- Recession Threat Due To Higher Oil Prices Grows
- Tunisia, Egypt, Yemen, Bahrain, Libya – The Beat Goes On
- Gas Shale: And The Beat Goes On!
- Is The Oil Industry On The Verge Of Major Restructuring?
- Rain, Rain Go Away, Come Again Another Day; But Can It?
- Offshore Wind Power Gets Push From East Coast State
Musings From the Oil Patch
March 1, 2010
Allen Brooks
Managing Director
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
Recession Threat Due To Higher Oil Prices Grows (Top)
The recent and growing civil unrest in Libya has raised the specter for an explosion in crude oil prices, the possibility of a supply cutoff and a potential global recession. These increasing fears come despite statements from Saudi Arabian oil minister Ali Naimi that the world is adequately supplied with crude and that his country stands ready to boost production to prevent a spike in world oil prices such as happened in 2008. He did acknowledge that recent oil price volatility will continue to be experienced in the near term but would fade as market participants recognize the large amount of surplus production capacity available to offset any supply shortfall coming from the problems of Libya’s oil industry.
At the present time, Libya produces about 1.6 million barrels per day, or about 2% of world oil supply. It is a major supplier of oil to Italy accounting for about 24% of that country’s oil imports in 2009. In addition, there is a major pipeline, Greenstream, from Libya to Sicily and then onwards to the Italian mainland that hauls natural gas from Libya. The pipeline supplies about 10% of Italy’s natural gas demand. According to media reports early last week, Eni (ENI-NYSE), the Italian oil and gas producer, has shut the pipeline due to the violence in Tripoli, but assured customers that it could still meet gas demand. The media was also reporting that western oil companies, including BP (BP-NYSE), Shell (RDS.A-NYSE), Total (TOT-NYSE) and Suncor (SUV-NYSE), to name just a few, had shut down their activities and were evacuating their employees and dependents from the country. The Nafoora oil field is reported to have been shut down due to worker strikes along with the Rus Lanuf oil refinery on the coast in the Gulf of Sirte. Repsol (REP-NYSE), the Spanish oil company, announced it had shut down the El-Sharara oilfield that pumps about 200,000 barrels per day, or roughly 13% of Libya’s daily production.
It is interesting that world oil markets were slow to react to the growing civil unrest and government protests throughout the Middle East until they arrived in Libya. Then oil prices started jumping. On December 18, 2010, Brent crude oil traded at $91.67 a barrel when protests against the leadership in Tunisia first broke out. By the time Tunisian President Ben Ali resigned on January 14th, Brent had risen in price to $98.68. But oil prices then retreated to $95.25 on January 25th when the protests first started in Egypt. Prices subsequently rose as the Egyptian protests grew, reaching $101.43 on February 13th, the day that Egyptian President Hosni Mubarak resigned. Oil prices rose the next day when violent civil protests erupted in Bahrain and Iran, but then actually fell when Libyan protests first emerged. On February 22nd when Eastern Libyan cities fell to protesters and gun fire was reported in the capital of Tripoli and Libyan Leader Moammar Gadhafi declared he would fight to the death against his opponents and threatened civil war to crush his opponents, Brent’s price jumped to $106.26 a barrel, up 8%. In the U.S., the new April WTI crude oil futures contract closed up $5.71 a barrel at $95.42. Prices for both Brent and WTI were moving higher on Wednesday of last week when we wrote this article.
Exhibit 1. Oil Prices React To Libya’s Civil Unrest
Source: The Globe And Mail
The biggest problem with the reduction in oil supplies as oil companies depart Libya is their impact on global oil markets and the potential impact on future economic activity. One analysis we saw pointed out that the jump in WTI prices since the end of the prior week to mid last week was the equivalent of a $0.13 per gallon increase in gasoline pump prices in the U.S. That will push the average gasoline pump price close $3.50 per gallon and in high-priced localities to $4.00 or more. We have found from previous studies that when gasoline pump prices breech the $3.50 per gallon barrier, driving is impacted as the cost of fuel takes a bigger share of consumer incomes. The $0.13 per gallon jump from higher crude oil prices was suggested to cost the typical American car driver $1,086 a year in additional expense, a not insignificant tax on consumer spending. As can be seen from the chart in Exhibit 2, whenever we experience a sharp jump in oil prices, there tends to be a recession in the immediate future. As the chart shows, since the late 1970s there have been five official recessions with sharp increases in oil prices immediately before four of the five. Only the 1981-83 recession was marked by falling oil prices, but that recession was the result of sharply increased interest rates as the Federal Reserve, led by Paul Volker and supported by President Ronald Reagan, waged a successful war against inflation that had gotten out of hand during the 1970s.
Exhibit 2. Oil Prices At Risk Of Triggering Another Recession
Source: Gluskin Sheff
The question on economic forecasters’ minds is whether the sharp rise in oil prices this time will also cause a recession. Some forecasters are calling for $200-300 a barrel oil prices as a result of the worst case political scenario for the Middle East. Other market experts suggest that there is a $10-15 per barrel risk premium in the current price of Brent crude oil for the worst case scenario, which could disappear if the unrest settles down. At the present time,
forecasters are sanguine about the Middle East civil unrest spreading to key oil producers such as Saudi Arabia and Kuwait. But as Robert Mabro, president of the Oxford Institute for Energy Studies put it, “This whole event has been so surprising. I don’t smell any danger in Kuwait, Saudi Arabia or Abu Dhabi, but things are so unpredictable you never know.”
It is interesting to note that world oil prices in real dollars are now inching above the $40 per barrel level that helped trigger the two worst recessions since the Great Depression of the 1930s. Crude oil prices crossed that magical $40 per barrel threshold in late 1979 in response to the removal of Iran’s oil supply from the world’s market following the overthrow of the Shah of Iran’s government, and then again in 2008 when speculation helped drive crude oil prices to $147 per barrel just before the financial crisis erupted causing a collapse in global economic activity. This is not a positive scenario if the violence in the Middle East continues or spreads and crude oil prices remain high or climb higher.
Exhibit 3. Real Oil Prices At Trigger Point Of Recessions
Source: Gluskin Sheff
Most oil industry forecasters don’t expect the Middle East turmoil to spread to the major oil exporting countries and remain sanguine about the outlook for crude oil prices. They give little chance for violence to breakout in Saudi Arabia. However, King Abdullah, the aged ruler of Saudi Arabia, has just returned home following three months away for treatment for medical problems. He has announced a plan for distributing $36 billion in the form of raises for workers, grants and other awards to Saudi citizens in order to help improve their current plight, and retain their allegiance. This approach, as we learned recently when visiting Oman, is followed by the country’s Sultan who lavishes money and benefits on his citizens to make sure they are happy and less susceptible to radical elements in the Islamist movement. Yet we heard there were still demonstrations by Omanis during the recent rash of demonstrations in countries around the Middle East. Opponents of the Saudi royal family were disappointed that only money was distributed and not any political freedom.
People listening to Saudi Arabian oil minister Naimi stating that OPEC had 5-6 million barrels a day of surplus productive capacity and would use that to keep oil prices under control must focus on both the reality of how real that surplus figure is and how quickly its use could impact the market. We suspect, but can’t prove, that much of this surplus could come on stream over a 90 – 180 day time period, not tomorrow. The odds are that the additional oil is not of the quality that has been lost from the violence in Libya, making it less the salvation it appears on the surface. Still, once any additional Saudi production is brought on stream, it will take time for it to reach markets, which probably explains why the Kingdom was meeting at the end of last week to plan to boost its production by several hundreds of thousands of barrels. We keep thinking that we’ve seen this movie before, and we didn’t particularly like the ending.
Tunisia, Egypt, Yemen, Bahrain, Libya – The Beat Goes On (Top)
The story line of 2011 so far has been civil unrest amidst a booming stock market. Civil unrest appears to be highlighted by the forced exit of autocratic rulers in several Middle East countries – Tunisia and Egypt so far – but it also can be seen in the recent demonstrations in Wisconsin. The pressures underlying the civil unrest in each region are different – demands for increased political freedom on the one hand and objections to the needs to alter the historic social contract between citizens and their employees on the other. While the world would like to see these problems resolved soon and peacefully, we suspect the tensions and explosion of emotions and protest will continue through the balance of the year. The immediate question is whether the civil unrest spreads and becomes more transformational in its outcome.
The protests in Madison, Wisconsin, involve public employees rallying against proposed legislation that would restrict the right of collective bargaining over work rules and benefits, something they currently have. The legislated change in the law is desired by the public that voted for a Republican majority in both chambers of the state legislature and a Republican governor who campaigned on the need to take this step to enable Wisconsin to balance its upcoming budget. The recession of 2008-2009 had a devastating impact on tax revenues and on housing values that has created a cataclysmic funding shortfall among states and local governments. A major portion of the funding problem is the current and unfunded medical and pension costs for municipal employees. These employees have gained tremendous power over the past 25 years through their ability to help elect politicians sympathetic to rewarding the workers with rich benefit plans that have been perceived as not costing the taxpayers anything. That myth was shattered with the recession and, in particular, the bursting of the housing bubble. The shredding of the real estate market that has resulted in dramatic declines in home values, the primary source of local tax revenues, occurred at the same time the aging of the municipal work force has driven medical insurance and retirement benefits up substantially. Therefore a huge gap between tax revenues and spending requirements has developed. How to close that gap is the core of the battle over the possible change in the social contract between the citizens and their employees.
Exhibit 4. Turmoil Throughout North Africa and Middle East
Source: Agora Financial
While the U.S. struggles to repair its financial house, the civil unrest in the Middle East has potentially greater implications for the future health of this country. When we look at the news shows covering the unrest in the Middle East, the maps highlighting the countries cover virtually all of the countries of North Africa and many of the oil producing countries around the Arabian Gulf. The turmoil started with protests that lead to the ousting of the long-time head of Tunisia, but then spread to Egypt, a long standing American ally in the region. The importance of the civil unrest and potential government overthrows grew because American interests in the region are at risk. For the world, the concern about the unrest in Egypt involved its role in the global oil and gas industry. Egypt is a small factor, producing only about 660,000 barrels per day out of global demand of 88 million barrels per day. Egypt’s oil consumption now slightly exceeds its domestic production, so that wasn’t really the problem. The more significant role played by Egypt in the energy market involves its control over the Suez Canal and the SUMED pipeline that connect the Red Sea with the Mediterranean Sea and facilitate the movement of oil globally.
Exhibit 5. Suez Canal Oil Chokepoint
Source: CIA
The Suez Canal traverses the Sinai Peninsula and provides a shorter transit route for ships moving oil and other cargo between the Mediterranean Sea and the Indian Ocean. The first canal connecting the Nile River delta and the Red Sea was dug by Egyptians in the 13th Century B.C. to expand Mediterranean and
Exhibit 6. Suez Canal Has No Locks For Water Control
Source: World Atlas
Middle East trade. Over the years, various Egyptian and Roman rulers would engage in restoration efforts until they were abandoned entirely in the 8th Century A.D. with the fall of the Roman Empire. The present canal structure was built over a decade-long period by French and Egyptian interests culminating in its opening in 1869.
The canal is 118.2 miles long and 73.8 feet deep. At the water line, the canal is anywhere from 900-ft to 1,125-ft. wide. It does not have locks but relies on a system that allows water levels to rise and fall. In 2010, about 18,000 ships transited the canal with about 20% carrying petroleum and 5% carrying LNG. Most of the petroleum transit is northbound from the Red Sea to the Mediterranean Sea. Ships carried about 1.9 million barrels per day of oil and petroleum products last year, down from 2.4 million barrels per day in 2008 before the recession.
Exhibit 7. Tonnage and Trips Rose In 2010 After 2009 Drop
Source: Suez Canal Authority
Another important aspect of the global petroleum transportation system in Egypt is the SUMED pipeline (Suez to Mediterranean). This pipeline is used primarily by ships too large to transit the Suez Canal fully loaded. They offload a portion of their cargo at the Ain Sukhna port on the Red Sea and then retrieve it at the Sid Kerir port on the Mediterranean Sea. The pipeline is 200 miles long and has a capacity to move 2.1 million barrels per day of oil. In 2010 it only carried 1.1 million barrels per day reflecting the impact of the global economic recession on Middle East oil demand.
In the oil market, the civil unrest in Egypt was reflected in a higher futures price for Brent crude oil as investors feared the potential closure of the Suez Canal and SUMED pipeline. As those closures didn’t happen, oil prices settled back. They then rose again as civil unrest spread to Yemen and Bahrain and on to Libya. About the same time, Iran, who is thought to be helping fuel the unrest, requested permission to send two naval vessels through the Suez Canal to participate in war training exercises with Syria. These
Exhibit 8. SUMED Pipeline Another Oil Chokepoint
Source: Wikipedia
Iranian naval ships would be the first to transit the Suez Canal since the Iranian revolution in 1979 and that prospect has raised concerns amongst the Israelis.
The spreading civil unrest has heightened concern about the stability of oil flows from the Middle East, especially those producers located in the Arabian Gulf. When the unrest spread to Bahrain, the island nation that also plays host to the U.S. Navy’s Fifth Fleet, concern skyrocketed. Bahrain, although ruled by a royal family, has been thought to be progressive. The problem is that it is controlled by minority Shiites over a majority Sunni population. The sharp military action to attack the protestors and the use of weapons killing and wounding numerous locals has spurred outrage. Government security has been helped by the fact that Bahrain’s military is composed 100% of Shiites.
The civil unrest given the religious split in Bahrain has put Saudi Arabia on high alert. About 20% of Saudi Arabia’s population is made up of Sunnis, mostly in the Eastern Province, which is an important center of the country’s oil production and just across the causeway from Bahrain. Saudi Arabia is ruled by a Shiite royal family headed by three elderly leaders, none of whom are in good health. Regardless of the current political environment, Saudi Arabia faces a significant leadership transition in the near future. Once the elderly brothers are gone, one of the 34 branches of the family will become the next ruler setting up the potential for inter-family rivalries. Given Saudi Arabia’s key supply role in global oil markets, any political or succession problems will alarm the petroleum industry and risk sending prices dramatically higher.
Exhibit 9. Oil Producers – Volume and Freedom
Source: Seeking Alpha
Exhibit 10. Leading Oil Importing Countries
Source: Seeking Alpha
The United States, Japan and China, as the world’s three largest oil importers, are at risk of economic volatility should the oil flow from Saudi Arabia be diminished or interrupted. While this development will continue to receive the greatest attention from the media and investors, there is another development that has been underway that will impact the role of Middle East oil in the global supply picture. That development is the rapid growth in Middle East oil consumption. This is a development that has received little attention, but could already be reshaping oil industry developments in the region. For example, many of the oil producing and exporting countries are hard at work developing their natural gas resources to power their energy needs and free up oil supply for export.
Exhibit 11. Middle East Oil Demand Growing Rapidly
Source: BP, IEA, PPHB
Over the past decade, Middle East oil demand has grown by 54% to nearly 7.5 million barrels per day. The importance of Middle East consumption is shown by its share of world consumption having grown from 6.3% to 8.6% over this period. The significance is demonstrated in Exhibit 11 that plots annual world demand growth alongside changes in Middle Eastern oil consumption since 1966. It is clear the importance of the Middle East in the world oil market is growing beyond merely being the primary oil supplier. The growing local demand may become more important as a vehicle to insure political stability in the region.
Another way to demonstrate the importance of Middle East oil demand growth is to compare its annual increase to that of China, the primary focus of most of the world’s oil industry watchers. China’s annual demand growth is still greater, but one cannot ignore the steady rise in Middle East consumption since the turn of the century. When we consider this recent Middle East oil demand growth in the context of our observations from our recent visit to the region, we see little evidence that suggests any future slowdown in
Exhibit 12. Middle East Oil Demand Growth Off Radar Screen
Source: BP, IEA, PPHB
energy consumption. That demand growth poses a potential problem, not just for the Middle East but for the world, also. If oil production fails to grow in the Middle East, then either those governments will need to accelerate the development of their natural gas resources or face having to restrict their oil export volumes and in turn their income. That possible outcome would be bad news for those countries heavily dependent upon imported oil for their energy supply. This will be true even for importers who are not highly dependent on supplies from the Middle East such as the United States that depends primarily on Canada, Mexico and Venezuela for its oil as supply constraints would impact the entire oil market and drive prices sharply higher.
Exhibit 13. A Bible Of 1978 Iranian Revolution
Source: Allen Brooks
The Middle East’s increasing domestic oil consumption is, in our view, the equivalent of a slow growing cancer in the oil market. The illness develops silently and then erupts with potentially devastating consequences. When it erupts will never be known, and it actually could be happening now. For us, it is reminiscent of the development of the Iranian Revolution in 1978 that reshaped both the oil market and the global economy and political balance. As an energy analyst during that time, we were forced to scramble to learn as much as possible about Iran, Islam and the Iranian political factions. The bible of our research was a book titled Iran Erupts. Notice how the media has almost overworked the action verb from that title in describing what is happening in Egypt, Yemen, Bahrain and Libya today. “Erupts” may become the word of 2011, much as we hate that thought. As people learn the history of the Iranian Revolution period, they may become more concerned about today’s events being a re-run of that regime change. That fear could drive oil prices substantially higher. That would have a negative effect on the global economy and the stock market – not a happy thought.
Gas Shale: And The Beat Goes On! (Top)
Just when we thought the bubble of corporate interest in the gas shale revolution might be starting to wane, along comes BHP Billiton Ltd. (BHP-NYSE) to dispel that thought. BHP has agreed to fork over $4.75 billion to Chesapeake Energy (CHK-NYSE) for its stake in the Fayetteville shale. The move was applauded by BHP shareholders who had been buffeted by the company’s failed takeover attempt of Canada’s Potash Corp. (POT-NYSE) and its inability to overcome regulatory hurdles to complete its proposed iron ore joint venture with Rio Tinto (RIO-NYSE). This move also comes after BHP’s coal mining business in Australia was hurt by the severe flooding that has devastated Queensland.
Exhibit 14. Fayetteville Shale Play
Source: Shaleblog.com
BHP will pick up Chesapeake’s 487,000 acres of shale gas properties in Arkansas, as well as infrastructure such as pipelines. This is the second largest acreage position in the Fayetteville Shale formation. The assets being acquired are currently producing about 415 million cubic feet a day of natural gas and will add 10 trillion cubic feet of natural gas resources to BHP, boosting its net reserve and resource base by 45%. Chesapeake will provide “essential services” for up to one year as BHP takes over the properties.
BHP has now become a major gas shale player in the U.S., but also important is that it will be gaining technical knowledge about how to drill and complete gas shale wells, which may help the company in Australia where the petroleum industry is embarking on a gas shale play in the Cooper Basin. Based on reports, there are numerous gas shale basins in Australia that will be of interest to producers in the future, so becoming more educated about the techniques of drilling and completing gas shale wells is of prime importance. Unfortunately for the U.S. gas market, BHP’s education may contribute to continued weak natural gas prices here.
Is The Oil Industry On The Verge Of Major Restructuring? (Top)
A recent article in The Wall Street Journal highlighted the challenges Exxon Mobil Corp. (XOM-NYSE) is having in replacing its annual oil and gas production with new reserves. The article was based on the company’s latest reserve report that showed it had added 3.5 billion oil-equivalent barrels (Bboe) to its proved developed reserves, or 209% of its 2010 production. This represented the 17th consecutive year that ExxonMobil has been able to more than replace its annual production with new reserves. Overall for the past ten years, ExxonMobil has averaged a 121% annual reserve-to-production replacement ratio. What was somewhat troubling, however, was the data showing that for every 100 barrels of oil the company has pumped out of the ground over the last decade, it has only been able to replace 95 barrels. On the other hand, for every 100 cubic feet of natural gas pumped, ExxonMobil has been able to find or acquire 158, which is largely due to the $41 billion purchase of XTO Energy Inc. last year.
At the end of 2010, ExxonMobil’s proved reserves totaled 24.8 Bboe of which XTO accounted for 2.8 Bboe. Approximately 47% of the company’s proved reserves are oil with 53% natural gas. The company stated that it added a total of 14.6 Bboe to its resource base marking the largest annual addition since the merger of Exxon and Mobil in 1998 and boosted the company’s resource base to a record. According to ExxonMobil, the XTO resource base is 60 trillion cubic feet of gas, which based on the oil equivalency measure of 5.6 cubic feet of gas to one barrel of oil, represents slightly over 10 Bboe that was added in 2010 from that acquisition.
The point of the article was to highlight the struggles of the oil industry in finding new reserves of crude oil, but how it is having better luck with natural gas. The article included a comment made by Royal Dutch Shell PLC’s (RDS.A-NYSE) chief executive in January that this year the company would produce more natural gas than oil for the first time in its 104-year history. The reserve results of ExxonMobil, Shell’s gas production statement and the rash of major oil company purchases of gas shale assets in the U.S. and Canada are signaling a sea change in the petroleum industry.
The sea change is driven not only by the twin challenges of replacing reserves and growing production, but also by understanding what investors want from petroleum company managers. The recent corporate restructuring move by Marathon Oil (MRO-NYSE) to split the company into two separate businesses – one focused on its downstream assets and the other on its E&P assets, and the breakup of Williams Companies (WMB-NYSE) into a pipeline company and an exploration and development company, have been warmly welcomed by investors.
Exhibit 15. Marathon Oil Outperforms On Restructuring
Source: BigCharts.com
As shown by the chart in Exhibit 15, the Marathon Oil announcement caused a jump in the share price in early January. But importantly, coupled with the rise in crude oil prices due to the civil unrest in the Middle East, Marathon Oil has greatly outpaced the recent performance of either ExxonMobil or the overall stock market. In the case of Williams, the share price was matching the performance of ExxonMobil until the restructuring announcement that has helped it to outperform since the middle of February. (See Exhibit 16.)
The oil industry has historically represented a solid investment for people. Typified by Exxon and then ExxonMobil, the stocks of the largest petroleum companies have generally performed in line with the overall stock market while also being known as generous dividend payers. As shown by the chart in Exhibit 17, ExxonMobil’s share price since 1980 has performed either in-line with the
Exhibit 16. Williams Gets Boost From Restructuring
Source: BigCharts.com
Standard & Poor’s 500 stock index, a reflection of the overall market, or it has outperformed such as the period since 2000. One can see that ExxonMobil’s shares underperformed the overall market in the late 1990s due to the combination of the Asian currency crisis that caused a sharp drop in global crude oil prices and the tech stock bubble. Once the latter bubble burst, the price of energy stocks has been helped both by investors seeking safety amongst large capitalization stocks and the rise in oil and gas prices driven by economic growth and growing investor interest in commodity-oriented investments.
Exhibit 17. Exxon Over Long-term Outperforms Market
Source: BigCharts.com
Outstanding investment performance by large cap oil companies has not always been the case, however. During the past decade, ExxonMobil has fared poorly when measured against the performance of companies oriented toward natural gas. In Exhibit 18, we show the 10-year performance of ExxonMobil against Chesapeake Energy (CHK-NYSE) and a smaller integrated oil company that boosted its focus on natural gas through a major acquisition, ConocoPhillips (COP-NYSE). During the commodity boom of 2005-2008, these latter two stocks blew past the performance of the larger, less nimble ExxonMobil. Although Chesapeake and ConocoPhillips crashed in the 2008 financial crisis-driven stock market collapse in contrast to ExxonMobil that suffered a more modest correction, once financial and economic stability returned, these smaller petroleum companies resumed their outperformance.
Exhibit 18. ExxonMobil Trails Others In Last Decade
Source: BigCharts.com
What is interesting in examining the share price performance of these three petroleum companies is how much relative performance is influenced by the starting point and the length of the measurement period. Over the most recent five-year period, ExxonMobil has outperformed the other two stocks. In the case of ConocoPhillips, the outperformance gap has narrowed in recent weeks as the surge in oil prices has lifted its share price. ConocoPhillips’s recent market performance was helped by the announcement it would dispose of assets to help improve its financial position and reduce the company’s size, enabling it to grow its reserves and production faster. Chesapeake, on the other hand, has struggled with a huge debt load from its strategy of grabbing leases in gas shale plays, while straining to generate cash flow in the face of unusually low natural gas prices. Chesapeake’s recent announcement of a business strategy shift and the sale of assets to reduce debt while not seriously damaging its expected production growth outlook has contributed to the better share performance recently.
In the shortest comparative period, one year, the restructuring moves of ConocoPhillips and Chesapeake were clearly seen by investors as positive catalysts to drive share outperformance. The big question is whether this short-term outperformance due to corporate moves and somewhat improved commodity prices and the outlook for future prices can be expected to continue. If we look at
Exhibit 19. Last Two Years Performance Goes To ExxonMobil
Source: BigCharts.com
the stock market reaction to the Marathon Oil and Williams Companies moves, one would have to say the answer to the question is Yes!
Exhibit 20. ExxonMobil Wins And Loses In Short-term
Source: BigCharts.com
It is interesting to note that of the top eight western integrated oil companies only three of them are headed by CEOs with technical educations. In Exhibit 21 we also show the education of the prior CEO, if the change was fairly recent. In only two companies have engineer-educated CEOs succeeded bosses with engineering educations. The fact that these CEOs have engineering backgrounds does not mean they are better or different managers, but it may suggest the approach they will take in analyzing their company’s opportunities and the industry’s outlook. In other words, these CEOs may be less willing to play the financial game to boost their share price performance.
Exhibit 21. Major Oil Company CEO Educations
Source: PPHB
While we’d like to think that engineers are less willing to engage in financial engineering, it is not a given that they have any better vision of the future for their company or industry than a financially-trained CEO. We reflect back on a conversation in the late 1970s with just retired Exxon chairman, Ken Jamieson, a civil engineer by education. That was a time when large oil and gas companies struggled to find new oil and gas (the North Sea was only just emerging and West Africa and Brazil were untested) and they were the targets of government regulation and public scorn. Mr. Jamieson told me over lunch that the future of Exxon was in “hard rock minerals.” Those were the days when Exxon was in coal and the mining of other minerals. It was also developing an office products business. There was soon to be a dalliance with electric motors as a play on energy efficiency. In the end all these businesses were abandoned. We always remembered Mr. Jamieson’s comment whenever we heard Lee Raymond or Rex Tillerson say that ExxonMobil is an oil and gas company. Being committed to oil and gas, however, doesn’t mean that there can’t be smart financial moves to enhance shareholder returns.
Rain, Rain Go Away, Come Again Another Day; But Can It? (Top)
Recently two studies about the linkage of climate conditions and greenhouse gas emissions were published in the magazine, Nature. These studies are the first to try to link global warming caused by humans with extreme weather conditions – in this case rain and flooding in the Northern Hemisphere. The studies generated extensive media coverage because there were press briefings to highlight the studies and their importance.
In the first study, climate researchers at the University of Edinburgh, UK, compared data from weather stations in the Northern Hemisphere with precipitation simulations from eight climate models. The purpose of the study was to attempt to determine whether the rise in severe rainstorms and heavy snowfalls could be explained by natural variability in the atmosphere. The study found that it could not. The increase could only be explained when the computer climate models factored in the effects of greenhouse gases released by human activities such as the burning of fossil fuels. The study concluded that the likelihood of extreme precipitation on any given day for the land areas of the Northern Hemisphere rose by about seven percent over the last half of the 20th Century. According to one of the participants in the study, Francis Zwiers, a Canadian climate scientist, the principal finding is that the seven percent is outside the bounds of natural viability.
The second study was an attempt to link climate change to a specific event – the damaging floods in 2000 in England and Wales. The researchers from the University of Oxford, UK, ran thousands of high-resolution seasonal computer forecast simulations with and without the effect of greenhouse gases. The conclusion of the study was that anthropogenic climate change may have almost doubled the risk of extremely wet weather that caused the floods. The leader of the study was quoted as saying that the previously thought 1-in-100 years event may actually occur twice as often in the future.
The press briefing dealing with the studies focused on how important the results are for the insurance industry that is developing policies for adapting to climate change, i.e., determining the odds for extreme weather-related events that cause property damage that is covered by insurance, which will help the companies to set more appropriate insurance rates for the risk being insured against. This is a legitimate and growing business problem. For residents and businesses situated along the coast, rivers or in flood plains, securing insurance coverage has become a growing problem. Because insurance companies cannot accurately determine the odds of floods or hurricanes happening, it becomes difficult to estimate the cost of insurance. As a result of recent frequent extreme weather events, insurance companies in certain geographic areas are abandoning the market. This shrinking of the insurance pool has the impact of driving insurance rates higher as companies that continue to write policies boost rates to protect themselves from devastating losses should future storms or floods occur. In other cases, the absence of adequate insurance coverage forces people and businesses to turn to state-run insurance pools that are not only expensive but provide substantially less coverage than typical commercial policies. In the event of severe storms or floods, often the state is left having to make up the money to pay the claims when the cost exceeds the income from policy premiums. So what originally was a private commercial issue quickly becomes socialized adding to financial pressures on state governments. That is a reason why states quickly turn to the federal government for disaster relief when these events occur.
The importance of the insurance issue has increased due to the recent global climate agreements negotiated at Copenhagen, Denmark, and Cancun, Mexico. Under these agreements, rich nations have pledged billions of dollars to help poor countries adapt to climate change. According to Myles Allen, a University of Oxford researcher involved in the British flood study, “Governments plan to spend some $100 billion on climate adaption by 2020, although presently no one has an idea of what is an impact of climate change and what is just bad weather. We need to urgently develop the science base to be able to distinguish genuine impacts of climate change from unfortunate consequences of bad weather.”
These climate studies would seem to be important developments in trying to address the issue of which extreme weather events are truly due to climate change. The problem is that the studies are totally based on comparing actual weather against theoretical climates generated from running thousands of computer models and then trying to measure the difference between the results. According to one of the media reports on the studies based on the press briefing is that it took a decade to reach the conclusion that the odds of the severe floods were roughly doubled due to the greenhouse gas emissions caused by humans. More questionable may be that the climate models used in the University of Oxford study were designed to develop a hypothetical climate in which the Industrial Revolution never happened and subsequently few greenhouse gases were ever emitted in the intervening several hundreds of years.
We beg your forgiveness when we say that the idea of measuring the historical weather history of England and Wales against a computer-generated model that assumes the Industrial Revolution some 200+ years ago never happened and thus the economy and society we have today never would have developed we find preposterous. To then tell us after nearly a decade of running these computer models that the chances of those floods were roughly doubled in a climate with increased greenhouse gases we find difficult to accept at face value. Because the scientists need years to run computer analyses of any specific weather event and calculate whether it was made more or less likely by global warming, there is a need for a more rapid analytical method. That could become a problem given the amount of money at risk for climate damages since it might lead to projections based on highly questionable science.
One commentator on the Nature.com web site pointed out that there was the potential for developing climate computer models that enable forecasting and backcasting at will and that always justifying the results obtained. He went on to say: “So what is the significance of what we’re left with? That given literally dozens of computer simulations they can run the data until someone stumbles on a convenient artifact, like trying to discern the causes of the financial crisis and finding some data indicating a sudden rise in Lady Gaga tickets right before the crash, then attributing – with a ‘good dose of probability’ as one author put it – a causal relationship between the two.” The point being made was that the study was not an empirical study and is carefully constructed to not use multiple working hypotheses to create competition between the study’s authors and their preferred conclusion. He went on to point out that in the study the authors reserved a “10% probability” that the complete opposite of their conclusion is actually the case, i.e., the study is meaningless. In the multiple news articles we read about the study, we never saw mention of this possible conclusion.
The article in The New York Times discussing these climate studies concluded with an interesting discussion that highlights their problem. It said that the studies would be challenged by climate-change contrarians (notice they didn’t use the term deniers, suggesting possible moderation by the liberal press) because they question computer simulations of the climate (count us among that group). The article then went on to state that midstream scientists acknowledge that point to a degree but contend that the programs are becoming more accurate and they are the only tools available today. Unfortunately, the writer of the article offered no evidence upon which to base his claim about the models getting better. Once again we are left with nebulous claims being offered as fact, which we know is a dangerous position as we found out when former vice president Al Gore admitted that the idea of ethanol fuel was a mistake some 10 to 15 years too late. As the blog commentator put it, this may have been a study constructed to prove a predisposed conclusion. It is much like the bug looking for a windshield.
Offshore Wind Power Gets Push From East Coast State (Top)
As one media story put it, there is a rush on along the East Coast to become the first state to develop an offshore wind project. In the lead at the present time is the Cape Wind project targeting the waters of Nantucket Sound off Cape Cod. After nearly 10 years of effort, the project finally has secured its federal permits for siting and has concluded a purchase contract for the electricity, despite the fact that the cost of this power for power customers in Massachusetts is considerably greater than the cost of alternative wind power from onshore projects and substantially greater than power generated from conventional fuels such as natural gas. There still remain some small legal issues and permits to be secured. Then the project needs to raise the money to fund the project.
In Rhode Island, the wind energy demonstration project off Block Island planned by Deepwater Wind has met all the regulatory and contractual requirements for a go ahead. It is, however, now bogged down in court due to several lawsuits from legal objectors to the jury-rigged Rhode Island Public Utility Commission (PUC) process that approved the power purchase agreement that was key to the project moving forward. The power purchase agreement was originally rejected by the PUC but was re-heard following a revised state law mandating changes in the legal requirements for what needed to be considered and what could not be ignored in approving a renewable power purchase agreement. The suits against the ruling were filed by the Constitution Law Foundation along with two large industrial power users in the state. The former Rhode Island attorney general had filed a suit similar to that of the Constitutional Law Foundation, which challenged the legality of the state’s process for approving the power purchase contract. Following last November’s election in which the then-Rhode Island attorney general did not stand for re-election, the new attorney general, supported by an environmentally-friendly new governor, dropped the state’s suit.
Last week the Rhode Island Supreme Court, who is required to hear the appeal of the PUC decision, demanded that all the parties file legal briefs addressing their legal standing to appeal the case. The legal briefs are due in a couple of weeks. It would appear to us that the constitutional think tank might have a problem proving its standing (right) to sue. On the other hand, it seems obvious that the two industrial customers should have the right to sue over the ruling as it impacts their cost of electricity by a substantially amount, which is the outcome of the PUC approval process. While we believe the consumers have the right to sue and the think tank has the right to question the legality of the legislative maneuvers, we will never underestimate the ability of the courts in ultra-liberal states such as Rhode Island to find unique and original ways to reshape the law in response to political pressures.
The latest twist for offshore wind development is the request from an offshore wind development company for the New Jersey Board of Public Utilities (NJBPU) to approve offshore renewable energy certificates (OREC) to assist in the financing of an offshore wind energy demonstration project. This financing scheme has been used to promote the introduction of solar energy projects and is now proposed for expansion to offshore wind energy. ORECs are certificates that electric utilities must purchase to demonstrate that a percentage of their electricity has come from offshore wind. This provision was part of the Offshore Wind Economic Development Act signed into law by New Jersey Governor Chris Christie in August of last year. That law authorizes 1,100 megawatts of offshore wind projects and gives the NJBPU the ability to set up a 20-year OREC price for offshore wind energy projects and provides $100 million in tax credits to attract manufacturers to set up plants in the state.
The use of offshore ORECs may be necessary for New Jersey electricity utilities to meet the state’s mandate that 22.5% of their energy comes from in-state renewable resources by 2021. Proponents of the change argue it will make the state a leader in offshore wind production and create green jobs. Opponents are skeptical of the cost of the program especially after business groups claim the cost could go as high as $14 billion. OCERS will impact the future cost of electricity as offshore wind is the second most expensive renewable energy trailing only solar, of which New Jersey is second behind California in installed solar generating capacity. This is merely another way of subsidizing high cost energy and socializing it across all the electricity ratepayers in the state of New Jersey, which would seem to fly in the face of everything else Gov. Christie is doing to reduce taxes and the cost of living in the state.
Further north a study released by researchers affiliated with the University of Maine claims that floating wind turbines in deepwater in the Gulf of Maine could be delivering electricity in 2020 at costs equal to what consumers are paying today, or 13-16 cents per kilowatt/hour. The U.S. Department of Energy funded the $1 million cost of the study that collected data for four years to answer many detailed questions about constructing and floating to the site the offshore wind turbines and hooking them into the state’s power grid. The study was designed to help developers who the state is hoping will provide proposals for a 25-megawatt demonstration project by 2016. This would follow a planned test model to be installed off Monhegan Island in 2012. Assuming the demonstration project proves successful the state anticipates a commercial-size wind farm with a capacity of up to 1,000 megawatts by 2020 and additional ones by 2030. The total investment to achieve the commercial project is estimated at $20 billion.
To date in Europe, all offshore wind turbines are positioned on structures anchored to the seabed. The performance of wind turbines is dictated by both the intensity of the wind and its direction. In other words, there is a sweet spot for optimal performance. By being fixed, the angle of the turbine’s blades can be set for the normal direction of the wind to maximize the unit’s efficiency. Floating turbines, even anchored by tensioned tie-downs, will experience movement of the structure in concert with wave and current action. This movement can reduce the turbine’s efficiency.
The European offshore wind business experienced a record year in 2010, largely driven by stepped up government subsidies. The European Wind Energy Association reported recently that 308 new offshore wind turbines worth some €2.6 billion ($3.6 billion) were fully grid connected last year representing 883 megawatts of power, a 51% increase over 2009. Eight wind farms were fully completed and grid connected, one wind farm was partially grid connected and one wind farm was completed but not grid connected. Cumulatively, there are 1,136 turbines installed and grid connected, totaling 2,946 megawatts in 45 wind farms in nine European countries. The average wind turbine is 3.2 megawatts in size. Some 65% of those turbines installed are on monopoles, 25% are gravity based and 8% are on offshore platforms. The average water depth of turbines installed in 2010 was 17.4 meters (57 feet), a 5.2 meter (17 foot) increase over 2009.
This push for increased investment in offshore wind energy is driven by European mandates to reduce carbon emissions. It is also coming at a time when there are growing concerns about the need to shut down old coal-fired and nuclear power plants and fears that North Sea oil and gas production is on a steadily declining trend. It is interesting to see which European countries are leading the charge into offshore wind. Denmark has been the historical leader, but with huge support from the UK government, it has surged into the lead.
Exhibit 22. European Offshore Wind Energy In 2010
Source: EWEA, PPHB
Last month, however, the John Muir Trust, one of Scotland’s leading conservation bodies, challenged the common assertion that wind turbines run at an average of 30% of capacity. A study conducted for the trust of dozens of wind farms, the majority of which are in Scotland, between November 2009 and December 2010, found that they actually ran at only 22% of capacity or 25% less than advertised. The trust said that hundreds of wind farms across Scotland secured planning permission based on this inaccurate assumption of their output potential, which will have negative implications for consumers.
The trust study examined the performance of 47 wind farms capable of producing 2,430 megawatts of green energy. The research showed that over the span of 395 days, the wind farms could have produced 17,586,000 megawatt-hours of energy running at full capacity. In reality, only 3,881,900 megawatt-hours was generated, equal to 22.07%. Over the past two years, wind generation across the sites fell below 20 megawatts on 123 separate days for a combined duration of 25 days. For a total of nine days, the output dipped below 10 megawatt-hours, barely enough power for a couple of thousand homes for a day.
A battle over the study’s results was not surprising. The author of the study suggested that “It doesn’t matter how many wind farms you build, if the wind isn’t blowing, the blades aren’t turning.” Defending the wind industry, Niall Stuart, the chief executive of Scottish Renewables, a group representing renewable energy companies, pointed out that the winter of 2009-2010 was one of the calmest on record and it was “no surprise” that the output figures for the year were below average. But as we have uncovered from other European wind research, the continent may have just experienced a decade of above-average wind and now is moving into an extended period of below-average wind, just when European governments have embraced wind energy as its preferred solution for greenhouse gas emissions. Who’s right in this debate? As Peter, Paul and Mary said, “The answer is blowing in the wind.”
Contact PPHB:
1900 St. James Place, Suite 125
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.