Tag Archives: International

Iraq, A New Frontier And A Few Question Marks

Global Economy, On the cover, Sin categoría

IRAKWe’ve talked on other occasions of the difficulties that big oil companies find to grow. The reserve replacement ratio is still disappointing.

In my opinion, the true hope of the sector is Iraq, one of the largest proven oil reserves in the world, 145 billion barrels of oil, behind Saudi Arabia, with 264 and above Iran’s 138 billion barrels of oil.

Iraq is presently outside the normal OPEC system, which is based on reserves, and given it currently produces around 2.5mbd they have stated they will not discuss a quota until output reaches 4mbd (in line with Iran). So the increase in estimated reserves can be viewed cynically as a way of preparing itself ahead of an OPEC quota.

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 11 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 onerous, 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.

Iraq’s 11 deals with foreign companies should in theory help increase capacity to 12mbd by 2017. 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. And Iraqi production hasn’t exceeded 3 million barrels/day since 1979. 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).

Of the reserve revision seen this week, the bulk of the increase comes from the West Qurna field, now thought to hold 43bn bbl compared to 21.5bn previously. Exxon signed the PSC for West Qurna development Phase 1, Lukoil for Phase 2. The next largest source of uplift is Zubair (up from 4.1bn to 7.8bn bbl), where ENI is leading the development consortium. On the flipside, Rumalia (BP-CNPC) was revised downwards slightly from 17.8 to 17.0bn bbl, and Majnoon (Shell) from 12.6bn to 12.0bn bbl.

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 sharing contract). And IRRs can vary significantly, but in most cases only surpass 16% if ramp-up is in a straight line.

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. In total, the capex will exceed $100bn, and a lot needs to happen in terms of services (still small relative local presence), infrastructure and administration (there is no real government to manage the process and give the approvals).

We see most of the rates of return for the companies involved in the Big Six Iraqi oil fields fall within the 10%-18% IRR range, with higher returns for the pre-existing PSCs and government-owned entities. The key Kurdistan operators get very high IRRs under the Kurdish PSC, which has much more favorable terms than the Iraqi TSC. However, the Kurdistan situation is less than clear, and Iraq still considers all these contracts illegal. It is very difficult to believe that the contracts will be validated after elections.

For Iraq, 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 billion 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.

Update: Iraq reached 2.75 mbpd production in July 2011, the highest since 2003.

US Natural Gas … The picture gets bleak(er)

Global Economy, On the cover, Sin categoría,

US GAS

As I mentioned a few weeks ago… It could get worse, and it did. The bulls of the market have been calling for the need of a drastic cut in production in US gas and it hasn’t happened. No wonder the Hedge Funds net long positions on US gas have been reduced by 50%.

The environment is still strong for producers to keep increasing volumes, credit is abundant, hedges are in place and companies still think that growth and production is more important than supply management and economics. As an example, Chesapeake has entered into a 5 year VPP with Barclays on the Barnett 280 mmcfed of production relating to 390 BCF of 1P for $1.15 bn. This is after costs, so I imagine the price of the hedge is $4.50 (considering 20% royalty and $0.80 operating costs). Over the past three years Chesapeake has averaged $4.70 per mcf on their VPPs. This is generating utility-type returns in a very cyclical industry where everyone claims to be the low cost producer. So as long as there is credit, gas will flow regardless of diminishing returns.

Not only have we broken through 2003 lows (these are nominal prices), we are doing so in an environment where gas drilling and services day-rates remain robust, activity flush and inventories at cyclically long highs.

What has happened? Oil at $81/bbl, for starters. Wet gas changes the economics of drilling, so loads of ‘uneconomic’ gas fields are made economic by selling the liquids. Tough for dry gas-dominated producers, like in the Barnett shale.

Additionally, efficiencies in extraction, principally in horizontal drilling are forcing the cost curve lower despite the stronger environment for services. So day-rates are up, but cost per mcf produced is down.

Credit is also an important factor. Almost any producer of size can tap higher amounts of debt financing to keep drilling.

However, gas can self-correct rapidly. Once the situation becomes A few months of drastically curtailed production; or a few months of ultra-low prices like $2.50 would quickly re-equilibrate supply and demand, and force us back to long-term averages on the cost curve…but that cost curve itself is not static.

Meanwhile, the curve contango steepens. Cal 2012 is 16% above 2011. The bull case here is that by 2012 we could see conventional decline (6% pa) meet unconventional plateau, added to a view o demand improving, albeit slightly. The risk to believe this case is that the forward curve is slightly polluted by the hedges being taken in the financial markets.

The Increased Isolation of Iran versus Saudi Arabia and Israel

Global Economy, On the cover, Sin categoría

(Article published in Spanish in Cotizalia on Sept 30th, 2010)

It is the largest arms contract signed in U.S. history. $60 billion in weapons to Saudi Arabia. More importantly, that huge contract probably includes a long-term agreement to ensure oil supplies to the U.S. from the Saudi Kingdom. After so many empty words about energy independence from the Middle East, it seems that gone are the days of anti-OPEC messages from the current administration. But it is also of paramount importance to secure the protection of Israel from the threats of the Iran regime. After all, the Saudi Kingdom has as much to fear from Iran as Israel has.

The United States faces a future that needs Israel and Saudi Arabia as much as it did twenty years ago, if not more. Israel as the representative of Western values and democracy in the region, and Saudi Arabia as the best balancing factor as a West-friendly regime versus Iran and other radical Arab nations. And this is needed because the US will only be able to focus on recovering economic growth on the foundation that is provided by cheap energy, the only possible way, and through three pillars: the abundant reserves of conventional natural gas and shale gas (more than 250 years of supply, as Peter Voser, CEO of Royal Dutch Shell, says), oil from the Saudi + U.S. + Canada triangle and to a lesser extent, clean energy (nuclear and wind).

Of course, this agreement is intended to send a message to Iran, that is continuing with its nuclear program, despite the virus threats to its IT systems, and its anti-Israel but also anti-Saudi messages. It is not just a prevention message, it is a way to strengthen the Saudi government as leader of the moderate wing of the Arab countries. The Iranian regime is not supporting the King Abdullah, and continues to try to grab influence in the Shia community versus the Suni majority, while Saudi Arabia is undertaking the most ambitious program of modernization and opening up in its history, more than a billion dollars of investment in infrastructure and services, and, after sporadic protests in August, a very specific focus on education and securing employment for the population younger than 25 years, more than half of its 18 million inhabitants. A stronger Saudi Arabia and a lower influence of Iran on the Shia muslims means also a safer Israel and a better balance in the region.

We are aware that arming the Saudi Kingdom with $60 billion to send a message to a country, Iran, whose military budget is less than the $10 billion a year, must start from the view that conflict is most likely than what we believe or obey other strategic objectives. That goal may be the security of oil supplies ahead of an eventual geopolitical problem that significantly reduces exports from the Persian country.

Since March we have seen all Western oil companies cancel, reluctantly, supplies to Iran. The embargo is effective and is already evident in the prices of oil and the increase of Saudi crude exports to the United States that has analysts all over the world scratching their heads.

Why grow imports when U.S. demand is not really rising and inventories are at a five year high? At the end of the day, imports are going up because someone is buying these boats, and not, as some analysts seem to assume, because suddenly, lo and behold, boats appeared out of the blue one afternoon to download. Are the US building a cushion, an additional strategic reserve? Maybe.

Add to that the increase in the number of vessels storing oil on sea, which has risen 10% in two months, and it is plausible to estimate that if they are not preparing an environment of conflict, at least they may be seeking to ensure supplies of oil in a more complex geopolitical environment, taking advantage that oil trades with virtually no political risk premium.

It is true that OPEC now has 6.3 million barrels per day of spare capacity and that between Russia and Iraq they are expected to increase global supply by 2.5 million barrels per day in 2013, but I fear that not even Hussain al-Shahristani , Iraq’s oil minister, assumes the country’s goals as easily achievable in the medium term, particularly if the investments of international business concession of the fields start to slow down following the recent local incidents at the premises of the Al-Ahdab East field (CNPC, China).

But if Iran has to be considered out of the equation in a tense geopolitical environment, spare capacity is gone, and the additional barrels will only be able to come from the only country that can immediately increase capacity from 9 to 11 million barrels a day … You guessed it, Saudi Arabia.

Oil in Greenland… A New Frontier?

Global Economy, On the cover, Sin categoría,

greenland(Article published in Cotizalia.com in Spanish on Sept 23 2010)

Today we will talk again about finding new oil frontiers. And it’s time to talk about the arctic. Until recently a disappointing area for oil exploration, both due to environmental constraints, water limit disputes and dry wells. But the war for natural resources, the recent encouraging exploration results, and the constant global goal to diversify and achieve energy independence, is bringing back billions of dollars in investments to Greenland.

Greenland has a lot of oil. Studies of various consultants, PFC and the U.S. government estimate that it has the second largest oil reserves yet to discover, larger than the discovery of Brazil and Kashagan and behind Iran (Zagros). We talk of more than 45 billion barrels. And yet we have only seen minimal exploration activity in the last ten years.

The technical difficulties and costs are not negligible. Now, however, everything can change, and turn Greenland in the great new frontier for the oil industry after Uganda, Ghana and Brazil.

In the 70’s, companies such as Chevron, Total, Mobil and Statoil explored Arctic waters without success, and until recently the results have been more than disappointing, as all wells explored were not viable. I do not want to bore you with technical details, but one of the reasons that there were no discoveries was the type of oil accumulations that were being sought, focusing on concentrations in sediments of the Tertiary or Cenozoic era, ie about 65 million years old . However, the oil discoveries in Brazil and Ghana have made the industry more recently set its targets in sediments from the Cretaceous era (about 145 million years old) and in deep water, more expensive and riskier, but with enormous potential .

West Greenland can be one of those surprises. Just the same as in the first part of this decade the industry doubted the exploration potential of Brazil, West Greenland probably shows a very similar accumulation.

However, some media say, erroneously, that the exploration in Greenland is only possible thanks to global warming, which allegedly contributed to the melting of the ice in the area and using alarmist arguments about the impact of the oil industry in the area and the ecosystem. For starters, exploration in the area has been carried out since the 70’s, as I said, with no environmental impact. The difference is that the technology of deepwater drilling has improved substantially, allowing access as already mentioned sediment depths greater than, 2,200 feet and 300 km from the coast, completely away from any ecosystem to be preserved.

The challenge of industry in Greenland is not to take advantage of the alleged global warming, which of course is not evident in the area, with oversized icebergs migrating from North to South that have grown, not shrunk, and temperatures which have dropped two degrees on average since Statoil prove its last well, Qulleq 1, in 2001. The industry challenge is to prove the commercial viability of this enormous potential. Considering the current cost environment, projects in Greenland recover investment at $ 60/bbl, with development costs of about $ 25/bbl and operating costs of $ 12-14/bbl. In other words, to get a return on investment (IRR) of 25% on a typical minimum investment of 5 billion dollars, you need an oil price of $80/barril.

Independent explorers, good friends of ours many of them, are the ones taking the lead in the new frontiers. Cairn Energy, is conducting an exploratory program of 14 wells in Greenland, the highest risk (especially in the south, where it is less obvious to see the oil accumulation), but high potential. And the big oil companies are already participating in the race for operating licenses in the area. Exxon, Chevron and others are already prepared. We will follow this closely.