No consensus at OPEC; quota unchanged

In a surprising announcement here in Vienna, OPEC ministers decided not to change the cartel’s production quota contrary to market expectations. At the conclusion of the meeting, OPEC Secretary General Abdalla Salem el-Badri said the cartel will wait another three months at least before revisiting the subject.

El-Badri also said the crude market was “not in any crisis” and that no extraordinary meeting had been planned. Instead, the ministers would meet as scheduled in December. However, he admitted that there was no consensus at the meeting table with some members in favour of a production hike while some even suggested a cut.

“Waiting (at least) another three months for a review was not to everyone’s liking but the environment around the table was cordial even though it was a difficult decision,” he said after the meeting. However, as expected, he did not reveal which member nations were for or against a decision to hold production at current levels.

El-Badri put OPEC's April production at about 29 million b/d and refused to answer many or rather any questions on Libya except for the conjecture that while Libyan production was not taking place, others can and will make up for the shortfall within and outside of OPEC.

The surprising stalemate at OPEC HQ has seen a near immediate impact on the market. ICE Brent crude oil futures rose to US$118.33, up US$1.55 or 1.3% while WTI futures rose US$1.30 to 100.61 up 1.3% less than 20 minutes after el-Badri spoke.

He added that the environment was cordial, but many suggested that it was anything but. The Saudis left the building in a huff with minister Ali al-Naimi describing it as the "worst meeting they have attended."

The analyst community is surprised but only mildly with many opining that the Saudis may well go it alone. Jason Schenker, President & Chief Economist of Prestige Economics says, “I think that what we have witnessed today is very similar to the group’s quota suspensions in the past. High volatility in the markets is clearly visible and there was no consensus at the meeting table about how to respond. At the end of the day, most OPEC member countries are going to react to what we have seen today as they see fit. Atop the list are the Saudis – the OPEC heavyweights - who will react as they always do and go it alone.”

Ehsan Ul-Haq, an analyst with KBC Energy Economics agrees with Jason. “Quite simply, if the Saudis want more oil on the market, they don’t need the Iranians, they don’t need the Venezuelans; they can and now probably will do it alone."

No wonder the new man at the table – the meeting’s President Mohammad Aliabadi of Iran spoke of a “nervous” two quarters for the oil market. The Oilholic felt this 159th ordinary meeting would be ‘extraordinary’ and so it has turned out to be. Venezuela, Iran and Algeria reportedly refused to raise production with a Gaddafi-leaning Libyan delegation backing their calls.

Meanwhile, the latest Statistical Review of World Energy published by BP earlier today with an impeccable sense of timing, noted that consumption of oil appreciated on an annualised basis at the highest rate seen since 2004. Christof Ruhl, BP group's chief economist, puts the latest growth rate at 3.1%.

According to BP, much of the increased demand for oil continued to come from China where consumption rose by over 10% or 860,000 b/d. The report also notes the continued decline of the North Sea with Norway, followed by the UK, topping the production dip charts. The take hike announced in the recent UK budget is not going to help stem the decline.

© Gaurav Sharma 2011. Photo: OPEC logo © Gaurav Sharma 2008

Buzz at Central Bank of Oil Before 1600 CET

Ahead of the OPEC decision, prices for the forward month ICE Brent and NYMEX WTI futures contracts have fallen by US$2-3 on average over two weeks if the last fortnight is taken into consideration. That is largely down to the fact that traders have begun to factor in a possible increase in OPEC crude production quotas in the run up to the meeting here in Vienna today.

For the purposes of a price check, at 11:00am CET, ICE Brent is trading at US$116.26 down 0.5% or 16 cents, while WTI is down 99 cents or 1% at US$98.46. Additionally, the OPEC basket of twelve crudes stood at US$110.66 on Tuesday, compared with US$110.99 the previous day according to OPEC Secretariat calculations this morning.

Mike Wittner of Société Générale notes that if an increase in OPEC quota is made from a starting point of actual production, rather than the previous quota, it is that much more real, that much more serious, and potentially that much more bearish, at least in the short term.

“In contrast, if OPEC were to increase quotas by 1.5 million b/d, but versus previous quotas and not actual production, all they would be doing would be legitimising recent/current overproduction versus the old quota,” he adds.

Most analysts including Wittner and those present here believe a physical increase would be coming our way. Speaking of analysts, it is always a pleasure meeting Jason Schenker, President & Chief Economist of Prestige Economics at these OPEC meetings. He’s to be credited for describing OPEC as the Central Bank of Oil. The Oilholic heartily agrees and could not have put it better. Schenker believes OPEC is looking at the medium term picture and not just the next few months.

“As anticipated if there is a production hike today, the thinking at the “Central Bank of Oil” would be that it could carry them across to the end of Q4 2011 perhaps without facing or acting upon further calls for alterations of production quotas,” he says.

On a somewhat 'crude' but unrelated footnote, hearing about my recent visit to Alberta, Canada, Jason agrees there are a whole lot of crude opportunities for Canadians to be excited about. It would not be easy and it is certainly not cheap. But then cheap oil has long gone – this not so cheap resource is in a safe neutral country. Furthermore, one must never say never, but Canadians are not exactly queuing up to join OPEC any time soon (or ever).

Finally on a totally unrelated footnote, one can see the “Made in UK” label at OPEC HQ – it’s the paper cups near the water dispenser - not something extracted from the North Sea.

© Gaurav Sharma 2011. Photo: Oil well in Oman © Royal Dutch Shell

Arriving at the not so ‘Ordinary’ OPEC meeting

The Oilholic probably has to go back to Q1 2008 when an OPEC meeting last generated as much interest as the soon to be held 159th Ordinary meeting of the cartel here in Vienna. Interest of this magnitude usually gains traction when the cartel contemplates an alteration of production quotas. Initial signals are that come 1600 CET tomorrow, we could see a rise in the OPEC member nations’ quotas by 0.5 to 1.5 million b/d.

Such talk has intensified in the three weeks leading up to the meeting. OPEC’s May crude oil production report notes that the cartel’s total crude output was 28.99 million b/d. If Iraq, which is not subject to OPEC quotas at present, is excluded, then the production came in at 26.33 million b/d, or 1.5 million b/d higher than the quota of 24.8 million b/d as set in Q4 2008.

This begs the question, what would the increase be like in real terms – i.e. would it be an increase in paper targets (to which methinks not a lot of attention would or should be paid by the markets) or would it be an increase over the already existing, but not officially acknowledged physical production levels. If it is the latter, then that would be something and Société Générale's Mike Wittner reckons it would be a physical increment rather than a paper one.

Furthermore, in a note to clients, Wittner observes: “Before analysing what OPEC is thinking about, why it will probably increase quotas, and what the dangers are of doing so, it is very important to note the latest signal regarding the meeting. Early Monday evening (EST), it was reported that the Saudi-owned al-Hayat newspaper, based in London, quoted an unnamed source as saying that if OPEC decides to lift its output by more than 1 million b/d, Saudi Arabia’s production will reach about 10 million b/d during the summer period, when its domestic demand increases. This compares to around 8.9 - 9.0 million b/d in May, according to preliminary wire service estimates, with an increase of 0.2 - 0.3 million b/d expected in June, according to various sources."

The initial feelers here seem to be following the norm. The Saudis for instance, according to various media reports, would increase production anyway even if an increase is not announced. Approach of the others is more nuanced while some would suggest there are bigger factors at play rather than a straight cut decision on production.

Earlier today, following a meeting at 1600 CET, a ministerial monitoring sub-committee comprising of ministers from Algeria, Kuwait and Nigeria overseen by the OPEC secretariat proposed a 1 million b/d increment to the existing quotas. This could be a harbinger of what may follow tomorrow. However, few here expect anything other than stiff resistance to an increase in quotas by Iran and Venezuela.

Both countries have provided interesting sideshows. Iran's President Mahmoud Ahmadinejad sacked his oil minister and seized control of his ministry ahead of the meeting. He then appointed his close ally Mohammad Aliabadi as caretaker oil minister after parliament and Iran's constitutional watchdog said the president had no right to head the ministry.

Oilholic regrets that he knows little about the right honourable Aliabadi who has precious little experience of oily matters. Guess being greasily close to Ahmadinejad is a resume builder in that part of the world. Additionally, Venezuela is to complain about US sanctions on PDVSA.

Meanwhile, crude oil futures rose slightly either side of the pond following concerns that OPEC’s spare capacity will tighten pending on what happens tomorrow. OPEC had 5.94 million b/d in spare capacity in May, down 2.7 per cent from April, based on Bloomberg estimates. Spare capacity was 6.31 million barrels a day in March, the highest level since May 2009.

The official line from OPEC as of this evening is – “We’ll pump more if needs be.” But do we? Tracking arrivals of OPEC ministers in Austria one by one since 09:00 CET not one has said much about what may happen on this occasion. Based on past experience that is always a sign that something will happen.

© Gaurav Sharma 2011. Photo: Empty OPEC Press conference table © Gaurav Sharma 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

Valero, BP, Crude price & the week that was!

The seven days that have passed have been ‘crudely’ interesting to say the least. First off, early May saw one of the biggest market sell-offs in recent memory as commodities of all descriptions did a mini battle with price volatility. Brent crude for its part fell nearly 6% before recovering and stabilising above US$110 per barrel.

Macroeconomic factors aside many in the City believe the ongoing conflict in Libya no longer appears to be a key driver of oil prices as the loss of Libyan oil exports were fully discounted by the market some time ago. The profit takers agree! Société Générale CIB analysts noted in a report to clients that they estimate:

“the fair value for the Brent price would be about US$100 if no MENA risk premium were included. It is difficult to see the MENA risk premium rising much further near-term unless significant unrest emerges in countries with substantial oil exports such as Algeria and Saudi Arabia.”

That is not happening and Syria is of peripheral importance from near term instability premium perspective. Société Générale CIB analysts further note that the Brent crude oil price may correct lower over coming weeks as speculative traders may be tempted to take some profit on long positions as:

• recent significant events in the Middle East & North Africa (MENA) have been limited to countries with little oil exports


• tentative signs of demand destruction in the US, and


• growing concerns of a bumpy or hard landing in China.

Moving away from the crude price, heads of the big five oil firms Shell, Exxon, Conoco, BP America and Chevron and some Democrats on the Senate finance committee squared up to each other on May 6^th over the age-old issue of tax subsidies for oil companies. The latter want the tax subsidies removed, but big oil contests that they are benefitting from the subsidies like any other US business does and furthermore they are heavily taxed already.

That same day BP’s shares rallied in the UK following news that an arbitral panel has issued a consent order permitting BP and the AAR consortium to assign an Arctic opportunity to TNK-BP, subject to consent from Russian state-controlled firm Rosneft. The long drawn out saga may finally be reaching a favourable conclusion for BP.

Also last week ratings agency Moody’s changed US refiner Valero Energy's rating outlook to stable from negative and at the same time affirmed Valero's existing Baa2 senior unsecured note ratings. It said the stabilisation in the rating outlook reflects the expectation that Valero's cash flow will remain strong over the short term due to rising industrial activity pushing modest growth in demand for distillates and the expectation of supportive light/heavy spreads.

The stable outlook also reflects the assumption that Valero will maintain investment grade leverage metrics over the next 12-18 months as it continues to pursue organic growth and acquisition opportunities.

Additionally Moody's expects Valero's earnings to remain highly cyclical, and noted that the 2010 sale of the company's secularly weaker US East Coast refining assets, willingness and financial capacity to idle underperforming assets, as well as its recent cost reduction efforts should enhance the company's ability to withstand the inherent cyclicality of the sector. Moody's also expects that Valero will remain acquisitive. In March of this year, Valero announced the purchase of Chevron's Pembroke refinery in the UK for US $1.7 billion.

Rounding off - the Oilholic turned 33 years young today, last seven of which have been a ‘crude’ affair ;-) Thanks for all the birthday messages!

© Gaurav Sharma 2011. Photo: Alaska Pipeline with Brooks Range in background © Michael S. Quinton / National Geographic