Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies. The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations. Allen Brooks
Cape Wind Dealt Devastating Blow; Is Cape Cod Next?
The politics of energy continues to confound logic. The Cape Wind project to construct this country’s first offshore wind farm in Nantucket Sound between Cape Cod and Nantucket Island is being challenged again to perform a Houdini-like escape from the clutches of politicians and wealthy industrialists determined to keep their vistas pristine clear, even if it means harming the long-term economic health of the region. This time, though, it looks like
We have written previously about the efforts of Representative Don Young (R-Alaska), chairman of the House Transportation Committee, to attach an amendment to the Coast Guard spending authorization bill that would ban all offshore wind farms within one and one-half miles of navigation or shipping lanes. Since
To break the legislative impasse, a new, more narrowly targeted measure was proposed by Senator Ted Stevens (R-Alaska), after he was called upon by
Exhibit 1.
Source: CIA
This new legislation, which was initially deadlocked 3-3 in the Senate conference committee, with an additional undecided vote, was passed when U.S. Senator Gordon H. Smith, Republican from
Besides effectively killing the
Barring a battle in the Senate or House, or both, over the compromise legislation, or President Bush vetoing the bill, it looks like the
If the project were to be built, under normal winds, its 130 wind turbines, covering a 24-square mile area, would have produced about three-quarters of the power used by Cape Cod and the islands of Nantucket and Martha’s Vineyard at a very low cost. Today, this power is supplied by conventionally fueled power plants. This aspect of the project appears to have been ignored by opponents who largely represent wealthy family and friends with homes on the coast of Cape Cod or on
What was most interesting in following the
One evening in March, Brooks noticed that there were only two other tables of diners besides himself in a large, very popular
Brooks’ research showed that the decline in this discretionary spending had begun at the start of the new year. It seemed to coincide with the arrival of electric bills for the 184,000 Cape Light Compact member/clients, which were 81% higher than the previous bill.
On March 8, Brooks noted two stories juxtaposed on the front page of his local paper. One discussed the local political opposition to the proposal by Rep. Young to prohibit any wind farms within 1.5 miles of shipping lanes. The other covered a plan to pump more electricity into the
Based on his estimates and guesses, Brooks believes the hike in electricity rates is costing
Last year,
Shifting Oil Market Trends
Last week’s data on crude oil and petroleum product inventories sparked an interesting debate. Crude oil inventories rose by 3.2 million barrels to 346.0 million barrels, well above the upper end of the average range for this time of year. Moreover, crude oil inventories are the greatest they have been since the week ending
Exhibit 2. Crude Oil Stocks Are Well Above the 5-Year Average
Source: EIA
In May 1998, the world was confronting the implosion of Asian oil demand as a result of the economic convulsions due to the regional currency crisis in the fall of 1997 caused by the devaluation of the Thai Bhatt. At about that same time in 1997, OPEC increased its crude oil production trying to head off what it perceived as sharply escalating oil demand that had triggered a jump in oil prices from the high teens to as much as $22 per barrel by October. The growing Asian economic problems resulting in lower oil demand in the region, combined with increasing OPEC supplies, contributed to the build in
Today’s oil market outlook is quite different. Global oil demand has been rising, driven by escalating Chinese and Indian demand. Projections call for demand in these two countries to continue to rise because of their developing economies. Moreover, there continues to be a string of crude oil supply disruptions –
Besides the fear of rapid oil demand growth and continued oil supply disruptions, speculative investment funds are piling into the crude oil futures market attempting to capitalize on the rise in oil prices. Additionally, there is a growing fear that we are at, or have passed, the peak in global oil production that will force economic and life-style changes on the western world. There is a growing fear that inflation will ravage financial holdings causing investors to seek commodities, such as crude oil, as a haven for protection. Until some of these fears are arrested, we should expect world oil prices to sustain the risk premium already present in the oil price – an amount that is unknown and maybe unknowable. If adverse demand or supply events occur, the risk premium could expand. In any case, it is not likely to shrink much in the near future. How large the premium is will only be known after the price has collapsed.
There are other factors that are impacting the crude oil and petroleum market that may influence the future market price. First is the peak oil debate. As this subject has moved from an arcane academic discussion to center stage, people have begun to focus on the potential impact on their lifestyles. There has yet to be any concrete estimates of how the global economy will be impacted by peak oil. Add to peak oil, the issue of global warming, and you have a growing anxiety about consuming hydrocarbons among many people. In the mean time, we continue to consume energy at a healthy rate that is contributing to other challenges.
The logistics of moving crude oil and refined petroleum products to market is becoming a great challenge. The
Prior to the tightening of pollution controls concerning the dumping of bilge water used in cleaning, it was easier for tankers to switch from dirty to clean service. Originally, oil tankers used high pressure jets of hot sea water to clean oil residue from the storage tanks, which was then dumped overboard. Over time, environmental regulations have been tightened to where tankers are not allowed to discharge any oil-contaminated water into the ocean. Today, cleaning a dirty tanker for clean cargoes takes about two weeks, using streams of crude oil to remove the sludge and residue in the storage tanks, which then must be piped out.
Unusually high refinery maintenance in the
Exhibit 3. Clean Tanker Rates and Gasoline Imports
Source: EIA
On a contrary note, Clarkson’s Research Services Managing Director Martin Stopford recently said that tanker rates will decline in 2006 as owners take delivery of ships they began building in the prior couple of years. He forecasts a 6% expansion in tanker supply over the next three years. However, the oil trade is set to grow by only 1.5 million b/d until 2010, or about 500,000 b/d less than required to meet the fleet additions. This view was seconded in a forecast by RS Platou Director Erik Anderson. He said that additional oil production and refining capacity would grow by 2-4%, while the tanker fleet would expand by 5-6%, resulting in a decline in tanker rates in 2006-07.
While it is highly likely that tanker freight rates will be lower in 2006 than last year, there is the potential for the clean tanker market to be stronger than the overall market. This would be a reflection of the structural challenges the global petroleum market is facing after about a 20-year period of under-investment in the business. There are announced plans for expansions of several
First Road Maps, Now Cartels Are OPEC’s Problem
Several months ago,
So with little help from the IEA and its oil-consuming members, OPEC oil ministers, attending the summit, focused instead on the problem of cost inflation impacting their capacity addition plans. According to media reports, a number of oil ministers talked about the problem of inflation in the oil patch. Qatari Oil Minister Abdullah al Attiyah said, “Our costs have tripled from two years ago, due to high (commodity) prices. And it’s not just that, it is also contractors who have tripled their prices.” His comments were echoed by United Arab Emirates Oil Minister Al Hamli. According to Hamli, due to higher commodity prices, the UAE is uncertain of the cost to raise its crude oil production to 3.5 million barrels per day (b/d) from 2.5 million b/d by 2010. OPEC’s Secretary General even joked that OPEC had been criticized in the past for acting as a cartel, but in reality it was contractors who are acting that way and driving up costs.
The thrust of the oil ministers’ message was that rising commodity prices and escalating contractor costs could imperil the much-needed investment required to boost OPEC production capacity. While the road map issue was an excuse for the slow pace of new investment in production capacity by OPEC members, the sharply higher commodity prices and contractor costs may be the excuse for OPEC to demand a higher oil price threshold for their target basket of crude oils. So from a demand pull environment, we are seeing the first signs of a cost push scenario. All this before we have truly seen the inflationary impact of high oil prices on the cost of goods and services in the major economies around the world.
Natural Gas Heating Season Ends With a Whimper
The Energy Information Agency (EIA) released natural gas storage data on April 6th that covered the week ending
For the week ending April 7, reported on April 13, expectations initially were for an injection into storage of between 25 Bcf and 35 Bcf of gas. Those expectations were reduced to 20 Bcf to 30 Bcf two days before the release of the data. The actual result was an injection of 19 Bcf, which helped boost energy stocks early Thursday morning. The gas industry now has the challenge of where to put all the gas that is likely to want, and need, to go into storage during the next few weeks.
Exhibit 4. Natural Gas in Storage Exceeds 5-Year Average
Source: EIA
There are 393 subterranean reefs, aquifers and caverns in the
The Minerals Management Service (MMS) estimates that the amount of shut-in natural gas production in the
If we do not experience a seasonally warm, or “hot,” summer this year, triggering increased air conditioning load that would boost natural gas-fired electric power consumption, we can imagine a scenario of gas volumes being shut in at the wellhead. Electric utility consumers of gas will be reluctant to pull gas from storage that was purchased at higher than current spot gas prices since they would be forced to recognize a loss on that gas. If demand is insufficient for current consumption and desired storage injections, then the only alternative will be to shut in gas wells. We are not sure either the commodity or stock markets are prepared for this potential since the conventional wisdom about the
Another Forecast Calls for Less Severe Hurricane Season
The April 4, 2006, Colorado State University tropical storm forecast echoes all the other recently released forecasts that this hurricane season will be more active than the average 1950-2000 season, but it will not be as severe a season as last year. The CSU 2006 forecast calls for 17 named storms, 9 hurricanes and 5 intense hurricanes, unchanged from their forecast issued in December 2005.
The CSU forecast is based on a 4-5 parameter model. Based on their research, 50-60% of year-to-year and month-to-month hurricane variability can be explained by combining 4-5 semi-independent atmospheric-oceanic parameters together. They also want their model to show significant hindcast skill in application to long periods of prior data, which this model achieves.
The other consideration in preparing the forecast is to find analog years to the upcoming season the forecasters anticipate. They look for certain years in the historical record that have substantially similar global oceanic and atmospheric trends to 2006. They select among prior hurricane seasons since 1949. There are four hurricane seasons with characteristics similar to what were observed in February-March and what are projected for August-September. The best analog years according to CSU are 1964, 1996, 1999 and 2003. CSU believes that the 2006 hurricane activity will have slightly more activity than what was experienced in the average of these four years. They also believe 2006 will be a very active season in the Atlantic basin.
Exhibit 5. Analog Years for 2006 Hurricane Forecast
Source:
The other forecast CSU participates in is calculating the probabilities for at least one major (Category
The CSU forecasters have been investigating the potential predictability of steering current patterns likely to be present during the upcoming hurricane season could have on their landfall probabilities. They have found that by combining their Net Tropical Cyclone forecast and several April-May steering current predictors, they have improved their landfall probability scheme considerably. CSU plans to issue a revised forecast along with its documentation in its May 31 update. Improving the forecast of landfall probabilities in advance of the storms would be a major advance in the science and its applicability.
Professor William Gray, the originator of the CSU hurricane forecast, has stepped back from his lead position to become a co-contributor so he can devote more time to improving the landfall probability work and examine the linkage of hurricanes and global warming. Gray does not believe in a linkage between global warming and increased hurricane activity. He points out that sea temperatures have warmed by about 0.5°C over the past three decades, but that the global number of hurricanes and their intensity has not shown increases in recent years except for the Atlantic basin. He further points out that there have been similar past periods (1940s-1950s) when the
In his discussion of the global warming issue, he makes two interesting points about the recent hurricane seasons. The first is that Southeast coastal residents probably do not know how fortunate they had been in the prior 38-year period of 1966-2003. During that time period, there were only 17 major hurricanes (0.45/year) that crossed the
Gray’s second point is that it is rare to have two consecutive years with such a strong simultaneous combination of high amounts of major hurricane activity together with especially favorable steering flow currents. The historical record and the laws of statistics indicate that the probability of seeing another two consecutive hurricane seasons like 2004-2005 is very low. Even though Gray expects the current active period of Atlantic major hurricane activity to continue for another 15-20 years, it is statistically unlikely that the coming 2006 and 2007 hurricane seasons, or the seasons that follow, will have the number of major hurricane U.S. landfall events as we saw in 2004-2005.
The media has seized upon the CSU and other hurricane forecasts that call for another very active season as a reason to be very worried this year. They have failed to focus on the mitigating key points made by highly experienced forecasters such as William Gray. No one knows what will happen this coming summer and fall, but we would be surprised if the
Politicians Continue to Target Oil Industry
In early April, six
The problem areas lie with the effort to remove the prohibition against suing a sovereign government in
The other detail problem is related to the increased merger scrutiny. The legislation would amend the Clayton Antitrust Act by adding a prohibition of oil and gas mergers that may “appreciably diminish competition.” The current law allows the government to challenge any acquisition that may “substantially” lessen competition. The question would then become one of determining the difference in meaning (magnitude) between “substantially” and “appreciably.”
Anyone have a Webster’s Dictionary handy?
Additionally, there is a question of modifying the antitrust laws specifically for a single industry. It has been pointed out that in the 1950s the Clayton Act was modified in response to mergers among the steel industry companies, but the modification to the law was applicable to all companies in all industries. While we might think this is a problem, the recent proposal to modify generally accepted accounting principles for valuing inventories by the three largest U.S.-based oil companies as a way of extracting greater taxes from their huge stream of profits suggests that politicians care little about equity and more about political pandering.
The last issue with the increased merger review is that the Spector bill would add an additional government office to review oil mergers – the
So while the antitrust review effort cranks up, it seems the windfall profits tax movement has lost steam. But second quarter oil company earnings results due to be reported shortly will likely resurrect that movement, especially as gasoline pump prices continue to climb. The potential for spot gasoline shortages, as a result of the logistics of switching over to ethanol- rather than MTBE-based oxygenation agents to satisfy clean air emission restrictions, could further exacerbate consumer, and thus political, ire directed at the oil companies. The first weekend in April reportedly brought some spot gasoline shortages in the
Energy News Bits You May Have Missed
IEA Says World Oil Demand Higher in 2004 and 2005
The IEA, while cutting its global oil demand forecast for 2006 by 126,000 b/d to an increase of 1.47 million b/d, said that it has determined that oil demand growth in 2004 was 4% rather than the previously estimated 3.8%. It also said that 2005’s growth was 1.3% rather than the previous 1.2% estimate. The IEA also said in its monthly energy report that “the negative effects of high oil prices are visible in most areas,” principally the OECD where growth is now forecasted at well below 1%, and that there remains a “downside risk due to high prices” in their
For the first time in quite a while, the IEA is becoming more concerned about demand growth in light of high oil prices.
Venezuela Warns About Additional Taxes on Oil Producers
Deputy Oil Minister Bernard Mommer told a reporter in
Surprise! Surprise! The only real surprise is that a Venezuelan oil official is probably telling the truth. Do you think he will be working at that job much longer?
Russia to Export Less Oil than Expected
Claude Mandil, Executive Director of the IEA, said that
We’ve previously speculated about
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Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.