UK PM flags up crude credentials

The Oilholic attended the British lobby group CBI’s annual conference earlier today listening to UK Prime Minister David Cameron flag-up his crude credentials (admittedly among other matters). The PM feels investment in the Oil & Gas sector and British expertise in it could be part of his wider economic rebalancing act.

“In last few weeks alone I have visited an £4.5 billion new investment from BP in the North Sea…And today I hosted Britain and Norway signing a 10-year deal to secure gas supplies and develop together over £1 billion of Norwegian gas fields,” he said.

That deal of course was part of British utility Centrica’s 10-year agreement worth £13 billion to buy natural gas from Norway's Statoil and jointly develop fields.

"Gas plays a central role in powering our economy, and will continue to do so for decades to come. Today's agreement will help to ensure the continued security and competitiveness of gas supplies to Britain, from a trusted and reliable neighbour," the PM concluded.

Admittedly, from a gasoline consumers’ standpoint successive British governments have long lost street cred when it comes to taxing fuel a long while ago; still the present lot fare better in relative terms if the UK ONS is to be relied upon. The British statistics body announced last week that the Government’s Share of petrol pump price dropped to 66p in the pound in 2009/10; from nearly 81p in 2001/02.

The data also show that the poorest 20% of UK households paid almost twice as much of their income in duties on fuel than the richest 20%. In 2009/10, the poorest 20% of households paid 3.5% of their disposable income on duty, compared with only 1.8% for the top 20%. Overall, the average UK household spent 2.3% of its disposable income on duties on fuel.

However, in cash terms, the richest 20% of households paid almost three-times the amount paid by the bottom 20%. In 2009/10 the richest 20% of households spent £1,062 on petrol taxes, compared with £365 for the poorest 20% of households. Overall, the average UK household spent £677 on duties on fuel in 2009/10.

Finally, the UK, US and Canada announced new sanctions against Iran following growing concern over its nuclear programme in wake of the IAEA report. In a statement the US government said that Iran's petrochemical, oil and gas industry (including supply of technical components for Upstream and downstream ops) and its financial sector would be targeted by the sanctions.

Canada will ban all exports for the petrochemical, oil and gas industries without exceptions while the British government would demand that all UK credit and financial institutions had to cease trading with Iran's banks from Monday afternoon. The Oilholic notes that this is first time the UK has cut off a petro-exporting country’s banking sector, in fact any country’s banking sector in this fashion. Its highly doubtful if the move will tame misplaced Iranian belligerence.

© Gaurav Sharma 2011. Photo: British Prime Minister David Cameron speaking at the CBI Conference, November 21^st, 2011 © Gaurav Sharma 2011.

Of Argentina, Petrobras & a few odd pipelines

Last ten days has seen the crude focus shift to Argentina for a multitude of reasons which may be construed as good or bad depending on your point of view. To begin with, BP’s move to sell assets in Argentina has fallen through after its partner withdrew from the deal. BP wanted to sell its 60% stake in Pan American Energy (PAE) to its partner in Argentina, Bridas Energy Holdings, which is subsequently owned by CNOOC, China's largest offshore oil producer.

However, on November 6th CNOOC said it was terminating the deal, signed a year ago as BP was grappling with the fallout from the Gulf of Mexico oil spill. The stake sale was worth an estimated US$7 billion and was one of the largest sales agreed by the firm following the disaster. It is understood that BP will now have to repay its US$3.5 billion deposit on the agreement which had been contingent on regulatory approval.

Barely days later, on November 8th, Spanish giant Repsol’s Argentine subsidiary – YPF Sociedad Anónima – said it had found 927 million barrels of recoverable shale oil in Argentina which could catapult the country to the energy elite league.

In a statement, YPF said the discovery – located in the Vaca Muerta basin of Argentina's Neuquen province – "will transform the energy potential of Argentina and South America, boasting one of the world's most significant accumulations of non-conventional resources".

The discovery is likely to give renewed impetus to the country’s creditors who have been chasing the Argentine government for almost a decade since its default in 2002. Most bondholders took part in debt exchanges in 2005 and 2010, but a brave crew of EM and NML Capital – an affiliate of Elliott management – along with a group of 60,000 individual Italian investors have been bravely holding out and using legal avenues to recoup the US$6 billion-worth of debt plus interest. They may think it’s about time the country paid courtesy of a commodities-led boom.

Regrettably for YPF though, the find came only days after Moody's downgraded Argentine oil & gas companies. These included YPF, Pan American LLC, Petrobras Argentina, Petersen Energia and Petersen Energia Inversora.

According to Moody’s, the ratings downgrade and review for further downgrade were prompted by the new presidential decree requiring oil, gas and mining companies to repatriate 100% of their export proceeds and convert them to Argentine pesos. Previously, oil and gas companies operating in Argentina were permitted to keep up to 70% of their export proceeds offshore.

Neighbouring Brazil’s oil & gas behemoth Petrobras has been busy too. On November 3rd, it announced a new oil discovery in the extreme South Western part of the Walker Ridge concession area, located in the Gulf of Mexico’s ultra-deep waters. The discovery confirms the Lower Tertiary's potential in this area. (see map on the left; click to enlarge)

The discovery – Logan – is approximately 400km southwest of New Orleans, at a water depth of around 2,364 meters (or 7,750 feet). The discovery was made by drilling operations of well WR 969 #1 (or Logan 1), in block WR 969. Further exploration activities will define Logan's recoverable volumes and its commercial potential.

Norway’s Statoil is the consortium's operator, with 35% stake. Petrobras America Inc. (a subsidiary of Petrobras headquartered in Houston, Texas) holds 35% of the stake, while Ecopetrol America and OOGC hold 20% and 10%, respectively.

Petrobras holds other exploratory concession areas in this region, which will be tested later on, growing the Company's operations in the Gulf of Mexico. The Brazilian major is the operator of Cascade (100%) and Chinook (66.7%) oilfields and holds stakes in the Saint Malo (25%), Stones (25%) and Tiber (20%) discoveries, all with significant oil reserves in the Lower Tertiary. Additionally, Petrobras has stakes in the very recent Hadrian South (23.3%), Hadrian North (25%) and Lucius (9.6%) discoveries, all with significant oil reserves and in the Mio-Pliocene.

The company has been pretty busy at home as well, announcing that the first well drilled after the execution of the Transfer of Rights agreement confirmed the extension of the oil reserves located northwest of the Franco area discovery well, in the Santos Basin pre-salt cluster (see map on the left; click to enlarge).

The new well, informally known as Franco NW, is at a water depth of 1860 meters, approximately 188km from the city of Rio de Janeiro and 7.7km northwest of discovery well Franco (or 2-ANP-1-RJS).

The discovery was confirmed by oil samples of good quality (28º API) obtained through cable tests. The well is still in the drilling phase with the aim of reaching the base of the reservoirs containing oil. Once the drilling phase is complete, Petrobras will continue with the investment activities provided in the Mandatory Exploratory Program (or Programa Exploratório Obrigatório, PEO as it’s referred to locally).

From South American discoveries to North American pipelines as it emerged last night that the Obama administration has chickened-out of making a decision on Keystone XL. Faced with the environmental lobby on one side and the Unions craving jobs on the other, the US government has requested further studies on the project which would in theory delay the decision to build the 2700km pipeline well after 2012 presidential election. Frustration across the border in Canada is likely to grow as the Oilholic noted from Calgary earlier this year.

If he rejected the project, Obama could be accused of destroying jobs. If allowed it to go ahead, it could lose him the support of some activists who helped him win the Presidency. So he chose to do what political jellyfish usually do before a crucial vote – nothing.

Additionally, reports surfaced earlier in the week that Houston-based Cardno Entrix – a company involved in the environmental review – had listed developer TransCanada, the pipeline’s sponsor, as a "major client".

A review is now likely to look into this as well as state department emails related to a TransCanada lobbyist who had worked in Secretary of State Hillary Clinton's 2008 presidential campaign. TransCanada says that while it is disappointed with the delay, it continues to “conduct affairs with integrity and in an open and transparent manner.”

Continuing with pipelines, Moody's has assigned a Baa3 rating to Ruby Pipeline's US$1.075 billion senior unsecured notes. The senior unsecured notes have staggered maturities and will be used to refinance US$1.5 billion of project construction loans. The rating outlook is stable.

Stuart Miller, Moody's Vice President and Senior Analyst, said last week that the pipeline is a strategic link that provides diversity of supply to the utilities and industrial markets in Northern California and the Pacific Northwest.

"Hence, the primary drivers for Ruby's Baa3 rating are its initially high leverage tempered by a high level of ship-or-pay firm contracts with counterparties with a weighted average credit rating of Baa1 as well as our expectation that the ratio of debt to EBITDA will rapidly decline to below 4.5x," he concluded.

Ruby's leverage is expected to improve over the next five years as its capital structure includes a five year amortising term loan. Because of the required amortisation, Ruby's leverage, as measured by debt to EBITDA, should decline from approximately 5.2x to less than 4.5x by the end of 2013. Any revenue earned from the 28% un-contracted pipeline capacity would reduce leverage quicker, the agency noted. Finally, Nordstream I gas pipeline came onstream earlier in the week. Here's the WSJ's Oilholic approved take on it.

© Gaurav Sharma 2011. Map 1: Petrobras prospections in Gulf of Mexico © Petrobras 2011. Map 2: Petrobras in Santos Basin, Brazil (Courtesy: Petrobras)

Crude markets & the Eurozone mess

The Eurozone sad show continues alternating from a Greek tragedy to an Italian fiasco and woes continue to hit market sentiment; contagion is now – not entirely unexpectedly – seen spreading to Italy with the country’s benchmark debt notes rates rising above the 7% mark at one point deemed ‘unsustainable’ by most economists. Inevitably, both crude benchmarks took a plastering in intraday trading earlier in the week with WTI plummeting below US$96 and Brent sliding below US$113. Let’s face it; the prospect of having to bailout Italy – the Eurozone’s third largest economy – is unpalatable.

The US EIA weekly report which indicated a draw of 1.37 million barrels of crude oil, against a forecast of a 400,000 build provided respite, and things have become calmer over the last 24 hours. Jack Pollard, analyst at Sucden Financial Research, noted on Thursday that crude prices gathered some modest upside momentum to recover some of Wednesday’s losses as equities pared losses and Italian debt yields come off their record highs.

“One important factor for crude remains the Iranian situation with Western diplomats adopting a decidedly more hard-line approach to their rhetoric. For example, the French Foreign Minister has said the country is prepared to implement ‘unprecedented sanctions’ on Iran whilst William Hague, British Foreign Secretary, has said ‘no option is off the table’. Should the geopolitical situation deteriorate, the potential for supply disruptions from OPEC’s second largest producer could provide some support to crude prices,” Pollard notes.

From a Brent standpoint, barring a massive deterioration of the Iranian scenario, the ICE Brent forward curve should flatten in the next few months, mainly down to incremental supply of light sweet crude from Libya, end of refinery maintenance periods in Europe and inventories not being tight.

In an investment note to clients, on October 20th, Société Générale CIB analyst Rémy Penin recommended selling the ICE Brent Jan-12 contract and simultaneously buying the Mar-12 contract with an indicative bid @ +US$1.5/barrel. (Stop-loss level: if spread between Jan-12 and Mar-12 contracts rises to +US$2.5/barrel. Take-profit level: if spread drops to 0.)

The Oilholic finds himself in agreement with Penin even though geopolitical risks starting with Iran, followed by perennial tensions in Nigeria, and production cuts in Iran and Yemen persist. But don’t they always? Many analysts, for instance at Commerzbank, said in notes to clients issued on Tuesday that the geopolitical climate justifies a certain risk premium in the crude price.

But Penin notes, rather dryly, if the Oilholic may add: “All these factors have always been like a Damocles sword over oil markets. And current disruptions in Nigeria, Yemen and Iraq are already factored in current prices. If tensions ease, the still strong backwardation should as well.”

Additionally, on November 1st, his colleagues across the pond noted that over the past 20 years, when the NYMEX WTI forward curve has flipped from contango into backwardation, it has provided a strong buy signal. Société Générale CIB, along with three others (and counting) City trading houses recommend buying WTI on dips, as the Oilholic is reliably informed, for the conjecture is not without basis.

There is a caveat though. Société Générale CIB veteran analyst Mike Wittner notes that it is important to take into account the fact that crude oil stocks at Cushing, Oklahoma, consist not only of sweet WTI-quality grades but also of sour grades. “Most market participants, including us, do not know the exact breakdown between sour and sweet crudes at Cushing, but the recent move into backwardation suggests that there is little sweet WTI-quality crude left,” he adds.

Société Générale CIB analysts believe market participants who are reluctant to go outright long WTI in the current highly uncertain macroeconomic environment may wish to consider using the WTI sweet spot signal to go long WTI against Brent. Any widening of the forward-month Brent-WTI spread towards US$20 represents a trading opportunity, as the spread should narrow to at least US$15 and possibly to as low as US$10 before year-end, on the apparent shortage of WTI and increasing supply of Atlantic Basin waterborne sweet crude.

© Gaurav Sharma 2011. Photo: Trans Alaska Pipeline © Michael S. Quinton / National Geographic

Is "assetization" of Black Gold out of control?

Crude oil price should reflect a simple supply-demand equation, but it rarely does in the world of oil index funds, ETFs and loose foresight. Add to the mix an uncertain geopolitical climate and what you get is extreme market volatility. Especially since 2005, there have been record highs, followed by record lows and then yet another spike. Even at times of ample surpluses at Cushing (Oklahoma) - the US hub of criss-crossing pipelines - sometimes the WTI ticker is still seen trading at a premium defying conventional trading wisdom. The cause, according to Dan Dicker, author of the book Oil’s Endless Bid, is the rampant "assetization" of oil.

The author, a man with more than 20 years of experience on the NYMEX floor, attributes this to an influx of "dumb money" in to the oil markets. Apart from introducing and taking oil price volatility straight to the consumers' wallets, this influx has triggered a global endless bid for energy security. Via a book of just under 340 pages split by three parts containing 11 chapters, their epilogue and two useful appendices, Dicker offers his take on the state of crude affairs.

While largely authored from an American standpoint, Dicker throws up some unassailable truths of global relevance. Principal among them is the fact that visible changes that have taken place in the oil markets over the past 20 years. Go back a few decades, and everyone can recollect the connection between price volatility and its association with a major economic or geopolitical crisis (economic woes, Gulf War I, OPEC embargo, etc.)

Presently, there is near perennial volatility as the trading climate and instruments of trade available place an incessant upward pressure on black gold. Reading Dicker's thoughts one is inclined to believe that at no point in history was the phrase "black gold" more appropriate to describe the crude stuff than it is now; particularly in the last six years, as investment banks, energy hedge funds and managed futures funds have come to dominate energy trading and wreak havoc on prices.

In his introduction to the book, Dicker makes a bold claim - that we've lost control of our oil markets and it has become the biggest financial story of the decade. When the Oilholic began reading it, he was sceptical of the author's claim, but by the time he reached the ninth chapter the overriding sentiment was that Dicker has a point - a huge one, articulated well and discussed in the right spirit.

Ask anyone, even a lay man, a non-technical question about why the price of oil is so high - the answer is bound be China and India's hunger for oil. A more technical person might attribute it to the US Dollar's weakening and perhaps investors playing with the commodities market as the equities markets take a hit.

But are these reasons enough to explain what caused prices to soar 600% from 2003 to 2008, only to take a massive dip and soar again over the next couple of years? Something is fundamentally wrong here according to the author and the latter half of his book is dedicated to discussing what it might mean and where are we heading.

Whether you agree or disagree is a matter of personal opinion, but the author's take on what broke the oil markets, and how can they be fixed before they drag us all down into an economic black hole, strikes a chord. He also uses part of the narrative to reflect on his life as a trader before and after passage of the US Commodities Futures Modernization Act opened up the oil markets to a flood of "dumb money."

Sadly, as Dicker notes, the biggest victim of oil markets frenzy is the average consumer, who pays the price at the pump, and in the inflated costs of everything - from food and clothing to electric power and even lifesaving medications. The Oilholic is happy to recommend this book to those interested in crude oil markets, the energy business, US crude trading dynamic, petroleum economics or are just plainly intrigued about why getting a full tank of petrol has suddenly lost the element of predictability in the last half decade or so.

© Gaurav Sharma 2011. Photo: Cover of ‘Oil’s Endless Bid’ © Wiley Publishers, USA 2011.

Crude M&A activity, Majors' profits & more

As we approach the end of the year, the Oilholic is convinced that 2011 will see M&A activity in the oil & gas sector returning to, or perhaps even exceeding pre-crisis deal valuation levels. Research for Infrastructure Journal by this blogger suggests that while the year still has a little over two months left the deal valuation figure for acquisition of oil & gas infrastructure assets, using September 30th as a cut-off date, is well above the total valuation for 2008, the year that the global credit squeeze meaningfully constricted capital flows.

In fact, back in 2008, Infrastructure Journal noted 23 oil & gas M&A corporate finance transactions valued at US$19.33 billion. Deal valuation then declined to US$18.14 billion and US$16.70 billion in 2009 and 2010 while the number of transactions first fell to 19 and then rose to 32. In fact 2009 would have been a wretched year in relative terms, had it not been for a US$6.3 billion transaction concerning the acquisition of Stogit & Italgas. Big ticket deals were largely absent in 2010 and while the number of transactions rose, valuation declined. IJ analysts have so far noted 21 transactions and a deal valuation to the tune of US$27.11 billion (and counting) in 2011. (Click on graph to enlarge © Infrastructure Journal)

Michael Byrd, Houston-based partner at Baker & McKenzie feels that conditions for making an oil & gas asset acquisition are quite conducive, more so for upstream assets. “Opportunities exist in all three – Downstream, Midstream and Upstream projects, but in case of the latter, projects in remote offshore and onshore basins have become more economical due to new technologies and more favourable oil prices (long-term),” he said in recent webinar which makes for compelling listening, caveats and all, if asset acquisition is on your mind. You could possibly download a recording here.

Alternatively, Baker & McKenzie have another one of these webinars coming-up on November 16 under their Global Energy Webinar Series. This one would discuss the full cycle of tax planning and compliance issues around permanent establishments for major energy and power projects.

Moving away from IJ’s figures and Baker & McKenzie webinars, financial advisers Ernst & Young’s research on a related note suggests that increases in M&A of London-based AiM-listed oil & gas firms are to be expected following substantial falls in their market valuation.

The firm’s quarterly index shows the value of AiM-listed oil and gas companies fell 26% in the three months to September. The index has been in decline since the start of 2011. Additionally, fundraising by AiM-listed oil and gas companies totalled £168.7 million during the third quarter - a fall of 48% on the same quarter last year.

Jon Clark, oil & gas partner at Ernst & Young, said, "Those companies with weaker balance sheets and particularly those with development projects will be looking towards larger, better capitalised acquirers. The slowdown in the global economic recovery and the market turbulence created by issues including the US credit downgrade and the eurozone sovereign debt crisis will continue to turn investors off riskier assets. This doesn't bode well for the fourth quarter."

All-in-all, the remainder of 2011 would be a good time to swoop for an asset or even an entire mid-cap company. Concurrently, the oil majors are queuing up to announce decent profits. The third quarter’s current cost of supply net income at Shell doubled to US$7.2 billion, compared with US$3.5 billion during the same period a year ago. ExxonMobil saw its quarterly profits rise by 41% to US$10.3 billion.

Earlier in the week, BP said its operations were “regaining momentum” and that it had “turned a corner” reporting third quarter profits of US$5.14 billion, a near tripling of the US$1.85 billion replacement cost profit it made in the same period a year ago. The firm is also increasing its asset selling programme from US$30 billion to US$45 billion.

Meanwhile, the British Energy and Climate Change Select Committee of MPs has criticised the UK Treasury's move earlier this year to increase a levy on the oil & gas industry calling it an "opportunistic raid". On the back of recent good news from the North Sea – they said in a report that the way in which the £2 billion hike was announced may have undermined investor confidence.

The report notes: "If the (UK) government is serious about maximising production from the UK Continental Shelf (UKCS), it needs to consider the long-term impact of changes to the tax regime on investment. The evidence on the impact of 2006 increase in the supplementary tax charge on oil and gas production in the North Sea is inconclusive, but there is a clear need to sustain investor confidence by avoiding surprises, such as the further increase announced in the 2011 Budget. It is not sensible to make opportunistic raids on UKCS producers." Powerful stuff – well delivered!

Finally, in Thursday intraday trading the crude oil price registered a strong rebound of over 2%, accompanied by a rally in the equity markets following the positive vibes from the European leaders’ summit overnight where an agreement to raise the European rescue fund to €1 trillion was finally reached.

Sucden Financial research expects further gains in crude oil prices, as the market seems relieved after the European Summit. The stronger euro provides further support, while most commodity prices enjoying a strong rally. WTI crude oil has further upside potential toward US$95/$96 per barrel, while Brent oil might find modest resistance near the US$115 per barrel area, Sucden analysts note further.

© Gaurav Sharma 2011. Graph: Corporate Finance infrastructure M&A deals 2008-2011 (year to date) © Infrastructure Journal, October 10, 2011. Photo: Shell Gas Station © Royal Dutch Shell