Category Archives: Energy

Energy

Energy, On the cover, Sin categoría

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Just wanted to share some thoughts as I am seeing brokers call a bounce on utilities based on mean reversion and sector rotation. 

Despite being the biggest underperformer YTD, the utilities sector has four mounting problems:

a) €65bn to refinance to 2010
b) €35bn in asset disposals to keep single A rating
c) ROCE keeps sliding after five years of M&A at peak multiples
d) €20bn in capital increases (Enel, Gas Nat, Snam, Vestas, SSE, Centrica…)
Look at the chart attached, because it’s scary. The utilities have been re-rating year on year on commodity exposure, asset valuation increase from M&A and multiple expansion from new technologies (renewables) and at the same time it has become more cyclical, but with very inflexible capex (the sector spends 33% of its market cap every year on capex to deliver 3-4% EPS growth)… while ROCE has been deteriorating steadily (see chart).
On top of this, the sector trades on “growth” multiples (7x EV/EBITDA), but considering the loss of industrial demand and the forward cruve on spark and dark spreads, we could see a continued de-rating of the sector to ex-growth multiples.

The Illusion of Natural Gas Liquids

Energy, On the cover, Sin categoría

I have been reading in detail with interest (but not joy) the reports from OPEC, IEA and EIA.

The main argument raised by the bears about these reports has been to highlight the increase in supply estimates month on month, with different degrees of conviction by the three entities.

There are two main observations to make:

  1. Seems the consensus has stalled on demand around 83-84 million barrels a day. IEA sees demand down 3% year on year. EIA catched up with this figure and OPEC lowers it a bit (still 0.8mbpd above IEA at 84mbpd).
  2. Supply estimates remain optimistic: Effective spare capacity has contracted slightly to 5.3mbpd (versus 5.5mbpd) for IEA, which is more optimistic about non-OPEC supply than OPEC (which basically sees non-OPEC output down around 200,000 bpd less than the others).

Two interesting things come in the details though. The fact that supply estimates come predominantly from higher natural gas liquids and production of heavier crudes from mature basins (EIA calls for all projects forecasted in 2009 to deliver in line with expectations in 2009, something that has never happened). Additionally heavier oil means more refining costs and lower quantity of output. Heavy Arabian is trading at $54/bbl. While WTI is trading at $58. Crack spreads are at $10.3/bbl ($8.8 in Cushing). Heavy oils and the increasing cost of de-sulphurization are putting part of the floor on oil prices.

But the interesting point to me comes from what I call the illusion of Natural Gas Liquids (NGLs) which we saw in the past oil “down” cycle (which I painfully lived in the industry). Natural gas liquids are the hydrocarbons in natural gas that are separated from the gas as liquids through the process of (mainly) absorption or condensation. While the EIA, OPEC and EIA estimates continue to put current oil production at around 86m bbl/day, over 10% of this daily production is not oil at all but NGLs. More importantly, all the upward revisions in the three studies about non-OPEC supply come from NGLs. While these liquids are valuable, especially propane and butane, they are not a viable substitute for oil. Fractioning is a highly expensive process and neither can be economically used as a feedstock for gasoline or diesel and cannot be used for current diesel or gasoline engines.

So it is interesting to assess why the estimates are worthy but should be taken with caution. Obviously demand is poor and a clear concern, and while it remains weak it will be a strong driver of oil price movements

Crude Contango… How To Benefit

Energy, On the cover, Sin categoría

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The crude contango is making big profits for oil majors as they make money from storage and selling forward, but oil remains posed to stay in the current range ($55-60) short-term. Conoco and ENI beat consensus by 15%… If these two beat witht heir exposure to domestic gas, imagine the rest. We’re nearing a peak in refinery maintenance, and from here until the middle of the year, more capacity is expected to come online and generally crude demand follows that.

On supply news, an oil pipeline linking Russia’s far east to China’s northeast is set to start operation by the end of 2010, Zhou Jiping, deputy general manager of the China National Petroleum Corp. confirmed at a conference Thursday. The pipeline would run from Skovorodino, Russia to China’s northeastern city of Daqing. Construction will start at the end of this month, according to earlier reports. The pipeline will transport 15 million tonnes of crude oil annually from Russia to China from 2011 to 2030. I believe no way this kind of pipeline is built in 12 months. Meanwhile, China says they will inject funds into oil companies for acquisitions (watch out E&Ps).

OPEC sailings are seen to drop by 232 kb/d (-1.0% w/w) to 22.17 mb/d (-7.8% y/y)for the four weeks ending the 9th May. OPEC oil in transit (excluding floating storage) is expected to fall by 5.58 mmbbls (-1.5%). North American long haul arrivals are forecast to continue their decline, falling by 512 kbpd (-8.7%) to  5.36 mb/d for the four weeks ending the 23rd May. European arrivals are expected to up by 357 kb/d (13.8% w/w) to 2.95 mb/d.
Pemex is rumoured will exercise its 30-day contract cancellation rights on some incumbent rigs in order to purge some high day rates and then re-contract at lower market rates.
Now, on UK gas, despite the strong messages on support for E&P spending in the North Sea, decline rates have steepened to c7% according to Venture.

 In terms of price dynamics, all UK gas contracts softened as the reduction in Norwegian volumes was replaced mostly by increases from Morecambe, and LNG through Teessport. The fight to tighten supply is ongoing, but de-stocking and spot LNG are offsetting Statoil and other suppliers’ dropping 8mm3 off supply intraday.

 On US Natural Gas, Conoco results yesterday showed the extent of weak demand in the US (despite the beat on estimates) and the main problem is that the company is very slow in cutting capex. Although inventory data was mildly above consensus estimates the risk comes from a warmer summer in the midst of a weak demand and economic environment. I doubt we will see $2.5/MMBTU gas as some predict, but $3.5 levels are likely to be tested.

Finally, CO2 remains tight in the range.  EUA seems reluctant to test another time the 14€ level and yesterday movement shows how much it would be difficult to go over this resistance. Of course Carbon fell towards the end of the session amid weakening German power prices but the recent correlation with equity market in the wake of better economic condition looks to early and exaggerated in accordance to the real slowdown of European industrial production. So to go through 14.50€ and test 16.00€ will definitely need to have better economic indicators but not only improved equity market.

Keep rockin’ and stay long energy… The contango works for you

Oil prices and the future of E&Ps

Energy, On the cover, Sin categoría

oil_gas_rig_countIn a previous post I mentioned the end of oil investment as we know it. We are seeing it happen in front of us. Oil companies are not willing tocommit vast amounts of capital (BP consumes its entire market cap in capex in three years) unless there is a secure valid return.  Return on Capital Employed is falling to  almost utility level, and this is a cause of concern.

However, the big supermajors are comfortable given their low gearing (20-23% net debt to  equity), but with oil entrenched at c$50/bbl , which for most assets is below break-even price, the independent E&Ps are set to fall one by one like pieces of a domino. The credit crunch is taking care of the really small ones, as they are finding it impossible to refinance their development and drilling programs. Oilexco and Bowleven have already succumbed. Others will follow.
For the lucky ones,  the ones that have been smart enough to increase capital and refinance in the past years, enjoy strong assets and attractive development opportunities (Tullow, Dana) the end will likely come through M&A. The supermajors and utilities need access to reserves to either replace their declining assets (BP, RDS, Total) or get the desired access to equity gas (EDF, GSZ, E.On, RWE). We have already seen Centrica buy 23% of Venture at 725p. This means paying less than $6/boe for 2P reserves, a highly attractive valuation compared to developing their declining North Sea assets. The stock trades at 805p. Still below the average historical transaction price of $12-15/boe.
The problem here, is that, as I have mentioned in the past, some of these independents will be taken over and still be the worst performers of the sector (remember when ENI acquired Burren).  Investors will likely stick to the attractive exploration companies with strong balance sheet and the added positive factor of M&A … Tullow, Dana, Venture and Premier are set to deliver strong returns to shareholders as downside is limited at $50/bbl NAV valuations and upside on exploration could deliver between 15 to 35% returns in the short term… and forget about the “boom or bust bets” in really troubled small independent producers. They could be taken over, yes, but at $1 like Oilexco.