Buyers' market & an overdue oil price correction

Recent correction in the price of crude oil should come as no surprise. The Brent front month futures contract fell to a 26-month low last week lurking around the US$98 per barrel level.

The Oilholic has said so before, and he’ll say it again – there is plenty of the crude stuff around to mitigate geopolitical spikes. When that happens, and it has been something of a rarity over the last few years, the froth dissipates. In wake of Brent dipping below three figures, a multitude of commentators took to the airwaves attributing it to lower OECD demand (nothing new), lacklustre economic activity in China (been that way for a while), supply glut (not new either), refinery maintenance (it is that time of the year), Scottish Referendum (eh, what?) – take your pick.

Yet nothing’s changed on risk front, as geopolitical mishaps – Libya, Sudan, Iraq and Ebola virus hitting West African exploration – are all still in the background. What has actually gotten rid of the froth is a realisation by those trading paper or virtual contracts that the only way is not long!

It’s prudent to mention that the Oilholic doesn’t always advocate going short. But one has consistently being doing so since late May predicated on the belief of industry contacts, who use solver models to a tee, to actually buy physical crude oil, rather than place bets on a screen. Most of their comparisons factor in at least three sellers, if not more.

Nothing they've indicated in the last (nearly) five months has suggested that buyers are tense about procuring crude oil within what most physical traders consider to be a "fair value" spot trade, reflecting market conditions. For what it’s worth, with the US buying less, crude oil exporters have had to rework their selling strategies and find other clients in Asia, as one explained in a Forbes post earlier this month.

It remains a buyers’ market where you have two major importers, the US and China who are buying less, albeit for different reasons. In short, and going short on crude oil, what’s afoot is mirroring physical market reality which paper traders delayed over much of the second quarter of this year from taking hold. Furthermore, as oversupply has trumped Brent’s risk premium, WTI is finding support courtesy the internal American dynamic of higher refinery runs and a reduction of the Cushing, Oklahoma glut. End result means a lower Brent premium to the WTI. 

However, being pragmatic, Brent’s current slump won’t be sustained until the end of the year. For starters, OPEC is coming to the realisation that it may have to cut production. Secretary General Adalla Salem El-Badri has recently hinted at this.

While OPEC heavyweight Saudi Arabia is reasonably comfortable above a $85 price floor, hawks such as Iran and Venezuela aren’t. Secondly, economic activity is likely to pick up both within and outside the OECD in fits and starts. While Chinese economic data continues to give mixed signals, India is seeing a mini-bounce. 

Additionally, as analysts at Deutsche Bank noted, “With refineries likely to run hard after the maintenance period, this will support crude oil demand and eventually prompt crude prices, in our view. This may be one of the factors that could help to eliminate contango in the Brent crude oil term structure.”

While the general mood in the wider commodities market remains bearish, it should improve over the remainder of the year unless China, India and the US collectively post dire economic activity, something that’s hard to see at this point. The Oilholic is sticking to his Q1 forecast of a Brent price in the range of $90 to $105 for 2014, and for its premium to WTI coming down to $5.

Meanwhile, Moody's has lowered the Brent crude price assumptions it uses for ratings purposes to $90 per barrel through 2015, a $5 drop from the ratings agency's previous assumptions for 2015. It also reduced price assumptions for WTI crude to $85 per barrel from $90 through 2015.

The agency’s price assumptions for 2016 and thereafter are $90 per barrel for Brent crude and $85 for WTI crude, unchanged from previous assumptions. Moody’s continue to view Brent as a common proxy for oil prices on the world market, and WTI for North American crude.

On a closing note, here’s the Oilholic’s second take for Forbes on the role of China as a refining superpower. Recent events have meant that their refining party is taking a breather, but it’s by no means over. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo: Russian Oil Extraction Facility © Lukoil. Graph: Brent curve structure, September 19, 2014 © Deutsche Bank

‘Crude’ sanctions on others always hurt Japan

The Oilholic finds himself in a rain-soaked Tokyo one final time before the big flying bus home! How Asian importing countries cope with sanctions on major oil & gas exporting jurisdictions is an interesting topic in this region reliant on foreign hydrocarbons for obvious reasons.

Mentioning Iran and of late curbs on Russia, deliberations over the past week with market commentators here in Tokyo, as well as Shanghai and Hong Kong, resulted in a consensus of opinion that Japan’s 30-odd oil & gas companies and regional gas-fired utilities feel the pain of such curbs more than corporate citizens of most other Asian importing nations.

The reason is simple enough; of the quartet of major Asian importers – namely China, Japan, India and South Korea – it’s the Japanese who are the most compliant when international pressures surface. Now, whether or not they can afford to is a different matter. According to the EIA and local publications, Japan consumed nearly 4.6 million barrels per day (bpd) in 2013, down from 4.7 million bpd in 2012. 

Going by the IEA’s latest projections, Japan is the third largest petroleum consumer in the world, behind the US and China. Yet domestic reserves are paltry in the region of 45.5 million barrels of oil equivalent, concentrated along the country’s western coastline. Inevitably, Japan imports most of its hydrocarbon requirements as a major industrialised nation.

Given the equation, if sanctions knock out or have the potential to knock out imports from one of its major partners, finding an alternative is neither easy nor simple. Forward planning also gets thrown right out of the window. We’ll discuss the recent Russian conundrum in a moment, but let’s examine the 2012 Iranian sanctions and the Japanese response to them first.

The country, almost immediately complied with requests to import less oil from Iran when European Union and US sanctions escalated in Q1 2012. At the time, Japan accounted for 17% of Iranian exports, above South Korea and India, but below China. The Japanese phased bid to reduce Iranian oil imports was lauded by the West, whereas China largely ignored the call, South Korea asked for more time and the Indians came up with ingenious ways to make remittances to Iran, until curbs on the insurance of tankers carrying Iranian crude began to bite.

Make no mistake, the sanctions on Iran hurt all four back in 2012, but Japan had to contend with the biggest refocusing exercise based on the level and speed of its compliance in moving away from Iranian crude. In the Oilholic’s opinion, for better or worse, that’s the price of being a G7 nation; and “having internationalism factored into the thinking,” adds a contact.

Fast forward to 2014, and the potential for securing of natural gas supplies from Russia to Japan seems to be taking a hit in wake of the Ukraine crisis. At the 21st World Petroleum Congress in June, when the tension had not escalated to the current level, prior to the downing of MH17, policymakers in on both sides were cooing over the potential for cooperation. 

The Institute of Energy Economics, Japan and the Energy Research Institute of the Russian Academy of Sciences even put out a joint white paper at the Congress contemplating a subsea gas pipeline route from Korsakov, Russia, to Kashima, Japan with an onshore Ishikari-Tomakomai section. It was claimed that technical feasibility of the ambitious project, capable of carrying a projected 8 bcm of natural gas to the Pacific Coast of Eastern Japan, had been positive.

Now it’s all gone a bit cold. One can’t directly attribute it to Russia’s face-off with the West, but currently both Japan and Russia describe the project as “just another idea”. This blogger can assure you, people were way more excited about it in June at the WPC than they are at the moment, and one wonders why?

Afterall, post-Fukushima with the rise of natural gas in Japan’s energy mix, however wild a project might be, carries weight rather than being relegated to just an idea. Contrast this with China, which has recently inked a long-term supply contract with the Russians. Quod erat demonstrandum!

With the evening drawing to a close, it’s time to digress a little and disclose the venue of this animated conversation – that’s none other than Tokyo’s iconic Hotel Okura. While a wee tipple is not cheap (average JPY1,700 for a swig of single malt), visiting this modernist institution is something special. 

When Tokyo first hosted the Olympic Games in 1964, the hotel was built in preparation to welcome the world. Since then, Hotel Okura has hosted every serving US President from Richard Nixon onwards.

Author Ian Fleming made James Bond fictitiously check-in to the hotel while in Tokyo in a chapter of "You only live twice". In recent work of fiction, the hotel also makes an appearance in Haruki Murakami’s 1Q84. It’s eclectic lobby, paneling, general sense of tranquility and overall panache of modern Japan is simply splendid (see above left). 

So here’s to 007, Murakami, Queen and Country and all the rest; but also it could be the Oilholic’s last drink at Hotel Okura as we know it. Alas, this grand place is about to fall prey to cultural philistinism in the name of progress as Tokyo prepares to host the Olympic Games once again in 2020. 

Last time around, for the 1964 games, Tokyo got the wretched Nihonbashi Expressway, a ‘clever’ project which included building an expressway over the Nihonbashi bridge, obscuring the magnificent view of Mount Fuji from the bridge and covering-up an ancient river flowering through the heart of Tokyo with steel and much more (see below left)!

Now atop a lot of flattening and rebuilding plans all over town, it seems Hotel Okura’s original main wing has been marked for demolition in August 2015, leaving only the South Tower operational. A proposed spending plan of US$980 million will see the wing open in the spring of 2019, reborn according to an employee as a “mixed-use tower” with 550 guest rooms and 18 stories of office space.

Life it seems will never be the same again for Hotel Okura and its many admirers including the Oilholic, who’d made it his mission not to leave Tokyo without visiting. Glad one got to see it before the demolition men get in. Well that’s all from the Far East folks as its time to bid a sad goodbye to the region!

Tokyo, Hong Kong, Macau and Shanghai, planes, trains, speedboats and automobiles – it was one heck of a crude ride that one will treasure forever. Next stop is London Heathrow, a reminder that all good things must end! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo 1: Tokyo Stock Exchange. Photo 2: Lobby of the Hotel Okura, Tokyo. Photo 3: The Oilholic at Hotel Okura’s Orchid Bar. Photo 4: Nihonbashi Expressway, Tokyo, Japan  © Gaurav Sharma, September, 2014.

China’s thirst: A few 'crude' notes from Shanghai

The Oilholic finds himself in Shanghai, the financial capital of China. Home to some 24 million people, this bustling metropolis, and what makes it tick, explains away the country’s consumption pattern of hydrocarbons, colossal state-owned oil & gas companies and a progressive lurch forward in the world of finance.

China uses more energy per GDP unit than any other country in the world, and factored in that equation is Shanghai which burns more hydrocarbons that any other major Chinese metropolitan area. While savouring the glitzy lights of the Shanghai waterfront, should the haze and weather permit, most visitors either fail to notice or attach importance to oil tankers frequently passing up and down the Huangpu River (see above left, in the darkness below the Oriental Pearl TV & Radio Tower).

China is the world’s largest net importer of crude oil, and its financial gateway is also its gateway for imported crude to be processed and moved. The city’s Pudong district alone has 240,000 barrels per day (bpd) of refining capacity. According to a distillates market commentator, plans are being spearheaded by Sinopec to take old creaking facilities offline and replace them with a new cleaner low carbon refinery with a whopping 400,000 bpd processing capacity at Caojing Industrial Park, some 50 km south of downtown Shanghai.

The capacity would have to be whopping, catering to Shanghai's Yangshang Port which overtook Rotterdam in 2004 to become the world’s busiest container port by volume and cargoes. Of the city's two main airports – Pudong International – is the world’s third-biggest mover of air cargo. Then with an area of 6,340.5 sq km, Shanghai is the world’s largest city and China’s most populous. 

Its growing, and growing fast. In 2001, the Oilholic remembered watching a BBC report on the city’s construction drive. Much of it was focussed on Pudong’s financial district which resembled something of an urban metallic mess. As yours truly came out of the Lujiazui Metro Station on Friday afternoon to see for himself, the said urban mess has in fact progressed to a sprawling skyscrapered representation of Chinese economic prowess in less than a decade.

Furthermore, yet more skyscrapers keep springing up. A trader correctly pointed out that the Oilholic has arrived to witness the party a bit late. Guilty as charged, more so as flat macroeconomic data has taken some (but not all) of the fizz out of late. Nonetheless, the inexorable eastward movement of importers’ petrodollars is manifestly apparent, more so as Chinese imports (and refining capacity) rises, while US imports decline and conditions for OECD refiners remain challenging.

To provide some context, Wood McKenzie notes that by 2020, US crude oil imports would have fallen below 7 million bpd thanks to shale and lower demand, while China’s would have risen above 9 million bpd. Bearing the wider market dynamic in mind, Chinese regulators are trying to bolster Shanghai’s clout in the wider commodities and financial markets.

For instance, three reliable financial sector sources expressed confidence that the domestic market regulator will introduce options trading over the fourth quarter of this year. A spokesperson for Shanghai’s International Energy Exchange says it will commence the trading of crude oil futures this year. It must also be noted that Shanghai’s commodities exchanges are backed-up by those in Dalian and Zhengzhou.

As for corporate deal flow, propped up by state-owned enterprises, it’s a case of more said the better. A Reuters report suggests spending by state-controlled oil & gas majors is likely to rise over the coming months, led by Sinopec and PetroChina, as the industry recovers from a government probe into industry graft allegations.

Some market commentators here in Shanghai are forecasting an overall annualised jump of over 45% in the total value of mergers and acquisitions (M&A) by Chinese companies, with oil & gas majors leading the way. It can’t be said for sure whether that’s a fair assessment or an overoptimistic take by local commentators, but it is in line with empirical evidence from elsewhere. 

For instance, Mergermarket recently noted that China was, perhaps unsurprisingly, the biggest market for M&A deals in the region, with deals worth US$128.4 billion over the first half of the year. Recent studies by EY, PwC and Deloitte have also noted the Chinese clout in terms energy sector M&A deals.

There’s potential for foreign direct investment as well. For instance, a stake, possibly as high as 30%, is up for grabs at Sinopec Sales, the company’s retail and marketing unit, which could be worth Yuan 100 billion (£10.04 billion, $16.29 billion) in terms of market valuation. It has attracted 37 bidders, including international participants and joint consortiums, according to local media.

Rather unusually, Sinopec Chairman Fu Chengyu also told media outlets that new stakeholders could be offered seats on its board. As with everything in China, it’s not done till it’s done. However, should such a level of holistic reform at regulatory and corporate levels go through to fruition, this blogger can see two major Asian commodities and financial markets – i.e. Hong Kong and Singapore – really feeling the heat.

Yet, there are stumbling blocks in Shanghai’s march forward. Red tape is a big one, for everything is described by spokespeople as “imminent” but with no verifiable timeline for execution or a firm date. While one can sense the positive intent for reforms, that alone won’t lead to end-delivery.

Another is pollution in the city, which is making residents restless about new refinery capacity, and rightly so. Shanghai’s horrendous traffic jams pose another problem though a fantastic metro, mass rail transit systems and not to mention the world’s first commercial magnetic levitation railway line do make residents and visitors’ lives a significantly easier.

Finally, the biggest stumbling block is the Yuan, which isn’t a fully convertible currency. The Oilholic thinks it’s probably why Shanghai's Free Trade Area (FTA), due to celebrate the first anniversary of its establishment this month, has largely turned out to be a dud so far. The 28.78 sq km zone in where else but Pudong was supposedly modelled on a mini Hong Kong.

The FTA found promises of attracting a wider range businesses and looser custom intervention easy to deliver along with swanky logistics and construction work. However, a full convertible Yuan and a market-based interest rate mechanism have proved to be anything but deliverable.

While the authorities have permitted companies in the FTA open “special accounts” facilitating cross-border capital flows, transactions between these and overseas accounts can hardly be described as “free transfers” in a British or American business sense. It’s also difficult to envisage how the creation of 8 spot trading platforms for commodities ranging from iron ore to cotton would work in the FTA, as is being planned, without a convertible currency.

All in all, and to be quite honest, FTA fans expecting a fully convertible Yuan were perhaps being overoptimistic. The Chinese will find their currency pathway at their convenience and in their own time. Nonetheless, crude reality is that the Chinese juggernaut will roll on, and in the context of the commodities market, dominate the discourse for some time yet.

That’s all for the moment from China folks as its time to bid a sad goodbye to Shanghai! It was great being here to get a first hand feel of the Chinese oil & gas sphere rather than commentating on it from the comfort of a desk in London. Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo 1: Shanghai Huangpu River Waterfront. Photo 2: Pudong Financial District. Photo 3: Flag of the Peoples Republic of China. Photo 4: East Nanjing Road. Photo 5: Traffic Jam, Shanghai, China © Gaurav Sharma, September, 2014.

That need for speed: Meet Shanghai’s Maglev

After years of wanting to, months of planning, waiting, visa applications and what have you, the Oilholic has finally made it to China, via Shanghai’s sprawling Pudong International Airport.

Before even entering the city limits, you get a sense of expansiveness, development, progress and a country in overdrive, despite Chinese economic data being less than flattering of late. It’s all capped by a general desire for getting things done, something that’s epitomised by one project in particular – the Shanghai Maglev Train, acknowledged as the world’s first commercially operated magnetic levitation line.

The Americans, Brits, Germans, Swiss and Japanese, have all flirted with magnetic levitation. Birmingham and Berlin even had low-speed pilot maglev trains before being abandoned owing to costs and other permutations. That’s where China is different – they wanted it done, wanted to spend towards that need for speed and the end result is splendid.

The Oilholic got from Pudong International to Longyang Road Metro Station, close to Shanghai’s financial district some 30.5km from the airport, in 8 minutes and 10 seconds at a speed of 301km/hr (see right), according to the speed indicator in one’s carriage.

Had yours truly travelled earlier in the afternoon, when the Maglev does 431 km/hr, it would have taken 7 minutes, a Guinness Book World Record land speed for public transit carriage. A non-commercial scientifically monitored journey on November 12, 2003 saw the maglev hit 501km/hr. Now beat that!

The need for this speed does not require the ‘crude’ stuff, but it doesn’t come cheap either. It’s almost certainly why the Brits and Germans abandoned projects after initial efforts. That sort of thing however doesn’t hold the Chinese back. This high-speed thrill ride cost US$1.33 billion to build entering commercial service in January 2004.

While yours truly was indeed enjoying the thrill ride, one got an acute sense that there were more thrill seekers onboard than regular commuters. There’s a reason for that; unlike the Oilholic, not everyone likes to get off an airplane head straight to the financial district!

So you still have to get on the Shanghai Metro at Longyang Road to go further, which you could have done earlier in any case since the metro line actually goes to Pudong International Airport. The tickets are pricey by local standards going at RMB85 (US$13.80, £8.50) for a return ticket and day-metro pass, RMB80 for a return and RMB50 for a single-journey. While this blogger, felt it was worth his while for the experience, the roughly 30% average carriage occupancy rate suggests that average Shanghai dwellers don’t in the main.

Nonetheless, that’s not something to knock the Maglev down with. You’ll get a similar occupancy dynamic if you compared the Heathrow Express and the cheaper option of taking the London Underground’s Piccadilly Line from the airport. Except, that in the case of Shanghai Maglev, it’s not an express – it’s a super-cool super-express. Having used mass transit and public transport systems from 67 airports (and counting) and many rail/seaport hubs, the Oilholic can safely say nothing beats this experience; not even the TGV or Shinkansen.

The initial train set was built by a joint venture of Siemens and ThyssenKrupp. Since then, under a limited technology transfer deal, the first Chinese built four-car train has also gone into service. 

Nonetheless, the Shanghai Maglev remains a demonstration project. Costs and other factors have delayed expansion beyond Shanghai. Most analysts and local media commentators here reckon the Pudong- Longyang Road Maglev Line will probably be it for the foreseeable future if not forever. If the Chinese reckon the Maglev is turning out to be difficult in terms of feasibility and affordability then there sure as hell isn’t much of chance for the rest of us.

If that’s the case, this blogger is privileged to have ridden on the “fastest ground transport toll in the present world” to quote the Guinness Book. And whatever the economics, it’s a pretty slick train ride into town.

Righty, enough of gawking and admiring a mass transit system that’s unlikely to take-off in Europe and time to get down to the dynamics of the oil & gas market. That's all for the moment from Shanghai folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo 1 (click on images to enlarge) : Shanghai Maglev Train. Photo 2: Carriage interior at 301km/hr speed. Photo 3: Shanghai Maglev's Guinness Book Record Certificate. Photo 4: Shanghai Maglev Train arrives at Longyang Road Metro Station. Photo 5: Illustration of magnetic levitation technology at SMT museum, Shanghai, China © Gaurav Sharma, September 2014.

Bright lights, energy finance & PE in Hong Kong

It is jolly good to be back in Hong Kong after nearly a decade and half. The city is home to some 7 million souls who live, work and sleep mostly in high-rise buildings given it is one of the world’s most densely populated places and space is at a premium.

Having soaked in the dazzling lights, magnificent views from the Victoria Peak (see left) and the ubiquitous Star Ferry ride from Central pier on Hong Kong Island to Tsim Sha Tsui in Kowloon, the Oilholic decided to probe what’s afoot in terms of energy sector finance, and the market in general, in this part of the world. 

The timing couldn’t be better as the Hang Seng Index recently soared to a six-year high and that can only bode well for the 48 companies on there who account for 60% of market capitalisation of the Hong Kong Stock Exchange. While Alibaba.com might have opted to list in New York, rather than here, CGN Power Co, mainland China’s largest nuclear power producer by operational capacity, has decided to file for a US$2 billion initial public offering in Hong Kong.

For regional energy companies, Asia’s self-styled capital of finance has always been a key destination for equity finance, even though real estate and services stocks understandably dominate the market. In CGN Power’s case, the move is part of its strategic goal to turn-on more nuclear reactors and turn-off coal-fired power plants. The listing will see it in the company of China Resources, CLP Holdings, Hong Kong and China Gas Company, Hong Kong Electric Holdings (Towngas), Kunlun Energy (formerly CNPC Hong Kong) and of course trader SS United Group Oil & Gas Company to name a few prominent players. 

Away from public listings, the search for liquidity and capital raising exercises bring many mainland, regional and (of late) Western energy firms to the doors of Hong Kong’s Private Equity (PE) players, a trend that’s now firmly entrenched here and continues to rise. According to a local contact, there are currently just under 400 major PE companies operating in Hong Kong. The Chinese special administrative region (SAR) and former British colony is Asia’s second largest PE centre, second only to mainland China.

The energy sector (including oil & gas and cleantech), one is reliably informed, comes third in terms of PE finance after real estate and regional start-ups. A striking feature of PE funding flows originating in Hong Kong is the depth of international investment. The Oilholic noted oil & gas investments in Australia, India, Japan, South Korea and of course mainland China.

Furthermore, synergy and happy co-existence with PE groups based in mainland China is seeing funding stretch to jurisdictions previously untouched by them with the sizing up of international assets well beyond Australasia with oilfield services companies and independent E&P companies being the unsurprising targets (or shall we say beneficiaries).

For instance, Denise Lay, Chief Financial Officer of Tethys Petroleum, a London and Toronto-Listed oil and gas exploration firm, recently told yours truly in a Forbes interview about her company’s decision to sell 50% (plus one share) of its Kazakh assets to SinoHan, part of HanHong, a Beijing, China-based private equity fund.

Some notable PE players on everyone’s radar for oil & gas investments include Affinity Equity Partners, Baring PE Asia and Silver Grace AM. The funding pool, according to three local analysts is set to expand. One even complained of there being too much investment capital around and not enough deals, which is causing assets to go for inflated prices.

“But amid the synergy and seamless funding flows, there’s a bit of competition as well between SAR Hong Kong and China. For instance, the Hong Kong local administration is unashamedly pro-PE. Part of its overtures to attract more PE funds to be domiciled in Hong Kong includes amendment and extension of the current offshore fund exemption,” adds another.

Away from PE, most state-owned Chinese oil & gas firms have approached Hong Kong’s capital markets although the extent of their presence varies. While it’s a view that is not universally shared, for the Oilholic, the SAR with a convertible Hong Kong dollar (unlike the Yuan RMB which isn’t) serves as a good base for regional expansion and overseas forays for these guys.

On an unrelated note, one isn’t trying to establish any connect between gambling and the preferred currency, but the Hong Kong dollar is also the  legal tender of choice in the casinos of nearby Macau. 

The Oilholic discovered it the hard way this afternoon, having paid a visit to the Wynn Casino and trying to insert a Macau pataca note into the slot machine only to be told to use Hong Kong dollars. 

As of last year, gambling revenue in the former Portuguese colony and another Chinese SAR of US$45.2 billion, seven times the total of the Las Vegas strip, has made it the world’s largest gambling destination. Since photography is not permitted inside casinos, even with the presentation of an international press ID as the Oilholic did, here’s the exterior of the Wynn Casino with rival MGM in the background.

According to the World Bank, Macau’s GDP per capita came in at US$91,376 last year. That makes it the richest country globally after Luxembourg, Norway and Qatar. Mainland money flowing around Macau is pretty apparent, but not sure how much of it is filtering through to the masses.

There have been repeated calls of late for a better wages by casino workers facing higher inflation. It is a soundtrack gamblers from many countries ought to be pretty familiar with - wages not keeping pace with inflation. That’s all from Hong Kong and Macau folks! It’s time to head off to Shanghai. Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo 1: Hong Kong evening sky as seen from the Victoria Peak, Central, Hong Kong. Photo 2: Wynn Casino & Resort with MGM in the background, Macau © Gaurav Sharma, September 2014.

Geopolitical loving: When Abe met Modi

The Oilholic finds himself roughly 6,000 miles east of London in Tokyo, Japan. While yours truly is here for cultural and ‘crude’ pursuits, another visitor was in town to firm up a crucial strategic tie-up. It was none other than India’s recently elected Prime Minister Narendra Modi, who popped in to see Japanese counterpart Shinzo Abe.

There’s been something of a political loving between these two heads of state. Abe hardly follows anyone on Twitter; Modi being one of the only four people he currently does follow! The Japanese PM was the first among international counterparts to congratulate Modi following his stunning mandate after elections in India. If you think that’s not a big deal, well US President Barack Obama got a welcoming handshake from Abe; NHK footage of Modi’s arrival in Japan shows one heck of a ‘best pal’ Abe-Modi bear hug. Protocol and formality not required between friends seems to be the message.

It is only Modi’s second and most prominent foreign visit since he assumed office this year; no offence to Nepal which was the first destination of his choice. Both leaders lean right, though the Indian PM’s right-wing credentials are stronger in a strictly domestic sense. The Japanese and Indian media went positively ballistic over the visit, atop giving it front-page stuff prominence. It’s extraordinary for all of this to be related to a bilateral meeting between two heads of state, with no priors, unless there was a collaborative attitude behind the scenes.

Any analyst worth his/her weight would note that at the heart of it is a move to counterbalance China, a country that has an uneasy relationship with both India and Japan. As if to underscore the point, Modi, visibly moved with the superb reception he received, criticised the “expansionist” maritime agenda of certain states. Wonder who he could possibly be referring to with the South China Sea so close-by?

Both countries are wary of China, have similar economic problems (cue inflationary concerns) and remain major importers of natural resources. As if for good measure, throw religion into the mix as Japan’s primary faith – Buddhism – was founded in the Indian subcontinent. So finding common ground or the pretext of a common ground is not hard for Abe and Modi.

Now is the Abe-Modi summit a big deal? In the Oilholic’s opinion, the answer is yes. We’ll come to natural resources and ‘crude’ matters shortly, but hear this out first – Japan is to invest US$34 billion spread over the next five years in terms of deal valuation. The trade between the two is insipid at the moment, either side of 1% of the total export pile in each case with the Japanese exporting marginally more than they’re importing from India. That makes the announcement a very positive development.

Japan, according to both men, could turn to India for its rare earth needs, a market led by China. While claims of India becoming a wholesale manufacturing base for Japanese electronics and engineering giants are a bit overblown, to quote the Indian PM: “We see a new era of cooperation in high-end defence technology and equipment.”

As for exchanging views on inflation - India’s, until recently was out of control and has only just been somewhat reigned in with the country's economy starting to gain momentum. Japan's on the other hand, “Abenomics” or not, has not managed to gain momentum (economy has shrunk in annualised terms last quarter by 6.8%). Inflation, thanks to a sales tax rise which came into effect in April, is not under control either with the country’s Consumer Prices Index (CPI) up 3.4% in July. That's well above the Bank of Japan’s target rate of 2%.

Given both countries are major importers of crude oil and natural gas, even a minor price rise has a major knock-on effect right from the point of importation to further down the consumer chain. At the moment, both are benefitting from a two-month decline in oil prices. Both PMs think they can work together towards the procurement of liquefied natural gas, according to an Indian source. The idea of two major importers strategising together sounds good, but concrete details are yet to be released.

If there was one hiccup, the two sides did not reach an agreement over the transfer of nuclear technology to India. Politics aside, Japan for its part is still grappling with the effects of Fukushima on all fronts - legal, natural and physical. Tepco, the company which operated the plant, is still in courts. The latest lawsuit - by workers demanding compensation - is a big one.

But not to digress, how did the men describe the summit themselves? For Modi, it was an “upgrade” in bilateral relations. For Abe, it was “a meeting of minds”. China would, and should, view it very differently. There is one not-so-mute point. Abe did not take any direct or indirect swipes at China, Modi (as mentioned above) was not so restrained. One wonders if in Modi’s quest for geopolitical rebalancing in Asia, would it serve in India well to improve relations with Japan and let them deteriorate with China?

That’s all the contemplation from Tokyo for the moment folks. The Oilholic is heading to Hong Kong, albeit briefly, after a gap of over a decade. Its a sunny day here at Narita Airport as one takes off. More soon, keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo 1: Tokyo Bay Waterfront. Photo 2: Narita International Aiport, Japan © Gaurav Sharma, September 2014.

Brent’s flat feeling likely to linger

It’s been that sort of a month where the Brent futures contract seems to set record low after low in terms of recent trading prices. Earlier this week, we saw the price plummet to a 26-month low and lurk above US$102 per barrel level remaining largely flat. In the Oilholic’s opinion there is room for further connection yet.

The only reason the price has stayed in three figures is down to demand from refineries in India and China, met largely by West African crude. The jury is still out on whether a $100 price floor is forming, something which is not guaranteed. Macroeconomic climate remains a shade dicey and much might depend on how China’s fares.

With the Brent prices falling 5.6% in month over month terms, last week Bloomberg reported that Chinese refiners bought 40 cargoes of West African crude to load in September, equating to about 1.27 million barrels a day. As the Indians bought another 27 cargoes over the biggest monthly drop in prices since April 2013, the total volume purchased lent support to the price or the $100 floor would have almost certainly been breached. Geopolitics is not providing that much of a risk driven bearish impetus, even hedge funds have finally realised that by reducing bullish bets on Brent by 12.5% to just 63,079 contacts in the week beginning August 19, as wiser heads appear to be prevailing of late.

From price of the crude stuff to those trying to make money on it – as some in the UK oil & gas sector have suggested that London-listed exploration and production (E&P) firms might be down the dumps. Investec analyst Brian Gallagher clearly isn’t one of them. In a note to clients, he said the sector should not be feeling sorry for itself. 

“Brent has been above $100 per barrel all year and broadly above $100 per barrel for three years now. Performance of E&P companies generally has just not been up to the mark from an operational and exploration perspective. Unique events have also disrupted narratives. Valuations are however becoming tempting again and we maintain bullish views on Amerisur and Cairn.”

Aside from these two, market valuations are still pricing in exploration barrels, which Investec analysts don’t necessarily disagree with. “Nevertheless, if you want to trade discovered barrels, you’ll have to wait for lower levels in Amerisur, Genel, Ophir and Tullow, in our view,” Gallagher added.

Sticking with corporates, here’s the Oilholic’s latest interview for Forbes with Barbara Spurrier, Finance Director of London’s AIM-listed Frontier Resources on the subject of potential barrels in Oman’s Block 38. Yours truly also recently interviewed Alexis Bédeneau, Head of IT at Primagaz France, a company owned by international conglomerate SHV Group on the crucial subject of cybersecurity and IT process streamlining within the oil & gas sector.

Finally, a Fitch Ratings report titled “European Union has Little Chance of Cutting Reliance on Russian Gas” rather gives away the concluding argument. The agency opines that Europe is unlikely to be able to reduce its reliance on Russian natural gas for at least the next decade and potentially much longer. 

“At best the EU may be able to avoid significantly increasing its gas purchases from Russia. Any attempt to improve energy security by reducing European reliance on Russia would require either a significant reduction in overall gas demand or a big increase in alternative sources of supply, but neither of these appears likely,” Fitch said.

European shale gas remains in its infancy and Fitch believes it will take “at least a decade” for production to reach meaningful volumes. By that point, of course it would probably only offset the decline in production from Europe's conventional gas wells and won’t be a US-style bonanza some are imagining. 

Piped gas imports to Europe from markets other than Russia are also likely to remain limited. Fitch opined that the Trans Anatolian Natural Gas Pipeline is the only viable non-Russian pipeline under consideration. This could provide 31 billion cubic metres of gas per annum by 2026, but that’s not enough to cover the incremental increase in gas demand the agency expects over the period, let alone replace any supplies from Russia!

Additionally LNG supplies will rise, but the market is unlikely to be large enough to gain market share against Russian gas. A candid and brutal assessment, just the sort this blogger likes, but maybe not the policymakers with camera facing soundbites in Brussels. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo: Oil tanker in Bosphorus, Istanbul, Turkey © Gaurav Sharma, March 2014.

Not that taut: Oil markets & geopolitical tension

The month of August has brought along a milestone for the Oilholics Synonymous Report, but let’s get going with crude matters for starters as oil markets continue to resist a risk premium driven spike.

The unfolding tragedy in Iraq, Libya’s troubles, Nigerian niggles and the fear of Ebola hitting exploration and production activity in West Africa, are more than enough to provide many paper traders with the pretext to go long and spook us all. Yet, the plentiful supply and stunted OECD demand scenario that’s carried over from last month has made geopolitical tension tolerable. As such its not percolating through to influence market sentiment in any appreciable fashion, bringing about a much needed price correction.

It wasn’t the news of US air strikes on ISIS that drove Brent down to a nine month low this week, rather the cautious mood of paper traders that did it. Among that lot were hedge fund guys n’ gals who burnt their fingers recently on long bets (that backfired spectacularly in July), and resisted going long as soon as news of the latest Iraqi flare-up surfaced, quite unlike last time.

According to ICE data, hedge funds and other money managers reduced net bullish bets on Brent futures to 97,351 contracts in the week to August 5; the lowest on books since February 4. Once bitten, twice shy and you all know why. Brent price is now comfortably within the Oilholic’s predicted price range for 2014.

Away from pricing, the other big news of course is about the megamerger of Kinder Morgan Inc (KMI), Kinder Morgan Energy Partners (KMP) and El Paso Pipeline Partners Operating (EPBO), into one entity. The $71 billion plus complicated acquisition would create the largest oil and gas infrastructure company in the US by some distance and the country’s third-largest corporation in the sector after ExxonMobil and Chevron.

Moody’s, which has suspended its ratings on the companies for the moment, says generally the ratings for KMP and its subsidiaries will be reviewed for downgrade, and the ratings for KMI and EPBO and their subsidiaries will be reviewed for upgrade.

Stuart Miller, Moody's Vice President and Senior Credit Officer, notes: "KMI's large portfolio of high-quality assets generates a stable and predictable level of cash flow which could support a strong investment grade rating. However, because of the high leverage along with a high dividend payout ratio, we expect the new Kinder Morgan to be weakly positioned with an investment grade rating."

Sticking with Moody’s, following Argentina’s default on paper, the agency has unsurprisingly changed its outlook on the country’s major companies from stable to negative. Those affected in the sector include YPF. However, Petrobras Argentina and Pan American Energy Argentina were spared a negative outlook given their subsidiary status and disconnect from headline Argentine sovereign risk.

Switching tack from ratings notes to a Reuters report, a recent one from the newswire noted that the volume of US crude exports to Canada now exceeds the export level of OPEC lightweight Ecuador. While the Oilholic remains unconvinced about US crude joining the global crude supply pool anytime soon, there’s no harm in a bit of legally permitted neighbourly help. Inflows and outflows between the countries even things out; though Canadian oil exports going the other way are, and have always been, higher.

On the subject of reports, here’s the Oilholic’s latest quip on Forbes regarding the demise of commodities trading at investment banks and another one on the crucial subject of furthering gender diversity in the oil and gas business. 

Finally, going back to where one began, it is time to say a big THANK YOU to all you readers out there for your encouragement, criticism, feedback, compliments (as applicable) and the time you make to read this blogger’s thoughts. Though ever grateful, one feels like reiterating the gratitude today as Google Analytics has confirmed that US readers have overtaken the Oilholic's ‘home’ readers as of last month.

It matters as this humble blog has moved from 50 local clicks in December 2009 to 148k global clicks (and counting) this year and its been one great journey. The US, UK and Norway are currently the top three countries in terms of pageviews in that order (see right), followed by China, Germany, Russia, Canada, France, India and Turkey completing the top ten. Traffic also continues to climb from Australia, Brazil, Benelux, Hong Kong, Japan and Ukraine; so onwards and upwards to new frontiers with your continuing support. Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Oil rig, USA © Shell. Graphics: Oilholics Synonymous Report, July 2014 clickstats © Google Analytics

Crude market, Russia & fretting over Afren

There's been an unsurprising calm in the oil market given the existing supply-side scenario, although the WTI's slip below three figures is more down to local factors above anything else.

Demand stateside is low while supplies are up. Additionally, the CVR Refinery in Coffeyville, Kansas which uses crude from Cushing, Oklahoma and churns 115,000 barrels per day (bpd) is offline and will remain so for another four weeks owing to a fire. It all means that Brent's premium to the WTI is now above US$7 per barrel. Despite (sigh) the latest Libyan flare-up, Brent itself has been lurking either side of $105 level, not as much down to oversupply but rather stunted demand. And the benchmark's current price level has triggered some rather interesting events.

Brent's premium to Dubai crude hit its lowest level in four years this week. According to Reuters, at one point the spread was as low as $1.20 following Monday's settlement. The newswire also reported that Oman crude actually went above Brent following settlement on July 31, albeit down to thin trading volumes.

Away from pricing, the Oilholic has been busy reading agency reports on the impact of the latest round of sanctions on Russia. The most interesting one came from Maxim Edelson of Fitch Ratings, who opined that sanctions could accelerate the decline of Siberian oilfields.

Enhanced recovery techniques used in these fields are similar to those used for shale oil extraction, one of the target areas for the sanctions. As the curbs begin to hit home and technology sales to the Russian oil & gas sector dry up, it will become increasingly harder to maintain rate of production from depleting West Siberia brownfields.

As brownfields are mature, major Russian oil companies are moving into more difficult parts of the existing formations. For example, GazpromNeft, an oil subsidiary of Gazprom, is increasingly relying on wells with horizontal drilling, which accounted for 42% of all wells drilled in 2013 compared to 4% in 2011, and multi-stage fracking, which was used in 57% of high-tech wells completed in 2013, up from 3% in 2011.

"In the medium term, [EU and US] measures are also likely to delay some of Russia's more ambitious projects, particularly those on the Arctic shelf. If the sanctions remain for a very long time they could even undermine the feasibility of these projects, unless Russia can find alternative sources of technology or develop its own," Edelson wrote further.

Russian companies have limited experience in working with non-traditional deposits that require specialised equipment and "know-how" and are increasingly reliant on joint ventures (JVs) with western companies to provide technology and equipment. All such JVs could be hit by sanctions, with oil majors such as ExxonMobil, Shell and BP, oil service companies Schlumberger, Halliburton and Baker Hughes, and Russia's Rosneft, GazpromNeft and to a lesser extent LUKOIL, Novatek and Tatneft, all in the crude mix.

More importantly, whether or not Russia's oil & gas sector takes a knock, what's going on at the moment coupled with the potential for further US and EU sanctions on the horizon, is likely to reduce western companies' appetite for involvement in new projects, Edelson adds.

Of course, one notes that in tune with the EU's selfish need for Russian gas, its sanctions don't clobber the development of gas fields for the moment. On a related note, Fitch currently rates Gazprom's long-term foreign currency Issuer Default Rating (IDR) at 'BBB', with a 'Negative' outlook, influenced to a great extent by Russia's sovereign outlook.

Continuing with Russia, here is The Oilholic's Forbes article on why BP can withstand sanctions on Russia despite its 19.75% stake in Rosneft. Elsewhere, yours truly also discussed why North Sea exploration & production (E&P) isn't dead yet in another Forbes post.

Finally, news that the CEO and COO of Afren had been temporarily suspended pending investigation of alleged unauthorised payments, came as a bolt out of the blue. At one point, share price of the Africa and Iraqi Kurdistan-focussed E&P company dipped by 29%, as the suspension of CEO Osman Shahenshah and COO Shahid Ullah was revealed to the London Stock Exchange.

While the wider market set about shorting Afren, the company said its board had no reason to believe this will negatively affect its stated financial and operational position.

"In the course of an independent review on the board's behalf by Willkie Farr & Gallagher (UK) LLP of the potential need for disclosure of certain previous transactions to the market, evidence has been identified of the receipt of unauthorised payments potentially for the benefit of the CEO and COO. These payments were not made by Afren. The investigation has not found any evidence that any other Board members were involved," it added.

No conclusive findings have yet been reached and the investigation is ongoing. In the Oilholic's humble opinion the market has overreacted and a bit of perspective is required. The company itself remains in a healthy position with a solid income stream and steadily rising operating profits. Simply put, the underlying fundamentals remain sound.

As of March 31 this year, Afren had no short-term debt and cash reserves of $361 million. In 2013, the company improved its debt maturity profile by issuing a $360 million secured bond due 2020 and partially repaying its $500 million bond due 2016 (with $253 million currently outstanding) and $300 million bond due 2019 (with $250 million currently outstanding).

So despite the sell-off given the unusual development, many brokers have maintained a 'buy' rating on the stock pending more information, and rightly so. Some, like Investec, cautiously downgraded it to 'hold' from 'buy', while JPMorgan held its 'overweight' recommendation on the stock. There's a need to keep calm, and carry on the Afren front. That's all for the moment folks. Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Russian Oilfields © Lukoil

Hedge Funds have been ‘contangoed’

Recent events may have pushed the Brent front month futures contract back towards US$108 per barrel; but there's no denying some have been 'contangoed'! Ukrainian tensions and lower Libyan production are hard to ignore, even if the latter is a bit of a given.

Nonetheless, for a change, the direction of both benchmark prices this month indicates that July did belong to the physical traders with papers traders, most notably Hedge Funds, taking a beating.

It's astonishing (or perhaps not) that many paper traders went long on Brent banking on the premise of "the only way is up" as the Iraqi insurgency escalated last month. The only problem was that Iraqi oil was still getting dispatched from its southern oil hub of Basra despite internal chaos. Furthermore, areas under ISIS control hardly included any major Iraqi oil production zone.

After spiking above $115, the Brent price soon plummeted to under $105 as the reality of the physical market began to bite. It seems European refiners were holding back from buying the expensive crude stuff faced with declining margins. In fact, North Sea shipments, which Brent is largely synced with, were at monthly lows. Let alone bothering to pull out a map of Iraqi oilfields, many paper traders didn't even bother with the ancillary warning signs.

As Fitch Ratings noted earlier this month, the European refining margins are likely to remain weak for at least the next one to two years due to overcapacity, demand and supply imbalances, and competition from overseas. Over the first half of 2014, the northwest European refining margin averaged $3.3 per barrel, down from $4 per barrel in 2013 and $6.8 barrel in 2012.

Many European refineries have been loss-making or only slightly profitable, depending on their complexity, location and efficiency. They are hardly the sort of buyers to purchase consignments by the tanker-load during a mini bull run. The weaker margin scenario itself is nothing new, resulting from factors including a stagnating economy and the bias of domestic consumption towards diesel due to EU energy regulations

"This means that surplus gasoline is exported and the diesel fuel deficit is filled by imports, prompting competition with Middle Eastern, Russian and US refineries, which have access to cheaper feedstock and lower energy costs on average. Mediterranean refiners are additionally hurt by the interruption of oil supplies from Libya, but this situation may improve with the resumption of eastern port exports," explains Fitch analyst Dmitry Marinchenko.

Of course tell that to Hedge Funds managers who still went long in June collectively holding just short of 600 million paper barrels on their books banking on backwardation. But thanks to smart, strategic buying by physical traders eyeing cargoes without firm buyers, contango set in hitting the hedge funds with massive losses.

When supply remains adequate (or shall we say perceived to be adequate) and key buyers are not in a mood to buy in the volumes they normally do down to operational constraints, you know you've been 'contangoed' as forward month delivery will come at a sharp discount to later contracts!

Now the retreat is clear as ICE's latest Commitments of Traders report for the week to July 15 saw Hedge Funds and other speculators cut their long bets by around 25%, reducing their net long futures and options positions in Brent to 151,981 from 201,568. If the window of scrutiny is extended to the last week of June, the Oilholic would say that's a reduction of nearly 40%.

As for the European refiners, competition from overseas is likely to remain high, although Fitch reckons margins may start to recover in the medium term as economic growth gradually improves and overall refining capacity in Europe decreases. For instance, a recent Bloomberg survey indicated that of the 104 refining facilities region wide, 10 will shut permanently by 2020 from France to Italy to the Czech Republic. No surprises there as both OPEC and the IEA see European fuel demand as being largely flat.

Speaking of the IEA, the Oilholic got a chance earlier this month to chat with its Chief Economist Dr Fatih Birol. Despite the latest tension, he sees Russian oil & gas as a key component of the global energy mix (Read all about it in The Oilholic's Forbes post.)

Meanwhile, Moody's sees new US sanctions on Russia as credit negative for Rosneft and Novatek. The latest round of curbs will effectively prohibit Rosneft, Novatek, and other sanctioned entities, including several Russian banks and defence companies, from procuring financing and new debt from US investors, companies and banks.

Rosneft and Novatek will in effect be barred from obtaining future loans with a maturity of more than 90 days or new equity, cutting them off from long-term US capital markets. As both companies' trade activities currently remain unaffected, Moody's is not taking ratings action yet. However, the agency says the sanctions will significantly limit both companies' financing options and could put pressure on development projects, such as Novatek's Yamal LNG.

No one is sure what the aftermath of the MH17 tragedy would be, how the Ukrainian crisis would be resolved, and what implications it has for Russian energy companies and their Western partners. All we can do is wait and see. That's all for the moment folks. Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo: Oil pipeline © Cairn Energy