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
Thoughts on Unocal Bid
Late last Wednesday evening, CNOOC Limited (CEO-NYSE), the 70%-owned subsidiary of China National Offshore Oil Corporation, launched a counter offer to acquire California-based Unocal Corporation (UCL-NYSE), who had previously agreed to be acquired by Chevron Corporation (CVX-NYSE). CNOOC is offering to pay $18.5 billion in cash, roughly $67 per share, for Unocal. This tops the Chevron stock and cash offer currently valued around $60.
When rumors of the potential CNOOC bid surfaced, concerns were raised in this country about the impact of having a domestic oil company acquired by the Chinese. Under the normal acquisition review process since 1988, foreign company acquisitions of
Demands that the CNOOC offer be blocked based on national security grounds stretches credulity. Yes, the buyer is a subsidiary of a Chinese government-controlled oil company, but 30 percent of CNOOC’s stock is held by private investors. There are accusations that the CNOOC bid is unfair since the company is getting no-interest and low-interest loans from its government-owned parent and state-owned banks to fund the deal. Maybe these loans are the first indication of how the pile of U.S. dollars accumulating in
A tougher concept to grasp is that by banning this transaction because we fear Chinese ownership of some of our oil and gas resources, how do we justify today’s huge presence of foreign-based companies in the
The oil industry is a strange beast at times. Companies that partner in exploration and development projects in one part of the world may be fierce competitors for leases in other regions. CNOOC has said it will continue to sell Unocal’s domestic oil and gas in the
CNOOC is the leanest Chinese oil company, having only about 2,500 employees. It is run by a western-educated manager, and it has been aggressive in trying to grow. This takeover battle probably still has several chapters yet to be written. Chevron has a clear advantage by the fact it has received Federal Trade Commission approval. It also has an advantage in that it has the ability to force a vote on its offer, and that vote will probably take place in the next 45-60 days. However, will investors, looking at the $7 per share cash premium of the CNOOC offer, be willing to vote down the bird-in-the-hand-Chevron bid for a riskier, alternative bid that may still be rejected by the
Canada Oilfield Industry White Hot!
We attended the Petroleum Service Association of Canada (PSAC) investor seminar June 16-17 in
There were 29 company presentations grouped into panels of three or four managements. Each management had 20 minutes to present the investment merits of its company. While the companies spanned the entire scope of the oilfield service industry, there were several common themes.
While
Exhibit 1. PSAC Forecast
Source: CAPP; PSAC; PPHB
Many of the presentations relied on industry association forecasts of the number of wells to be drilled in 2005. The working assumption behind these forecasts is that the well count also will increase in 2006, but not by a significant amount due to expectations for lower oil and gas prices trimming industry cash flow and incentives to drill. PSAC’s forecast, revised in April, calls for the industry to drill 23,825 rig-released wells in 2005, up five percent from the 22,696 wells drilled last year and about 24,000 wells in 2006. On the other hand, the total number of wells drilled in 2004, according to the Canadian Association of Petroleum Producers (CAPP), was 23,920. This is a difference of 1,224 wells. In 2003, that difference was 1,563 wells. We believe these differences reflect both the way the wells are counted, either rig-released or merely completed, along with a difference in the service well count.
The primary influencing factor in the outlook for
Exhibit 2. Oil and Gas Quality Pyramid
Source: Schlumberger
An influencing factor in the well drilling forecasts is the outlook for coal bed methane (CBM), or natural gas from coal (NGC) as it is often called in
Just like the drilling industry, every pressure pumping company is building new equipment for the expanding domestic market. Several of these companies were also building new pressure pumping equipment for the Russian and Former Soviet Union markets, where they have expanded.
A number of the presentations discussed the difficulty in hiring new workers. Historically, the Canadian oilfield service industry has relied on farm youths from the plains of
Exhibit 3. Age of Canadian O & G Workers
The highly seasonal nature of the Canadian oilfield service market has always made retaining employees in the industry a challenge. Few workers enjoy being hired in the fall only to be laid off when spring breakup arrives and have to hope to get rehired in the summer. The lack of employment continuity has discouraged many potential workers from staying with the oilfield business. PSAC has been a leading force in trying to convince provincial governments to provide incentives to encourage oil and gas companies to try to drill through the spring breakup period. What are needed to achieve a more level 12-month activity profile are financial incentives to offset the inherently higher costs of operating during the breakup period. British Colombia has stepped forward with incentives and actions such as strengthening roads to carry the heavy equipment during the spring thawing period.
Exhibit 4. Canadian O & G Worker Tenure
One way producers can help fight rising finding and development costs is to reduce the time it takes to drill wells and to improve the quality of the wells they drill and complete. Canadian producers have been pushing the service industry to develop the new equipment, tools and techniques to achieve these objectives. Coiled tubing drilling rigs, new combined drillpipe and coiled tubing rigs and faster moving rigs are populating the industry. Drilling and downhole information is contributing to better drilling results. Pason Systems, Inc. (PPP–TSE) has developed drilling measurement equipment that has improved the knowledge of wells as they are being drilled. IROC Systems Corp. (IROC-TSE) has developed remote gas monitoring and high speed, high quality communications based on voice over internet protocol (VOIP). These two companies are examples of the cutting edge in drilling communications. We have always believed that more, better and faster information during the drilling, well completion and production life of wells can help boost reservoir recovery factors. Pason has expanded operations to the
New oilfield information technologies continue to be developed in the
E&P Spending Signs Point Higher
Lehman Brothers released its mid-year E&P spending survey confirming what everyone knows – spending is going up faster than the end-of-2004 surveys projected. The 356 companies surveyed by Lehman indicated spending would rise by 13.4% this year, or more than twice the 5.7% increase projected at year end. The increase is being driven by greater spending in the
Exhibit 5. Lehman Brothers Mid-year E&P Spending Survey
Source: Lehman Brothers
While the number of companies surveyed is greater than in December (356 vs. 327), we doubt this accounts for much of the substantial spending increase projected. The intriguing fact is that oil companies are already looking at healthy spending increases in 2006. At this point, 65% of the companies surveyed indicated they planned to spend more in 2006, with 80% of those companies indicating they planned double-digit hikes. These higher spending indications reflect the greater confidence producers have in the sustainability of high commodity prices. That belief is supported by the report that the companies are using a West Texas Intermediate price of $40.85 per barrel in their budgeting compared to $35.81 in December. For natural gas (Henry Hub) the estimate is $5.74 per mcf versus $5.39 at year-end 2004.
Exhibit 6. Surveyed Oil Company Outlook for 2006
Source: Lehman Brothers
Given the level of global oil and gas prices, the stubbornly tight global oil supply/demand balance and producers’ growing confidence that these conditions will last for some time, it is not surprising to see very healthy spending increases projected for both 2005 and preliminarily for 2006. This spending outlook is certainly music to the ears of oilfield service company execs and investors.
Here Come The Norwegians
Today there are 34 jackup and 4 semisubmersible rigs on order or under construction. A number of these units have been ordered by Scandinavian-based oilfield service companies. Many of the companies are Norwegian, and many are start-up companies. Why is capital flowing into
Interestingly, U.S.-based offshore contract drillers are barely participating in this wave of new rig orders. They know that every time they order a new rig, investors punish them by selling their stock. Domestic drillers are trying to maximize their earnings and generate returns for investors by paying down debt, upgrading rigs and paying dividends. It will be interesting to see, in the next 18-36 months when these newly ordered rigs arrive, whether the Norwegian owners become acquisition targets. This phenomenon occurred in the past. Stay tuned.
Exhibit 7. Recent
Exhibit 8. Pipeline of Possible
Oilfield Service Stocks Continuing to Move
In our last issue, we discussed a technical analysis of oilfield service industry stocks. In that article, we noted that based on point and figure analysis, the Philadelphia Oil Service Index (OSX) had given a Bearish Signal Reversal. That is a bullish signal and based on research by the Dorsey Wright firm, 92% of the time this chart pattern appears there can be a 24% price increase from the prior low (124). That percentage increase would take the OSX to 154.
Exhibit 9. OSX Stock Index Breakout Pattern
Source: Courtesy of Dorsey, Wright & Associates, Inc.
Now the index has established another significant chart trend that could further power it, and the underlying oilfield service stocks, higher. When the OSX reached 144, it was even with three Xs in columns to the left, stretching back to early 2005. When the OSX reached 146, it broke this pattern, referred to as a triple wide spread. For stock market technicians and investors who follow chart patterns, breaking this pattern should bring more money into the group and possibly take the index to the 165 level. The fundamental catalyst for that move would likely be continued strong oil prices ($60 per barrel is a new record), positive 2Q05 earnings reports from the service companies starting in about three weeks, upward revisions of analyst earnings estimates for 2005 and 2006 and further weakening in the outlook for other investment sectors.
One caution, however, is that
Exhibit 10. Rainy Spring Weather Hurts Rig Count Progress
Source: Baker Hughes; PPHB
UK More Aggressive On Fallow Fields
UK Energy Minister Malcolm Wicks is leading the charge to force oil companies holding acreage in the
As a result of discussions with the industry about this new initiative,
Under the Fallow Field Initiative, 19 fallow discoveries were initially identified by the DTI. Today, only six of them remain with the original operator and still have no activity plan. Under the new Stewardship initiative, the DTI has the power to ask for extensive information about how every field in the
In the face of a maturing
The move to increase the pressure on the holders of fallow acreage is being driven by a study jointly commissioned by the DTI and the UK Offshore Operators Association that showed the potential impact on the
Two forces have been at work slowing up the asset transactions anticipated to come from the Fallow Field Initiative. One has been the high cost of decommissioning offshore fields and the other is high oil prices. High oil prices have made field owners reluctant to want to sell fields. On the other hand, buyers have been somewhat reluctant to step up in the face of high decommissioning costs. Another agreement between the DTI and the industry is to develop a plan to have a standardized formula for decommissioning costs of
Expectations are that the agreements coming from the Stewardship initiative should lead to even more fallow fields moving into the hands of more aggressive oil companies. A fixing of decommissioning costs should also help buyers in figuring their economics. These agreements could help extend the life of the
More Capacity and Lower Prices Starting Next Year
The venerable energy consulting firm, Cambridge Energy Research Associates (CERA) introduced a new study suggesting that in the latter part of 2006, oil production capacity growth will contribute to a weakening in oil prices sending them back towards $35 per barrel. Dr. Daniel Yergin, the head of CERA, said in a television interview that when you do a field by field analysis of production scheduled to come on stream by 2010, there will be an increase in capacity of 16 million b/d. That means, based on the current level of demand (84 million b/d), almost a 20% increase in supply. More important, even after factoring in the firm’s demand growth over this period, the global supply cushion could grow to 6-7 million b/d. That margin of surplus production capacity would certainly lead to a weakening in oil prices.
Based on its outlook, CERA believes that oil prices will remain above $50 per barrel for the next four quarters before starting to fall in late 2006 toward $35 per barrel. While CERA is offering this optimistic (for consumers) oil supply and price forecast, the heads of three of the major oil companies have arrived at a different view. Lord Browne, the chief executive of BP plc, said that prices could remain above $40 per barrel for three to four years. Mr. Jeroen van der Veer, chief executive of Royal Dutch/Shell, said that sustained heavy investment in costly projects would require higher long-term prices than in recent years. The leading bullish oil company Chairman and CEO is Chevron’s David O’Reilly. Recently he made the point that oil prices would remain high for some time to persuade investors that the industry is worth their time. Maybe he adopted this view because of his company’s deal to buy Unocal, which is now being challenged by a competitive bid from
The most cautious oil company chief is ExxonMobil’s (XOM-NYSE) Lee Raymond who cautions against embracing a new paradigm for the industry. “Where this cycle will end, we can all speculate on that, but I would suggest to you it will take a few years to sort out where it’ll all end,” Raymond told Reuters last week. Yet even with this conservative view, the ExxonMobil long-term energy outlook presentations have focused on the massive volume of new oil that needs to be discovered and developed in order to support global oil demand. In addition, ExxonMobil has emphasized how dependent it and the industry are on new technology to achieve these results.
What we find interesting in the CERA announcement is that they are not relying on
So what is the supply challenge facing the world? When we look at CERA’s number of 16 million b/d of incremental producing capacity, we know it will require finding and developing a substantially greater volume of reserves. If the generally accepted four percent depletion rate per year is applied to existing global crude oil production, then the industry needs to find an additional 16 million b/d of crude merely to sustain today’s oil supply. Between the incremental new production and replacing depletion production, the industry must develop upwards of 32 million b/d of new reserves.
Where will the new supply come from to meet CERA’s forecast? CERA expects OPEC production capacity to climb by 24%, or from 36.8 million b/d in 2004 to 45.6 million b/d in 2010. That is an average annual increase of 1.47 million b/d, which compares against the 525,000 b/d annual growth rate experienced in the first four years of the decade.
Non-OPEC production capacity is forecast to grow by 15.5%. CERA expects an additional 7.5 million b/d of capacity boosting this group’s total to 55.8 million b/d by 2010. The production increase is projected to come from the Caspian,
CERA forecasts that there will be approximately 20-30 new major fields (greater than 75,000 b/d of production) coming on stream every year to 2010. These new major fields will contribute between three and four million b/d of new capacity annually. Many of these fields are in West Africa with others in the Gulf of Mexico,
CERA’s optimism appears out of the mainstream of current industry thinking. On the other hand, CERA’s view reflects the historical record of the oil industry over-achieving just when everyone thinks it can’t. However, the forecast appears extraordinarily bright for the near term, but considerably less optimistic beyond 2010. So are we merely witnessing CERA’s view that the peak in oil production comes later than the peak dates projected by other forecasters? To us the CERA forecast is the opposite of the traditional ‘over the horizon’ view adopted by securities analysts when forecasting company earnings, i.e., things are bad as far as one can see, but over the horizon it’s all blue skies and good times.
One wild card in the CERA forecast, as in any forecast, is the timing of the startup of new field developments. Supply always comes in discrete chunks, i.e., in a step pattern, never in a smooth flow, so delay-related dislocations can cause a forecast to go awry. Additionally, supply and demand forecasts are always at risk for understating depletion that can sop up a greater amount of the projected new supply. Lastly, demand remains a huge wildcard that can distort a forecast’s conclusions. As we analyzed last year, if just the middle classes of
In the end, all forecasts are designed to attempt to shed some new light on the trends impacting the development of a market. Given the nature of the global oil market with all the geopolitical and geophysical considerations, it is not surprising that we find a range of views about how tight the crude oil market will be for the foreseeable future. We are comfortable in holding to the view that the extended period of under-investment in energy and its infrastructure that occurred between 1982 and 2000 can only be reversed after an extended period of higher than comfortable commodity prices that will stimulate over-investment. We tend to agree with Lee Raymond’s view that there is no new paradigm, but reaching a more normal (comfortable) market will take time – the duration of which is impossible to forecast.
Contact PPHB:
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Houston, Texas 77056
Main Tel: (713) 621-8100
Main Fax: (713) 621-8166
www.pphb.com
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.