Easwaran Kanason

Co - founder of NrgEdge
Last Updated: September 10, 2016
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Business Trends
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In 2007, the Financial Times named the ‘new seven sisters’, the most influential energy companies in the world that were challenging the old seven sisters – now shrunk to four: ExxonMobil, Shell, BP and Chevron – for dominance over the global industry. Brazil’s Petrobras was one of the new seven sisters, but what was once an ascending jewel is now a group mired in financial and existential crisis. How did it happen?

Like the other seven sisters – Saudi Aramco, Russia’s Gazprom, China’s CNPC, Iran’s NIOC, Venezuela’s PDVSA and Malaysia’s Petronas – Petrobras is mainly state-owned, with 64% of the company held by the Brazilian government. This meant the government could direct policy and channel funds; Petrobras’ energy policies were effectively Brazil’s energy policies. This is not unique to Petrobras – Saudi Aramco is effectively the Kingdom’s capital account, while the ties between Petronas, Gazprom and NIOC and their respective governments are known to many. The new seven sisters were certainly better-run and well managed than other state oil companies, say Indonesia’s Pertamina or Mexico’s Pemex, but there was still corruption, just comparatively less of it.

With Petrobras, it was Brazil’s massive pre-salt deposits that triggered the crisis. Wanting to keep the assets out of foreign hands, the Brazilian government, led by Luiz Inácio Lula da Silva, made Petrobras the sole operator of the offshore fields. The resulting project was the highest capital expenditure in the world, and Lula and his Workers’ Party (PT) appointed their own candidates to the Petrobras bard, diverting up to 3% of all contracts back to the PT party for personal use and also to keep the party in power. This was, again, not unique to Petrobras among the new seven sisters, but why Petrobras fell was because of the scale of the scandal, as well as a measure of democracy and judicial autonomy. From a simple investigation of black market money lenders in a small petrol station, police and criminal investigators traced the trail back to Petrobras, claiming the scalps of numerous politicians, including President Dilma Rousseff, along the way. This, coupled with weak oil prices, has left Petrobras bruised, battered and with over US$130 billion in debt, the highest debt burden of any global oil firm.

To pare down this debt, Petrobras has had to embark an ambitious divestment program, with a target of raising US$15.1 billion this year. This has included some sales of its crown jewels in the past quarter, including a US$2.5 billion sale of its interest in the offshore Santos BM S-8 licence to Norway’s Statoil, a US$5.2 billion sale of its gas pipeline network to Canada’s Brookfield Asset Management and a sale of its domestic petrochemicals units to Mexico’s Alpek, as well as selling off stakes in its Argentinian and Chilean subsidiaries. More sales will come, but Petrobras has so far resisted encroaching upon its pre-salt fields, betting upon it as a key asset when the market changes. It may not be able to resist much longer, with buyers eyeing prized assets with the leverage to secure good deals. At the end of this, what will emerge will be a weaker Petrobras but a strong oil industry in Brazil. From a dynamic company expanding furiously globally, Petrobras’ fall from grace is a sad reminder of the insidious nature of state corruption, and perhaps a cautionary tale as well. 

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High Oil Prices and Indonesia’s Ban on Oil Palm Exports

Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.  

A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.

Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.

Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.

And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.

That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.

Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.

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Market Outlook:

  • Crude price trading range: Brent – US$110-1113/b, WTI – US$105-110/b
  • As the war in Ukraine becomes increasingly entrenched, the pressure on global crude prices as Russian energy exports remain curtailed; OPEC+ is offering little hope to consumers of displaced Russian crude, with no indication that it is ready to drastically increase supply beyond its current gentle approach
  • In the US, the so-called NOPEC bill is moving ahead, paving the way for the US to sue the OPEC+ group under antitrust rules for market manipulation, setting up a tense next few months as international geopolitics and trade relations are re-evaluated

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