Tag Archives: Energy

Russian Energy Stocks To Watch

Global Economy, On the cover, Sin categoría

(This article was published in Spanish in Cotizalia on Thursday 28, 2011).

In Moscow there is no crisis. Russia is the world’s largest oil exporter, 10.2 million barrels a day, and the leading exporter of natural gas to Europe, 134 BCM per year, and it shows in all parts of the economy. The country will have its 2012 accounts in surplus at $125/bbl, but at $93/bbl still meets its goals with flying colours. Also, credit default risk is 14% below the annual average, the country has no risk of contagion from the European debt because Russia has almost nothing invested in EU bonds, the economy continues to grow by 4% annually and unemployment is at historical lows. With over $20 billion in scheduled IPOs, foreign fund flows at record highs and a reserve fund of at least 25 billion dollars to invest ahead of the elections, seems to me an environment that does not justify a discount of 40% to other emerging markets.

The Russian market (RTS) has been one of the best performers (+15%) so far this year. However, it is still trading at a discount, which in my opinion unjustified. Russia was accused of being “closed, corrupt and driven by state and oligarchic interests” Well, as half of the EU, then, in my opinion.

Not to be cynic, but I think we criticize other countries with faults that we have at home, and with many Russian companies the investor has the same guarantees as in Brazil, China or even Spain, Italy or France, increasingly interventionist countries, especially on energy. But Russia has much cheaper stocks, which enjoy higher growth, higher profitability and a better financial position than its peers in Europe.

In 2011 the average EBITDA growth of the Russian market is estimated at 49%, with margins of 29%. And with a 40% discount. I, therefore, believe that any “concern for corporate governance” is more than discounted.

My readers know I am a big supporter of several Russian energy companies, especially Novatek, Eurasia Drilling and Bashneft, which in terms of value creation, corporate governance, efficiency, and management team have nothing to envy of any international peer. Of course, my readers also know that having great stocks ​​such as these, I’m not a big fan of integrated state-owned stocks, Rosneft or Gazprom, mainly because I never liked semi-state owned stocks ​​(conflict between state interests and shareholders, from EDF to ENI, to Petrobras and Petrochina) or large conglomerates of any country, with the exception of Exxon and Chevron, which are the only ones who stand up to their government and defend the shareholder above all else.

To invest in Russia the first thing to do is to avoid betting that the government will do something that the rest of the world does not do (for example, thinking that the government will allow state enterprises to generate excessive profits when it does not happen in any EU country). Or that Russia is a joke and you have to go for it, as Yukos thought using state exploration licenses for private interests.

Another example is the disaster that BP has made when trying to trick its partner, TNK (25% of the reserves of BP), signing an agreement with Rosneft behind their back. BP thought that in Russia everything is arranged by dealing with the government and has seen the agreement canceled by a court of international arbitration and the most likely outlook for BP is it will have to sign a cheque for several billion (rumored $ 40 billion) to the shareholders of TNK (AAR) to “divorce” from their alliance. A partnership that was signed and prepared in detail by Tony Hayward, BP’s former CEO, where everything was tied up to the smallest detail. But his successor, Bob Dudley, thought that an agreement with a state company, Rosneft, and a supposed tacit government support would make this partnership with TNK and its shareholders interests (AAR) worthless. Bad idea.

Total, Statoil and Exxon invest in Russia with more logic.

There are several reasons to invest in Russia :

1. Despite being the most geared to oil prices, the Russian market is discounting an oil price below $90/bbl and traded only 7.2 times PER 2012. It is true that between Gazprom and Lukoil (30% of the index) there is more than a 40% discount in PE, but stock by stock the market is still significantly cheaper than the other EMs.

2. Although the economy grows by 4%, the budget is balanced at $125/bbl and corporate profits will rise 30% on average, Russia trades with a risk premium of 8.7% compared with China or Brazil at 6.5%.

3. Russia is the only country in the EU and emerging economies where I foresee widespread upward revisions to long-term profit forecasts. It is also the country where corporate and state debt is more controlled of the major economies.

4. Medvedev announced in March in Magnitogorsk a very ambitious set of measures of transparency and corporate governance. The market has not reacted yet, but we must remember that after his “Go Russia!” speech in September 2009 the market rose 22% despite the oil price staying flat.

In the energy market, Russia is, for obvious reasons, a goldmine. And it should continue to highlight four areas:

1. The creation of new oil and gas giants. Russia has decided, rightly, to support the creation of companies to develop their oil and gas fields more quickly, efficiently and cheaply than the big state conglomerates. The two beneficiaries of this process of optimizing the exploitation of natural resources are Novatek (gas) and Bashneft (oil). Total has bought 10% of Novatek, and is rumored that Statoil and Shell will participate in its flagship project, Yamal LNG. Despite the stock rally, it is still trading at just $3.33/boe (2P reserves) and 12x EBITDA for a company growing 20% ​​annually. Bashneft, meanwhile, is trading at $ 5.6/boe (2P) and with production growing by 4%, benefiting from an agreement with Lukoil to develop the mega fields of Trebs and Titov (7 million barrels per day in 2013) it is not surprising to see consensus estimates grow by 46%.
epidemic
2. The ridiculous antinuclear and anti-shale gas campaign around the EU benefits Russian gas exports. 145BCM in 2013. And the more interventionist that Europe is, the better and better for Gazprom, which could trade 40% higher if its investment plan was less “opaque” (nearly 40% of Gazprom’s investments generate returns below 7%),and this makes it trade at low multiples (5x PER). However, Novatek, domestic gas player, profits from the same environment (without such a “government-led” capex plan).

3. The goal to keep oil production at 10.2 million barrels a day and develop new fields in Siberia and the Arctic will benefit the efficient service companies, which compete with internationals as equals and have proven their effectiveness with their clients (Rosneft , Lukoil). Eurasia Drilling and Integra, two of the top ranked service companies may see its order book doubled and margins increased by 34%. Eurasia Drilling also has a very competitive cost structure and presence in countries such as Azerbaijan. From the integrated oils, Rosneft and Lukoil are obviously favorites of many funds given the large resource base, but the risks investors face is to bet that margins will recover or that taxes in Russia are reduced, which is unlikely, and investors should also take into account the risk (similar to that of all conglomerates) that these companies decide to move aggressively in their international expansion by buying assets at high prices.

4. The liberalization of utilities. The major European electric utilities have invested in Russia with great success. It is worth looking at those utilities partially controlled by European groups which generate very strong returns, with world class efficiency and transparency. E.On (OGK-4), Enel (OGK-5) and Fortum (TGK- 10) have been the first to invest large extensively. The TGKs and OGKs and trading at $250/Kw installed and 5.6x EV/ EBITDA 2012 on average. Discounts of over 20% compared with the European power groups, which are widely hit by regulatory risk and interventionism.

Many people ask me if it is too late to invest in Russia. I think not, and I think if there is a slight correction, as in May-June 2010, it can be a great opportunity to invest in a country that is becoming less “emerging”, which is the largest exporter of oil and gas to Europe and undertaking a very interesting process of reforms that recalls the one we saw in Spain in the late eighties and early nineties. But with oil and gas in abundance.

Exxon was right. Where will oil companies invest in 2015?

Global Economy, On the cover, Sin categoría,
(This article was published in Spanish in Cotizalia on 14th April 2011)

In 2008, Rex Tillerson, CEO of ExxonMobil, was facing a General Shareholders Meeting with a request, almost a demand, by a California pension fund, a group of nuns and the Rothschild family. The requirement: to dedicate a substantial portion of its investment program to renewable energy. It was the culmination of a process of harassment of U.S. oil majors that started with the then young administration of President Obama. The request was unsuccessful. The general meeting of shareholders rejected it by a majority. Not even to make a “wink” to an administration hostile to the sector.

The explanation was simple. It is a different business. It is valid for other companies, where the competitive advantage requires in sustained institutional support and where returns are well below those demanded by the Exxon group. With or without subsidies. Because, as Tillerson himself “if we really wanted to see subsidies for renewables eliminated, the only thing we should do is spend millions on those technologies, because then the government would immediately withdraw the premiums, or rather, retire them for us only.”

Today, Exxon is the most profitable oil company in the world, with a return on capital employed of 22%, has distributed $112 billion to shareholders over the past five years, has the highest return per barrel in the industry ($20 per barrel produced 2006 -2010), a reserve replacement ratio 210%, with virtually no debt and no divestiture requirements from ruinous adventures like other competitors. And the interesting thing is that these rates of return are not be generated because they are a very large company (just check the poor returns of comparable European companies), but because of the focus of its strategy on two principles that I would call:

a) Focus on the core business and activities where they have real competitive advantage to return those benefits to their shareholders. It’s a company that invests $35 billion a year of capital that belongs to its shareholders, not an NGO.

b) An organization focused on generating superior returns, not intangible objectives. Return on capital employed (ROCE) as an absolute objective. Intangible benefits and costs are imaginary inventions to justify losses.

Chevron and ConocoPhillips also turned away from experiments and generated significantly higher returns than those oil companies that diversified into other technologies, despite the weak dollar. Meanwhile, competitors who took to strategic adventures outside their industry are in the process of selling at a bargain price their “star” projects.

Many European oil companies boast in their advertising of their investments in alternative energy. But behind the image lies a very different reality. In fact, after years of multibillion-dollar losses, the reality is that most have returned to their core business.

We made a detailed analysis of the plans of oil companies for the next five years. The results (only Oil Majors, ie Big Oil) are:

. Over 85% of the annual investment in the sector, ie, well above the $200 billion annually, will be dedicated to Exploration and Production. Nearly half destined for natural gas and half oil. Of this amount, almost 30% will be dedicated to exploration of new reserves in “frontier areas” or areas where they expect to find the next mega-field, the new Kashagan, Tupi (Brazil), Uganda or Jubilee (Ghana). Greenland, the Russian Arctic, Mozambique and Namibia in addition to the large investments (over $10 billion in 2011) in the U.S. in shale oil, where it is estimated that we could see a revolution similar to the gas shale (shale gas).

. Less than 14% will be dedicated to refining, marketing and chemicals. The returns are relatively poor and do not justify further investments. The OECD industry is facing overcapacity with nearly 7 million barrels per day of excess capacity in refining and 65% of average utilization in chemicals.

. Less than 1% of investments will be devoted to “alternative energies.” And when the oil majors talk about alternative energy, over 67% of that money is for “biofuels” which is a derivative of refining, not wind turbines or solar panels. ExxonMobil invests in technology and development more than $200 million per year, mostly to improve transport efficiency and liquefied gas.

. The only companies that will explicitly invest in wind turbines and solar panels are BP ($10bn in ten years, less than 2% of their annual investment), and the market does not reward them for this low-return capex, Petrochina (a gigawatt in wind, less than 1% of their investment) and Total (a little solar and CO2 capture and storage). Shell divested most of its activities in solar and wind energy smartly at peak valuations (2009).

Why don’t these companies invest more in alternative energy?.

. First, because the returns are very low and more risky (politically) than its main activity, and as the average cost of capital of Big Oil is close to 9% upstream, the sector should require higher returns than those generated by regulated sectors. Alternative energies generate returns of 11-12% with a debt of c80% at project level, which is impossible to for oil companies, who know you can not gear by more than 25% an energy project, being a cyclical business. So the integrated utilities, which have a lower cost of capital and relatively low but stable returns, are more willing to include alternative energy in their investment plans. At the end of the day, renewable energies are utility-type of businesses, as we have seen now that the “supernormal growth” prospects have moderated to more logical 5-6% pa.

. Second, because the electric-utility model requires concentration in countries with great political influence and government control and concentration is exactly what the oil sector tries to avoid, following the disasters seen from 1975 to 1999. Thus, since the end of the era of nationalization and break-ups forced by anti-trusts, the oil companies want to avoid accumulating more than 20% of their assets in one country. Governments are very greedy when it comes to demanding long term investments from private companies but also very quick to cut private profits.

. Third, avoid subsidies because they are removed at the first opportunity. The oil industry endures some of the most onerous taxes (up to 80% in some countries) in the industrial sector, multi-million dollar investments with very long maturity periods in cyclical sectors, risks in unstable countries, PSCs (Production Sharing Contracts), and the sword of Damocles of “surprise” taxes, as we saw in France last week. $400 million into the pockets of government. that is the reason to avoid regulated activities, and the oil sector has divested more than $30 billion in these activities since 2008.

I read many articles saying that oil subsidies are enormous, but such analysis is flawed, by bringing together private companies and state owned ones. For the IEA and others to count as subsidies what Saudi Arabia gives to its company, Aramco, or what Rosneft and Gazprom get from Russia or China provides to PetroChina and Sinopec, etc. is a joke. When comparing subsidies to industries, these should not be included, that’s cheating. And most of what the articles call “subsidies” are deductions for double taxation. It is quite funny to expect that oil companies pay 60% tax in the North Sea, for example, and then pay for them also in the U.S or elsewhere.

For years the chief executives of American oil companies were criticized because they did everything wrong and were obsolete while counterparts in Europe and the United Kingdom were betting “on the future”, from investments in Business To Business and the Internet (in 2001 some oil companies spent more on this part of their strategic plans than in E&P), transmission networks, nuclear energy, healthcare (I swear), or hydrogen fuel (with multibillion-dollar losses). No more experiments. As an example, Shell, after the arrival of Peter Voser, immediately imposed a “back to basics” focus on exploration and production, generating cash flow and high returns on any part of the cycle. They reached in three years the goal of becoming the second most profitable company in the sector.

Now, with the sector at record levels of cash generation, investment plans in the oil sector are simple. No more adventures. Exxon was right.

Further read:

http://energyandmoney.blogspot.com/2009/11/china-exxon-and-war-for-resources.html

http://energyandmoney.blogspot.com/2010/07/five-risks-of-big-oil.html

Given all that has happened… Oil prices have not gone up a lot

Global Economy, On the cover, Sin categoría
(This article was published in Spanish in Cotizalia on April 5th 2011)

The most interesting debate in the energy sector in recent weeks does not focus on how much the barrel has appreciated, but the opposite: How little it has risen in such a geopolitical storm.

A good friend, with over thirty years experience in oil, from National Oilwell Patterson and working for the DOE (Department of Energy, USA) told me recently that “the positive surprise is that oil is not trading at prices close to $200 per barrel”.

The main reason behind this is that the market is well balanced and the risk of shortages is very low. Crude inventories at Cushing (Oklahoma) are at record highs. In China, we have seen demand growth slowdown for two months, something very similar to what happens in Europe.

European and American refineries are operating at frankly poor capacity levels, close to 82%, and inventories of refined products remain at levels above the average of the last five years.

With everything that has happened in the oil market, it is curious that the price is only at $122/bbl (Brent), $ 108/bbl WTI at the close of this article. Also, we should not forget the collapse of the dollar as and additional mitigating factor. My friend alerts that “raw materials rise due to the emphasis on printing money and stimulus plans, which destroy the value of currencies.”

Let us review what has happened, with disparate effects. Let’s start with the supply side:

. The war in Libya has cut nearly 1.3 million barrels a day. And while the market welcomed the “news” that the rebels are going to sell 100 thousand barrels a day, it is hard to see a recovery of the Libyan barrels for several months. For my readers who still think it is a humanitarian action in Lybia, I recommend reading, “Resource Wars and the Shape of Global Conflict” by Michael Klare .

. Iraq, which has launched nineteen major oil projects to restore production to pre-war levels from 2.1 million barrels per day to 3.5 million, is still struggling, and will probably end the year about 300,000 barrels per day below objectives, according to friends at ExxonMobil and BP. In March, exports fell 2%. Part of the problem is that oil companies are taking up more time to get the country rid of land mines (and have funded the removal of 5%) than getting rigs installed. According to the minister of environment in Iraq, Hussein Kamal Latif, without the help of the sector Iraq would take 100 years to clear the mines scattered by the army of Saddam Hussein throughout the country. On the positive side, Kurdistan now exports about 80,000 barrels a day … hoping to exceed 200,000 in December.

. Nigeria. Yemen and Syria are all over the news. But with Nigeria, which is 2.1 million barrels a day to the market, nobody seems to want to talk. And in Nigeria the conflict is relevant, with the elections delayed several days due to fights between supporters of Prime Minister Goodluck Jonathan and the opposition. The parliamentary elections have had to be delayed, and presidential elections to April 16. Moreover, Nigeria is the largest oil producer in Africa and its political stability is crucial to the balance of supply and demand. Do not forget that in 2010 Nigeria accounted for almost 60% of the increase in OPEC production, and is the second largest oil exporter to the U.S. and Europe. Around 70% of Nigerian crude is exported to Europe and the U.S.. Therefore, Nigeria is much more important for oil market stability than many countries in the Middle East.

. Russia maintains its output at 10.2 million barrels a day, although still below the peak of 1987 (11.5mbpd).

. What role is left for Saudi Arabia? The kingdom continues to be the “World Bank” of oil, and just announced a 30% increase in investments in exploration. But from Riyadh they will not decide to increase production “just because the West wants it” after enduring years of anti-Saudi rhetoric from western governments.

These effects have made ​​the spare capacity of OPEC as perceived by the market drop to less than 5 million barrels/day. But OPEC has cut its crude exports by 363,000 barrels per day in March . That’s not because they are evil, but because demand is well covered.

On the demand side:

. Although demand will rise 1.2 million barrels per day in 2011, an increase of $10/bbl has an estimated negative effect on global GDP of slightly less than 0.3%.

. U.S. demand has stagnated since January, increasing marginally compared with 2010.

. China has reduced its imports to 19.95 million tonnes, 9% below the January figure.

. The effect of demand destruction, as always, happens with a delay of about six months. And then, as JP Morgan said in an analysis released Tuesday, the price of oil can go from having an “Arab spring to a Western winter”. Same as in 2008.

A reader of mine was surprised to read here that since 1974 U.S. oil demand has only increased by 14%.

The real peak oil is in demand, which stalled in the OECD in 2007 and still has not recovered as much as the IEA says it will, and they have always been wrong. And China imports huge quantities until the Chinese government says “stop.”

Oil is trading with no discernible geopolitical risk premium and may not reflect it unless things get much worse. So what’s really interesting is that in this environment it is “only” 20% below the peak price of 2008, when then there was no reduction in spare capacity as we see today, or widespread conflict in the Middle East.

However, if geopolitical conflicts continue to soar and we continue printing money-debt with interest rates kept artificially low, where the OECD is totally to blame, be prepared to pay another 20% more to fill the tank of your car.

Unsustainable energy policy, higher debt, higher unemployment

Global Economy, On the cover, Sin categoría
(This article was published in Spain’s Cotizalia on 31st March 2011)

Beware. The European Union, Germany and the UK have implemented some of the most harmful energy measures both for their economies and, ironically, for the objectives they strive to achieve.Let us review the measures and their consequences:

. 20-20-20 Roadmap : The goal that forces to impose a 20% of renewable energy in the electricity mix hides behind its seemingly ambitious and unanimous goals the danger of percentages. As absolute targets are not specified, the cost of the measure is higher for smaller countries. 20% of renewables in a generation park like the German, 120GW (giga watts) is not the same in cost (subsidies, tariffs, investment in new transmission networks) than for a country like Portugal, Spain or Greece. Even more if we compare it relative to GDP.

Achieving that goal will cost Germany (if they implement it) that is an economy 2.8 times larger than the Spanish, the same as for Spain in subsidies and extra-cost of networks, but only 0.3% of GDP, while in Spain it’s almost 1%. This restricts the competitiveness of small countries compared to its EU partners, but even worse compared to the rest of the world. It removes the ability to recover the economy and therefore create jobs. In energy, costs are everything.

Studies of the Universidad Juan Carlos I (“Study of the Effects on Employment of Public Aid to Renewable Energy sources”), and six other universities at European level have quantified the loss of jobs by the introduction of the so-called green economy (badly called green, because it does nothing but increase the consumption of coal, which had been deemed obsolete) in 1.8 jobs lost for each created.

. Decommissioning or closure of nuclear plants : If 7GW of closed nuclear plants in Germany do not return to work, this means increasing by 8 million additional tons of coal imports to Germany. If they stop all new nuclear projects globally, coal consumption will increase by 80,000 tonnes between 2010 and 2020. And nuclear generation is “base-load” (ie, works almost without a break), so can not be replaced by renewables in its entirety. And this leads us to gas. The importance of natural gas as back-up in the energy mix will make energy dependence (a term I find ridiculous) increase. An Ostrich type of anti-nuclear policy, because in the middle of the EU we have France with 58 nuclear reactors, but some seem to think that if there is a radiation accident it will stop short at the border.

. Minimum price for CO2. The UK does things as badly as anyone, and has shown it this week. Intervening in the market and imposing a minimum price of CO2 while raising taxes on gas production in the North Sea has managed to increase consumption of gas by 15% at a higher price. In addition, the UK has increased dependence on foreign energy by forcing the closure of several projects, over $10 billion, in exploration and production in the North Sea. And a loss of 120 jobs in the first day. Success!.

The European Union plans as if the world was limited to our 27 countries. The EU is 13% of world coal consumption and 16% of natural gas. But supports 100% of the cost of CO2 and 70% of the cost of premiums for renewables worldwide. Thus the effect of their actions is amplified by the loss of global competitiveness in a group of highly indebted countries.

. Remove petrol and diesel transport by 2050. Again, without calculating the cost or impact on the economy. We are “only” talking about a cost close to twenty-six billion euros only in costs of network infrastructures. But most importantly, these do not reduce energy dependence or improve costs. Electrifying the park could reduce oil consumption (paradox, to be more competitive again), but will increase coal and natural gas prices, and adding to the renewable premiums, taxes lost from petrol and diesel, over 56% final price, will be transferred to the consumer of electric cars in the power bill.

We must not forget the impact of these measures and their cost of implementation, the impact on budget deficits and on the battered state of European countries’ debt. To add a cost to the system involving another 1-1.5% of GDP on debt with “supposed” benefits in 2050 has an enormous impact on employment and working conditions. At the end of the day in most companies the four major costs include energy, taxes, debt costs and wages. If the first three parts rise disproportionately, the third invariably suffers.

Besides, these measures have a minimal effect at European level, let alone globally. Only the planned investments in coal plants in China offsets all efforts of the EU to meet the Kyoto targets. Thus, the weight of coal as global primary energy source increased by 1.3% in 2010 to 52.3%.

And do not forget that apart from xenophobic arguments about good and bad countries, which are embarrassing, the cost of the “ostrich policy” of energy self-sufficiency that they want to impose far exceeds (all costs included) the equivalent of $700/barrel (source: CERA, Utilities Weekly). And who do we expect to sell the haemorrhage of debt we will issue to achieve the above objectives? … the oil-producing countries, China and the U.S… Amazing.

It is rather sad that the “success” of Europe in its emissions reduction target is due mainly to the displacement of its energy intensive industries to the Far East, with the consequent loss of European jobs, and the effect of reducing industrial demand runaway that the debt orgy has generated. A success. And to close the circle, it has increased the energy dependence from Russia, Qatar (gas) or Australia and South Africa (coal).

What about pollution? We forget that the rare earths required to manufacture solar panels and batteries pollute hundreds of thousands of tons of water per year. But it pollutes in China (97% market share), so no problem.

These measures give off a smell of stale paternalism, or as Professor Dieter Helm would say, “the addiction of politicians to” roadmaps “that set the future direction of energy with Soviet precision”. And with the same disastrous results as the ridiculous five-year plans.

Until governments stop trying to plan and intervene in the energy market like the rest of the world did not exist, they will be doomed to failure. And we have spent many years with dreadful results. The green economy, which seems phenomenal, as long as it doesn’t have to be paid by my grandchildren, will only succeed if it is competitive. Governments should only create a reasonable and stable regulatory framework for technology and let the market offer solutions. Competing.