Category Archives: Energy

Energy

Yes, energy equities still make sense

Energy, On the cover, Sin categoría

nonopec12oil20090220

Our friends at UBS and the Oil Drum have reminded us again… Beware, oil bears because the decline in supply will come to haunt you. According to UBS most of the new projects expected to come on stream until 2015 require $60/bbl to break even.  Meanwhile the market continues to  believe Opec capacity additions will grow. However, supply is still not enough to cover the demand (IEA data) if we assume 85mbpd (2mm below current levels) in the next three years. Simply because the market perception of 4mm boe of spare capacity is massively optimistic.

So being bearish, what does the market bet on?: Opec capacity additions beyond historical achievements. I call it the Perceived Oil NGO, willing to lose money and develop below cost no matter what.

Remember what bears expected in January:

A) After a disappointing 2008, non-OPEC supply should bounce back “rapidly” in 2H09 (this is essential to strip any geopolitical risk out of the oil price)

B) New start-ups add 1.4MBD to gross production by mid-09, 1.9 MBD by end ‘09

C) Demand is in structural decline and will never recover to 87 mmbpd (and efficiency and the electric car will take care of any bounce).

Starting from the end, demand destruction due to expensive, subsidised marginal technologies would be totally acceptable at $140/bbl, not at $40/bbl (below the marginal cost of several areas), not to mention the impact of credit crunch on marginal technologies, the lack of proven substitution of electric cars (minimum horse power, need more than 60  minutes to charge half the battery) and the huge need of gas and oil as electricity generating sources if electric vehicles are successful.

As for supply, remember the “dead certain projects adding 1.925kboepd of production” in 2008? Either not on stream or flows c60% way below expected.

This is no peak oil view. Peak oil is about reserve depletion to extinction. This is about massive increased technical challenge and cost to achieve secondary and tertiary recovery in a world with 39 available rigs to 2009 and only 140 new rigs built until 2020 (for information purpose, Saudi Arabia would need them all to keep its current flows).

Has anyone stopped to think how much of incremental supply relies on Kashagan starting up in 2012 and flowing peak in 2013? 15%. 

We are betting on Opec capacity including Iraq to increase 1.3mbpd every year in the next two years. Where are the rigs and the equipment on those projects?  The two giant projects we expected are “delayed sine die”… and the service providers, Schlumberger and Technip, have no comment on timeline.

If you could take the rig counts in Saudi Arabia from 45 to 50 up to 2,000 over a decade they could basically sustain their current production at best. What you would have to do is take every rig in the world to Saudi Arabia. They are going to have one hell of a time going to 160 rigs by the end of 2009, which is their announced plan.  Where are those rigs? 

Saudi Crude Production in 2007 was 8.47m bl/d. Incremental crude volumes for 2008 came from:

 1) Khursaniyah, Fadhili, Abu Hadriyah (AFK) which is due to start up in 3Q with peak production of 500k bl/d. 2008 contribution of 155k bl/d (500k bl/d in 4Q plus half quarter in 3Q).

 2) Shaybah II with 250k bl/d in 4Q, peak production of 250k bbl/d, contributing 30k bl/d in 08 (half quarter in 4Q).

 Adding these volumes together would imply crude volumes of 8.24m bl/d.

 However, Khursaniyah is delayed and at the start of the year it was expected Q1. The delay equates to 280kb/d shortfall vs. expectations, or 3.3% of Saudi production.

In addition there is the decline of the base. CERA put Middle Eastern decline at ~5%, which would be about 400kb/d versus some commentators which have assumed less.

So the explicit slippage is 280kb/d or 3.3%, the impact of decline and delay is 680kb/d or 8%.

The International Oil Daily mentioned in January industry sources stating that Saudi Aramco looks set to miss deadlines on most of its projects. Khursaniyah may not reach full output of 500 kbd until December 2009, two years after schedule, as the contractor has struggled to source corrosion-resistant materials for the natural gas separation unit. Khurais (1.2mbd by end 2009) is expected to be six months late, although indications of 0.8mbd by end 2009 would be in line with my view anyway (there is room to slip more). Shaybah and Nuayyim (250kbd and 100kbd respectively) are both expected to slip from end 2008 to 1Q 2009. Khurais remains a key sensitivity, for both Saudi and the global market.

Meanwhile the signs of demand bottoming down started to appear last week (draws in crude versus an expected build of 3.5mm barrels).

Yes, it is still time to buy energy stocks… As long as they are strong in balance sheet, good cycle managers with strong dividend streams.  As for renewables… the future is solid, but the near-term is heavily dependent on credit. Too tough a bet short-term.

The market, the market

Energy, On the cover, Sin categoría,

me_1126

A pretty humorous chart I received last week, with obvious political connotations, but some truth embedded in it.
The basic thing that this chart shows me is that leverage and asset bubbles create huge volatility and will continue to  do so. For the market to stabilize we need debt at all levels to go back to 1981-82 levels, returns to sustainable moderate growth, open market policies, lower taxes for families and industries and liberalization. What European (not only UK) governments are doing is precisely the opposite and why even after a 14% fall in the market year-to-date I see downside… It’s not about “valuation” (most valuation tools, like EV/EBITDA  or Sum Of The Parts are bull market asset inflation tools) , it’s about sustainable returns over a WACC that is doing nothing but increase (cost of debt down, yes, cost of equity and risk premium up) and balance sheets that keep eroding after a period of furious M&A, growth and capex.
Worth a watch:

Intervention ahead

Energy, On the cover, Sin categoría,

“The most dangerous words in the English language are: I am from the government and I come here to help” (Ronald Reagan).

It is starting to get scary. Politicians all over the world are congratulating themselves for tackling the crisis (a debt and gearing crisis) with more debt and more gearing. Threatening banks to intervene if they don’t lend, threatening companies to intervene if they don’t lower prices below their cost of production, threatening hedge funds for using shorts to hedge long positions, threatening to  close borders to save domestic industries. Nice.
The stock market falls again in January and hedge funds are to blame again (de-leveraging and sell-out of long-only funds never was a problem)…. As if banning shorts helped the market in any way.
It is easy. Governments have found in this crisis the perfect storm to do what they always wanted to  do and found difficult: intervene everywhere, regulate to death. And that would not be a problem if the governments and their advisers had constructive solutions and were made accountable and audited. But as a recent cartoon stated, we are bailing out the iceberg to save the Titanic. Governments have created this crisis by giving mass incentives for companies to grow beyond normal levels of debt (in many cases, like in Spain, to fulfill egotistical empire-building desires), by allowing abnormal lending to people that could not afford it, by massively increasing public expenditure and promoting “high growth” industries like construction and subsidy-driven energies. Debt was solved with more debt and now it is expected to be solved with more debt, more money printing and, icing on the cake, government intervention. So who takes care of the revenue problem? You and I and the poor companies that actually made money and good returns without gearing themselves to death.
Wait a minute, so in order to bail out the auto industry, the over geared renewable energy sector, the banks and the construction companies the perfect solution is to tax the oil and gas sector (20% net debt to  equity average) and tax the population to cover the opex of the ever increasing government?. Who is going to invest? Who is going to take the risk of being entrepreneurial if the solution is to subsidise unsuccessful irresponsible management by taxing successful business models?. Why do we have to  save jobs in the auto industry and not save any in small businesses and new enterprises?.
Remember, “a government that is big enough to solve your problems is also big enough to create them”. More and more countries (particularly in Europe) are constantly brainwashing the population into believing that the ones (the Governments) that caused the problems will solve them, and gradually asking them to “let go” of their economic and deciding freedom to “allow the government to undertake the necessary actions”. Obviously, they are not to be monitored or controlled, they are not held responsible for what they do with your (our) money. They just want you to trust that in the end everything will be alright. If it is, the economy will be driven by semi-state owned oligopolies that drown any entrepreneurial  opportunity, if it’s not, the world leaders will shrug off the blame and point at someone else. Pity that hedge funds might not be there to lay the blame. Next task: find the scapegoat. It’s urgent. Suggestions welcome.

The end of investment in oil as we know it

Energy, On the cover, Sin categoría

crude_oil_oilwatch_feb_1

This image from the great www.oildrum.com shows something I believe is very important: despite an increase in capex of 20% per annum in the period, global oil production did not increase significantly.
This unprecedented level of capex in the oil industry happened thanks to a combination of technology and access to credit.  Widespread access to credit is gone, maybe for a very long time, but more importantly, oil companies’ appetite for investment is not going to increase quickly. When oil fell to $10/bbl in the early 90s it scared an entire generation of oil company managers. This is exactly what will happen after this period. 3D seismic, deep offshore exploration, high cost projects, oil sands, … wave bye bye to capex. Remember, Capex in 2001 was $250bn and in 2002 went to $100bn.
Meanwhile the average requirement of oil per capita in the planet is 4.9barrels and 454 cm of gas a year.

In OECD countries with current demand oil consumption is 18.3barrels a year

So if OECD countries slash their demand by 25% it will still be 14.64 barrels a year

However, if oil exporting countries demand goes up by a mere 7% their consumption will be 4.28 barrels a year.

Indigenous population growth in OECD is +0.1%, and growing 1% from immigration (ie going from countries where the average person consumes 2 barrels a year to countries where they will consume at least 4)

Population growth in oil exporting countries is up 5%.

Doing the maths, the demand doom picture is overestimated.

On to Supply:

A) In a tough credit environment, even large and medium sized E&Ps are and will have to drastically cut expenditure in exploration and development. Even worse, service companies are too small and cannot get credit  for large rig projects (look at SBM and PFC).

B) Large caps are cutting expenditure (albeit selectively) already. If they see a weakening of demand all that RDS has to do is reduce the number of trucks in Canada bringing oil sands product from 35 trucks to 5. Boom.

C) Demand needs to fall at least 3%pa to come back in line with the usual demand-supply balance going forward

D) Even if all these things happen the call on OPEC increases, as non-OPEC supply is doing nothing but shrink.

E) 75% of the current projects require at least $40/bbl (technical, not service charge). Companies are not waiting for oil to fall to $20/bbl to revisit these projects which are only being developed because demand exists. If not, these projects can be shut down rapidly (Khursaniyah, Khurais, Genghis Khan, Atlantis, Kashagan, Rosa, Dalia).

Demand NEEDED to fall more than what consensus and sellside expected. I am happy with demand falling  a lot, because the problem is depletion.

Supply is not there, and deffinitely not from non-Opec as consensus estimates (a ramp up of 1mmbpd when year to date it is down). Depletion rates are 4-6%. Even if you consider 0% depletion you need demand to fall a another 5%.

Call on OPEC increases, and self-consumption of producing countries is rising. Price, as such, is adjusting to see where mid term supply, demand and depletion go. That is not an indicator of bearishness.

I bet:

A) 12 month trail reserve replacement will be less than 90%

B) demand will fall accordingly

C) Demand – supply balance will remain the same

More importantly, I am happy that oil falls because the contango curve is steepening again… and bears have yet to explain why, if this is an anomally and fundamentally unjustified, it has continued and widened for seven months at levels never seen before October 08. As the only true safe havens of the equity market, I expect in less than a month investors will come back to revisit high quality, differentiated stocks that discount $30/bbl, trade at 7xPE 2010, 3-4.5x EV/DACF 2010 and FCF yield of 14%.