Tag Archives: International

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

War in Libya and the possible Algerian black swan

Global Economy, On the cover, Sin categoría
(This article was published in Cotizalia on 24/3/2011)

The UN resolution 1973, supported by the Arab League and accepted by Russia and China, has a clear immediate goal: Overthrow the Qaddafi government. What is not clear is what the ultimate goal is and what will be the position of the West after supporting a rebellion without defined leaders, common goals or government project. As we discussed in this column, the reality of Libya and its many tribes is more complex than we would like to admit. As a friend of mine says, “careful what you wish for,” because we are still regretting the support to the “freedom fighters”, the Taliban, in Afghanistan.I commented several weeks ago to our readers that the information that came from friends in companies based in the area, Schlumberger, Halliburton, Petrofac, Saipem and Technip were not encouraging for those who expected a quick fix. And my fear that this conflict will lead to a long, bloody and difficult transition with multiple factions similar to the Iraq and Afghanistan examples is increasing. I hope I’m wrong.

Indirectly, the two powers that derive benefit from all this are Russia and China . Russia has gone from being viewed, unfairly in my view, as a country in which western investment was a big risk to be a huge opportunity, and Gazprom is now the best source of security of supply of gas, with annual volumes of 136BCM that are cheap and safe for the European Union. The agreement between Total and one of my favourite companies, Novatek, which is likely to include Statoil, is a clear example. China has very little presence in Libya, a few Petrochina exploratory wells, but benefits in two sides . On the one hand, less international competition in Sudan, Uganda, Nigeria and West Africa, where they continue accumulating reserves, and on the other, potential access to new licenses, as they did in Iraq.

In Libya, the fact that rebel forces are multiple and with no clear leaders means that the balance of power in a future without Qaddafi depends largely on the support of Western countries, becoming with Iraq as a second vertex of control and strategic deterrence both to contain Iran and to protect Saudi Arabia and Israel. Libya is not only important for its production 1,660,000 barrels of daily exports, but as a test scenario of the fragile process of a possible change to democracy .

The exposure to Libya of major energy companies is relatively small, except in the case of ENI, OMV, where Libya is 20% and 24% of their net assets, and Repsol, with 7%. From other oil companies the most exposed are Marathon (12% of its production), Gazprom (less than 6%), and to a much lesser extent, Conoco Phillips (USA), Total (France), Hess, Statoil (Norway) and Occidental (USA).

But I have the feeling that the ultimate goal of an operation of this size, without forgetting to support the civilian population, which is obvious, is to have an operations center that allows to monitor Algeria and other neighbors that can potentially be a greatest destabilizing factor.

Libya has gone from being acclaimed in 2006 by our countries to the Chair of the Human Rights Commission of United Nations (the only vote against was the USA) to a regime to remove. But the danger of intervening, with a weekly cost, according to the Daily Telegraph , of $500 million for the allies, is that the war goes on forever and then it becomes more difficult to support other countries. And this brings us to Algeria, a country of enormous strategic importance , with 4,500 million cubic meters of proven gas reserves, the tenth country in the world, and 12 billion barrels of proven oil reserves.

Algeria is essential for Spain. It’s almost 30% of the natural gas consumed in the country according to official sources. But it is a relationship that benefits both countries, and Portugal. The joint venture of Repsol-Gas Natural, has the Algerian national company, Sonatrach, as one of its main suppliers. And, despite the legal dispute that the two companies hold (€ 1.5 billion in arbitration) and the loss by Repsol-Gas Natural of the Gassi Touil contract in 2007, there is no doubt that Spain is very important for Algeria, and that both parties are bound to understand each other. Additionally, a consortium involving Endesa (12%) and Iberdrola (20%) with France’s GDF Suez and Sonatrach, among others, has invested in the Medgaz pipeline that links Algeria to Spain. Spain’s energy investments in Algeria are around $5 billion. The Algerian company also holds shares in the Portuguese EDP (and hence its subsidiary in Spain, Hidrocantabrico) and provides another 2BCM of annual gas supply to Portugal. Algeria, therefore, is not at all irrelevant to the Iberian Peninsula.

In Libya, the opposition is tribal, and the religious-ideological content is limited, but in Algeria strategists perceive that the risk of a revolt against the regime of Abdelaziz Bouteflika can not only affect the supply of gas to Spain, with the devastating effect that this could have on the battered economy of the EU and its credit risk, but there are also fears that moderate opposition can again be dominated by radicals. In Algeria, in addition, the impact on Western investments extend to many more countries than those mentioned in Libya. Therefore, it is hard to think of the action on Libya as an isolated event.

Further read:

Lybia in Flames:
http://energyandmoney.blogspot.com/2011/02/lybia-in-flames-and-clash-of.html

Egypt and MENA risk:
http://energyandmoney.blogspot.com/2011/01/here-is-summary-of-my-views-on-egypt.html

Anti-nuclear State of Fear. Japan and the impact of the tsunami

Global Economy, On the cover, Sin categoría

(This article was published in Cotizalia on 19/3/2011)

Let me begin this article by sending a heartfelt remembrance to the great country of Japan, and to all those affected by the disaster and their families. We don’t forget them.

But my job is to talk about energy and the disaster has a huge importance for the market of oil, gas, nuclear energy and CO2.

The perceived risk of nuclear energy has soared , even leading to Angela Merkel to take the populist measure of ordering to stop the seven nuclear plants built before 1980 for a period of at least a month. This implies a loss of about 7.1 giga watts of electricity generation in a country that has not seen a nuclear accident of any relevance in many decades.

What has been achieved with this measure has been to make the country poorer as energy prices soared, but also impacting the EU, as wholesale electricity prices in UK, France and other countries, which remained depressed for months, are up 11%, coal is up 14%, gas (NBP) is up 12% and CO2 prices, which had not moved for nearly eighteen months, have risen 10%, above the expected increase in thermal generation, thus slashing any remote possibility of meeting the Kyoto targets, in addition to giving a blow to competitiveness. The price of uranium plummeted 19% to $ 54/lb on the risk of loss of at least 7% of annual demand. All for the perception of political risk, ie that the European Union will take action against nuclear energy.

The Fukushima Daiichi’s accident is very important. But it is an exception. And if there is proof of the security and reliability of nuclear power, it is shown by the fact that out of the 11 reactors affected by the earthquake, only two have suffered an accident. And this exception originated in the midst of a natural disaster which unfortunately coincided other unusual circumstances, such as the blackout of eight hours. To make wild and hasty conclusions about the rest of nuclear power stations, particularly in a country, Germany, where there is no seismic risk, is incredible. That does not mean that we should not review and improve all security systems. But … stop 30% of nuclear power stations in Germany due to an accident in Japan?.

The loss of the capacity of 11 nuclear plants in Japan has an immediate effect of increasing demand for liquefied natural gas (LNG) by substitution effect. In 2007, when Japan closed the Kashiwazaki-Kariwa nuclear plant, 40% of the lost capacity was immediately replaced by gas.

The impact on the demand for LNG (liquefied natural gas) caused by the loss of nuclear plants mentioned can be up to 0.7 BCF/ day, ie, absorbing 50% of the current excess capacity of the gas system. This would send to Japan from 5 to 6 additional LNG tankers per month . At the time of writing this article, the price of liquefied natural gas contracts for new ships had soared, from $ 9/MMBTU a month ago to nearly $14/MMBTU. Still at prices well below those of 2006, making the LNG the cheapest alternative back-up energy source today.

For the oil market, the Japanese tsunami is, to give you an idea, similar in volume to the impact of Libya for the supply side, but of opposite sign. That is, Japan means a possible loss of demand of about 1.3 million barrels per day. Assuming only the impact of Japan, which is about 4% of global refining capacity, and no contagion effect on the economies of the West, there could be a further impact on oil demand.

And all this leads to renewables. Interestingly, the initial effect has been an avalanche of buyers into solar stocks . But in a sector with structural overcapacity, the loss of demand in Japan, which is about 7-8% of global demand for solar panels, will be a real problem that will not be easily offset despite the dreams of launching more aggressive environmental policies.

The view that solar will suddenly grow exponentially is questionable particularly when U.S. and European gas is still much cheaper than solar energy (photovoltaic) despite the cuts in the premiums seen in Germany, Spain and other countries . And coal is also much cheaper and reliable. Even if CO2 prices soar to €23/tm (it’s at €17.5/mt right now), coal generation runs at a fraction of the cost of solar photovoltaic. To give you an idea, in Germany, the same government that takes action against nuclear plants has seen the brutal effect of solar energy on prices. Germany has accumulated 40% of global solar installations over the past two years and has seen the cost of subsidies reach to more than €56/MWh, 56% of the retail price for the consumer.

Alternative energies are valid but can not replace nuclear power and, as any alternative, should prove to be cheaper than the incumbents. Because if not, the anti-nuclear rhetoric, anti-oil, anti-everything that is going on is going to prove to be anti-competitive and anti-growth. And forget about reaching Kyoto targets if Germany dismantles the nuclear park.

Nuclear energy accounts for 14% of the electricity generated in the world at a cost of about €33/MWh if we assume all costs, including closing and cleaning. Solar energy is less than 0.08% at an average cost of €410/MWh, twelve times more expensive. Solar energy today costs about $700 per barrel of oil equivalent, and therefore more than 25 times the average price for liquefied natural gas. This without mentioning the necessary investments in transmission networks, estimated at one trillion US dollars in Europe alone.

Solar energy, by definition is intermittent, ie, its plants operate at less than 10% utilization, as opposed to nuclear or hydro, operating with load factors of 70-80%. Wind energy has a much lower cost, an average of € 78/MWh, although still higher than gas, coal, nuclear and hydro, but also has the disadvantage of a low and unpredictable utilization factor (23-24 %). Additionally, it requires huge investments in networks. Therefore, an aggressive energy policy change based on an accident in a distant country seriously affects the competitiveness of countries and, after a decade of clean energy implementation, no significant net job creation or reduction in the cost of energy. It is clear that the costs exceed the alleged benefits. And studies made in Spain and the US show that for every green job created, two are lost from lost competitiveness, as industries’ costs soar. First Solar’s CEO says that solar energy will be competitive within ten years. They said the same thing years ago, referring to 2010. They have to prove it.

If we multiply by ten the OECD investments in prevention and safety of the nuclear power plants currently in operation, this would not pose anywhere near the same cost that would be needed to replace 10% of nuclear power by solar energy. And the latter would still have to compete with other sources of energy that are more abundant, cheaper and flexible.

It is worth continuing to invest in security, investigate further about economically viable and safe energy, but the greatest risk we face now is to take populist measures that sink competitiveness, curtail security of supply and make the system more expensive.

In energy, substitution can only come from competition. Either you compete or you disappear. Crude oil beat whale oil on price 120 years ago. The same happened with gas and coal. Anything else is dreaming.

Brent-WTI Spread…. More Fundamental than Market Perceives

Global Economy, On the cover, Sin categoría,
brent wti
(This article was published in Cotizalia on Feb 17th 2011)

I write to you this week from Oman. Impressive country, producing 900 thousand barrels of oil a day, and 9% of GDP from oil revenues, which finances amazing investments in infrastructure and civil works from Musqat to Salalah and other cities that are downright impressive.

As a country, it’s an example of how different the countries of the area are, despite the Western media efforts to put them all in the same basket of so-called risk of Egyptian contagion.

Another week and now that the Egyptian crisis has been solved, the market continues to focus on that country and the risk involved in the Suez Canal for crude supplies. And there is no real risk. The importance of the Suez Canal for the transportation of crude oil has fallen sharply in recent decades. During the 60s and 70s, almost 10% of global oil traffic passed through the canal. Today, it’s less than 1%. Moreover, as the three largest companies working in the channel say, the traffic is roughly balanced, with 55% of oil on ships heading north (992 thousand barrels/day) and 45% (about 850 thousand barrels/day) due south. Any problem in the Canal is, first, negligible for the transit of oil and, second, very easy to re-route around the Horn of Africa, an increase of transit time of less than 15 days.

For those who care about Egypt and the Sumed pipeline, just remind them that it only moves 1.1 million barrels per day despite having a capacity of 2.4 million barrels per day. And as a good friend of EGPC told me, there are few safer places than this pipeline, where the army has more troops than any city in the country except Cairo.

And in this environment we find the Brent and WTI spread at historical highs. Two clear effects: first the inflationary impact on Brent added to the deflationary impact on WTI to create the largest differential between the two ever seen: $14.5/bbl. Also very wide differential relative to other crude, Bonny Light (Nigeria), in particular, and Asian Tapis.

Let’s start by explaining what justifies the weakness of WTI:

Inventories at Cushing (at Oklahoma) are at historically high levels. 50% higher than the average for the past five years (25022). The problem is that the WTI weakness shows the growing isolation of the North American market and infrastructure problems to evacuate excess oil.

WTI crude trades on the basis of inventories at Cushing, in the middle of the American continent, and it is hard to move oil out of the area (called PAD II) or the large refineries on the Gulf.

1) There is enough transport capacity to carry crude from the Gulf to the center of the continent, but not vice versa. The fact that the Enbridge pipeline has had problems has increased the glut of crude in Cushing.

2) There has been an increase in exports of crude oil (oil sands) from Canada to the U.S., which increases the overcapacity in Cushing. Transcanada launched the second phase of its Keystone pipeline, which attracts even more crude to Cushing bottleneck.

3) The increase in U.S. domestic production, including Bakken, is also filling the stores in Cushing. The over-production in the U.S. is partly because the gas companies take advantage of high oil prices to produce more natural gas liquids, whose price is close to oil, in order to fund production of natural gas which today at $4/mmbtu, is not giving the best economics, actually very poor returns. Therefore they compensate for the low profitability of the gas with the price of associated liquids.

Add the fact that three refineries have been closed for maintenance, and we have the perfect storm. Excess production of high oil prices, withdrawal of the American system because of lack of infrastructure, and reduced refinery demand .

Meanwhile, Brent is affected some powerful inflationary forces:

1) The decline of production from Norway and North Sea, that previously functioned as a cushion against price increases, and does not produce that effect anymore.

2) The increase in OPEC oil transit to Asia, and rising domestic demand in exporting countries have reduced the oil for export. Saudi Arabia expects to increase its exports by 1 million barrels per day, but, for now, demand does not justify it.

3) The perception of geopolitical risk and the effect that we mentioned of transport cost increase. The market assumes that the cost of transport must rise. We are already seeing freight day rates recover, particularly in the VLCC segment, as I commented with Oman Oil. Having seen the Baltic Dry Index tumble to record lows due to excess spare capacity of ships, we could start to envision a horizon of recovery. Very gradual, and certainly not to be bullish, because overcapacity still exists (especially in the Capesize and Panamax segments.) And if freight costs rise, the chance to evacuate American crude to Europe is reduced.

As I mentioned two years ago on the differential between gas (Henry Hub) and oil, it is very dangerous to play against a very clear structural effect of isolation of a market, the American, in which the administration has no intention of promoting improvements in the system, and as a result, crude oil and domestic gas (WTI and Henry Hub) at lows is a clear boost from the country’s competitiveness.

Further read:

http://energyandmoney.blogspot.com/2010/01/revolution-of-shale-gas.html

http://energyandmoney.blogspot.com/2011/06/iea-releasing-strategic-reserves.html