Easwaran Kanason

Co - founder of NrgEdge
Last Updated: May 7, 2017
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Business Trends
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It’s earnings seasons again and for oil firms, the numbers have not looked this good for some time. ExxonMobil, Shell and BP profits all surged, and Chevron moved back into the black. Elsewhere, profits have generally been up over the first three months of 2017, as firms reap the benefits of years of cost-cutting and, crucially, the OPEC supply freeze that lifted prices. There are arguments to be made on whether the OPEC cut has been successful or not, but at least from a Q12017 financial perspective, the answer is yes. Compared to the same period in 2016 average crude prices are up 50%.

Big daddy ExxonMobil more than doubled it profits to US$4.01 billion, even as its production fell by 4%. Chevron, which declared a rare loss in Q417, swung to a US$2.68 billion profit and turned its cash flow positive, beating all Wall Street expectations. Actual production at Chevron’s fields was weaker, so better performance is down to better prices. At both companies, American shale oil and LNG are characterising their growth over the rest of the year. Both expanded their shale portfolios in the Permian Basin, starting up low-cost fields in response to improving prices, while shying away from high-cost, challenging crude production. LNG marks the case forward for both as well, over the longer term. ExxonMobil sealed its purchase of Papua New Guinea’s InterOil for US$2.5 billion and bought a stake in a Mozambique gas field for US$2.8 billion. In Australia, Chevron brought its third Gorgon LNG facility online, and has the mammoth Wheatstone project coming up, delays nonewithstanding.

BP’s profit tripled to US$1.51 billion, and expects the good times to continue as the British supermajor starts up seven projects this year, including Oman and Azerbaijan, adding some 800 kb/d of new production by 2020. Shell’s profit rose to US$3.75 billion, with the firm saying that its upstream and chemicals arms – the area of concentration for Shell recently - performed particularly well. Both have had success in paring down debt in the quarter (BP for the Deepwater Horizon incident and Shell for its purchase of the BG Group). Last quarter’s best performer, France’s Total, reported first this time; its 56% jump in quarterly profits y-o-y previewing the bountiful season.

It isn’t just the private oil firms rejoicing. State oil players too are benefitting, with China’s PetroChina swinging back into profit and Sinopec and CNOOC reporting good figures. From Petronas to Tullow Oil, it has been a good quarter for almost all. This has created a mood to start cautiously spending again. After releasing its earnings, Total sanctioned its first project since 2014, approving the development of the Aguda Pinchana Este project in Argentina’s Vaca Muerta shale gas, while Shell had earlier announced a start to the Kaikias deepwater field in Mexico, it’s first since 2015

But while the mood to invest has picked up, long memories are applying caution. Oil sands, for example, fell out of favour over the quarter, with assets in Canada’s Alberta sold off en masse as firms retreat from the once promising developments. It may be years before they come back to look into them again.

For now, the industry is happy that days of red balance sheets are over, however they  will be celebrating cautiously, as the market still remains oversupplied and prices are low for much longer. 

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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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