Tag Archives: Energy

Urgent: Refineries for Sale. Cheap… or Free

Energy, Global Economy, On the cover, Sin categoría

refineria

(This article was published in Spanish in Cotizalia on February 4th 2009)

The results of Shell, Chevron and BP have shown once again the extremely serious problem plaguing the oil industry: refineries lose more money every quarter and completely offset the positive results of exploration and production or gas trading. In fact, the refining sector in the OECD has generated returns of c3% below the cost of capital since 2003. Tony Heyward, CEO of BP, Europe’s largest oil company, was forced to acknowledge at the presentation of Tuesday’s results what has been a concern for the investment community for years.”Refining margins shall remain depressed for the foreseeable future.”

Indeed, the world finds itself with excess refining capacity of more than four million barrels a day. In addition, between China, India, Saudi Arabia, Russia and Korea there are planned refinery projects for more than 8 million barrels a day, many of them justified for purely political reasons. Even if half of them were canceled, the overcapacity will remain for at least 10 years. Meanwhile, Europe and the United States see the value of refining assets plummet every day, well below replacement cost, and no buyers. ENI has been unable to sell its refinery in Livorno and Total is not only unable sell its Flanders plant, but due to government intervention they are forced to keep it operating despite the fact that Total loses around € 100 million per month in the refining area.

The situation is desperate, even for companies like these, who do not have debt problems. As you can imagine, much of the refinery projects were built with the frightening words “security of supply” and “strategic” as a justification, regardless of the volatility, low return and very high investment requirements. We have not learned from the debacle of 1981-86, which led to curtail refinery capacity in the OECD by 20%.

In the past, integrated oil companies wanted to sell the message of their refining activity as an alternative to volatile oil prices, but it has proven to be a source of massive capex requirements and destruction of market value for the sector.

At the end of the day, a refinery creates value only if it can extract superior returns by using cheap and low quality oil (heavy) to produce high priced gasoline and products. Expensive oil, with the differential between heavy and light crude at a 10 year low, added to excessive costs, declining demand and efficiency improvements have led refining margins to plummet to $ 3.8/barrel on average, the lowest levels of the past 15 years. And this even when refineries are running at an average of 80% capacity. But the differentiating factor is that excess capacity far exceeds the most optimistic expectation of improving demand.

Some might say that this is scaremongering, that refining is a cyclical business and that when demand recovers everything will be fine (amazing to see how many times one hears this lately). I disagree. None of these large oil companies look to their activities on a short-term basis, and yet all of them seek to reduce refining capacity, the sooner the better. Apart from ENI and Total, Royal Dutch Shell aims to reduce its capacity by 15%, Valero has closed its plant to 200,000 bbl/ day in Delaware, BP wants to reduce its capacity by 14%, Chevron also … In summary, the 10% fall of demand in 2009, that all oil companies see as structural, not cyclical, will lead to the closure of at least 3.4 million barrels per day, up to 18% of the entire European capacity, between 2010 and 2020. And still capacity will be more than adequate.

Spain has refineries to bore, nine, with a capacity of over 1.1 million barrels a day. Within the complicated picture of the sector, some are reasonably profitable. For this reason, they could be sold without any problem at a price close to $1 billion per plant. The opportunity to raise cash and reduce investments has to be taken. But beware of waiting around for the return of the “golden age of refining” which may be decades away … or not return.

Energy Opportunities in Brazil

Energy, Global Economy, On the cover, Sin categoría

(This article was originally published in Spanish in Cotizalia.com)

Today I am writing from Rio de Janeiro, and while reviewing some news of the week, I am struck by the following: Jim Cramer recommends buying a bank, Santander, for their exposure to Brazil. Without questioning the merits of the financial institution as a stock, the first thing that comes to mind is: if you want to buy something, do not do it with hybrids. And I agree. It seems obvious to say but if you want to buy Brazil, buy Brazil directly. And there are many reasons to invest in the country: an expected increase of 5% of GDP, energy demand increase of 6% per annum, … And oil, a lot of oil. 14 Billion barrels in proven reserves and in the Santos basin, almost 7 billion barrels of resources, some of the largest discoveries of the decade.

On one side we have Petrobras, with increases of 6% p.a. in production. Petrobras also offers very competitive costs (average cost $ 13/bbl total F&D). However, it suffers from the forthcoming $55bn capital increase and, as Shell or Conoco, also suffers from the discount of large business conglomerates. It is cheap, but its huge investment needs in diversified businesses weigh on their return on capital employed.
Therefore, if you are interested in the almost 7 billion barrel discoveries in Brazil I would encourage you to analyze the two companies that offer absolute exposure in this area: Lupatech and OGX.

The first, Lupatech, as priority local oil services firm for Petrobras, is the great beneficiary of the investment needed to develop the discovered fields. It has an attractive balance sheet, expected growth of 12-15% and higher margins than their European competitors. And remember that Brazil needs to monetize quickly these discoveries, since the government sold in the last ten years oil concessions for a price of $1bn that today are worth approximately $50bn.

The second company, OGX, specialized in exploration, bought at 20 cents per barrel fields that seemed unproductive and nobody wanted and that have proven to contain at least 2.5 billion barrels recoverable, an amount that could be expanded to 7 bn as shown by the 3D seismic exploratory studies, which so far have been successful. OGX has $ 1.5 billion of cash to fund the exploration program of its five fields. And instead of gearing up to develop these reserves, with estimated costs of $ 14/barrel given that they are all shallow water finds, OGX is likely going to sell minority stakes to other investors. From a conservative standpoint, these 2.5 billion barrels could be worth between $10 and $ 12/barrel.
Brazil also offers opportunities in the electricity sector, which expects to increase its installed capacity from 102 GW to 153 in 8 years. 85% of generation is hydro while domestically produced natural gas will play a key role in the future. The sector delivers low-cost production and margin expansion as prices for electricity are higher than the Europeans (by more than 15%), also offering dividend yields above 6 -7%. There are more opportunities for low risk, high yield than the market would normally expect from an emerging country.

The Olympics and oil will be two factors to contribute to a dramatic growth in infrastructure investments. And energy companies are the major beneficiaries of this momentum. It is worth looking at Brazil in detail.

Iraq, the last hope for Big Oil

Energy, Global Economy, On the cover, Sin categoría,

IRAK (1)

(This article was originally published in Spanish in Cotizalia.com)

We’ve talked on other occasions of the difficulties that big oil companies find to grow. The reserve replacement ratio is still more than disappointing, below 100% since 2004. But in 2010 the industry could change course. In my opinion, the true hope of the sector is Iraq, the third country in the world in proven reserves, 115 billion barrels of oil, behind Saudi Arabia, with 264 and Iran with 138.

The country has generated much controversy in the press for the war but, since Saddam Hussein was overthrown, Iraq has achieved a production increase that was unthinkable under the previous regime, generating tax revenues for the domestic economy of almost $20 billion more that in the period 1980-2005.

Currently the geopolitical environment has improved substantially. Service firms are established, but the risks are not negligible, with nearby local elections, conflicts with the Kurdish minority and the gradual withdrawal of U.S. troops. For example, it remains unclear if the city of Kirkuk, home to a giant oil field, belongs to the Arabs or the Kurds, which prevents investment there.

The local government has advanced rapidly, licensing more than ten fields in the last year. After a false start in which the license auction was declared void (except the Rumaila field, BP -CNPC) because the conditions imposed by the government were too expensive, between the second half of 2009 and 2010 the government has auctioned licenses to operate up to 60 billion barrels in estimated reserves, with a national strategy to increase production from 2.5 million barrels per day today to a very ambitious target of 12 million. From BP, Shell, Statoil and ENI, to Russia’s Lukoil, China’s CNPC or Exxon, most big oil companies have participated in the process.

From my point of view, the goal of exceeding Saudi Arabia’s production is very ambitious. No one has managed to multiply by 5, as intended, the production of a country in 10 years. I think it’s much more logical to assume that production will rise to 3.5 million barrels per day in 2015, in line with the history of typical production recovery in this region (including Iran).

And the problem now is the costs, estimated at $ 19/barrel (F&D), plus an additional fee of nearly $ 2/barrel. The contracts allow the oil companies to cover costs up to a minimum production level. Until there is a contract typical of the industry,within what is called a PSC(production sharingcontract).

But if minimum production targets are not met, oil companies will suffer from profits lower than the average cost of capital, or even losses. The Zubair field, won by ENI and their partners, for example, will likely generate an internal rate of return of less than 20% below $55/barrel, while requiring investments in excess of $20 billion over 20 years.

If you have enjoyed Avatar (great movie, by the way) and the not-so-subtle allegory about the oil companies, you probably think that this whole process is abominable, but the increase in gross domestic product, infrastructure and wealth for the country that these projects, neglected or poorly managed so far, will generate, will be a giant leap for the country’s ailing economy. The investments to be carried out are astronomical, nearly $ 100,000 million between 2009 and 2029, including infrastructure, water, schools, hospitals , almost the construction of entire cities. Consider that some of these fields require about 500 workers. And the fact that contracts are aggressive and costly conditions for oil is a minor problem, because for them it is probably the last opportunity to improve their low reserve replacement for once.

The Revolution of Shale Gas

Energy, On the cover, Sin categoría

As I expected in my predictions for 2010, the process of mergers and acquisitions in the energy sector is not waiting. Total surprised us last week following on the footsteps of Exxon and embarking on the adventure of shale gas, through a joint venture with Chesapeake. The benefits of shale gas for oil companies are many and varied. Let me try to explain the environment as concisely as possible.

The technologies that allow the extraction of gas have proven to be much more competitive than it was initially estimated. We will not expand in technical terms, but basically through a process of fracturing the rock with water injection or horizontal extraction companies can stimulate the production of a gas that otherwise would not be economically produced. In fact, large companies are extracting gas at costs of $1.8 to $3/MMBTU compared with previous estimates of $ 5.5-$ 7. This cost levels allow very attractive returns, over 30% ROCE, even at current gas prices in the U.S., despite how much these have fallen from levels near $12 to $6/MMBTU today.

Moreover, the geological differences between areas of the United States that have shale gas (Haynesville, Marcellus, Barnett, and others) have proved to be lower than estimated, which allows a more comfortable environment for investment, as the potential economies of scale are very important. This is why the companies are buying large areas of land, as the shale gas production grows very fast but declines quickly once reached plateu. After this abrupt decline, production can be sustained for a long time at economical levels.

Furthermore, for companies like BP, Exxon, or Total it is an excellent opportunity to access abundant reserves of gas in a country with almost no risk (United States). Not to mention that it is a platform to learn and explore opportunities in shale gas in Europe, mainly in the North Sea and some Eastern European countries.

Matt Simmons and his team expect that by mid 2020 half of the US gas production will comes from U.S. shale gas, and the estimated reserves of unconventional gas in the most conservative scenario would cover 65 years of production, c1.35 billion cubic feet.

Total has paid the equivalent of $30,000 per acre of land in its joint venture with Chesapeake in Haynesville. In 2008, BP paid an average of $19,400 in Woodford. 2007 saw how Shell paid for Duvernay $13,100 per acre. Meanwhile, Statoil paid for their participation in the Marcellus area c$7,000 per acre. The price has jumped fourfold in just over two years. Not surprisingly, therefore, that US independent exploration and production stocks with shale gas exposure have soared, even though gas prices continue to be low.

Interestingly, amid all this, the financial market assumes that the oil majors are kind of large NGOs, which will exploit the reserves purchased in an indiscriminate manner, flooding the market and accepting gas prices well below the current ones. I can not believe that companies which operate under a strict target of return on capital employed will accumulate reserves to lose money monetizing the production at suboptimal prices. Meanwhile, the six big oil companies control more than 25% of the reserves of U.S. shale gas. What do you think are going to do? The consolidation process will continue and we will see that the profits will be very substantial in the medium term.