Brent-WTI price divergence, OPEC & Eni

Since Q1 2009, Brent has been trading at premium to the WTI. This divergence has stood in recent weeks as both global benchmarks plummeted in wake of the recent economic malaise. WTI’s discount reached almost US$26 per barrel at one point. Furthermore, waterborne crudes have also been following the general direction of Brent’s price. The Louisiana Light Sweet (LLS) increasingly takes its cue from Brent rather than the WTI, and has been for a while. Its premium to WTI stood at US$26.75 in intraday on Wednesday.

The fact that Brent is more indicative of the global economic climate has gone beyond conjecture. OPEC has its own basket of crudes to look at, but got spooked on Wednesday as Brent dipped below the US$100 mark, albeit briefly and WTI came quite close to settling below US$75.50.

Iraq’s Deputy Prime Minister for energy, Hussain al-Shahristani, said that there was “no need” for the cartel to review its oil output at the next OPEC meeting (on December 14th in Vienna), but stopped shy of calling for a cut in oil production. Nonetheless, al-Shahristani did say that it would be “difficult” for his country to accept crude prices below the US$90 mark.

There also appears to be little appetite within the cartel to hold an emergency meeting and the Oilholic sees the chances of that happening being quite remote. If the oil price continues to slide, then it would be a different matter but quite simply a correction rather than a freefall would be the order of the day. On Thursday morning prices rose, aided by a weaker US Dollar, the US Fed’s indication of implementing further stimulus measures and the Bank of England’s move to initiate £75 billion worth of quantitative easing.

Sucden Financial research notes that after Tuesday’s bullish reversal, crude oil saw mixed trading early Wednesday as private reports about the US employment situation were mixed. Some optimism regarding more willingness to strike some solutions for the European debt issues seemed to underpin some trading as the euro generally maintained its gains.

“Technically, WTI futures may still have vulnerability toward the US$74 area but the recent gains have set technical potential for gains which could test toward US$83 area. Brent futures have technical patterns that may suggest tests of strength toward the area of US$106; supports may be expected near US$100 and US$95 areas,” Sucden notes further.

Whichever way you look at it, OPEC heavyweights led by Saudi Arabia, while not averse to cuts, have no appetite for an emergency meeting of the cartel as December is not that far away. Rounding things off, following Italy’s rating downgrade, it came as no surprise that debt ratings of Italian government-related issuers (GRIs) would be impacted, as Moody’s responded by downgrading the long term senior unsecured ratings of Italian energy firm Eni and its guaranteed subsidiaries to A1 from Aa3 and the senior unsecured rating of Eni USA Inc. to A2 from A1. The Prime-1 rating is unchanged.

Approximately €13.1 billion of long-term debt securities would be affected and the outlook for all ratings is negative. However, Moody’s notes that in the context of weakened sovereign creditworthiness, the likelihood of Eni receiving extraordinary support from the Italian government has significantly diminished.

Moody's has consequently removed the one-notch ratings uplift that had previously been incorporated into Eni's rating. It also added that Eni's A1 rating continues to reflect the group's solid business position as one of Europe's largest oil & gas companies.

“The group displays a sizeable portfolio of upstream assets that has been enhanced in recent years by a string of acquisitions. Looking ahead, the planned development of Eni's attractive pipeline of large-scale projects should help underpin its reserve base and production profile,” the agency concludes.

Eni, which is also Libya’s biggest producer, resumed production in the country for the first time since the uprising against Col. Moamar Gaddafi’s regime. A company source says it may begin exporting Libyan crude by the end of October or earlier.

© Gaurav Sharma 2011. Photo: Oil Drill Pump, North Dakota, USA © Phil Schermeister / National Geographic

Sucden to Soc Gen: The fortnight’s crude chatter

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

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

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

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

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

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

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

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

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

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

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

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

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

Addressing the information gap on Abu Dhabi

While Dubai often hogs the limelight, the principal emirate in the United Arab Emirates is Abu Dhabi which holds over 8 per cent of the world’s oil reserves. It is a key regional player and an economic power in its own right, yet few written works have examined its culture, politics, influence and economic prowess on a standalone basis. Abu Dhabi: Oil and Beyond is author Christopher Davidson's commendable attempt at addressing the perceived information gap.

The author justifies his quest to write a comprehensive volume on Abu Dhabi by noting that with 90 years of remaining hydrocarbon production and with plans to increase oil output by 30% in the near future, the emirate of will have the resources and surpluses it needs – regardless of the vagaries of broader economic trends. Simply put, ignore Abu Dhabi in a regional or global context at your peril.

Yet it is not all about the oil as Davidson explains via his book of just under 250 pages split by seven detailed chapters. He dives into history and sequentially charts Abu Dhabi’s transformation from an 18th century sheikdom to its current status in the global economy. Dynastic politics, culture, strategic investment (via its mammoth sovereign investment fund), regional influence, have all been examined in some detail, along with the emirate’s “new economy” and its moves away from a traditional oil and gas export oriented structure.

However, the book need not be mistaken for a glorified tale or positive spin about Abu Dhabi. Rather it is a pragmatic examination of the emirate. To this end, the author does not shy away from discussing a number of problems that may surface to impede economic development and undermine political stability in his concluding chapter.

Civil and socio-economic issues, media censorship, an underperforming education sector, terrorism and rising federal unrest have all been discussed. Overall, Davidson’s work is interesting and informative. It is a must read for those interested in Middle Eastern geopolitics and oil. That aside, students of history, the oil business and those of a curious disposition fascinated by the Emirates might find it well worth their while to pick this title up.

© Gaurav Sharma 2011. Photo: Front Cover – Abu Dhabi: Oil and Beyond © Hurst Publishers, May 2011.

Greece isn’t hitting crude on a standalone basis

Now how many times have we been here in recent times when yet another week begins with market chatter about Eurozone contagion and Greece weighing on the price of Black Gold? Quite frankly it is now getting excruciatingly painful – the chatter that is! The linkage between the abysmal state of affairs in Greece and lower crude prices is neither simple nor linear and a tad overblown from a global standpoint.

Bearish trends are being noted owing to an accumulation of macro factors. Worries about state of the US economy, should lead and actually led the bearish way not Greece. Nonetheless, since Greece’s economic woes have become the poster children of wider problems in the Eurozone for a while now, concerns about its economy never fail to dampen intraday trade on a Monday.

Sucden Financial Research’s Myrto Sokou notes that crude oil prices have started the week on a negative side, as weaker global equity markets and persistent concerns about Greek debt crisis weighed heavily on market sentiment and prompted investors to lock in recent profits. WTI crude oil slid lower 1% toward US$87 per barrel, while Brent oil contract retreated to retest the US$111 per barrel area.

Simply put, European leaders’ decision to delay the Greek tranche payment and EFSF expansion decisions until October, has hit futures trading this side of the Atlantic. Additionally, in the absence of major economic indicators this week, Sokou notes that investors will now be watching for currency movements that could give some direction to the energy market. In any case, investors are being cautious ahead of the two-day US FOMC meeting which concludes on Wednesday.

This week comes on the back of Société Générale’s research published last week which suggested a meaningful slide in oil prices should begin in the next 30-45 days. It is worth rewinding to last Christmas when a stunted recovery was taking hold and people were forecasting oil prices in the circa of US$120 per barrel for 2012. Here’s an example of a JP Morgan research note to clients from December 2010. This not to say that a US$120 price is not achievable – but the last six weeks of ‘over’ listening (or not) to the Greeks’ problems, economic stagnation in the US and even declining consumption forecasts for Asian markets has seen most analysts revise their 2012 forecasts down by almost US$10 per barrel on average.

OPEC Secretary General Abdalla Salem el-Badri certainly thinks there isn’t one economic woe without the other – not just Greece! Speaking at a forum, el-Badri noted that global demand for oil was seen rising at a level which was below expectations. He attributed this to fiscal woes in Europe (sigh!), high unemployment in the US and possible Chinese government action to prevent overheating of their economy.

El-Badri, a Libyan himself, also expressed hope that Libyan production would rise by 500,000 to 600,000 barrels per day (bpd) sometime in the near future. Club all bearish sentiments together, and even the OPEC secretary general is surprised that there has not been an even greater price correction in the crude markets.

Moving away from pricing, two noteworthy corporate stories these past few days have come from the US and Falkland Islands. On September 12, French engineering firm Technip announced its intention to acquire 100% of shares of US-based subsea company Global Industries Ltd. for a total transaction value of US$1.073 billion in cash, including approximately US$136 million of net debt.

The deal is slated for completion over Q1 2012. Elsewhere, British company Rockhopper Exploration, which is searching for crude stuff off the coast of Falkland Islands said on September 15 that it has made further significant finds.

It now expects to start pumping oil by 2016 and would need US$2.1 billion to develop its Sea Lion prospect. Company estimates are for 350 million barrels of recoverable reserves and production peak of 120,000 bpd is expected in 2018. Given the figure, smart money is on Rockhopper either partnering with another company or being taken over by a major. While Rockhopper continues to surprise, that the Argentines are moaning is hardly a surprise.

The Falkland Islands have always be a bone of contention between Argentina and UK who went to war over the Islands in 1982 after the former invaded. UK forces wrested back control of the islands, held by it since 1833, after a week long war that killed 649 Argentine and 255 British service personnel according to UK archives.

The prospect of oil in the region has renewed diplomatic spats with the Argentines complaining to the UN and launching fresh claims of sovereignty. Since, most Falkland islanders want to retain British sovereignty – UK PM David Cameron has declared the issue “non-negotiable”, while Argentina has declared him “arrogant”. It is at present, as the Oilholic noted last year, nothing more than a bit of diplomatic argy-bargy with an oily dimension and is highly likely to stay there.

Finally, concluding on a much lighter note, the London Stock Exchange (LSE), a preferred destination for oilholics, energy majors and miners for their listings, has quite literally become a hive of activity. One is reliably informed via its press office that the LSE has introduced 60,000 bees to their new home in hives situated on the roof of its City HQ at Paternoster Square (see photo on the left).

The introduction of the busy bees is aimed at encouraging growth of the urban bee population in the UK. The initiative is in a partnership with award-winning UK social enterprise - The Golden Company - which works with young people to develop viable businesses that produce, market and sell honey and honey-based natural cosmetics.

Xavier Rolet, CEO of LSE Group describes the move as the perfect example of community and business working together. Ilka Weissbrod, Director of The Golden Company says bees on the roof will be looked after by their ‘Bee Guardians’ together with members of LSE staff and everyone was looking forward to seeing the bees settle in their new home. Sounds like fun!

© Gaurav Sharma 2011. Photo 1: Pump Jacks Perryton, Texas, USA © Joel Sartore / National Geographic. Photo 2: Bees atop the London Stock Exchange © LSE Press Office, September 2011.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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