LIMITED UPSIDE: CRUDE OIL PRICES ON THE RECOVERY

IT’S not a situation where oil prices are about to party as it did in 2013.

It’s just that oil prices have reached their bottom and the recovery appears to be starting.

The Organisation of the Petroleum Producers (Opec) and non-Opec producers confounded doubters by agreeing to have its first production cut in eight years on Nov 30. Their move will drain oil inventories by a cumulative 1.8 million barrels of oil per day, for a total global production cut of 2%. Now thats pretty significant.

The reaction in oil prices was immediate. WTI crude and Brent crude rallied by some 10% that day. WTI Crude is now trading roughly at US$52.61 while Brent Crude stands at US$54.63.

Right after that Opec deal, US shale oil companies used this as an opportunity to hedge their oil price risk between 2017 and 2019 at above US$50 a barrel.

This means that producers are looking to lock in future cash flows and sales prices at above US$50.

This also implies that the US$50 level will be a buffer for oil prices moving forward.

According to Bloomberg, a record 580,000 crude option contracts traded on the New York Mercantile Exchange that day, while the number of puts, used by producers to guarantee a minimum price, hit the highest since 2012.

But what is a bigger deal is that globally, the oil majors have started reinvesting. First it was Royal Dutch Shell, then it was French oil major Total SA, and this month, BP Plc announced two large deals. The experts are investing. Could this be a sign that after two years of pain, the revival is beginning.

And here’s another sweetener.

Saudi Arabia’s state oil producer Saudi Aramco feels “comfortable” that by 2018 oil prices will have recovered and the market conditions will be right for what could be the world’s largest public listing, according to its chief executive Amin Nasser.

Speaking at the World Energy Congress in Istanbul, Nasser said that all markets were still being considered for the initial public offering (IPO) of up to 5% of Aramco. He also said the company planned to invest US$300bil over the next decade, with the focus on gas.

There are huge aspirations for this IPO, as it is an important component of diversifying the kingdom away from oil revenue.

Envisaged by deputy crown prince Mohammed Salman, this public offering will allow the government to invest proceeds and future dividends into non-oil investments, as well as showcasing Saudi Aramco as a big participant in global capital markets, enabling its international expansion and boosting transparency.

Would this future IPO then provide an invisble buffer for oil prices as Saudi Aramco looks to get the best possible valuation to one of the kingdom’s most prized industries

Separately the White House announced that President Barack Obama will permanently ban offshore drilling in most of the US controlled Arctic as well as off much of the Atlantic seaboard.

Obama this week moved to indefinitely block drilling in vast swaths of US waters in the Artic.

The move hinges on a provision in the 1953 Outer Continental Shelf Lands Act as a law desighed to protect marine santuaries. This represents a last-ditch measure by Obama to strengthen his environmental legacy in advance of President-elect Donald Trump taking office in January.

Trump has said he will boost the oil and gas industry by undoing many Obama-era environmental regulations.

This move gives the president authority to block indefinitely oil and gas drilling in some waters controlled by the US government.

The law does not include a provision for a future president to undo the decision and so far, no president has ever tried such a move.

Future energy interests or a Republican-dominated Congress could look to challenge this law.

M&A activities by oil majors

There are two significant merger and acquisition exercises following Royal Dutch Shell’s US$54bil acquisition of BG Group Plc in February, that points to oil majors starting to see the sector turning around.

On Dec 16, BP announced that it has signed agreements with Kosmos Energy to acquire a 62% working interest, including operatorship, of Kosmos’ exploration blocks in Mauritania and a 32.49% effective working interest in Kosmos’ Senegal exploration blocks.

This acreage holds world-class deepwater gas discoveries and exploration prospectivity across both countries.

BP CEO Bob Dudley says: “The deal gives BP a leadership position in an emerging world-class, low-cost gas basin with advantaged access to global gas markets.”

BP will invest nearly US$1bil mostly for its multi-year exploration and development working and operatorship interest.

Then on Dec 17, the Supreme Petroleum Council of the Emirate of Abu Dhabi and the Abu Dhabi National Oil Company (Adco) granted BP a 10% interest in Adco’s onshore oil concession.

The actual production of the area is 1.66 million barrels of oil per day with a life of the deposit of 40 years. The deal covers 15 principal onshore oil fields of Abu Dhabi.

BP will issue 392.92 million new shares at £4.47. BP is now the second oil major to acquire a 10% stake in Adco after French oil giant Total SA acquired on Jan 1, 2015, 10% of Adco last year.

And perhaps another move which many people have yet to fully realise its full significance, is that President-elect Donald Trump has selected Rex Tillerson, Exxon’s chief executive, to be his Secretary of State. This gives the oil and gas sector, and by a natural extension, Exxon – an influential voice in the Trump administration.

Now, Opec countries have decided to reduce their output by 1.2 million barrels per day next year in a bid to lower the oversupply in the oil market. But, another piece of good news is that other non-OPEC producers are joining the cuts as well.

The Opec and non-Opec plan encompasses countries that pump 60% of the world’s oil but excludes producers such as the US and Canada, which have benefited from the boom in shale output, as well as China, Norway and Brazil.

‘The 558,000 barrel decline from non-Opec together with the Opec agreement will total 1.8 million barrels a day of cuts, which is about 2% of global production.

Therefore, as 60% of the world’s oil producers reduce output, theoretically, the oversupply in the end-market is bound to come down.

Lower oil inventories ought to lead to better pricing.

Reach Energy Bhd managing director and CEO Shahul Hamid Mohd Ismail is of the opinion that crude oil prices have indeed bottomed out and a short-term gradual increase is imminent.

In light of the production cuts by Opec and non-Opec countries, Shahul expects a rebalancing act of global crude inventories that is in favor to higher crude oil prices.

“A notable risk that would undermine this projected oil price rally is the actual compliance of countries associated with the production cut agreement and the recently announced production boost from Libya from its Sharara and El Feel fields that could potentially be disruptive.

“Nonetheless, I am confident that the Opec cartel would come through together this time and comply with the agreed cuts and react to any crude supply disruptions, if necessary,” says Shahul.

He believes that crude oil prices will average in the US$55 to US$60 range in 2017 despite this recent positive development in the industry as any uptrend in crude oil prices will be capped by the expected return of shale oil production.

Shahul expects this to happen in the mid-half of 2017 due to an increasingly favorable oil price environment for the higher-cost shale oil producers to restart production.

“The supply balance between conventional and non-conventional oil would be more evident in the periods ahead. This balance would keep the oil prices in the US$60 to US$80 range in the subsequent period,” he says.

He adds that the high costs, high wages and wastages of players in the industry are starting to get more orderly.

Not out of the woods

The oil production cut by Opec last month, is its first official action of this sort since oil began crashing in 2014.

Fisher Investments MarketMinder said that Opec is obviously going back to its traditional role of attempting to target a price range for oil.

Fisher Investments feels there are good reasons to be skeptical of oil price rallying.

“First, and most importantly, Opec does not control the price of oil in the long or even intermediate term. True, the cartel members account for a little more than a third of daily production, so their actions and words matter in the short run. But Opec cannot counteract market forces, which tend to bring supply back relatively quickly when prices rise,” it said.

It added that US shale producers have typically responded within 3 to 6 months to big moves in oil prices. Furthermore, many operators are profitable with crude prices significantly below current levels, suggesting they won’t hesitate to keep pumping.

“Additionally, costs continue to fall, lowering break-even prices in several US shale fields and further incentivising production. The market is too nimble and too global for Opec to manipulate for long,” it said.

A seasoned industry observer pointed out that the industry lags share price and oil price volatility by up to 2 years.

“Meaning oil companies won’t increase their spending until late 2018 at earliest as they want to see oil price stability and cost of services go down further. Also, whats there to say that Opec and non Opec countries won’t honour their pledge to cut production,” he said.

Fisher MarketMinder said that at a high level, energy stocks’ outlook depends on supply and demand drivers.

Oil supply has fundamentally changed with new production technologies, and the Opec production cut doesn’t alter that backdrop. With crude oil prices likely to remain sluggish, this isn’t the time to drill down deep for smaller, lower-quality oil producers, which will likely continue to struggle. Rather, the largest integrated—and global—firms are likely best suited to weather the continued storm,” it concluded.

So stick to the leaders, as the small producers will still suffer.

CIMB Investment Research analyst Raymond Yap said that the outlook for drilling rigs remain weak.

In his outlook report for 2017, he expects tough times to persist for oil and gas players in 2017, with companies financial results probably not much different from what it was this year.

“Jack-up utilisation levels began their precipitous decline in early-2015 as oil prices crashed and oil majors scaled back their drilling capex plans aggressively. In South-EastAsia, Clarksons reported that jack-up utilisation for November 2016 was only 43%, down from 59% in Nov 2015 and 94% in Nov 2014. Meanwhile, Riglogix reported utilisation for tender drilling rigs was only 44% in November 2016, down from 58% in November 2015 and 68% in November 2014,” says Yap.

– ANN