousing. Just ask the Brits. Yet, in Mexico, bar the odd noise made by labour unions, the Oilholic feels the general public has largely embraced sector reforms potentially moving Pemex away from state protectionism that has plagued it for years.

Right now Mexicans have a lot of things to protest about including socio-political mishaps, but oil and gas sector reform isn't one of them. Furthermore, the reform agenda extends beyond Pemex, something which external commentators often forget to take into account, says Ingrid Castillo, Head of Research at Grupo Bursátil Mexicano (GBM).

“Beyond Pemex, Comisión Federal de Electricidad (or CFE - the state-owned electricity firm) and government agencies are likely to feel the effects. For CFE, improved and viable access to natural gas is crucial, and market reform puts it on the agenda. Mexico has its own ambitions for shale exploration and there is clear recognition of the role played by the private sector in bringing shale gas to market across the border in US.”

Castillo also says industry stakeholders are more pragmatic than many of their European partners about a future windfall from shale and the time it takes to materialise. “We have noted the pitfalls, false starts, challenges, time scale and the ultimate success when it comes to US shale exploration. People are under no illusion about the effort required and the private sector’s role in bringing it about in Mexico.”

An unbundled, improved pipeline infrastructure seen in the US also remains a pipedream according to GBM, Baker & McKenzie and commentators from the big four global advisory firms. “The good thing is we’re finally talking about it more seriously than we used to. The chatter has not cooled off despite turmoil in the oil markets,” says a senior financial adviser.

Castillo’s GBM colleague Olaf Sandoval, a Senior Regional Economist, says the Mexican government has handled the oil price decline well so far. “The government recently introduced austerity measures to the tune of MXN124 billion (US$8.26 billion) with implications for Pemex and CFE. However, what's key here is that most cuts will primarily take place in the shape of ordinary expenses rather than capital expenditure on infrastructure with a 65:35 split in favour of the former.”

While the price decline is not an immediate concern this year, subsequent years could prove challenging if bearish sentiments get entrenched. For the current fiscal year, the Peña Nieto administration has already hedged via seven global financial institutions. The price of oil negotiated was $76.4 barrel, which implied a cost of $773 million in line with previous years. So 2015 would see the government largely protected for the spread between its budgeted price of $79 per barrel and currently chaotic spot markets. 

“Yet, in 2016 and 2017, it could be a very different story. Concerns over volatility could be more pronounced then, which could have implications for capital expenditure on infrastructure much more than it is currently having,” Sandoval adds.

But Mexico is undoubtedly in a much better shape than before. “We’re in the middle of intense economic pressure in Greece and talks of a Venezuelan default. Not that long ago, Mexico would be in that club. That the country is not, suggests things while not perfect, are certainly on the right track,” says Linares-Garcia.

As for the viability of oil and gas projects, Torres-Barrón says some would even be profitable at an oil price as low as $30 per barrel. “Additionally, selected shallow water prospects could cope with even $20. The first contracts are expected to be awarded this year and there is no anecdotal indication of delays or lack of investor appetite. Several IOCs will turn-up, and there’s the inevitable interest from Asian, especially Chinese, state-owned firms.”

The sector remains on the cusp of something important. Market reforms could add as much as 1%-1.5% to headline economic growth by 2018. An increase in gas production could boost the nation’s industrial production and grandiose forecasts of Mexico achieving 6% growth are around should you want to believe them.

“But you shouldn’t; for in Mexico we have had many false dawns. If we exceed 3% in 2015, that would be something to cheer about. Energy sector reform is likely to play a part, but there is no point getting ahead of ourselves,” says Castillo.

Linares-Garcia adds that diversification to other oil and gas export markets would be crucial for future prospects. “If China’s economy is not growing as fast and the US is importing less, we should be [and are] looking other markets. Even so, reliance on the US market persists. The next five years would be critical but Mexico is on the right track towards market diversification.”

A return to 2004 oil production levels by 2018 would be more than welcome. For that, welcoming new participants to town seems to be the mantra as oil price fluctuation dominates headlines.

That’s all for the moment folks, as one leaves you with a view of the Monumento a la Independencia (see above right) built in 1910 to commemorate Mexico's war of Independence. It's now a focal point for everything from celebrating a win of the national football team to political protests! The Oilholic spotted a few protests himself but none were of the 'crude' variety. More from Mexico City soon. Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo 1: Mexican Flag at Palacio Nacional, Mexico City. Photo 2: Monumento a la Independencia, Mexico City, Mexico © Gaurav Sharma, February, 2015

Downward revisions of gas price assumptions

While oil markets have grabbed all the headlines in recent weeks, there is something afoot in the natural gas markets that’s telling. Several analysts and rating agencies have revised their short to medium term gas price forecasts downwards over the past six weeks.

Earlier this month, Fitch Ratings revised its base case for Henry Hub down to US$3/mcf from $4/mcf in 2015, while not losing sight of a long-term value of $4.50/mcf. The agency’s stress case for credit ratings purposes this year has been revised to $2.75/mcf from $3.25/mcf, and the long run price to $3.25/mcf from $3.50/mcf.

There is nothing to sensationalise here, we’re not slipping down to April 2012 levels and sub-$2 prices. Yet, there is little to be broadly upbeat about over the medium term for US producers given the current abundance of gas. Alex Griffiths, Managing Director at Fitch Ratings, says the agency has merely reacted to rebounding inventories as noted by the EIA and other sources.

“A warmer US winter, and continued strong growth in domestic shale gas supply, including ongoing efficiency gains in drilling are having a bearing. The drop in forward oil prices is also likely to have a dampening effect on US gas demand over the medium term, as lower oil prices suggest lower profits and reduced economic feasibility for at least some US based LNG projects still at the planning stages,” he adds.

In fact, natural gas abundance could stunt the growth of new nuclear build in the eyes of many contacts. At present, nuclear power share of the overall US market is just shy of 20%. Cheap gas means the level is likely to be severely tested over the coming years. Only two new nuclear plants are currently under construction, with the first not expected to come online before 2018 at the earliest.

Gas producers, unlike their oil counterparts, can at least take some solace now in exporting their proceeds of shale to Europe and Asia as Sabine Pass LNG export terminal kicks into gear in 2017. However, Fitch says while the European gas price is in a much better place than the US, it too is going through testing times.

Fitch uses UK’s National Balancing Point (NBP) gas price as proxy, which it has also revised down to $6/mcf in 2015 from $8/mcf to reflect downward movements in the market price since last year. Overall, the NBP has fallen nearly 20% since a year ago to around $7.50/mcf.

“We believe that due to seasonal factors and the downward impact of oil-linked gas contracts elsewhere in the market, which typically readjust price with a six or nine-month lag, it is appropriate to reflect a weaker market as our base assumption for the rest of the year. From 2016, the base case price deck for NBP sees a gradual improvement back to $8 in the long run,” Griffiths adds.

So should US producers continue to look elsewhere in order to get more bang for their invested bucks? Exporting to Europe and Asia seems to be the answer. Invariably though, as pointed out by opponents of US gas exports, this would lead to a rise in domestic gas prices.

US gas will continue to trade at some discount to European prices and at a considerable discount to Asian prices. As the Oilholic noted last year in a Forbes column, the Henry Hub is not relocating to Wales or Singapore any time soon! Even in a depressed gas market, disparities will persist.

That the European market is the most depressed of all shouldn’t be in any doubt. On February 3, Russia’s Gazprom, still Europe’s leading provider of natural gas (Ukraine-related sanctions or not), said it would reduce gas imports from Turkmenistan and Uzbekistan, which it passes on to end clients, by 60% and 75% respectively, to compensate for weak demand.

Not only does it have heavy implications for both those countries, but Moody’s unsurprisingly views it as a credit negative for Intergas Central Asia (ICA, Baa3 positive), Kazakhstan's gas transmission company operating one of main Central Asian pipelines.

The agency says Gazprom’s move has the potential to trigger a 40% dip in ICA’s profits on an annualised basis. “Such revenue deterioration would weaken the credit metrics of ICA, which generates more than 50% of its revenue from the transportation of Asian gas under contract for Gazprom. It would also reduce the company's ability to generate cash, as well as its resilience to foreign currency risk associated with its predominantly US dollar-denominated debt,” it adds.

In summation, these are serious if not precarious times for the gas markets, and it’s not the just US players who ought to be worried.

On a closing note, here is the Oilholic’s recent chat for Forbes with US Department of Energy CIO Donald Adcock. Additionally, here is one’s take on how oil traders, trading houses and of course hedge funds are looking to play contango. As usual they’ll be winners, losers, sinners and pretty happy shippers.

That’s all for the moment folks! The Oilholic is off to gather fresh intel from Mexico City and Houston. Until next time, keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Offshore rig, USA  © Shell

Oil markets & producers on a tricky skating rink

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The $40-50 range, CAPP on Capex & Afren's woes

The first month of oil trading in 2015 is coming to a much calmer end compared to how it began. The year did begin with a bang with Brent shedding over 11% in the first week of full trading alone. Since then, the only momentary drama took place when both Brent and WTI levelled at US$48.05 per barrel at one point on January 16. Overall, both benchmarks have largely stayed in the $44 to $49 range with an average Brent premium of $3+ for better parts of January.

There is a growing realisation in City circles that short sellers may have gotten ahead of themselves a bit just as those going long did last summer. Agreed, oil is not down to sub-$40 levels seen during the global financial crisis. However, if the price level seen then is adjusted for the strength of the dollar now, then the levels being seen at the moment are actually below those seen six years ago.

The big question right now is not where the oil price is, but rather that should we get used to the $40 to $50 range? The answer is yes for now because between them the US, Russia and Saudi Arabia are pumping well over 30 million barrels per day (bpd) and everyone from troubled Libya to calm Canada is prodding along despite the pain of lower oil prices as producing nations.

The latter actually provides a case in point, for earlier in January the Western Canadian Select did actually fall below $40 and is just about managing to stay above $31. However, the Oilholic has negligible anecdotal evidence of production being lowered in meaningful volumes.

For what it’s worth, it seems the Canadians are mastering the art of spending less yet producing more relative to last year, according to the Canadian Association of Petroleum Producers (CAPP). The lobby group said last week that production in Western Canada, bulk of which is accounted for by Alberta, would grow by 150,000 bpd to reach 3.6 million bpd in 2015. 

That’s despite the cumulative capex tally of major oil and gas companies seeing an expected decline of 33% on an annualised basis. The headline production figure is actually a downward revision from CAPP’s forecast of 3.7 million bpd, with an earlier expectation of 9,555 wells being drilled also lowered by 30% to 7,350 wells. Yet, the overall production projection is comfortably above 2014 levels and the revision is nowhere near enough (yet) to have a meaningful impact on Canada’s contribution to the total global supply pool. 

Coupled with the said global supply glut, Chinese demand has shown no signs of a pick-up. Unless either the supply side alters fundamentally or the demand side perks up, the Oilholic thinks the current price range for Brent and WTI is about right on the money. 

But change it will, as the current levels of production simply cannot be sustained. Someone has to blink, as yours truly said on Tip TV – it’s likely to be the Russians and US independent upstarts. The new Saudi head of state - King Salman is unlikely to change the course set out by his late predecessor King Abdullah. In fact, among the new King’s first acts was to retain the inimitable Ali Al-Naimi as oil minister. 

Greece too is a non-event from an oil market standpoint in a direct sense. The country does not register meaningfully on the list of either major oil importers or exporters. However, its economic malaise and political upheavals might have an indirect bearing via troubles in the Eurozone. The Oilholic sees $1= €1 around the corner as the dollar strengthens against a basket of currencies. A stronger dollar, of course, will reflect in the price of both benchmarks.

In other news, troubles at London-listed Afren continue and the Oilholic has knocked his target price of 120p for the company down to 20p. First, there was bolt out of the blue last August that the company was investigating “receipt of unauthorised payments potentially for the benefit of the CEO and COO.” 

Following that red flag, just recently Afren revised production estimates at its Barda Rash oilfield in the Kurdistan region of Iraq by 190 million barrels of oil equivalent. The movement in reserves was down to the 2014 reprocessing of 3D seismic shot in 2012 and processed in 2013, as well as results from its drilling campaign, Afren said. 

It is presently thinking about utilising a 30-day grace period under its 2016 bonds with respect to $15 million of interest due on 1 February. That’s after the company confirmed a deferral of a $50 million amortisation payment due at the end of January 2015 was being sought. Yesterday, Fitch Ratings downgraded Afren's Long-term Issuer Default Rating (IDR), as well as its senior secured ratings, to 'C' from 'B-'. It reflects the agency’s view that default was imminent.

Meanwhile, S&P has downgraded Russia’s sovereign rating to junk status. The agency now rates Russia down a notch at BB+. “Russia’s monetary-policy flexibility has become more limited and its economic growth prospects have weakened. We also see a heightened risk that external and fiscal buffers will deteriorate due to rising external pressures and increased government support to the economy,” S&P noted.

Away from ratings agencies notes, here is the Oilholic’s take on what the oil price drop means for airlines and passengers in one’s latest Forbes piece. Plus, here’s another Forbes post touching on the North Sea’s response to a possible oil price drop to $40, incorporating BP’s pessimistic view that oil price is likely to lurk around $50 for the next three years.

For the record, this blogger does not think oil prices will average around $50 for the next three years. One suspects that neither does BP; rather it has more to do with prudent forward planning. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Oil pipeline with Alaska's Brooks Range in the background, USA © Michael S. Quinton / National Geographic

Brent’s premium gets dents as oil price dips

It’s definitely a moment worth recording and the Oilholic was rather glad he was awake earlier today when it happened. For at one point in Asian trading, both Brent and WTI were in perfect sync at US$48.05 per barrel as the oil markets rout continues (see screen grab below, click to enlarge). What's more, for a precious few minutes, the WTI actually traded at a premium of a few cents to Brent marking only the third such occurrence since 2010.

Of course, Brent’s premium has been since been restored back to well over a dollar and rising. However, it is a far cry from 2012 when the premium was averaging around $20 per barrel above the WTI, and did touch $25 at one point if this blogger’s memory serves him well.

The near coming together of both global benchmarks shouldn’t come as a surprise as it was on the horizon. What transpired today was merely for the sake of a record which might not be all that unique over the coming weeks and months of volatility. That said, once the projected supply correction kicks in around midway point of this year, the Oilholic does see Brent’s single digit premium to the WTI climb up to around $5.

As of now, one's 2015 oil price forecast is for a Brent price in the range of $75 to $85 and WTI price range of $65 to $75. Weight on Brent should be to the upside, while weight on WTI should be to the downside of the aforementioned range.

Meanwhile, a Baron’s article is suggesting oil could fall to $20, while industry veteran T. Boone Pickens says he’s seen several slumps in his lifetime and reckons a return to a $100 level within the next “12 to 18 months” is inevitable.

Additionally, the Oilholic has called an end to the so-called “commodities supercycle” in his latest quip for Forbes. On a related note, Goldman Sachs has trimmed its six and 12 month 2015 estimates for Brent to $43 and $70, from $85 and $90, and to $39 and $65, from $75 and $80, for the WTI.

Finally, as talk of a Venezuelan default gains market traction, Moody’s has downgrades ratings of PDVSA and its wholly-owned US-based refining subsidiary Citgo Petroleum. PDVSA’s long term issuer rating and senior unsecured notes were downgraded by the agency to Caa3 from Caa1. Moody’s changed its outlook on the ratings to stable from negative. 

Citgo Petroleum's Corporate Family Rating was downgraded to B3 from B1; its Probability of Default rating to B3-PD from B1-PD; and its senior secured ratings on term loans, notes and industrial revenue bonds to B3 from B1.

Additionally, the rating on Citgo's senior secured revolving credit facility was downgraded to B2 from B1, reflecting a lower expected loss in case of default vis-à-vis other classes of debt in the company's capital structure. The rating outlook was also changed to stable from negative.

The rating actions follow Moody's downgrade of the Venezuelan government's bond ratings to Caa3 from Caa1 with a stable outlook, earlier this week. The principal driver of the decision to downgrade Venezuela's sovereign rating was "a marked increase in default risk owing to lower oil prices," the agency said. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Bloomberg screen grab as Brent and WTI futures achieve parity on January 15, 2015 © Bloomberg