- IEA Cuts Oil Demand Estimate Once Again
- Impressions of OTC 2006
- Coal Is Making a Big Comeback
- ExxonMobil – The Reluctant Growth Company
- The Impact of High Gasoline Prices
- Energy and Global GDP
- Presidents and the Gasoline Market
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
IEA Cuts Oil Demand Estimate Once Again
The inexorable impact from crude oil prices above $75 per barrel due to geopolitical tensions and supply concerns during April, coupled with warmer weather, resulted in weaker oil demand. As a result, the International Energy Agency (IEA) has reduced its estimate of global oil demand growth for 2006, once again. The reduction from an increase of 1.47 million barrels per day (b/d) to 1.25 million b/d, a cut of 15%, marks further erosion in the Agency’s initial expectation for a strong rebound from the weak demand growth of 2005. Last year’s growth of 1.05 million b/d was depressed by the impact of hurricanes and lagging global economic growth. Prospects for robust economic growth in the
In its January 2006 monthly oil report, the IEA estimated this year’s demand growth would be a robust 1.83 million b/d, or a 2.2% increase. This would have been above the average increase experienced in 1994-2004, but not as much as we experienced in 2004. The early warm weather in the
Recently, the International Monetary Fund revised its estimate of global economic growth up to 4.9% for this year. The current diversion between strong economic growth and weakening oil demand suggests that sky-high oil prices are taking a toll on consumers. As Eagles put it, “If that’s not a price effect, I don’t know what is.”
The more troubling issue is that weakening demand has been caused partly by Asian countries lifting fuel subsidies as the cost of subsidizing consumer energy bills is hurting their finances. The erosion in demand could increase further as the removal of fuel subsidies still has some way to go. A London-based oil broker suggested that it takes six to nine months for high fuel prices to feed through to deep-rooted changes in consumer behavior. He is quoted as saying, “I’d be surprised not to see something by the fourth quarter.”
The pattern of oil consumption growth in 2005, and possibly 2006, raises the question of whether 2004’s experience was an aberration in the growth trend rather than step-change in demand growth. In recent years, we became conditioned to accept that the growth rate in global oil demand was increasing, as shown by the almost 50% increase in the average growth for the 1994-2004 period compared to 1989-1999. Exhibit 1 shows the recent history of demand growth, but we see that in both 2005 and 2006, the initial growth projections were disappointingly high. Now we may need to question the assumption that global oil demand growth is accelerating.
Exhibit 1. Global Oil Demand Growth
Source: EIA, PPHB
The other interesting trend noted in the EIA’s report is the growing supply of oil from non-OPEC sources along with increased production out of
We have suggested for quite a while that oil demand is the variable that most industry observers and participants have been taking for granted. There is a long lag-time between the hike in oil prices and changes in consumer habits, but we may be reaching that infliction point. As demand growth erodes, with the likelihood it will continue, any supply growth will boost the global capacity cushion and undercut oil prices. Long-term there are still issues with supply, especially due to climbing depletion rates. Just as everyone settles in to the consensus view that this cycle is young and has a long way to go, things could be changing.
Impressions of OTC 2006
The Houston Chronicle reported that this year’s attendance at the Offshore Technology Conference of 59,236 surpassed the largest recent conference in Houston – the International Quilt Show. It is interesting to consider that one of the most important technical conferences in the world dealing with helping to solve the nation’s and globe’s shortage of hydrocarbon resources only barely surpassed a show built around a hobby – albeit an old and treasured hobby. This year’s OTC crowds experienced a jam packed show with 2,214 exhibits from 33 countries spread out over 475,000 square feet of space in the
Missing this year were the Pirelli girls. We couldn’t find them anywhere. We even asked some of our exhibitor friends if they knew where they were, but sadly they acknowledged that the girls weren’t there. However, we were directed to check out several other booths as potential alternatives. While there were numerous attractive women present at these targeted booths, some were even dressed in strategically-designed yellow dresses and serving drinks such as at the Bluewater Energy bar/booth, none of the alternatives offered the shear fun and excitement of the Pirelli girls.
We were told that one of the future OTC committee leaders openly discussed the need for OTC to “get the bouncing bimbos out of the booths” next year. We understand his concern about keeping OTC a serious technical and trade show, but it’s hard to imagine OTC not having its share of attractive women to spice up the dull iron that forms the backbone of the oil and gas drilling and production business. Our reaction to that future OTC leader’s comment: Good luck!
We came away from OTC with a number of impressions. First was the large number of Chinese rig equipment manufacturing companies present at the show. It seems as though they have taken over all the production of basic rig equipment such as mud pumps, valves and rotary tables. We know they have taken over the shelves at Wal-Mart, as Chinese-made goods account for about 70% of the items stocked by the giant retailer, but it is beginning to look like they are making their move on the American-dominated oilfield manufacturing industry. Will this be a good thing for the oil industry, as it has been for
We were also struck by the fact that for the first time ever, OTC hosted a panel on alternative energy sources and a session on global warming. I’m not sure whether these sessions were driven by the Peak Oil debate, or as a concession to the growing popular belief that burning hydrocarbons is impacting our environment. As more and more oil, gas and utility companies acknowledge the global warming issue, addressing it at this conference made sense. We only attended the alternative energy sources panel, which was outstanding for its presentations and quality Q&A, but were impressed that it was standing room only audience. We heard that the attendance at the global warming session was equally as impressive. It will be interesting to see if these topics are on next year’s OTC schedule.
We heard mixed reactions from exhibitors about the quality of the attendees. There were a large number of senior oilfield executives who made the show; some even attending for several days. But there weren’t as many oil industry people. Some exhibitors remarked that there were so many financial types (analysts, portfolio managers and investment bankers) that they started avoiding them.
There were also concerns expressed about the lack of international oil industry engineers at the show. Whether this reflects the increased difficulty in entering the
This year, OTC seemed not to have much in the way of new technology displayed. Whether that is a reflection of just how busy and stretched the oilfield industry is, or whether the pace of revolutionary new technology just hasn’t produced anything new, we are not sure. As usual, the new technology tended to be evolutionary rather than revolutionary. We remain confident the industry hasn’t run out of new ideas, but maybe given the tight labor market, more engineers and researchers are working on helping their employers meet current customer needs rather than dreaming up new things. If that is the case, then it argues for more hiring of technical types by the oil service companies.
Baring some unforeseen change in oil and gas supply and demand, we left this year’s OTC with the feeling that 2007’s show will be even bigger. That was clearly the view of most of the industry executives we either heard speak or with whom we conversed. The one cautionary note, however, was the repeated declarations by oil company executives about rig rates and service costs being too high. With Royal Dutch Shell (RDSA-NYSE) announcing the postponement of several
Coal Is Making a Big Comeback
TXU Corp. (TXU-NYSE) announced that it plans to spend $10 billion to construct 11 new coal-fired power plants at nine existing sites in
The new plants will burn coal in a pulverized form as opposed to turning it into a synthetic gas first. While environmentalists prefer the latter technology, TXU plans to spend about $2 billion of the funds on enhanced emissions control equipment.
Of the 11 proposed new plants, TXU is just filing air permit applications with regulators for eight. If approved, these plants will be on line by 2010. The other three plants had previously been announced and TXU had already started the permitting process. The new plants will replace four existing gas-fired plants.
About 72% of the power generation in
It is interesting to note that while Texans are paying record high utility rates, other states are trying to coddle their citizens by capping rates at the expense of the financial health of their local utilities and their shareholders. At some point, if we ever hope to address our profligate energy consumption, utility rates need to more accurately reflect the cost of generating the power.
TXU’s move is the latest in an increasing interest and investment in coal. We recently noticed a series of advertisements by
The text of the various ads spells out how coal, or a fuel derived from coal, can help boost our nation’s energy supply. Coal can be used to fuel electric power generation plants, and in fact has more than tripled in its use since 1970, while emissions have been reduced by more than a third. Coal can be converted into synthetic gas to ease the natural gas shortage and combat high prices. The technology exists to convert coal into a liquid fuel that can power diesel automobiles and trucks and jet planes. Since the
ExxonMobil – The Reluctant Growth Company
The world’s largest publicly-traded oil company sits squarely in the cross-hairs of politicians. It is a target because it is so big, so profitable and so arrogant. It is there because it paid its retiring chairman, Lee Raymond, $400 million in compensation and retirement benefits last year. It is there because Lee Raymond challenged the “accepted Beltway view about hydrocarbons and global warming.” It is there because Lee Raymond uttered the un-politically correct statement that ExxonMobil is, and would remain, an oil and gas company, and not an energy company. It is there because Lee Raymond debunked the prospects of ethanol saving the
Two weeks ago, ExxonMobil’s new chairman, Rex Tillerson, was interviewed on a TV morning talk show. He had the temerity to say that in the short-term there was little he or ExxonMobil could do to ease the gasoline situation. In addition, he told NBC’s Matt Lauer that ExxonMobil would not voluntarily give up profits to the American consumer because he worked for shareholders and making money was their mandate. He also told Lauer that the world will continue to rely on oil and gas for a long time as a primary energy source. The world has plenty of hydrocarbon resources, he said, but it will take technology to enable the world to consume more fuel at a price consumers are willing to pay. But this situation is nothing new for the industry – only for politicians.
Tillerson did say, however, that the only short-term solution to high gasoline prices was for consumers to use the fuel more efficiently. Buy less gasoline? What kind of an oil company chairman urges people to use less of his product? Only an oil company CEO who appreciates the silly season that
The recent jump in gasoline pump prices, spurred by the need to cut back refinery runs to do planned maintenance and the mandated switch to ethanol-blend fuels, started Washington’s silly season, as it was referred to by Robin West, the head of PFC Energy, in comments at OTC. We have attempted to list as many of the silly solutions proposed by politicians to cure the present gasoline crisis.
Exhibit 2.
Source: Various media reports; PPHB
Fortunately, some of these crazy ideas have disappeared as saner views have prevailed. There are still some serious potential political problems for the industry, but more and more we are seeing a shift in favor of rational strategies to make it easier to exploit the energy resources in the
While many people had trouble recognizing the acerbic Raymond’s leadership qualities, shareholders clearly benefited from his tenure as the head of Exxon and then ExxonMobil. In the flap over the $400 million being paid to Raymond, composed of his 2005 compensation, retirement benefits, long-term incentive awards and transition services payment, what seems to have gone unnoticed was the impact of his leadership on increasing shareholder wealth.
Shortly after the filing of the ExxonMobil proxy for its upcoming annual shareholder meeting, it was disclosed that Raymond received compensation and retirement benefits of about $400 million. The outrage on Capitol Hill at this disclosure at a time when gasoline prices were climbing toward $3 per gallon prompted calls for legislative and regulatory retaliation against the company and the oil industry. What was missed by the politicians is that the shareholders are the ones who should be either outraged or pleased. They were responsible for electing the directors who hired and compensated Raymond, not gasoline customers and certainly not the politicians.
According to an analysis by Fadel Gheit, senior energy analyst with Oppenheimer & Co., as reported in The Wall Street Journal, ExxonMobil provided total returns to shareholders of 223% over the past ten years. This compares with an average return of 205% for the other major integrated oil companies. The difference in returns is worth about $16 billion in shareholder value. Is it right for Raymond to earn about 2.5% of that incremental return? In an age where hedge fund managers earn 2% of the managed funds and 20% of their investors’ profits and movie stars can get 15% of a studio’s take from a movie, Raymond’s share is not outlandish.
In fact, Raymond’s compensation reflects several of the stated objectives of the company’s compensation program as set forth in the Compensation Committee Report presented in the ExxonMobil proxy statement. To quote from the report:
“The Company’s executive compensation program is designed with the following primary objectives:
▪ Reinforce the relationship between strong individual performance of executives and business results.
▪ Attract, develop, and retain the best executive talent across all industries, and align the interests of our executives with those of shareholders.
▪ Recognize the long investment lead times in our industry, which can exceed 10 years, depending on the nature of the projects in which we are involved.
▪ Given the long investment lead times in the business, reinforce a career orientation of employment coupled with a strong culture of superior performance among our executives.”
It is hard to argue that Raymond’s compensation was not in accordance with these objectives. And moreover, it is hard to argue that his leadership didn’t create substantial wealth for long-term shareholders.
The compensation program’s objectives reflect the long-term wealth-creation goal of the shareholders. If one looks at the very long-term performance of ExxonMobil’s stock, it is clear that the company has actually been a growth stock rather than a dull commodity-cyclical stock that the financial media would have you believe. In Wharton business school Professor Jeremy Siegel’s book, The Future for Investors, he makes a strong case for avoiding growth stocks. According to Siegel, “The relentless pursuit of growth – through buying hot stocks, seeking exciting new technologies or investing in the fastest-growing countries – dooms investors to poor returns. In fact, history shows that many of the best-performing investments are instead found in shrinking industries and in slower-growing countries.”
To illustrate this conclusion, Siegel contrasts the long-term (1950-2003) performance of Standard Oil of
Exhibit 3. Annual Growth Rates, 1950-2003
Source: Siegel
Using the above numbers (all of which are used by Wall Street analysts to pick stocks); Siegel compares IBM with Standard Oil. As the information technology sector began to grow in the 1950s, its share of the stock market rose from 3% in 1950 to almost 18% in 2000. On the other hand, the oil industry struggled over this time period. Oil stocks, which comprised 20% of the stock market in 1950 had fallen to just 5% by 2000.
He asked, if someone had whispered this information into your ear in 1950, which stock would you have bought?
If you answered IBM, you would have fallen victim to, what Siegel calls, the Growth Trap. “Although both stocks did well, investors in Standard Oil earned 14.42% per year on their shares from 1950-2003, more than half a percentage point ahead of IBM’s 13.83% annual return. Although this difference is small, when you opened your lockbox 53 years later, the $1,000 you invested in the oil giant would be worth over $1,260,000 today, while $1,000 invested in IBM would be worth $961,000, 24% less.” The performance divergence has increased since this analysis was performed.
Exhibit 4. Average Valuation Measures, 1950-2003
Source: Siegel
What investors missed during this period was that Standard Oil’s price to earnings (P/E) ratio was less than half of that of IBM’s. In addition, Standard Oil’s dividend yield was higher. Because Standard Oil’s price was low and its dividend yield much higher, those who bought its stock and reinvested the oil company’s dividends accumulated 15 times the number of shares they started out with, while investors in IBM who reinvested their dividends accumulated only three times their original shares. So the message is: it’s not just growth rates, but what you pay for that growth.
I think ExxonMobil’s Raymond, and the company’s prior leaders, understood this message. I have to believe that Tillerson has been schooled in the same techniques. So while Tillerson presents a different image to the public, he adheres to the same objective of making money for his shareholders. That’s a good thing.
The Impact of High Gasoline Prices
The mystery of why
However, these same analysts do acknowledge that for lower income people the price rise has been more of a burden. But they are quick to point to Bureau of Labor Statistics information from 2004, the last time that the weighting for gasoline in the consumer price index was revised, that shows 26.4% of households with more than $70,000 in annual income bought about 40% of all gasoline and motor oil. The 41.4% of households that earned more than $50,000 accounted for 58.4% of total expenditures. As a result, these high income households that collectively account for about 64% of overall consumer spending are still spending only a small portion of their income on gasoline.
This analysis is very interesting and had been presented in the context of the March retail sales figures that showed a gain of 0.6%, and the latest consumer confidence measure. In addition, the observers point to the April same-store sales for Wal-Mart that rose 6.8% as an indication of the minimal impact of rising gasoline prices on consumer spending. They also note that the April consumer confidence index reported by the Conference Board rose to its highest level since May 2002.
What we found interesting was to look at the gasoline consumption implied by the weekly data reported by the Energy Information Administration (EIA) during the first quarter of this year. The EIA reports both weekly volume and a 4-week moving average. For comparison purposes, we have the interesting choice of which starting point to select for measuring demand growth. If we measure from the last week in December 2005 (week ended 12/30), then weekly gasoline consumption has fallen by 3.1% through the end of March 2006 (3/31). On the other hand, if we start counting from the end of the first week of January 2006 (1/6) then gasoline consumption has risen by 1.3%.
Using the 4-week average figures, we find that since late December, gasoline consumption has fallen by 2.3%. Moreover, if measured from the early January week, then consumption has fallen 1.5%. When we look at gasoline prices, measured from December 26, 2005, to March 27, 2006, prices rose 13.4%, or from $2.241 to $2.541 per gallon. By selecting a
This conclusion was supported by the report last week of the April retail sales data that showed a significant slowing in growth. April retail sales advanced 0.5%, considerably slower than forecast. The growth was helped by a 4.6% gain for gasoline station sales that were boosted by higher pump prices. Without gasoline sales, retail sales increased only 0.1%. The recently released
Energy and Global GDP
While we have been digesting all the rhetoric about rising gasoline prices, the lack of oil company refining investment and the need for government action, we found the following chart on global petroleum expenditures as a percent of gross domestic product (GDP) quite interesting. As Exhibit 5 shows, the 2006 estimate is based on an average price of $70 per barrel of oil. If that comes to pass, then petroleum’s share of global GDP will be approaching 5%, and it will be back to about 1984’s level. If energy forecasters are right and we are headed toward $80 and eventually $100 per barrel oil, it is not difficult to see the future global GDP allocation for petroleum challenging 1980’s high of almost 7%.
Exhibit 5. Oil and the Global Economy
Source: ISI
There are two parts to the equation driving the data displayed – the amount of money spent on energy and the size of global GDP. If one considers the International Energy Agency’s (IEA) oil market projections, it expects high oil prices to continue through the balance of the decade coupled with solid consumption growth of 1.5-2.0 million barrels a year. That grow implies strong economic activity that would help moderate how quickly petroleum’s share of global GDP challenges its old high. On the other hand, if economic growth slows, than the pace of energy consumption growth would likely moderate. This scenario, after a quick jump in share, could produce a more moderate rise in petroleum’s share of global GDP.
There are a number of economic forecasts that suggest
It is interesting to note how petroleum’s share of global GDP has moved since it hit bottom in 1998. Since that time, petroleum’s share has about tripled if the 2006 estimate comes to pass. Of course, 1998’s low occurred when oil prices hit bottom due to the Asian currency debacle. The recovery in 1999 was followed by a four-year period of oil prices in the mid-$20s to low-$30’s per barrel range. But what is most impressive, although somewhat distressing, is the steady climb in petroleum’s share of global GDP from 2003. Those gains came from the healthy economic growth experienced in the
Presidents and the Gasoline Market
The
Democratic presidents Kennedy and Johnson failed to make the quote list as they served during the last years that the United States was an oil exporter, so gasoline prices were benign, and actually declined in real terms. We did notice the liberal bias in the chart by the paper ignoring the actions of President Bill Clinton to investigate gasoline prices and release oil from the Strategic Petroleum Reserve in order to drive down gasoline prices. Did I miss something, or did Bill Clinton never say anything about high gasoline prices? It’s hard to believe the latter since Bill Clinton seemed to talk about everything all the time.
It was interesting to note the tone and perceived culprit in the gasoline crisis du jour. President Richard Nixon targeted both the big oil companies and foreign oil producers as he wrestled with the fallout from the 1973 Arab oil embargo. Under President Gerald Ford, whose time in office was plagued by exploding inflation, the target was foreign oil producers who were manipulating the market. For President Jimmy Carter, it was the big, bad oil companies who were reaping windfall profits from the turmoil in the energy market. Of course, Carter left office after oil prices spiked to all-time highs due to the Iranian hostage situation and the failed
President Ronald Reagan was never confronted with high oil prices as he benefited from slowing inflation and the implosion of OPEC’s pricing power in the oil market. On the other hand, his successor, President George H.W. Bush had to deal with run ups in gasoline prices caused by the
As demonstrated by the chart below, for most of the 45-year period, politicians have been able to shift the blame for gasoline price spikes to foreign producers and/or big oil companies and away from government energy policy. One of these days we need to wake up to the fact that we do not have a coherent national energy policy. Trying to develop an economically- and environmentally-balanced national energy policy appears impossible, but shifting attitudes among the populous may signal we are near a tipping point that could produce such a policy.
Source: The New York Times
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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.
