Archive for February, 2010
The International Energy Agency, IEA, last year projected a crude oil price shock by the year 2012, just about two years away. The agency had argued that when the global economy began to rebound, crude oil demand would outstrip supply capability, the latter having been impacted by reduced capital expenditure (capex) associated with the global economic slump.
According to market reports, crude oil price reached US$80 per barrel in intraday trading on the last day of 2009, ending the year 78% up for the front-month contract on the New York market; that was more than twice the prices seen at the same period a year before. Price rallies saw some analysts adduce certain price markers, above which a surge would be triggered.
In a previous post on oil price shocks and market fundamentals, l argued, and for three reasons, that even in the unlikely event of a short-term oil price shock, such would be unlikely to show any market fundamental support. First reason was the somewhat, overstated figures for capex reduction as well as the increased viability of projects (due to reduced operational costs of mainly labor and materials) which arise from the economic slump; secondly, the increasing reserve additions; and finally, substitution and efficiency. Implicit in the reference above, to fundamentals, are the so-called “traditionals” or “physicals” such as inventories, demand and supply, as distinct from the “financials” such as currency values, bonds and equities.
Recent industry data do give credence to my arguments on all three scores:
1. Current data from IHS CERA and the U.S Department of Labor Statistics reportedly indicate that aggregate upstream capital costs declined by 12% (year-on-year) in November 2009. The implication then is that even with reduced capital deployment (some recent reports put the capex decline at 15%), effective investment in the industry may at worst, be little changed while actual production may increase. The latter has been the case with Russia for example; the Natural Resources minister for that country, as reported by Platts, revealed that even with substantial capex reductions, reserves in 2009 grew by 5.3% over the previous year. Even the capital-intensive tar sands projects of Canada are set to benefit from such costs reduction. Capex values however, though currently lower than those for the period before the global economic crises, have been increasing. According to Oil and Gas Financial Journal, capex in 2Q09 for the 20 largest U.S. publicly traded companies increased by more than 47.5%, nearly doubling the $28.1 billion spent in 1Q09.
2. Global crude oil production and reserves are also set to witness substantial additions (even in the short and medium terms). For example, Abdalla El-Badri, secretatry-general of the Organization of the Petroleum Exporting Countries, OPEC, as reported by Financial Times Energy Source has confirmed that “the current investment is going to be enough to satisfy demand and provide a cushion of spare capacity of 6 million barrels by 2013”. Rigzone reports that CEO of the Brazilian NOC, Petrobras says the company is on course to increase its reserves by 21 billion barrels from 2009 levels in just less than two years, increasing its production capacity in the process. In 2009, Russia’s addition to reserves exceeded production by 25% and, though there are still political hurdles to be crossed, Iraq’s oil production is set to equal or exceed that of the long dominant Saudi Arabia in seven to ten years. Substantial capacity increases are also expected from the massive Atlantic provinces of Africa, where first production from Ghana’s 1.8 billion-barrel Jubilee fields for example, is expected later this year. According to Argus, non-OPEC supply grew by more than 500,000 barrels per day last year mainly from Russia and the Gulf of Mexico. It also expects 2010 oil demand to rise by 1.5 million barrels per day, bbls/d, after falling by 2 million bbls/d last year, adding that 2010 consumption is unlikely to exceed 2006 levels. These are in addition to large inventories. Interestingly, recent United States Geological Survey, USGS, data have put Venezuela’s technically recoverable reserves in that country’s Orinoco oil belt at a massive 513 billion barrels (about the world’s largest), out of about 1 trillion barrels. In truth, though most industry operators know where Venezuela is, few if any, for the moment, would be rushing down there; but it could only take a regime change to spur fervent interest.
3. Finally, a steep rebound to robust, global economic activity, a major driver for energy demand, is not likely. The International Monetary Fund, IMF, for example, in its recent Global Financial Stability Report and World Economic Outlook press conference, expected global economic growth rates in 2010 and 2011 to be 4% and 4.3% respectively (another report has 2.7% for 2010). It also warned that recovery of the global economy remains rather sluggish and fragile (especially with fears of a ‘double dip’), and such is quite indicative especially when viewed in the light of the depths to which it slumped. Even when economic activity does fully rebound, oil demand in developed economies would most likely not return to pre-slump levels due mainly to substitution and increased efficiency. Driven principally by China and India, oil demand growth in emerging market countries is expected to outstrip that of developed economies; but product subsidies (many of which are now being repealed or reduced) in emerging economies often distort demand projection figures. According to the IMF’s Oliver Blanchard, China’s growth “is still partly based on very strong fiscal stimulus and credit easing” and some analysts have hinted at a scaling back on fears of economic overheating among others. It is also noteworthy that according to most evaluation accounts, China boasts the steepest growth rate in renewable energy development, matching her “aggressive” oil policies. The latter therefore may largely be interim and supplementary.
These factors largely do not admit a short-term (or even a medium-term) supply crunch, which has been projected as the driver for a short-term price shock. That said, prices may surge even with adequate supply. During the oil price surge of 2008 for example, prices spiralled higher while the market was well supplied. The causative factors were aptly described by Chris Cook, former Director of the International Petroleum Exchange (as quoted in an article on Oil-Price.net). He said “…the principal cause of the financial crises and of the volatility are one and the same – to wit, the ‘leverage’ or ‘gearing’ derived in the former case by deficit-based credit creation by banks, and in the latter case by both bank credit creation and forward/futures contracts”.
Subsequent price spikes were in spite of bloated (including massive floating or unconventional) inventories as well as very weak demand. The result was that in 2009, even with a doubling of crude oil prices (between Q1 and Q2), major IOCs posted as much as 76% decline in their Q2 earnings reports.
In an earlier article, International Oil Companies: The Challenges Ahead, l discussed three broad challenges that International Oil Companies, IOCs were and still are grappling with. Over the last decade for example, major IOCs have had increasing difficulty to profitable reserves addition. More worrisome for them is the rise of National Oil Companies, NOCs. The increasing domiciliation of national reserves with these NOCs, their access to large state funds on terms that are more favorable, as well as other perquisites of state, have sharpened their competitive edge over IOCs.
Investment interest has been shifting in favor of NOCs and not surprisingly so. According to PFC Energy, growth in market value of NOCs has far outstripped that of IOCs. For example, in 2009, NOCs gained an average 66% in market value compared with less than 1% for the six largest IOCs. The NOCs Rosneft (125%), Petrobras (103%), Sinopec (101%), Gazprom (67%) and Statoil Hydro (57%) showed stronger share price changes (y-o-y) than the IOCs ExxonMobil (-15%), Chevron (4%), ENI (8%), TOTAL (19%) and Royal Dutch Shell (26%). PetroChina recently replaced ExxonMobil as the largest group by market capitalization, while Brazil’s Petrobras moved up to the fourth position. Among the top 15 energy companies, 6 are NOCs.
While some smaller (even if newer) IOCs are showing good growth prospects (these companies will be evaluated in a subsequent post), major IOCs however, face growth constraints. For example, recent industry reports indicate that because of limited access to major new sources of reserves, major IOCs plan to increase upstream expenditure by a meagre 1% in 2010, compared to about 15% for NOCs (which boast greater access to sources of reserves).
Access to reserves is critical to growth. In Russia for example, access by foreign oil companies to strategic petroleum reserves (essentially, offshore fields or those with more than 500 million barrels of oil or 50 billion cubic meters of gas) is limited to companies in which the Russian stake exceeds 50%. In Nigeria, reserves are domiciled with the state, which extracts steep taxes and levies from operating IOCs. A recent proposal in Brazil provided for about two thirds of total rights in the massive sub-salt fields to be reposed with that country’s NOC. Even in those NOCs with lower domestic reserves, their easy access to massive state funds and product markets give them the competitive advantage over IOCs. Table 1 below is illustrative.
Proceedings of Iraq’s recently concluded, second, bid round for oil block, service contracts clearly demonstrate the rising dominance of these NOCs in the global oil and gas industry. The service contracts were auctioned for one of the world’s last, largest, easily (and cheaply) exploitable reserves and as such were highly competitive. In a bid round that initially registered more than forty oil and gas companies, the NOCs Petronas (Malaysia) and Sonangol (Angola) were successful in five bids while only three European IOCs were successful. No U.S. IOC was successful and Chinese NOCs entered the highest number of bids. The largest field (12.9 billion barrels) was won by a partnership between Russia’s privately held Lukoil (major) and Norway’s state-controlled Statoil (minor). The next largest (12.6 billion barrels), was won by another partnership between Royal Dutch Shell (45%) and Petronas (30%). In the earlier bid round, a partnership between BP and CNPC, a Chinese NOC for development of the supergiant Rumaila field (about 17 billion barrels) was the the only successful bid. Generally, these NOCs boast the advantage of lower operating costs (mainly personnel and matériel) and with state leverage, are able to operate even in high-risk zones.