Category Archives: Oil Market

Attack on Syria and the real risk for oil markets

‘The question is not whether there will be a military action against Syria. The questions are “who?”, “What?”, and “when”? ‘ – SocGen Analyst

In 1973, Hafez Al-Assad was the president of Syria . Between that year and 1982 the regime conducted a systematic terror campaign against the opposition, which led to the slaughter of up to 40,000 people after the rebellion of the city of Hama. Al-Assad remained in power until 2000, when he was succeeded by his son, Bashar , the current Syrian leader. During all those years, outrage and international criticism of the regime always ended in many words and little action. Continue reading Attack on Syria and the real risk for oil markets

Peak Oil Defenders’ Most Overlooked Myth: EROEI

“So long as oil is used as a source of energy, when the energy cost of recovering a barrel of oil becomes greater than the energy content of the oil, production will cease no matter what the monetary price may be.”– M. King Hubbert

Yes, friends, if EROEIs of unconventional and new oil production were as low as some defend, the industry would simply abandon those resources.

Peak Oil defenders continue to make new claims. While inventories reach the highest levels of the past five years, OPEC fights to keep quotas and for a third consecutive year reserve replacement remains strong, in a world that has not seen a single day of disruption in oil supply, the defenders claim that the problem is EROEI (energy returned on energy invested) and that therefore, it doesn’t matter if supply is abundant, because it is still negative.I had the pleasure of talking with industry leaders and this is their response.

eroeia) The concept of EROEI has to be clearly attached to profitability. Peak oil crash defenders scream at 4:1 levels as unsustainable. This is funny. An “alleged” low EROEI is not necessarily a negative in itself, given that low cost of capital and high technology developments have helped to have readily available and abundant energy all over the energy complex (not only in non-conventional, but in conventional resources), and there has been no issue with supply in any environment despite a few geopolitical bumps. Furthermore, that EROEI rises as efficiency and productivity help reduce power use and increase output.

b) The concept of EROEI is static, it uses an estimate of energy consumption that starts at an intensive point and that just stays or rises afterwards, and this has proven to be wrong (energy used per unit produced falls dramatically in virtually all industry projects, see Shell’s analysis of oil sands extraction).

c) If EROEI estimates published by peak oil defenders were correct, given the gigantic increase in E&P and non-conventional spending we have had, power usage, and electricity prices and gas prices would have rocketed… But they have fallen. Co-generation is barely considered by EROEI doomsters either.

More importantly, in projects as energy intensive as PNG LNG, cost of energy used has fallen by 34%.

In Oil sands we have seen drops of 25% per unit of production. In shale oil as dramatic as 34%. The graph below shows the EROEI estimates of the Department of Energy in 2006 (link here). This was in 2006. Since then the efficiency and lower use of power and energy in hydraulic fracking and oil sands extraction has significantly increased the EROEI.

d) EROEI is an excuse of peak oil defenders to justify that they have been wrong about supply, turning the debate to the alleged unsustainability of that same supply as a justification.

Finally, any of the peak oil defenders needs to explain how the development cost of the industry has fallen, the energy intensity of the industry has gone down dramatically (they don’t read companies sustainability reports?) yet reserves and production have improved 2006-2010, fundamentally in unconventional.

The EROEI theory takes an individual projection (and this is typical for peak oil), leaves the negative elements untouched and stable (as if techonology and resource development did not improve) and then expands it to the entire base.

This, obviously, leads to a massive generalization and a leap of faith that can be easily denied just looking at 20-F filings, detailed analysis per project, which are available to all shareholders in strategy presentations and Fact Books, and in the brutal fact that oil sector’s electricity and gas consumption has been falling while productivity, particularly in non-conventionals, has soared.

Never bet against human ingenuity.

Further read. The Oil Drum (link here):

On EROEI of oil sands

“EROI depends mostly upon the direct energy used and which alone suggests an EROI of about 5.8. Including indirect energy decreases the EROI to about 5.2”, “adding in labor and environmental costs have little effect”. “Nevertheless it appears that tar sands mining yields a significantly positive EROI”.

On shale oil “Reported EROIs (energy return on investments) are generally in the range of 1.5:1 to 4:1, with a few extreme values between 7:1 and 13:1”. “Tar sands and oil shales seem to be in the same EROI ballpark”.

EROI_oilsandsNote from Daniel Lacalle: Worth noting that the assumption of energy consumption in the article for shale oil is now widely seen as excessive, so real EROEI is currently close to the latter part of the analysis (7x to 13x)

Further read:

Oil and Nat Gas, two diverging commodities

oil vs gas

(Published in Spanish in Cotizalia on Thursday 15th Oct)

Oil has reached $80 a barrel. On the demand side, there has been an upward revision of estimates of the International Energy Agency, IEA and EIA. On the supply side, the fact is that in the last five years, increased investment in exploration and production ($220 billion per year), has not helped to replace 100% of the reserves consumed. Moreover, extraction costs are still too high and declines are affecting production in countries like Norway and Mexico, with falls of 6% and 3% respectively.

In natural gas, the situation is almost the reverse. The world has 60 years of life of proved reserves, which compares with fewer than 45 in oil, and to the estimate we must add large unconventional gas reserves. Proof of such excess is that in early 2009, British Gas decided to sell long-term 85% of its gas production expecting an environment of overcapacity in the medium term. Back then gas was trading at $ 7 per million BTU. Today is at $ 4.

On the demand side Eurogas expects zero growth in demand for gas in 2010, after a fall of 7% in 2009. This occurs while Qatar, Yemen and Australia, among others, are setting up more than 90 million additional tons per year of LNG capacity between 2009 and 2012. The projects in Qatar are competitive at $ 1.5 per million BTU, a level “only” three times less than the current one. This means nearly 9 trillion cubic feet per day of spare capacity. Um, does not look good.

As from 2013, the overcapacity created by excessive liquefied natural gas is reduced by lack of new projects. Since, according to international agencies, we will probably see a very moderate increase in demand in coming years, the supply of gas will remain ample. As for China, it can cover the vast majority of its gas demand with its own production, with the ability to have five times the current domestic production through its 756 trillion cubic feet of recoverable reserves.

Interestingly, gas E&P stocks have performed in line with their of oil peers, although the oil price has risen by 30% and gas has fallen by 4%, showing the market is already anticipating a return of oil-gas convergence. I do not know on what basis. I just came from a few days with gas producing companies and the expected returns on their investments remain significant. Is that what investors buy? We’ll see if the results prove it and if valuations are justified.

Tough times for equities

After years of solid performance, equities are a risk, more than an opportunity. A friend of mine said something very pertinent about the underperformance of equities versus corporate bonds: “If you can earn a 3% risk premium on the bonds why bother with equities”.
The market is on 10.4x 2009 P/E…  So stocks have fallen 45-50% and they are only marginally cheaper (in some cases more expensive!) than in 2007. The market 2009 EPS growth shows expectations of -13.3% , and dividend yield at 4.8% (6.7% for Telecoms, 6% for Oils, 4.6% for Industrials, Basic Materials Consumer Services, 3.8% for Technology, 3.4% for Healthcare and Consumer Goods).
See the picture? yields are at risk as well!. Does one really expect the yield of a 13% falling EPS market to stay sustainable at 5% in the current economic and credit environment? … Cash flows remain under pressure and so will dividend policies.
The new defensives are megacap oils (strong balance sheet, high yield and flexibility on capex) while telecoms and healthcare continue to perform well. However, it is only in telecoms and oils where I see “cycle management” of the balance sheet, true capex management and true focus on ROIC.
I believe this trend will continue. So far long Oils short the market has worked. The steep contango curve has helped, but it’s all about balance sheet today. I believe we will continue to enjoy performance versus the market while we see eranings downgrades everywhere, capital increases and dividend cuts.
But isn’t a 30% outperformance overdone? After all, it’s the biggest continued period of outperformance against the market and the underlying commodity since 1991.
Well, the good news is that the market will continue to find it difficult to “buy something else” but the bad news is that, like in 1991, if oil prices stay low we will see dividend cuts and drastic capex cuts.
In this environment, I cannot agree more with the messages of Morgan Stanley on the “new defensives” in the oil and gas sector: BG (hedged 80% of LNG output to 2010) and Tullow (no refinancing needs after the highly succesful capital increase) versus the highest geared stocks (and I disagree again with consensus) with dividend risk, BP or Statoil.  Stick with Exxon (ongoing buyback, $89bn in cash) and short Conoco.  Buffett was right when he bought into megacap oils in October 2008, but I believe he chose the wrong (relative to peers) stock, Conoco, with the most challenging production, earnings breakdown and growth profile of the US majors.
What? Stick with the expensive outperformers versus the cheap underperformers? Beware of this argument, because the cheap are getting more expensive as downgrades, and cuts in capex and dividend, feed through estimates. Remember that Total traded at 4xEV/DACF and after a 25% fall still trades at those estimated multiples… and the risk of going “nuclear” and putting billions in questionnable EPRs and nuclear plants is not to be overlooked.