Wednesday, May 25, 2011

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

Sunday, May 15, 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 6th 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

Tuesday, May 03, 2011

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

Monday, May 02, 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

Monday, April 11, 2011

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

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