David Fuller and Eoin Treacy's Comment of the Day
Category - Energy

    Musings From the Oil Patch April 18th 2017

    Thanks to a subscriber for this edition of Allen Brooks’ ever interesting report for PPHB. Here is a section:

    The worst downturn in the history of the oil industry has been followed by the fastest drilling rig recovery in history. From massive layoffs and corporate restructurings, oil and gas and along with oilfield service companies have had to switch gears and figure out how quickly and profitably they can grow along with the current recovery. As someone mentioned, the industry has crammed a year’s worth of rig activity growth into a few months – something that is creating a challenge for the oilfield industry. 

    As the energy companies are about to start reporting financial results for the January - March 2017 period, numerous oilfield service company managements have already signaled that the numbers will likely not reflect the levels of profitability Wall Street analysts had expected due to the costs of responding to the explosion in activity, especially following OPEC’s surprise output cut to help drive a recovery in oil prices. From the rapid climb in the rig count, it is clear that not only had investors and analysts bought into the recovery scenario, but so too had exploration and production (E&P) company managements. 

    There is an expression in English literature that “all things come to those who wait,” but that isn’t the case in the oil patch – especially if one wants to make money. In reality, the expression “the early bird gets the worm” is more appropriate to describe how people in the E&P business operate, but it is taking a toll on the pace of the recovery in oilfield service company profits. Service company managers have had to spend money to reactivate equipment and re-crew them before they can actually earn revenue. The more aggressive a company has been, or is, in ramping up its idle equipment, the greater are the costs incurred. At the present time, everyone is comfortable in the belief that the delay in gratification – increased profits – will be worth the effort, and the wait. Whether that proves a correct assumption or not will depend on how the recovery continues unfolding and what happens to well costs, which is what is driving the increased activity. Everyone has to make money going forward for the recovery to be sustained. That doesn’t mean, however, that everyone will enjoy the levels of profitability experienced during the era of $100+ a barrel oil prices. But, unless people make money, the industry will not be able to support additional activity, or possibly even support the current level of work. So where are we in this recovery?


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    Global Shipping Fleet Braces for Chaos of $60 Billion Fuel Shock

    This article by Firat Kayakiran for Bloomberg may be of interest to subscribers. Here is a section:

    Little more than 2 1/2 years from now, the global fleet of merchant ships will have to reduce drastically how much sulfur their engines belch into the atmosphere. While that will do good things -- like diminishing the threat of acid rain and helping asthma sufferers -- there’s a $60 billion sting in the tail.

    That’s how much more seaborne vessels may be forced to spend each year on higher-quality fuel to comply with new emission rules that start in 2020, consultant Wood Mackenzie Ltd. estimates. For an industry that hauls everything from oil to steel to coal, higher operating costs will compound the financial strain on cash-strapped ship owners, whose vessels earn an average of 70 percent less than they did just before the 2008-09 recession.

    The consequences may reach beyond the 90,000-ship merchant fleet, which handles about 90 percent of global trade. Possible confusion over which carriers comply with the new rules could lead to some vessels being barred from making deliveries, which would disrupt shipments, according to BIMCO, a group representing ship owners and operators in about 130 countries. Oil refiners still don’t have enough capacity to supply all the fuel that would be needed, and few vessels have embarked on costly retrofits.

    “There will be an absolute chaos,” said Lars Robert Pedersen, the deputy secretary general of Denmark-based BIMCO. “We are talking about 2.5 million to 4 million barrels a day of fuel oil to basically shift into a different product.”


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    Musings from the Oil Patch April 4th 2017

    Thanks to a subscriber for this edition of Allen Brooks’ ever interesting report for PPHB which may be of interest. Here is a section:

    As we contemplate the next cycle, we cast our view back on the industry’s history. The last great cycle came out of the explosion in oil prices in the latter half of the 1970s due to geopolitical events, but realistically it resulted from the peaking of U.S. oil output and the transferring of pricing power to the OPEC cartel. What broke the back of that price explosion was new, large sources of oil – offshore basins in the North Sea and West Africa, in particular, along with Alaska. Those were the resources that drove the industry over the subsequent 30 years. Shale is what is driving the industry now, and likely will drive it for the foreseeable future. What could that mean for oil prices? Look at Exhibit 1 where we show the inflation-adjusted oil prices from the late 1960s to 2016. After the bust of the early 1980s, the oil price traded for 18 years without ever going above $45 a barrel in current dollar prices except in response to one-off geopolitical events. 

    The recent oil price bust followed a much longer period of super-high oil prices than in the 1970s. To our way of thinking, we are likely to experience another extended period of lower, but stable, oil prices. Will it be 18 years? We don’t know. Will oil prices stabilize around $45 a barrel? We don’t know. Might the price range be $55-$60 a barrel? It could be. Will it be $70 a barrel or more? We doubt it, except for brief periods. This isn’t because we think history always repeats itself, but rather because the oil industry is fighting maturing economies around the world, meaning slower demand growth. Developing economies are where oil demand is growing the fastest, but those countries have the benefit of employing the most recent equipment designs and technologies, suggesting their economies will be much more energy-efficient than earlier developing economies at the same point in time. Think about how no country now would consider string telephone wires to allow communication – cell towers are the answer. The oil industry is also fighting a global push to de-carbonize economies in order to fight the damage of climate change, which has the potential to significantly lower global oil consumption growth.

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    Thanks to a subscriber for this report from Deutsche Bank which may be of interest. Here is a section: 

    Investors should be particularly sensitive to indicators that are associated with being in a misaligned world. This analysis can be applied both to sunk capital and new investment. For companies with low growth capex, margins on existing production will clearly be more important than incremental value creation or destruction on new investment. For high growth companies, returns relative to the cost of capital on new investment will be more critical. 

    Investors should be wary of high-carbon companies where decarbonisation is likely to be demand driven (for example coal generators facing lower production as subsidised renewable production is built). However there may be value opportunities where decarbonisation is supply driven (for example restrictions on coal production, or forced coal closures could increase margins on remaining capacity even while overall volumes drop). 

    Investors should look for low carbon companies in sectors where supply constraints are likely to be more significant than demand constraints as volumes grow. They should be wary of sectors where the mechanisms for growth are likely to drive down returns (for example long asset lives with technological progress and short-term market pricing). 

    By understanding the positioning of companies in the matrix of volume and value, investors can make an informed judgment. Market valuations can be set against current opportunities and future expectations. Shareholder engagement can help ensure the right corporate strategy

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    Energy Stat: Are Electric and Autonomous Vehicles Heading Down the Road to Peak Oil Demand?

    Thanks to a subscriber for this fascinating report by Pavel Mulchanov for Raymond James which may be of interest. Here is a section:

    There is no law of nature that dictates that global oil demand must eventually reach a peak and then begin an irreversible decline. The well-known “law” of Hubbert’s Peak applies to supply, not demand, and the advent of modern technology (fracking, horizontal drilling, enhanced recovery, etc.) has led to a fundamental rethink of whether oil supply will peak after all. In this context, we see comments such as the one from Shell, suggesting that peak demand will come first, rendering peak supply a moot point.

    There is no direct historical precedent for worldwide demand for a major energy commodity to peak on a sustained basis. (Sorry, whale oil doesn’t count.) Despite all of the regulatory and other headwinds, for example, global consumption of coal is still growing. But it is true that there is precedent for national and even regional demand to peak. Coal demand in Europe peaked in the 1960s, and has since fallen to substantially lower levels. Oil demand in Japan peaked in the 1990s. Oil demand in Europe peaked more recently, in 2006, one year after the U.S. By definition, a peak is something that can only be known in retrospect, but with a decade having passed, it seems abundantly clear that European oil demand will never get back to its pre-2006 levels. With regard to the U.S., the situation is less clear-cut because of the demand recovery in recent years, but 2005 may well be the all-time peak. The theory of peak global oil demand holds that when enough parts of the world reach a peak, a global peak will result, because the few places still growing will not be enough to offset the decliners. In this sense, the theory is conceptually valid. Thus, we would not argue with the notion that peak oil demand is a matter of time. The real question is: how much time?


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    Musings from the Oil Patch March 21st 2017

    Thanks to a subscriber for this edition of Allen Brooks’ ever interesting report for PPHB. Here is a section comparing the efficiency of a Tesla to a BMW 7 Series:

    “Liberals frequently care more about feelings than facts, and your smug Tesla-owning frenemy will never admit it, but in day to day usage, the big BMW is actually 18% more efficient, and 18% kinder to the planet. (Don’t get too cocky, Mr. 7 Series: at a US average 12 cents per KwH, the electricity cost to the Tesla owner for 1000 miles works out in total to about $81, as opposed to $98 for the gasoline. The reason the Tesla is less efficient, but still cheaper to run, is that the power company pays a lot less for fuel than the automobile driver does. But when the issue is green impact, not greenbacks, the BMW wins handily.)


    “Of course, no self-respecting Green Weenie would settle for powering his car by the sun, but his house by Con Edison. And with the average efficient house using 1 KwH per hour, i.e., 24 KwH per day, the house needs 4.8 KwH capacity, and considering efficiency losses and reserve requirements, that means 6.9 KwH for the house. So to power both the Tesla and the house, Green Man needs at least 1,443 square feet of power production, at a cost of $115,000. But even using a Tesla-only setup, $60k would buy 25,641 gallons of gasoline (at the current US average price of $2.34 per gallon). The Big BMW could travel, on that much fuel, 24,000 x 24 MPG = 615,384 miles. Game, set and match – Munich and Detroit. Sad!” 

    While we didn’t do the analysis, all of Mr. Karo’s numbers were sourced, which was not a surprise, given that he is a Philadelphia lawyer, and the math works. Although Mr. Karo expresses disdain for braggadocios Tesla owners, presumably because of his experiences with some owners he has encountered, the economics in this analysis suggest that gasoline-powered vehicles will have a longer future than EV-proponents suggest, or would like to see happen. Tesla owners will not be swayed by Mr. Karo’s analysis. Instead, they will declare that with falling battery and solar panel costs coupled with their improving efficiencies, the cost advantage will soon swing in favor of EVs. However, the inability of EVs to be swapped for gasoline-powered vehicles in a one-to-one exchange for all applications means there is an extensive convincing period ahead before the public fully embraces them. Just how long that convincing period will be is anyone’s guess. 

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    Google Might Run the Power Grid More Efficiently

    This article by Diego Marquina and Jahn Olsen for Bloomberg may be of interest to subscribers. Here is a section:

    The best way to send the right economic signals that reflect constraints is through locational marginal pricing – having different power prices in different parts of the grid.

    This is a politically unpopular mechanism, as it would see prices go up in zones of large demand – potentially industrial areas.

    The alternative is grid investment. But the costs are huge, as is the case for the bottleneck between Scottish wind farms and English demand centers. The 2.2 gigawatt HVDC cable currently being built there has an estimated cost of 1 billion pounds. Yet National Grid estimates as much as 8GW of additional transmission capacity could be required by 2030, on that particular border alone.

    Less human involvement might be part of the solution. Google’s DeepMind recently announced they are exploring opportunities to collaborate with National Grid. It has been successful elsewhere -- DeepMind demonstrated its immense potential by reducing cooling costs in an already human- optimized datacenter by 40 percent.

    Setting it loose on the extremely complex and quite probably over-engineered National Grid, with its many overlapping services and mechanisms, its rules of thumb and its safety margins, could provide novel ways to ensure system reliability cheaply and efficiently. DeepMind’s CEO conservatively hinted that it might be able to save up to 10 percent of the U.K.’s energy usage without any new infrastructure. Step aside, humans.


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    Round Two still much more to come

    Thanks to a subscriber for this report from Deutsche Bank focusing on the oil marketing companies' sector in India. Here is a section:

    Although there is understandable scepticism given the government’s track record, our confidence on the implementation of free pricing for petroleum products stems from the following measures that the government has already taken: 

    The extinguishing of the diesel subsidy in October 2014 and the revision of prices in line with changes in international prices without any government intervention; 

    The increase in LPG and kerosene prices each month since June 2016; 

    Increases in the auto fuel price even during elections and in times of sharp price increases for crude; 

    The aggressive implementation of Direct Benefit Transfer (DBT) to LPG and kerosene to contain subsidies. 

    FCF yield improves by up to 280 bps over FY17-20 
    Operating cash flow for OMCs will likely be driven by improvement in marketing margins, rising refining margins and higher volumes. Over FY17-20, the FCF yield of state-owned OMCs should improve dramatically, by more than 280bps for IOC and BPCL. HPCL, with capex starting from FY18, will likely see its FCF yield decline by 130 bps. We expect the OMCs to generate robust free cash flows of about USD10bn over FY18-22E. We also estimate net debt/equity of OMCs to decrease further over FY16-22E – HPCL from 1.6x in FY16 to 0.6x in FY22, IOC from 0.6x in FY16 to 0.2x in FY22, and BPCL from 0.7x in FY16 to 0.1x in FY22.

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    A Father of Fracking Seeks to Emulate U.S. Shale Boom in Alaska

    This article by Alex Nussbaum for Bloomberg may be of interest to subscribers. Here is a section:

    A pioneer of the U.S. shale revolution wants to take fracking to America’s final frontier. Success could help revive Alaska’s flagging oil fortunes.

    Paul Basinski, the geologist who helped discover the Eagle Ford basin in Texas, is part of a fledgling effort on Alaska’s North Slope to emulate the shale boom that reinvigorated production in the rest of the U.S. His venture, Project Icewine, has gained rights to 700,000 acres inside the Arctic Circle and says they could hold 3.6 billion barrels of oil, rivaling the legendary Eagle Ford.

    While the potential is huge, the difficulty of shipping millions of gallons of water, sand and chemicals -- the ingredients used in fracking -- to one of the most remote areas on earth is nothing short of monumental. At stake is an Alaskan industry that’s seen output tumble from 2.1 million barrels a day in 1988 to 520,000 in 2016 as reserves dwindled and explorers sought cheaper supplies in shale fields to the south.

    “The oil is there,” said Basinski, founder and chief executive officer at Houston-based Burgundy Xploration LLC, in an interview. “Now it’s a question of how quickly we can get it to flow and whether we can get the economics to work." One exploratory well has been drilled, he said, and a second is planned by mid year.


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