Archive for the ‘biodiesel’ Category

Rising Crude Oil Prices: Good Time to Buy Oil Stocks?

The current wave of unrest blowing across the Middle East , North Africa (MENA) region and the associated uptick in crude oil prices have raised concerns about another (and possibly sustained) global crude oil price shock — the region currently holds about 60% and 45% of global crude oil and natural gas reserves respectively and accounted for about 45% of global oil exports in 2009.  Current estimates of potential peak oil prices for the year range from US$130 per barrel to US$300 per barrel; recent investment considerations have therefore dwelt on the merits (or otherwise) of buying oil stocks at such times. Three points are noteworthy:

1. Oil Prices and Corporate Earnings

This may sound counterintuitive but rising crude oil prices do not always translate to higher corporate earnings for oil and gas operators and oversupply does not always bring about falling prices. In 2009 for example, crude oil prices doubled between early Q1 and end Q4 but major oil and gas companies recorded steep decline in earnings (for some, as much as 70%); this doubling of prices was in spite of massive, global crude oil inventories —  even floating and other storages were fully oil-laden.

According to a recent report by the energy research firm Evaluate Energy, the six largest IOCs by market capitalization to wit, BP, Chevron, ConocoPhillips, ExxonMobil, Royal Dutch Shell and Total, have, in spite of massive capital expenditure “failed to materially expand either their production or their proved reserve base over the past decade”; acquisitions alone accounted for 28% of their ten-year reserves replacement. The implication then, if these conditions persist, is that rising discovery costs per barrel of oil — which would probably become even steeper given the increasing geological complexities of available acreages — may test the profitability of these companies in due course, even in spite of rising oil prices.

2. Policies of State – royalties and windfall profits taxes

Among major petroleum exporting countries, the steep royalty and tax rates on oil proceeds have been more than an emperor’s ransom to the operating IOCs. In addition to reserves constraints, these have brought them under comparative disadvantages with their state-controlled counterparts, National Oil Companies or NOCs, especially those that have re-organized and have become partially-listed (see Figure 1 below for example).

That said, for some of these countries, these rates are tenured — and therefore stable even if unpalatable — and that significantly reduces investors’ worries about uncertainty. In Nigeria, Africa’s largest crude oil producer, IOCs have decried an “asphyxiating” government take on oil proceeds and some have even threatened to quit the country altogether. The country’s enabling Petroleum Industry Bill however, has been languishing, trophied in the legislature’s dust even as accusations of bribery have been rife.

Surprising and destabilizing however, was the announcement last week by the British Chancellor of the Exchequer in his new budget reading, of a substantial tax hike for oil companies operating in the North Sea; surprising, not just because it was unforeseen, but also because it was made by a Conservative (and presumably more business-friendly) government. The announcement saw dips in the shares of some mid-cap companies. While many companies are currently re-evaluating their North Sea operations, some mature field operators have warned that the hike would amount to an effective tax rate of as much as 81%, possibly a death knell. The government’s response was that higher oil prices would still make them profitable. A windfall profits tax by any other name…?

While there may be strident opposition to high taxes in some political quarters of the United States, one can never discount the degree of shrewd bargaining in those political back rooms. For example, though they may not want to admit it publicly, some oil and gas operators would not mind a little hike in tax if that would mean less restrictive regulatory regimes (such as much faster and more flexible permitting for drilling and exploitation) than are currently in place.

Oil and gas majors  such as Royal Dutch Shell and BP have been divesting North Sea assets for some time but this tax hike may dilute the value of both divested and retained assets, making such assets unattractive and even reconfiguring planned capital expenditure by reducing estimated divestment proceeds. Financial Times reports that companies with the biggest exposure in North Sea include BG Group, Premier Oil and Enquest.

NOCs in comparison, when operating in their domestic acreages are not subject to such asphyxiating operational regimes as IOCs and some have put such advantage to good use. Brazil’s Petrobras for example, has made what is arguably one of the largest ultra deepwater oil discoveries in recent times. Its market capitalization, grew by a 27% compound annual rate between 1999 and 2010 according to PFC Energy, the energy research group and its public offering in 2010 returned a record US$70 billion; also, Columbia’s Ecopetrol which had impressive 2010 results has attracted the investment attention of billionaire investor Carlos Slim.

3. Alternatives

When rising crude oil prices are sustained, investment windows inevitably open for alternative energy or oil sources such as oil sands. Early investors in Canada’s oil sands for example were on better footing than much later ones which had to grapple with spiraling project costs requiring crude oil prices of between US85 per barrel and US$95 per barrel for breakeven. Many of the latter projects were subsequently suspended after oil prices plummeted. Following project reconfigurations however, this breakeven point is now estimated at between US$60 per barrel and US$70 per barrel; and with current crude oil prices at about US$30 above the top of that  range, there is a seemingly comfortable operational window.

Cenovus, Enbridge and Total SA have all signed exploitation agreements with Canada’s First Nations to scale the second oil sands operational hurdle; now, just environmental considerations remain, which in the light of Japan’s recent nuclear reactor problems, may seem middling. Suncor and Husky Energy also have joint venture projects coming on-stream.

According to IHS Cera, three quarters of the projects which were previously set to bring about 2 million barrels of oil per day on-stream have already been restarted. Some may even start coming on-stream by next year.

The impact of technological breakthrough on resource production can be enormous. Hydraulic fracturing and horizontal drilling for example were crucial to the shale gas explosion in the United States and which explosion may be replicated in parts of Europe and Africa. While research into production of renewable petroleum fuels (such as diesel, gasoline and jet fuel among others) from bacteria is not new, a recent process — for which patents are being filed — celebrated a further step towards its actualization. Such a breakthrough if commercialized, could dramatically alter not just the global energy mix, but also the fortunes and even the very structure of oil companies involved in mostly conventional plays.

All said, while buying oil stocks in times of rising oil prices may not be ill-advised, it makes a difference however, what type of oil stocks one buys.

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Jatropha: Outsourcing For Biodiesel Production

The oil crop jatropha (Jatropha curcas) has suffered a spate of recent adverse reportage. First a research report concluded that it utilized a rather large 20,000 liters of water to produce a liter of biodiesel. This compares unfavorably with 14,000 liters for the biodiesel crops rapeseed and soybean. However, jatropha produces about four times more biodiesel per hectare of land than soybean and does not hold food-fuel issues that soybean would. The report assailed the much-bandied ability of jatropha to thrive on marginal soils, one of two main planks (the other being its high oil yield) on which its allure for biodiesel production rests. Then the oil major BP reportedly opted out of its joint venture with D1 on biodiesel production with jatropha as feedstock.

Water is a major factor in large-scale agriculture so when questions arose about jatropha’s water utility, various investors such as BP began to reconsider their investment.

In a previous post, l argued that when crops were grown in their natural environment, natural resources utility may be of little concern. For the palm oil plantations of the equatorial regions of West Africa and Southeast Asia for example, irrigation is of little concern as they have ample supply of water (rainfall) and sunshine. The same is applicable for jatropha. To argue then that these crops are “water hogs”, questioning their suitability for biodiesel production even when they are grown in their natural environment is misleading, if not untenable.

The quest to grow oil and other crops in their natural environment may have informed the spate of recent outsourcing contracts. An article in a recent issue of Economist detailed the outsourcing of crops by countries with natural resources constraints. Saudi Arabia, for example having become self-sufficient in wheat, had to abandon the grain fields due to severe drawdown in the associated aquifer beneath the Arabian sands. The country resorted to outsourcing – growing the crops in other mainly developing countries and repatriating a greater portion of the harvest. Then came South Korea and the oil-thirsty China. The latter, prompted by dewatering of areas like the North China Plain, reportedly acquired African acreages for jatropha cultivation in addition to the world’s largest oil palm acreage, which it intends to use for biodiesel production. The alternative would be to develop seed varieties that would be viable in consumer countries.

The risk may not be much different from that associated with importation of oil and gas from politically unstable or volatile regions. In this regard, for example the United States is currently increasing its supply of oil from Africa at the expense of the volatile Middle East suppliers. Some European Union countries are also evaluating supply prospects from the West African province to ameliorate the perennial problems with Russian gas supplies.

The success of these outsourcing contracts will depend more on political than agricultural considerations.

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Jatropha And Water Utility

A recent research report detailed the water utility for 12 energy crops and concluded that the oil crop jatropha (Jatropha curcas) utilized about 20,000 liters of water to produce 1 liter of biodiesel, compared to 14,000 liters for rapeseed and soybean. The implication being that its much-acclaimed ability to thrive on marginal soils is incorrect. The report conceded that while the data for other crops were obtained from countries around the world, those for jatropha were obtained from India, Indonesia, Nicaragua, Guatemala and Brazil. It also admitted that jatropha can indeed thrive on arid soil but that its oil yield would then be low.
Jatropha may indeed be a “water hog” as has been attributed but the limited data for such attribute in comparison with the other crops may render that report inconclusive. The use of water resources varies quite substantially around the world and as such applying utility data for 5 countries in the assessment of any crop, may not reflect the true global utility values for that crop.

Table 1 shows the biodiesel yield for common crops. While jatropha does have high biodiesel productivity, its value is certainly not the highest.

Palm oil, from the oil palm (Elaeis guineensis) for example, yields about four times as much biodiesel per hectare of cultivated land than jatropha and that does not include the added yield from the palm kernel. A crop of oil palm trees also has the advantage of extended productivity sometimes for decades.

The oil yield from some oil palm varieties has benefited from cross-breeding over the years. For example, in West Africa, the thick-shelled Dura variety has been crossed with the shell-less Pisifera variety to produce the Tenera, which has much larger pulp and smaller kernels, hence optimizing yield. The Tenera has now become the breeding and planting standard.
Such modification (for such qualities as improved yield, hardiness and climatic adaptation for example) is common agricultural practice and has been used in food and other crops such as wheat, soybeans, rice, sugarcane, etc. If indeed jatropha were a water hog, it would certainly benefit from such “tweaking” to produce “less thirsty” varieties for growth in regions where water resource utility is of concern.

One further note on crop resource utility: When crops are grown in their natural environment, natural resources utility may be of little concern. The oil palm for example thrives in the main, in the equatorial regions (with their ample rainfall and sunshine) of West Africa and Southeast Asia. For the vast oil palm plantations in these regions therefore, irrigation or water utility concerns do not arise, even if the oil palm were a monster of a water hog.
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