North Sea murmurs, Q1 profits & Bin Laden

To begin with good riddance to Bin Laden! The tragedy of 9/11 still feels like yesterday. I can never forget that morning as a junior reporter watching the BBC when initial reports began trickling in and we were asked to vacate the Canary Wharf building I was at. Miles away across the pond a great tragedy was unfolding – this brings closure to the many who suffered, many known to me.

Being mechanical, there is a near negligible impact on the wider market or crude market despite brave efforts of the popular press to find connections. How markets fluctuated since morning has no direct connection with Bin Laden being killed and instability premium reflected in the price of crude remains untroubled. The threat of Al-Qaeda remains just as real in a geopolitical sense and a Middle Eastern context.

Moving away from today’s news, ratings agency Moody’s noted last week that sharply higher prices for oil and natural gas liquids have boosted business conditions for the independent exploration and production (E&P) industry, and should remain high well into 2012, offsetting persistently weak natural gas prices. In the same week, ExxonMobil and Royal Dutch Shell reported appreciable rises in Q1 profits.

ExxonMobil posted quarterly profits of US$10.7 billion, up 69% over the corresponding quarter last year. It also announced a spend of US$7.8 billion over the quarter on developing new energy supplies and said its shareholders had benefited to the tune of US$7 billion in Q1 dividends.

Shell for its part reported quarterly profits of US$6.9 billion on a current cost of supply basis, up 41% on an annualised basis. It said cost saving measures as well as higher oil prices had contributed to its Q1 profitability. Earlier, BP reported first quarter profits of US$5.5 billion, down marginally from the corresponding period last year. Its production over the quarter was also down 11% after asset sales to help pay for the cost of Macondo clean-up.

Finally, unhappy murmurs about rising taxation amid the North Sea oil & gas producers are growing. In his Budget tabled in March, UK Chancellor George Osborne raised supplementary tax on production from 20% to 32%. Reports in the British media this morning suggest the owner of British Gas Centrica says it might shut one of its major gas fields because of increased UK taxes. It is closing three fields in Morecambe Bay for a month of maintenance, may not reopen one of them.

A fortnight ago, Chevron warned of possible "unintended consequences" from the UK Budget decision to raise North Sea taxes. Its Chairman John Watson told the Financial Times, “When you increase taxes every few years, particularly without consulting with industry, there will be unintended consequences of that in terms of where we choose to invest."

In 2010, Chevron received UK government’s permission to drill an exploration well to evaluate a major prospect - the deep-water Lagavulin prospect - is 160 miles north of Shetland Islands. All this comes after a report published on April 8th by Deloitte’s Petroleum Services Group noted that North Sea offshore drilling activity fell 25% over Q1 2011.

The North West Europe Review, which documents drilling and licensing in the UK Continental Shelf (UKCS), reveals just five exploration and four appraisal wells were spudded in the UK sector between January 1 and March 31; compared to a total of 12 during the fourth quarter of 2010.

Analysts at Deloitte’s Petroleum Services Group said while the drop cannot be attributed to the recent Budget announcement, which proposed increased tax rates for oil and gas companies, it could set the pattern for activity in the future.

Graham Sadler, managing director of Deloitte’s Petroleum Services Group said, “It is important to clarify that we are talking about a relatively small number of wells that were drilled during the first quarter of the year - the traditionally quieter winter months - so this is not, in itself, an unexpected decrease. The lead-in time on drilling planning cycles can be long – even up to several years - so any impact from the recent changes to fiscal terms are unlikely to be seen until much later in the year.”

“What is clear is that despite the decrease in drilling activity towards the end of last year, and during the first months of 2011, the outlook for exploration and appraisal activity in the North Sea appeared positive. The oil price continued to rise and there were indications that this, combined with earlier UK government tax incentives, was encouraging companies to return to their pre-recession strategies. Since the Budget, a number of companies have announced that they intend to put appraisal and development projects on hold and we will have to wait to see the full effect of this change on North Sea activity levels over the coming months,” he concluded.

Deloitte’s review shows that the Central North Sea has seen the highest level of drilling activity, with the region representing 55% of all exploration and appraisal wells spudded on the UKCS during the first quarter of this year.

It also showed that the price of Brent Crude oil has experienced sustained growth throughout the period, rising 20% between December 2010 and March 2011 to a monthly average of US$114.38. This increase in price is a continuation of a trend that started in 2010, however, so far this year, the rate and pattern of growth has been much more constant with regular increases rather than the rise and dip pattern seen during 2010.

© Gaurav Sharma 2011. Photo: ExxonMobil plaque outside its building, Houston, Texas, USA © Gaurav Sharma, March 2011

Discussing Offshore, BP & all the rest on TV

After researching the impact of BP’s disaster on offshore drilling stateside using Houston as a hub to criss-cross North America for almost a month, I published my findings in a report for Infrastructure Journal noting that both anecdotal and empirical evidence as well as industry data suggested no material alteration when it comes to offshore drilling activity. The reason is simple enough – the natural resource in question – crude oil has not lost its gloss. Consumption patterns have altered but there is no seismic shift; marginally plummeting demand in the West is being more than negated in the East.

So over a year on from Apr 20, 2010, on that infamous day when the Deepwater Horizon rig at the Macondo oil well in Gulf of Mexico exploded and oil spewed into the ocean for 87 days until it was sealed by BP on July 15, 2010, the oilholic safely observes that if there was a move away from offshore – its clearly not reflected in the data whether you rely on Smith bits, Baker Hughes or simply look at the offshore project finance figures of Infrastructure Journal.

After publication of my report on the infamous first anniversary of the incident, I commented on various networks, most notably CNBC (click to watch), that (a) while offshore took a temporary hit in the US, that did not affect offshore activity elsewhere, (b) no draconian knee-jerk laws were introduced though the much maligned US Minerals Management Service (MMS) was deservedly replaced by Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE) and (c) Brazil is fast becoming the “go to destination” for offshore enthusiasts. Finally as I blogged earlier, the sentiment that BP is somehow giving up or is going to give up on the lucrative US market – serving the world biggest consumers of gasoline – is a load of nonsense!

So what has happened since then? Well we have much more scrutiny of the industry – not just in the US but elsewhere too. This increases what can be described as the diligence time load – i.e. simply put the legal compliance framework for offshore projects. Furthermore, without contingency plans and costly containment systems, the US government is highly unlikely to award offshore permits. So the vibe from Houston is that while the big players can take it; the Gulf may well be out of reach of smaller players.

Now just how deep is 'deepwater' drilling as the term is dropped around quite casually? According a Petrobras engineer with whom I sat down to discuss this over a beer – if we are talking ultra-deepwater drilling – then by average estimates one can hit the ocean floor at 7,000 feet, followed by 9800 feet of rock layer and another 7,000 feet of salt layer before the drillbit hits the deep-sea oil. This is no mean feat – its actually quite a few feet! Yet no one is in a mood to give-up according to financial and legal advisers and the sponsors they advise both here in London and across the pond in Houston.

To cite an example, on Oct 12, 2010 – President Obama lifted the moratorium on offshore drilling in the Gulf. By Oct 21, Chevron had announced its US$7.5 billion offshore investment plans there – a mere 9 days is all it took! Whom are we kidding? Offshore is not dead, it is not even wounded – we are just going to drill deeper and deeper. If the demand is there, the quest for supply will continue.

As for the players involved in Macondo, three of the five involved – BP, Anadarko Petroleum and Transocean – may be hit with severe monetary penalties, but Halliburton and Cameron International look less likely to be hit by long term financial impact.

How Transocean – which owned the Deepwater Horizon rig – manages is the biggest puzzle for me. Moody's currently maintains a negative outlook on Transocean's current Baa3 rating. This makes borrowing for Transocean all that more expensive, but not impossible and perhaps explains its absence from the debt markets. How it will copes may be the most interesting sideshow.

© Gaurav Sharma 2011. Photo: Gaurav Sharma on CNBC, April 20, 2011 © CNBC

Talking SPRs & bidding farewell to North America

As the Oilholic prepares to leave North America and head home, oil prices are at a 32-month high with both the WTI & Brent forward futures contracts setting new records each week. Americans are grappling with gasoline prices of over US$4 per gallon. European tales of crude woes have also reached here.

Quite frankly, the global markets must prepare for a lengthy supply shortage of the 1.4 million barrels per day exported by Libya. Rest of OPEC is struggling to relieve the market pressure. Yet it is not the time for governments of the world to dig into their strategic petroleum reserves (SPRs) as has been suggested in certain quarters.

The loudest clamour here is coming from Senator Jeff Bingaman – a Democrat from New Mexico and chairman of the US Senate energy committee – who would like to see his country’s SPR raided to relieve price pressures. That SPR is tucked away somewhere in states of Texas and Louisiana and contains 727 million barrels of the crude stuff. The Japanese have stored up 324 million while European Union member nations should have just under 500 million barrels.

The Oilholic would like to tell Senator Bingaman and others making similar calls that such a move would add to the market fear and confirm that a perceptively short term problem is worsening! Long term hope remains that the Libyan supply gap would be plugged. Releasing portions of the SPRs would not alleviate market concerns and could even be a disincentive for the Saudis to pump more oil.

Meanwhile, the IMF also warned about further scarcity of supply, noting: “The increase in the trend component of oil prices suggests that the global oil market has entered a period of increased scarcity.” This does beg one question though – if supplies from the world’s 17th largest oil exporter can cause such market fear, then aren’t we glad it wasn’t an exporting nation further up the 'crude' chain?

Elsewhere, a share exchange agreement between BP and Russia’s Rosneft was blocked again on April 8 as an arbitration panel in London upheld an injunction on the deal following objections by TNK-BP. However, it gave BP until Apr 14 to find a solution. Shareholders of TNK-BP – an earlier Russian joint venture of BP – have argued successfully up until now that the tie-up breaches business agreements BP entered into with them.

The only good news here for BP is that it can ask for Rosneft's consent to keep the agreement alive. If the company bosses wished for an easier 2011, clearly the year has not started as such and as with much else, the injury is largely self-inflicted! And here is BP’s spiel on the Gulf of Mexico restoration work.

Additionally, on April 6 a three-judge panel of the Fifth Circuit Court of Appeals in Houston denied ex-Enron chief executive Jeffrey Skilling a new trial, upholding his conviction on 19 counts of conspiracy and other crimes. It vacated Skilling's 24-year prison sentence and sent it back to a lower court for re-sentencing.

Enron's collapse into bankruptcy in 2001, following years of dodgy business deals and accounting tricks, made over 5,000 people redundant, wiping out over US$2 billion in employee pensions and meant US$60 billion in the company’s stocks were worthless. The city of Houston bore the brunt of it but the Oilholic is happy to observe that it found the strength to move on from it.

Having left London on March 23, it has been an amazing three-week long journey across the pond starting and ending here in Houston, with Calgary, Vancouver, Seattle and San Francisco in between. Completing a full circle and flying back to London from Houston, it is apt to thank friends and colleagues at Deloitte, Barclays Capital (Canada), S&P, Norton Rose Group, Ogilvy Renault LLP, Heenan Blaikie LLP, Mayer Brown LLP, Pillsbury Winthrop Shaw Pittman LLP, Canadian Association of Petroleum Producers (CAPP), Stanford University, Rice University, University of Calgary and several energy sector executives who spared their time and provided invaluable insight for the Oilholic’s work.

© Gaurav Sharma 2011. Photo: Disused Gas Station in Preston, Connecticut, USA © Todd Gipstein/National Geographic Society

Oh the market ‘insouciance’ outside is frightful!

It is no longer strange to see Americans and Canadians complain about the rising price of gasoline. After all, it’s the price at the pump which hurts us all – something which has seen a steady rise.

A short-term respite is quite frankly not in sight; more so for Europeans but complaints from North American consumers and change in consumption patterns (in relative terms) have grown in the last five years. Although some in the English town of Bradford, who pay more for their petrol/per litre than North Americans, got a temporary one-off respite according to the BBC, after the station staff put a decimal point in the wrong place. The story is hilarious, aptly timed for April Fools Day and one for the little guy troubled by rising inflation in UK.

US President Obama finally pointed to Canada, Mexico as reliable sources of crude oil and said they could play their part in his consuming nation’s bid to slash imports from unfriendly governments. Both countries rank higher than Saudi Arabia in terms of crude exports to the US, so very welcome quotes – but as with all else about him – a bit late.

The short-term problem – and a global one it is too – is the widening of premium between easier to refine sweet crude oil and sour crude which is the opposite. Anecdotal evidence, either side of the Atlantic is that refiners (either European or European subsidiaries of overseas owners), are paying record physical premiums to secure supplies of sweet crude in wake of the Libyan stand-off.

The quality of Libyan sweet crude is excellent and as a short-term problem starts resembling a longer termed stand-off, the market is getting spooked as no one can make up their minds about who is in charge of the country. That’s despite the on / off media reports of oil being loaded on to tankers both on the rebels’ side and Gaddafi’s side.

End result - Brent Crude forward month futures (May) contract, more reflective of global conditions, has spiked to a 30-month high. Oilholic believes this is no ordinary or linear spike resulting from a geopolitical bias/risk premium to the upside. Rather it is clearly reflective of the rise in price differentials between sweet and sour crude in wake of Libya and hence impacts Brent as a benchmark to a greater extent than the WTI.

As early as a fortnight ago, the IEA rightly warned that we are underestimating the impact of the temporary (or otherwise) loss of Libyan sweet crude on traded paper barrels. In its monthly report for March, it noted, "Market insouciance may change abruptly as April approaches, when global crude demand is expected to increase by around 1 million barrels a day as Atlantic Basin refinery maintenance ends."

Sweet crude varieties are trading at a premium of US$2.80 to US$4.10 per barrel above sour varieties, according to the Oilholic’s sources. This is the highest for some time. Try as they might, Saudis won’t materially alter this; the premium has solid foundations!

Finally before I leave Canada for San Francisco, here is a brilliant editorial in The Economist about European nations trying to forget embarrassing ties in the Middle East and a BBC report on Transocean’s 'crude' announcement of bonuses related to their "best year of safety."

© Gaurav Sharma 2011. Photo: Gas Station, Houston, Texas, USA © Gaurav Sharma, March 2011

Crude Oil prices & some governments

I have spent the last two weeks quizzing key crude commentators in US and Canada about what price of crude oil they feel would be conducive to business investment, sit well within the profitable extraction dynamic and last but certainly not the least won't harm the global economy.

Beginning with Canada, since there’s no empirical evidence of the Canadian Dollar having suffered from the Dutch disease, for the oil sands to be profitable – most Canadians remarked that a price circa of US$75 per barrel and not exceeding US$105 in the long term would be ideal. On the other hand, in the event of a price dive, especially an unlikely one that takes the price below US$40 per barrel would be a disaster for petro-investment in Canada. A frozen Bow River (pictured above) is ok for Calgarians, but an investment freeze certainly wont be!

The Americans came up with a slightly lower US$70-90 range based on consumption patterns. They acknowledge that should the price spike over the US$150 per barrel mark and stay in the US$120-150 range over the medium term, a realignment of consumption patterns would occur.

This begs the question – what have Middle Eastern governments budgeted for? Research by commentators at National Commercial Bank of Saudi Arabia, the Oilholics’ feedback from regional commentators and local media suggests the cumulative average would be US$65 per barrel. Iran and Iraq are likely to have budgeted at least US$10 above that, more so in the case of the former while Saudi Arabia (and maybe Kuwait) would have budgeted for US$5 (to US$10) below that.

Problem for the Oilholic is getting access to regional governments’ data. Asking various ministries in the Middle East and expecting a straight forward answer, with the notable exception of the UAE, is as unlikely as getting a Venezuelan official to give accurate inflation figures.

Meanwhile, price is not the only thing holding or promoting investment. For instance, the recent political unrest has meant that the Egypt Petroleum Corp. has delayed the Mostorod refinery construction until at least May. The reason is simple – some 20-odd participating banks, who arranged a US$2.6 billion loan facility want the interim government to reaffirm its commitment to the project, according to a lawyer close to the deal. The government, with all due respect, has quite a few reaffirmations to make.

© Gaurav Sharma 2011. Photo: Bow River, Calgary, Alberta, Canada © Gaurav Sharma, April 2011