Easwaran Kanason

Co - founder of NrgEdge
Last Updated: November 23, 2016
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Business Trends
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Last week in world oil

Optimism that OPEC and Russia could agree on a supply freeze lifted oil prices near the US$50/b level, as traders bet that supply/demand fundamentals had a eroded to a point that would necessitate action on the part of the producers. This optimism is hopefully not misplaced, but at some point, OPEC members will be hurting enough to agree on something. 

Kuwait has stepped in after Saudi Arabia cut off crude deliveries to Egypt. Although the Kuwaiti government says the shipments, renewed from an existing contract for three more years, are not intended to replace the Saudi source, it provides a measure of relief for Egypt, forced to issue emergency spot tenders after Saudi Arabia cut off supplies in October. Under the new agreement, Egypt will receive 2 million barrels of Kuwaiti crude a month, an amount insufficient to meet total domestic needs.

In response to higher prices, the US oil rig count jumped by double digits last week. Nineteen new oil rigs were added last week, with a single additional gas site bringing the total number of oil and gas rigs drilling in the US to 588, with most of the increases coming from the Permian Basin. 

US refiner Tesoro has agreed to buy independent US refiner Western Refining for US$4.1 billion, creating a new company that will represent 6% of the American crude processing capacity and the fifth-largest in the country. Western Refining’s speciality is gathering oil in remote fields, pooling it together and bringing it to a hub, with its pipeline infrastructure in the Texan and New Mexico Permian shale basin filling a huge gap in Tesoro’s midstream business. 

Argentina has removed subsidies for crude purchases by state-run YPF, a move aimed at freeing up cash for the beleaguered Argentine government. YPF had previously accessed crude at a subsidised cost of about US$62/b, but will now be required to pay market price as President Mauricio Macri slashes subsidies to prevent a ballooning fiscal deficit. This applies to domestic crude oil, where subsidies were put in place by Cristina Fernandez de Kirchner to promote drilling. YPF controls some 60% of the refinery and oil products market in Argentina. 

ExxonMobil is exiting the western South America retail business, passing over its fuel and lubricants businesses in Colombia, Ecuador and Peru to Chile’s Empresas Copec. Copec will retain the licence to produce and distribute fuel and lubricants in the markets under the ExxonMobil brands, while taking ownership of the existing distribution network. 

Italy’s Eni has finalised its plans to develop the Coral South offshore gas project in Mozambique. In an investment of up to US$50 billion, the huge gas reserves in Eni’s Area 4 concession could produce up to 3.3 mtpa of LNG per year, requiring six subsea wells and a floating production facility. Coral South contains some 16 tcf of gas, and Eni has already signed a deal to provide BP with LNG from the project over 20 years. 

The giant Kashagan oil field in Kazakhstan has finally started commercial production. Halted in 2013, when a pipeline cracked open causing the entire field to shut down, Kashagan is now back on track to reach output of 630 million barrels by 2017 and 760 million barrels by 2020, from a reserve estimated at 16 billion barrels. 

This is why an OPEC deal in the next week is highly unlikely. In October, Iran overtook Saudi Arabia as the chief supplier of crude oil to India, underscoring a trend that has seen Iran ramp up its exports to Asian nations, often at the expense of Saudi Arabia, regaining market share lost during the years of the sanctions. In October, Iran delivered some 798 kb/d of crude to India, compared to Saudi Arabia’s 697 kb/d. On a YTD basis, Saudi Arabia is still India’s top supplier, followed by Iraq, but Iranian exports to India have generally tripled over the course of 2016. 

Japan’s Idemitsu Kosan has been forced to delay its planned purchase of Showa Shell Sekiyu from Royal Dutch Shell again, as a review by the Japan Fair Trade Commission is still underway. The deal is now expected to be closed by January from its already delayed timeframe of November, as Idemitsu seeks to acquire 33% of Showa Shell after a full takeover was shelved indefinitely with stiff opposition from the founding family members of Idemitsu Kosan. 

Japan’s Tokyo Gas has signed an MoU with the UK’s Centrica for location swaps of LNG, benefitting both parties by slashing transportation costs. Tokyo Gas will supply Centrica with 700-800 ktpa of LNG from the Cove Point project in Maryland, while Centrica will oblige with an equivalent amount from its Asia Pacific LNG network. Swap deals are still uncommon in the LNG space, but will become more common as European and Asian utilities – with their LNG assets and contracts in far-flung places – seek to optimise their supply and transportation network. 

Petronas has achieved first gas for the floating LNG facility from the Kanowit field in Sarawak, a sign that its floating production unit is ready to enter commercial operations and deliver cargos.  It will be a world’s first, with the PFLNG Satu operating as the world’s first FLNG facility as Petronas seeks to unlock gas reserves in remote and stranded fields. 

After a 96% drop in Q216 profits, Petronas’ financial performance has bounced back, with Q316 profits tripling to RM6.1 billion over lower net impairment on assets and higher average prices for most of its products. Sales volumes, however, remain a concern, with shipments of almost all major products lower across the quarter.  The outlook for Q416 is a bit rockier, given the weakening of the Malaysian ringgit since November. 

Have a productive week ahead!

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OPEC And The Current State of Oil Fundamentals

It was shaping up to yet another dull OPEC+ meeting. Cut and dry. Copy and paste. Rubber-stamping yet another monthly increase in production quotas by 432,000 b/d. Month after month of resisting pressure from the largest economies in the world to accelerate supply easing had inured markets to expectations of swift action by OPEC and its wider brethren in OPEC+.

And then, just two days before the meeting, chatter began that suggested something big was brewing. Whispers that Russia could be suspended made the rounds, an about-face for a group that has steadfastly avoided reference to the war in Ukraine, calling it a matter of politics not markets. If Russia was indeed removed from the production quotas, that would allow other OPEC+ producers to fill in the gap in volumes constrained internationally due to sanctions.

That didn’t happen. In fact, OPEC+ Joint Technical Committee commented that suspension of Russia’s quota was not discussed at all and not on the table. Instead, the JTC reduced its global oil demand forecast for 2022 by 200,000 b/d, expecting global oil demand to grow by 3.4 mmb/d this year instead with the downside being volatility linked to ‘geopolitical situations and Covid developments.’ Ordinarily, that would be a sign for OPEC+ to hold to its usual supply easing schedule. After all, the group has been claiming that oil markets have ‘been in balance’ for much of the first five months of 2022. Instead, the group surprised traders by announcing an increase in its monthly oil supply hike for July and August, adding 648,000 b/d each month for a 50% rise from the previous baseline.

The increase will be divided proportionally across OPEC+, as has been since the landmark supply deal in spring 2020. Crucially this includes Russia, where the new quota will be a paper one, since Western sanctions means that any additional Russian crude is unlikely to make it to the market. And that too goes for other members that haven’t even met their previous lower quotas, including Iraq, Angola and Nigeria. The oil ministers know this and the market knows this. Which is why the surprise announcement didn’t budge crude prices by very much at all.

In fact, there are only two countries within OPEC+ that have enough spare capacity to be ramped up quickly. The United Arab Emirates, which was responsible for recent turmoil within the group by arguing for higher quotas should be happy. But it will be a measure of backtracking for the only other country in that position, Saudi Arabia. After publicly stating that it had ‘done all it can for the oil market’ and blaming a lack of refining capacity for high fuel prices, the Kingdom’s change of heart seems to be linked to some external pressure. But it could seemingly resist no more. But that spotlight on the UAE and Saudi Arabia will allow both to wrench some market share, as both countries have been long preparing to increase their production. Abu Dhabi recently made three sizable onshore oil discoveries at Bu Hasa, Onshore Block 3 and the Al Dhafra Petroleum Concession, that adds some 650 million barrels to its reserves, which would help lift the ceiling for oil production from 4 to 5 mmb/d by 2030. Meanwhile, Saudi Aramco is expected to contract over 30 offshore rigs in 2022 alone, targeting the Marjan and Zuluf fields to increase production from 12 to 13 mmb/d by 2027.

The UAE wants to ramp up, certainly. But does Saudi Arabia too? As the dominant power of OPEC, what Saudi Arabia wants it usually gets. The signals all along were that the Kingdom wanted to remain prudent. It is not that it cannot, there is about a million barrels per day of extra production capacity that Saudi Arabia can open up immediately but that it does not want to. Bringing those extra volume on means that spare capacity drops down to critical levels, eliminating options if extra crises emerge. One is already starting up again in Libya, where internal political discord for years has led to an on-off, stop-start rhythm in Libyan crude. If Saudi Arabia uses up all its spare capacity, oil prices could jump even higher if new emergencies emerge with no avenue to tackle them. That the Saudis have given in (slightly) must mean that political pressure is heating up. That the announcement was made at the OPEC+ meeting and not a summit between US and Saudi leaders must mean that a façade of independence must be maintained around the crucial decisions to raise supply quotas.

But that increase is not going to be enough, especially with Russia’s absence. Markets largely shrugged off the announcement, keeping Brent crude at US$120/b levels. Consumption is booming, as the world rushes to enjoy its first summer with a high degree of freedom since Covid-19 hit. Which is why global leaders are looking at other ways to tackle high energy prices and mitigate soaring inflation. In Germany, low-priced monthly public transport are intended to wean drivers off cars. In the UK, a windfall tax on energy companies should yield US$6 billion to be used for insulating consumers. And in the US, Joe Biden has been busy.

With the Permian Basin focusing on fiscal prudence instead of wanton drilling, US shale output has not responded to lucrative oil prices that way it used to. American rig counts are only inching up, with some shale basins even losing rigs. So the White House is trying more creative ways. Though the suggestion of an ‘oil consumer cartel’ as an analogue to OPEC by Italian Prime Minister Mario Draghi is likely dead on arrival, the US is looking to unlock supply and tame fuel prices through other ways. Regular releases from the US Strategic Petroleum Reserve has so far done little to bring prices down, but easing sanctions on Venezuelan crude that could be exported to the US and Europe, as well as working with the refining industry to restart recently idled refineries could. Inflation levels above 8% and gasoline prices at all-time highs could lead to a bloody outcome in this year’s midterm elections, and Joe Biden knows that.

But oil (and natural gas) supply/demand dynamics cannot truly start returning to normal as long as the war in Ukraine rages on. And the far-ranging sanctions impacting Russian energy exports will take even longer to be lifted depending on how the war goes. Yes, some Russian crude is making it to the market. China, for example, has been quietly refilling its petroleum reserves with Russian crude (at a discount, of course). India continues to buy from Moscow, as are smaller nations like Sri Lanka where an economic crisis limits options. Selling the crude is one thing, transporting it is another. With most international insurers blacklisting Russian shippers, Russian oil producers can still turn to local insurance and tankers from the once-derided state tanker firm Sovcomflot PJSC to deliver crude to the few customers they still have.

A 50% hike in OPEC’s monthly supply easing targets might seem like a lot. But it isn’t enough. Especially since actual production will fall short of that quota. The entire OPEC system, and the illusion of control it provides has broken down. Russian oil is still trickling out to global buyers but even if it returned in full, there is still not enough refining capacity to absorb those volumes. Doctors speak of long Covid symptoms in patients, and the world energy complex is experiencing long Covid, now with a touch with geopolitical germs as well. It’ll take a long time to recover, so brace yourselves.

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June, 12 2022