Tag Archives: International

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.

Salamander, a case of de-rating through exploration

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

Being an E&P the main catalyst for the company’s stock is its exploration campaign. However, when it comes to this, Salamander Energy has not had the greatest run.Out of 3 exploration wells dug by Salamander Energy in 2010, none were successful in finding commercial hydrocarbon flows.

Bang Nouan 1 well was spudded in April 2010 in Lao PDR. However, in May the company reported that the zones of permeability encountered in the primary objective were water bearing. All hopes were turned to the gas shows encountered in the secondary objective, which upon a well test, failed to be of commercial level. Thus, the well was plugged and abandoned in early August.

The next blow came from the high-risk Tom Su Lua prospect, Vietnam, where TSL-1X well was drilled. However, in late June the company announced that the well has been plugged and abandoned having failed to encounter any commercial hydrocarbon levels. It had been drilled to a total vertical depth sub-sea of 1,380mt and encountered both, potential seals and high quality reservoir sandstones, which were water-wet in the Tertiary clastic section.

The company then focused on drilling the THX-1X well on the Tom Hum Xanh prospect in Vietnam, 250km south of the TSL-1X well. Similar to its neighbour, THX-1X was announced a dry hole in late July and subsequently was plugged and abandoned as it failed to encounter significant hydrocarbons in the target reservoir sections. It is important to note that the acreage in Vietnam was previously unexplored and therefore was high risk.

The key risk to the share price is the company’s drilling results. Since the start of the year the company has drilled 3 wells, all of which have been subsequently plugged and abandoned as dry holes. Thus, the results of its next planned wells, Angklung and Dambus in Indonesia’s Kutai basin, are the key risks to the stock performance. Serica Energy, operator of Dambus, has assigned a 40% chance of success for the well, while Salamander Energy has estimated the geological risk for the Angklung at 24%. However, both wells are located in a heavily explored acreage, which already contains several producing wells.

Unsuccessful drilling campaign has cost the company in the loss of 40% of its stock value since the beginning of the year. However, although the stock is in a downward trend, it has not reacted greatly to the drilling updates.

The market’s reactions to the updates were positive. Thus, the stock rose on average by 2.00% on the day Salamander Energy plugged and abandoned its wells. Moreover, it seems that the market was reacting to the negative news a day before the announcement was made public. The company is currently trading at 34% above its core NAV (164p/sh) while E&A risked upside is at 116p/sh (632p/sh unrisked).

Overall, the Dambus well looks low-risk, while although the company claims the same about the Angklung, the failure of Unicol as well as the delay in project have put an increased risk on the prospect. Thus, the results of these 2 wells will be crucial to the future position of the company.