Easwaran Kanason

Co - founder of NrgEdge
Last Updated: November 6, 2019
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Business Trends
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Lower crude prices across the board across July-August saw financial performance from oil supermajors fall in response. This was despite a temporary spike in prices from an attack on the world’s largest crude processing plant in Saudi Arabia; initially fearing the worst, the recovery in Saudi production capacity was largely re-instated within 2-3 weeks, returning oil prices to a downward trend. Worries about the overall health of the world economy is depressing demand for oil, with particular worrying economic data from India and China.

The decline were across the board, with ExxonMobil taking the biggest hit. Quarterly profits were down by almost 50%. Despite oil and oil-equivalent production rising by 3% (driven by shale liquids production in the Permian), the fall was largely due to lower crude prices. It was actually anticipated, and results actually topped analyst expectations. ExxonMobil has stated that it is making ‘excellent progress’ on its long-term growth strategy, citing potential production coming from its blockbuster discoveries in Guyana. ExxonMobil’s results were also clouded by its current trial in New York, over misleading investors over its financial reporting.

BP and Chevron also reported large drops in their quarterly results. BP’s net profit fell 39.7% - beating expectations on lower upstream earnings and weaker oil prices. BP’s CEO Bob Dudley will be stepping down from his role as CEO, completing a tenure that has seen him rebuild the company in the aftermath of the Deep Horizon disaster back to regular profitability. Chevron mirrored the decline with net profits falling by 36%, again within expectations.

The champion among the supermajors was, once again, Shell. Quarterly profits were down by 15%, with Shell citing prices and lower chemicals margins. Upstream profits were down 51.9% y-o-y, but Shell’s broader focus on downstream and natural gas over the past few years has paid off, with the downstream and integrated gas units reporting adjusted income that were 7.1% and 16.7% higher than Q318. Buoyed by this, Shell announced that it was launching the next tranche of its share buyback programme, repurchasing US$2.75 billion worth of shares up to January 2020 as part of its major, 3-ear US$25 billion buyback programme.

Total also performed relatively well. That doesn’t mean it was immune from the overall market trends, it was shielded by the start-up of the Culzean gas field in the UK North Sea bolstering its bottom line. Output contribution from Culzean, which started up in June, helped overall production rise to 3 mmboe/d. Better performance is expected in Q419, as the startup of Equinor’s massive Johan Sverdrup field, in which Total owns a 8.44% stake which should allow y-o-y production growth to reach 9%, up from the current 8%.

This does reflect the general pull back from offshore among the supermajors, as the focus  has defaulted to onshore opportunities of shale. In that sense, they are a victim of their own success, surging US shale production has blunted the ability of the OPEC+ club to keep prices in the higher US$60-70/b range, burdening their bottom line. The two best performers – Shell and Total – stand out as being the two with the strongest downstream and, in particular, natural gas businesses: a diversification that spreads the risk. And with prices in no position to climb back it, it is this distinction that will continue to colour performance among the world’s largest oil companies.

Supermajor Financials Q3 2019:

  • ExxonMobil – Revenue (US$65 billion, down 15.1% y-o-y), Net profit (US$3.17 billion, down 49.1% y-o-y)
  • Shell - Revenue (US$89.5 billion, down 11.9% y-o-y), Net profit (US$4.7 billion, down 15% y-o-y)
  • Chevron – Revenue (US$36.1 billion, down 17.8% y-o-y), Net profit (US$2.58 billion, down 36% y-o-y)
  • BP - Revenue (US$69.3 billion, down 14.2% y-o-y), Net profit (US$2.3 billion, down 40% y-o-y)
  • Total - Revenue (US$48.5 billion, down 11% y-o-y), Net profit (US$2.8 billion, down 29% y-o-y)

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Saudi Aramco Moves Into Russia’s Backyard

International expansions for Saudi Aramco – the largest oil company in the world – are not uncommon. But up to this point, those expansions have followed a certain logic: to create entrenched demand for Saudi crude in the world’s largest consuming markets. But Saudi champion’s latest expansion move defies, or perhaps, changes that logic, as Aramco returns to Europe. And not just any part of Europe, but Eastern Europe – an area of the world dominated by Russia – as Saudi Aramco acquires downstream assets from Poland’s PKN Orlen and signs quite a significant crude supply deal. How is this important? Let us examine.

First, the deal itself and its history. As part of the current Polish government’s plan to strengthen its national ‘crown jewels’ in line with its more nationalistic stance, state energy firm PKN Orlen announced plans to purchase its fellow Polish rival (and also state-owned) Grupa Lotos. The outright purchase fell afoul of EU anti-competition rules, which meant that PKN Orlen had to divest some Lotos assets in order to win approval of the deal. Some of the Lotos assets – including 417 fuel stations – are being sold to Hungary’s MOL, which will also sign a long-term fuel supply agreement with PKN Orlen for the newly-acquired sites, while PKN Orlen will gain fuel retail assets in Hungary and Slovakia as part of the deal. But, more interestingly, PKN Orlen has chosen to sell a 30% stake in the Lotos Gdansk refinery in Poland (with a crude processing capacity of 210,000 bd) to Saudi Aramco, alongside a stake in a fuel logistic subsidiary and jet fuel joint venture supply arrangement between Lotos and BP. In return, PKN Orlen will also sign a long-term contract to purchase between 200,000-337,000 b/d of crude from Aramco, which is an addition to the current contract for 100,000 b/d of Saudi crude that already exists. At a maximum, that figure will cover more than half of Poland’s crude oil requirements, but PKN Orlen has also said that it plans to direct some of that new supply to several of its other refineries elsewhere in Lithuania and the Czech Republic.

For Saudi Aramco, this is very interesting. While Aramco has always been a presence in Europe as a major crude supplier, its expansion plans over the past decade have been focused elsewhere. In the US, where it acquired full ownership of the Motiva joint venture from Shell in 2017. In doing so, it acquired control of Port Arthur, the largest refinery in North America, and has been on a petrochemicals-focused expansion since. In Asia, where Aramco has been busy creating significant nodes for its crude – in China, in India and in Malaysia (to serve the Southeast Asia and facilitate trade). And at home, where the focus has on expanding refining and petrochemical capacity, and strengthen its natural gas position. So this expansion in Europe – a mature market with a low ceiling for growth, even in Eastern Europe, is interesting. Why Poland, and not East or southern Africa? The answer seems fairly obvious: Russia.

The current era of relatively peaceful cooperation between Saudi Arabia and Russia in the oil sphere is recent. Very recent. It was not too long ago that Saudi Arabia and Russia were locked in a crude price war, which had devastating consequences, and ultimately led to the détente through OPEC+ that presaged an unprecedented supply control deal. That was through necessity, as the world faced the far ranging impact of the Covid-19 pandemic. But remove that lens of cooperation, and Saudi Arabia and Russia are actual rivals. With the current supply easing strategy through OPEC+ gradually coming to an end, this could remove the need for the that club (by say 2H 2022). And with Russia not being part of OPEC itself – where Saudi Arabia is the kingpin – cooperation is no longer necessary once the world returns to normality.

So the Polish deal is canny. In a statement, Aramco stated that ‘the investments will widen (our) presence in the European downstream sector and further expand (our) crude imports into Poland, which aligns with PKN Orlen’s strategy of diversifying its energy supplies’. Which hints at the other geopolitical aspect in play. Europe’s major reliance on Russia for its crude and natural gas has been a minefield – see the recent price chaos in the European natural gas markets – and countries that were formally under the Soviet sphere of influence have been trying to wean themselves off reliance from a politically unpredictable neighbour. Poland’s current disillusion with EU membership (at least from the ruling party) are well-documented, but its entanglement with Russia is existential. The Cold War is not more than 30 years gone.

For Saudi Aramco, the move aligns with its desire to optimise export sales from its Red Sea-facing terminals Yanbu, Jeddah, Shuqaiq and Rabigh, which have closer access to Europe through the Suez Canal. It is for the same reason that Aramco’s trading subsidiary ATC recently signed a deal with German refiner/trader Klesch Group for a 3-year supply of 110,000 b/d crude. It would seem that Saudi Arabia is anticipating an eventual end to the OPEC+ era of cooperative and a return to rivalry. And in a rivalry, that means having to make power moves. The PKN Orlen deal is a power move, since it brings Aramco squarely in Russia’s backyard, directly displacing Russian market share. Not just in Poland, but in other markets as well. And with a geopolitical situation that is fragile – see the recent tensions about Russian military build-up at the Ukrainian borders – that plays into Aramco’s hands. European sales make up only a fraction of the daily flotilla of Saudi crude to enters international markets, but even though European consumption is in structural decline, there are still volumes required.

How will Russia react? Politically, it is on the backfoot, but its entrenched positions in Europe allows it to hold plenty of sway. European reservations about the Putin administration and climate change goals do not detract from commercial reality that Europe needs energy now. The debate of the Nord Stream 2 pipeline is proof of that. Russian crude freed up from being directed to Eastern Europe means a surplus to sell elsewhere. Which means that Russia will be looking at deals with other countries and refiners, possibly in markets with Aramco is dominant. That level of tension won’t be seen for a while – these deals takes months and years to complete – but we can certainly expect that agitation to be reflected in upcoming OPEC+ discussions. The club recently endorsed another expected 400,000 b/d of supply easing for January. Reading the tea leaves – of which the PKN Orlen is one – makes it sound like there will not be much more cooperation beyond April, once the supply deal is anticipated to end.

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Market Outlook:

-       Crude price trading range: Brent – US$86-88/b, WTI – US$84-86/b

-       Crude oil benchmarks globally continue their gain streak for a fifth week, as the market bounces back from the lows seen in early December as the threat of the Omicron virus variant fades and signs point to tightening balances on strong consumption

-       This could set the stage for US$100/b oil by midyear – as predicted by several key analysts – as consumption rebounds ahead of summer travel and OPEC+ remains locked into its gradual consumption easing schedule 

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