Bottomline positive

Deepak Pareek, research analyst, oil & gas at Angel  Broking on the impact of the APM gas price hike

The Government of India has approved a hike in APM gas price sold by ONGC and OIL from nomination blocks from Rs 3.20/scm to Rs 6.82/scm. After the hike, APM prices are now in line with EGoM-determined gas prices for the KG-D6 (US $4.2/mmbtu; pre-royalty adjusted), from US $1.9/mmbtu earlier. APM gas prices have been at Rs 3.2/scm (at 10,000 Kcal) since July 2005. However, adjusted for calorific value, ONGC’s realisations were at Rs 2.88/scm (US $1.8/mmbtu). This move follows the finance ministry’s suggestion of bringing about pricing parity between APM and KG gas in one swift move rather than a phased increase in the APM gas prices as proposed by the petroleum ministry. The prices will be effective until March 2014.

In a related development, the cabinet has also approved marketing margins of US $0.112/mmbtu (Rs 200/scm) for GAIL on APM gas marketing volumes. Earlier, GAIL did not receive any marketing margin on sales of APM gas.

The decision comes as a big trigger for ONGC and Oil India, as it substantially improves the profitability of both the companies. The move would benefit ONGC, which had lost Rs 4,745cr in revenues on selling 17.71bcm of gas at the government’s fixed rate in FY2009. The move would lead to some profits now from the gas business for ONGC. The price hike is a pleasant surprise, both from the quantum as well as the timing perspectives. We were expecting a gradual hike in gas prices instead of an increase in one go; thus, the quantum of the hike is much higher than our estimates.

We expect ONGC to gain around Rs 6,086 crore on the topline, and Rs 4,047 crore on the bottomline during FY2012E on account of the price hike. Similarly, we expect Oil India to gain around Rs 941 crore on the topline and Rs 622 crore on the bottomline during FY2012E. Given the fact that Oil’s net gas realisations were lower than that of ONGC’s APM realisation, it stands to benefit more on account of the increase in the gas prices to US $4.2/mmbtu.

Though GAIL uses gas for its petrochemical and LPG operations yet, as it was not procuring APM gas, the company is not likely to be impacted by the gas price hike. However, we believe that marketing margins allowed to GAIL will add to its topline and profitability. According to our calculations, GAIL benefits by around Rs 344 crore on the PBT and Rs 239 crore on the bottomline.

Source: energybusiness.in

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Natural gas: time to invest

As of April 16, 2010, natural gas rotary rigs totaled 973, the highest level in close to 14 months, according to Baker Hughes. Horizontal rig growth has contributed to the general increase in the natural gas rig count since July 2009, according to basin-level rig data released by Baker Hughes on 30 March. Other major natural gas basins over the last two years for which data are available have not shown the same growth in rigs. For example, natural gas rig counts in the Western Gulf and Anadarko regions are well below their levels at the beginning of 2008.

Consumption growth in 2010 remains largely dependent on the timing and pace of economic recovery. Based on current assumptions, 2.2 per cent growth in the electric power sector combined with a slight growth in the residential and industrial sectors are all expected to contribute to 2010 consumption growth.

Included in the natural gas outlook, prices could remain low over the next few years as new coal-fired electricity plants open, reducing the overall amount of the natural gas used to generate power. According to Jen Snyder of Wood Mackenzie, when these new plants come online, demand for natural gas could rise sharply as older coal-fired plants are retired and government policies show a greater preference for cleaner energy sources.

According to the EIA, with so much gas in storage the outlook for natural gas annual production in 2010 is expected to decline relative to 2009 in the Federal Gulf of Mexico and Lower-48 non-Gulf of Mexico by 6.3 and 0.6 per cent, respectively.

Working natural gas in storage increased to 1,829 Bcf as of Friday, 16 April, according to EIA’s Weekly Natural Gas Storage Report. The implied net injection was 73 bcf, compared with last year’s net injection of 42 bcf and the five-year (2005-2009) average of 33 bcf for the reported week.

Contributing to the natural gas outlook, the price disparity between natural gas and oil has widened, leading some to believe that there is a natural upward pressure on natural gas. Part of the reason oil is experiencing higher prices is from the growing demand from emerging economies. While North America has an overabundance of natural gas, it is difficult and costly to export. Therefore, the market for gas remains within the continent. The relative price of natural gas to oil is changing as the dynamics of demand for oil are changing. We should not depend on the relationship to drive the price of gas in the future. Substituting natural gas for oil requires substantial capital investment. Following government policy, the focus is to bypass natural gas as a fuel for transportation and go directly to electricity.

With the high levels of storage, producers have curtailed drilling programmes. This means production will taper off in the spring to summer of 2010. If companies do not pick up their drilling in the middle of 2010, available supply will not come online to recharge storage. This could lead to an increase in prices as supply fails to reach prior levels, meaning the earliest natural gas prices can make a comeback is late 2010.

Bullish Factors
Climate change concerns will lend further support to gas demand. As carbon emissions start coming with a price attached, cleaner-burning gas will be increasingly favored over coal for fueling power plants. Many newer plants use dual-fuel designs, enabling them to switch readily to whichever fuel is cheapest. As the hidden subsidy of externalized emissions costs is taken away from coal, gas will be cheaper, and it will stay cheaper. The vehicle angle is another hugely bullish factor for gas, but so far the markets don’t seem to have discounted it at all. The longer prices remain too low to sustain increased drilling, the more tension there will be in the price slingshot.

A year from now, we will be looking back on those analysts who predicted US $2 natural gas by the end of this year with the same sad regard that we now have for the ones who saw oil trading in the US $40s in December and thought it was going to US $25.

You may recall that’s when market got bullish. I feel exactly the same way about gas now.
Another reason to start getting bullish is the extremely bearish gas sentiment itself. We haven’t seen gas prices stay this low in years, and gas continues to trade at a historically low price relative to oil on an energy basis. As Warren Buffett likes to say, “Be fearful when others are greedy, and be greedy when others are fearful.”

Source: energybusiness.in

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Lull in LNG Demand

The 60 metric million standard cubic meter per day (mmscmd) of gas, which Reliance Industries Ltd (RIL) is pumping currently out of KG D6 has had a curious effect on the demand for liquefied natural gas (LNG) in the spot market in the country. The demand for LNG has suddenly dried up.

However, most experts believe this is a temporary phenomena and demand will go up as more capacity is added in the power and fertilizer sectors. Apart from the availability of KG D6 gas, the other major problem the Indian gas market is facing is adequate infrastructure.

Petronet LNG, the leading player in the LNG market has not bought any spot cargo since November 2009. The biggest consumer of LNG in the country, RIL which used to buy at least two LNG cargoes a month in the spot market has now stopped buying in the spot market. It is only importing two cargos through Shell’s Hazira terminal under long-term contract. Out of KG D6 production, RIL gets 2.34 mmscmd.

Around 1.2 metric million tonnes of gas was being imported in the country every month before KG D6 started producing about 60 mmscmd but now it has come down by half.

As the basic output from KG D6 is being utilised by power and fertilizer plants, these companies are no longer ready to shell out US $8 or more for gas in the spot market.  With KG D6 gas available, they require additional gas only to improve plant load factors (PLF) in the power plants, said V Shunmugam chief economist, multi commodity exchange MCX.

But this is likely to be a temporary lull. Once more power generation capacity and additional capacities in the fertilizer sector come up, the demand for gas will go up substantially, said Ajay Arora, practice head for oil and gas at international consultancy firm Ernst and Young.

As demand picks up in the near future, there is a strong case for Petronet LNG to go full steam ahead on its plans for setting up an LNG terminal at Kochi.  The response may not be as good in the case of Ratnagiri Gas and Power Pvt Ltd (RGPPL), which is also developing an LNG terminal at the site of its Dabhol power plant.

An analyst with another international consultancy firm believes that the problem has more to do with structural flaws in the Indian gas market than with demand.

He said due to the pool price mechanism for imported LNG, none of the suppliers – IOC, GAIL, BPCL can offer advantage of prevalent prices at particular point of time to their customers. This disincentivices suppliers from taking risks and maximising profits.

Inadequate infrastructure

Most of the gas imported in the country is either at Shell’s Hazira terminal or Petronet’s Dahej terminal and is transported through GAIL’s Hazira-Baroda-Jagdishpur (HBJ) pipeline. At present the pipeline is almost choked and there is hardly any room for pumping more gas through this pipeline.

In 2009-10, the gap between demand and the ability to transport the gas is expected to be around 65 mmscmd and it is expected to halve to 30 mmscmd by FY 13. But the gap between the demand and the pipeline capacity is not expected to be bridged in the medium term.

 In an emailed response a Shell spokesperson said, “The recent gas discovery from the Krishna-Godavari basin has a current recoverable reserve of 10 trillion cubic feet (TCF) and  1 TCF can fuel a 1000 Mw plant for 20 years. Thus all of the new discovery can fuel 10,000 Mw and with the target for capacity addition at 75,000 Mw, i.e., 15,000 Mw per year. This current find cannot meet even a year’s capacity addition in power, leave alone entirely address other additional industry use.”

Source: energybusiness.in

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Mukesh Ambani donates Rs five crore to Tirumala temple

RIL chairman Mukesh Ambani donated Rs five crore to the famous hill shrine of Lord Venkateswara at Trimula.
 
Temple sources told PTI the donation was made to meet the TTD's ongoing Rs 100-crore gold plating project for the sanctum sanctorum.

The cheque was handed over to Tirumala Tirupati Devasthanam (TTD) chairman D K Adikesavulu Naidu by a RIL official.

Ambani, an ardent devotee of Lord Venkateswara, had earlier donated a Rs five crore guest house constructed by RIL on the hills in 2007.

Source: Economic times

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Nelp is good but needs to be better

The government seems to be banking on private players to expedite its oil and gas exploration programme. That is what comes out from the Economic Survey 2009-10, where discoveries made by RIL and Cairn India find special mention.

Credit should go to new exploration licensing policy (Nelp) introduced by the government in 1999. However, the question is if the government wants to attract private investment in exploration business, why is it so stingy in offering sops to the sector that—in any case—involves highly capital-intensive and risky ventures.

For example, the government has consistently declined to accommodate the oil sector’s request for exemption from service tax for services availed for undertaking exploration work. The government has also failed to adopt a clear-cut policy on extending the tax holiday for the oil and gas sector. There is merit in these demands of the oil sector given that contractors have to write off all expenditure incurred in exploration if they fail to make a discovery. Costs are recoverable only when contractors make a commercial discovery.

Meanwhile, the government has also started intervening in the determination of price for natural gas production from these blocks, despite committing full marketing freedom to contractors in production sharing contracts (PSCs) signed with them. The D6 gas is an example. In a bid to avoid the possibility of accepting government-determined pricing, many private players have already started going slow on their production plans for discovered fields. This does not augur well given that the number of prospective blocks is declining with every Nelp round.

The government has allocated 203 acreages for exploration through bidding held under Nelp. This has helped the government attract investment of $11.9 billion in the sector. Since introduction of Nelp, more than 600 million tonnes of oil and oil equivalent hydrocarbon reserves have been added.

“The availability of gas from the D6 and utilisation of surplus gas available on fallback basis resulted in better utilisation of capacity and higher plant load factor (PLF) as also high growth in electricity generated from gas-based plants,” the Survey says. It also makes special mention of Cairn India’s Barmer block in Rajasthan. At peak level, production from the block will account for as much as 20% of India’s total crude oil production.

The government has made a huge savings on fertiliser subsidy payment because of switchover of some naphtha-based fertiliser plants to natural gas after RIL started production from its D6 block last April. Meanwhile, power generation in the current financial year has also improved significantly because of increased domestic availability of gas. This is despite a fall in power generation from hydro and coal-based power projects.

The government plans to raise the share of gas-based power generation in the country’s energy mix. However, this cannot be achieved if domestic production starts stagnating. Significantly, the domestic coal sector is unable to keep pace with the fast-growing demand of the power sector.

The government should learn lessons from past experience. For example, the Union power ministry had envisaged a sizeable chunk of its capacity addition in the 10th Plan based on natural gas. However, most of these projects could not be commissioned in the absence of appropriate fuel linkages. The result was that coal continues to remain a fuel of choice for power generators and accounts for more than 50% of India’s primary energy consumption.

This trend started changing after RIL started production from its D6 block in the KG basin. Fertiliser plants are switching to natural gas. This has helped them to cut cost and increase production.

Oil and gas exploration is supposed to be the backbone of every country’s energy security. India meets about 80% of its crude oil requirement through imports. And the country’s dependence on imported oil is expected to increase in the coming years as its economy is on a high-growth trajectory.

But upstream companies like ONGC and OIL are feeling a strain on their finances as they have to share OMCs’ under-recoveries on retail sale of petrol and diesel. While the Kirit Parikh committee has recommended measures to deregulate the petroleum retailing sector, it has ignored the plight of upstream companies that are reeling under the subsidy burden.

For example, the committee has recommended mopping up a portion of the incremental revenue accruing to ONGC and OIL from their production in nomination blocks and providing cash subsidy from the Central budget to meet the remaining gap. This would impact upstream companies’ cashflows, forcing them to cut down on exploration budgets.

Consider that ONGC’s natural gas production has declined over the years because of the lack of investment by the company in ageing gas fields. The company is not able to recover even its cost of production by selling gas under the administered price mechanism to customers in sectors like power and fertiliser. So, it has little interest in investing in these ageing gas fields.

In such a scenario, India’s energy security cannot be ensured if private players also lose confidence in the government’s fiscal and regulatory policy relating to the upstream hydrocarbon sector.

Source: Financial Express

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Major oil, gas discoveries ensure energy security

The government remains bullish on domestic oil and gas sector even as serious bottlenecks in areas like land acquisition, fund mobilisation and timely regulatory approval are hampering growth in other infrastructure sectors.

India has made major oil and gas discoveries in recent years that should go a long way in ensuring the country’s energy security. And the credit goes to the national exploration licensing policy (Nelp) which has helped in expediting the government’s exploration programme by attracting private investment. Reliance Industries Ltd (RIL) and Scottish company Cairn Energy have made most significant discoveries from blocks awarded under the Nelp regime. Production from these discoveries—natural gas available from RIL’s K-G D6 block and crude oil from Cairn

Energy’s Barmer block in Rajasthan — have dramatically changed India’s energy sector scenario. Sectors like power and fertilisers that use natural gas as fuel and feedstock have also benefited from the D6 gas. These discoveries find special mention in the Survey.

“Availability of gas from K-G D6 and utilisation of surplus gas available on fallback basis resulted in better utilisation of capacity, higher plant load factor and high growth in electricity generated from gas-based plants,” the Survey has noted. With 75% of total oil consumption in the country being met via imports, the dependence on imports for petroleum and petroleum products continues to be high. During the past five years, domestic supply of crude oil stands at 34 mmt and natural gas at about 32 billion cubic metric tonne. “With 15 new oil and gas discoveries during the current fiscal, domestic availability is expected to improve. During 2009-10, the projected production for crude oil is 36.7 mmt, compared with 33.5 mmt in 2008-09. This is due to increase in crude oil production from Rajasthan (2.4 mmt) and the K-G deepwater (0.8 mmt). The projected production for natural gas, including coal bed methane in 2009-10 is 52.8% higher than the actual production of 32.8 bcm in 2008-09. The increase in gas production is primarily from the K-G block.”

Source: Financial Express


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Some things have gotta give - IV

In hindsight, it is shocking how easily almost everyone forgot the laws of supply and demand when it came to the world’s most important commodity. A half century ago, oil was so plentiful that prices fell to their lowest-ever levels (adjusted for inflation). A complacent West was exposed to the unsheathing of the ‘energy weapon’ a few years later.

By 1999, with the crisis a distant memory, complacency returned. Cyber-technology attracted copious capital while investing in dowdy extractive industries had become unattractive after 20 years of falling prices. The Economist magazine nearly called the bottom with its bold prediction of $5 oil.

By the second oil price shock 30 years ago, prices had risen tenfold in just a decade, and politicians were warning that we would ‘run out’ in a generation. But this weapon badly backfired for producers, spurring conservation and the development of areas such as the North Sea that cut the Middle East’s share of world production by nearly half.

Within nine years though, hydrocarbons prices had once again surged tenfold and talking heads fretted that demand would soon exceed supply. Few realised how illogical such statements were. Prices peaked near $150 a barrel in mid-2008, but oil demand per unit of economic output, even having fallen by half in 30 years, could not bear such a price.

The ensuing decade has seen output rise modestly and oil prices break new records, but there is no sense of crisis. The marginal barrel is now expensive enough for the value of saving one to roughly equal the utility of extracting it from the ground.

Petroleum’s dominance is giving way to alternatives. It is unlikely that we will ever bother to extract that last barrel.

Politicians seeking out villains in the oil market tend to fixate on stereotypes of heartless US speculators, mercenary Middle Eastern petrocrats and greedy Chinese industrialists. Rarely do they think of the Belgian dentist driving his Volkswagen hatchback or of an Indian worker driving a Tata Nano.

The Opec oil cartel has repeated through the year that as a contribution to global economy recovery, it was supporting moderate oil prices. Saudi Arabia put numbers on the cartel’s words, describing the $70-80 a barrel range as ‘excellent’. For sure, Opec’s aim of $70-80 a barrel—the group avoids stalking about a target—has helped the global economy, particularly of poor oil importing countries.

But there are signs that the oil cartel is not as altruistic at it appears at first glance. Opec appears to be as concerned about the global economy as about driving consumers away from oil. This is the clearest recognition yet that high oil prices could damage the cartel’s interest in the long term by reducing energy demand for ever.

The deliberation came to light as Opec—apparently in a mistake engendered by the chaos surrounding the meeting in Luanda, Angola—allowed reporters to remain in the plenary room while the group’s economists told ministers about their latest findings. “Crisis appears to have induced a permanent loss in oil demand in OECD and slower rate of growth in non-OECD, due to policy measures and changes in consumer behaviour,” the concluding remarks of the presentation read.

Crude oil comes in many varieties and demand patterns for the different products derived from it differ markedly. This is important because it means refining capacity, not just oilfield output, affects the crude price. When demand for a particular product rises quickly, refiners will bid up the price of their main raw material—crude oil—because they can still earn a bigger margin as the price of the end product will rise.

So called middle distillates (diesel, jet fuel and gas oil) comprise the single most popular segment of the oil barrel and enjoy a faster growth in demand. A big reason for this is Europe’s gradual switch to more efficient diesel vehicles. This year, the old world should burn 6.3m barrels per day of diesel and gas oil compared with 5.2m in North America and 2.8m in China.

Europe’s thirst for middle distillates—particularly those low in sulphur—strains a global refining system largely built to produce gasoline. Light, sweet (low-sulphur) crudes are best suited to producing middle distillates but comprise only about one-fifth of global output. What’s more, Nigeria is a leading exporter of these grades, so trouble there moves the oil price. Opec, meanwhile, complains that the extra oil it is pumping (mainly heavy, sour crude) struggles to attract buyers.

Faltering American demand for gasoline is already weighing on the oil price. Europe’s weakening economy will dampen demand for middle distillates. Easing of the refining bottleneck could be the next shoe to drop on the oil market—long before China’s thirst for oil diminishes.

A global surplus of diesel, heating oil and other distillates is creating opportunities for deep-pocketed traders and a big question mark for the Opec oil cartel. Distillates are the lifeblood of the industrial economy, powering trucks, trains and firing furnaces in winter. Among the rich nations where they are best measured, stockpiles are a stubborn 13% higher than a year ago, according to the International Energy Agency, the oil watchdog of the Western world.

The inventories’ spike has helped spur investment in tank capacity and led traders to charter ships to hold what does not fit on land. But it is also a big concern for Opec.

Distillates’ stocks are one reason why Opec decided to leave quotas alone, even after oil prices gained 65% in 2009. “Stocks of distillates are high,” said a senior Opec official in Luanda. “That is a strong sign that global industrial activity is still weak.”

The oversupplied distillate market has prompted oil majors, commodity trading houses and even banks to chase the so-called ‘floating storage’ trade, filling tankers and mooring them outside ports in the UK, the Netherlands and Singapore. Opec estimates that about 100m barrels of distillates were stashed in tankers last month, equal to two weeks of European demand.

On land, tank farms are brimming. Royal Vopak, the world’s largest independent operator of oil storage terminals, says its facilities are 93% full. It is building new capacity from Sweden to Singapore. Kinder Morgan, the largest US independent terminal operator, is also increasing capacity in response, in part, to traders’ demand.

Commodity trading companies have also entered the storage game. Vitol, the world’s largest independent oil trader, recently bought storage facilities in the Dutch port of Antwerp and in Cushing, the delivery point for US crude futures. They have decided to have their own facilities at strategic locations in the world to secure their trading position. Oil majors such as BP are expanding storage, and banks are approaching the traders to finance storage deals in exchange for profit shares. With the price of heating oil, a distillate benchmark, for delivery a year from now 11% higher than January futures, it could make sense for financial traders to book storage.

While onshore and floating storage of distillates has been rising, the amount of crude oil stored offshore started declining earlier this year, as prices for future delivery fell closer in line with spot markets. Yet, at some point, an oversupply of distillates will clog up the market for crude refiners’ main raw material. “Given the overhang in middle distillate inventories and the slow recovery in products demand, product market circumstances are not expected  to support crude fundamentals,” Opec said in its monthly market report.

While the economic recovery and winter heating demand could burn off some of the glut, it will take more of an Ice Age rather than just seasonal weather to correct this overhang.

Iraq has the potential to be a game-changer

One of Opec’s founding members, Iraq has invited foreign oil companies back into the country to develop its vast oil reserves. The auction promises to bring Iraq’s oil production up from 2.5m barrels a day to as much as 12m barrels a day within a decade, an increase equal to Saudi Arabia’s current output. A significant portion of the oil will arrive far sooner.

Iraqi officials are already arguing that the country has a special right to pump extra oil to make up for the decades during which it pumped very little because war and sanctions decimated its industry. The International Energy Agency, the Western countries’ watchdog, has based its long-term supply and demand scenarios on Iraq pumping 6.7m barrels a day by 2030, significantly lower than what the country now believes it will pump by 2020. If Baghdad ramps up its production and no other Opec country accommodates the surge by cutting their own output, prices could drop significantly.

However, Baghdad and the international oil companies face huge political difficulties in raising output. Second, Iraq’s new output could be needed to compensate for declines elsewhere, including the North Sea or Mexico, resolving Opec’s quandary.

If Iraq ramps up its output, analysts say the blow could be especially severe to big investors, particularly pension funds, which are now buying forward-dated oil contracts above $100 a barrel, in the belief that the oil market will remain tight. But any decision to withhold new Iraq oil from the market would also be deeply unpopular among big oil companies such as Royal Dutch Shell, BP, ExxonMobil and Lukoil, which have committed to rebuilding Iraq’s oil sector for low fees.

Mexican strategy matters

Mexico’s decision to spend more than $1bn to guarantee that it will earn a minimum of $57 a barrel on all its 2010 net oil exports appears to suggest that it is pessimistic about the outlook for prices and demand next year. After all, it hedged its 2009 output at $70 a barrel—a strategy that netted it a profit of more than $5bn. That deal, struck in mid-2008 as oil rocketed towards $150 a barrel, was bravely contrarian when forecasts for a price peak of $200 a barrel were widespread. So, should its view about 2010 set alarm bells ringing among oil market analysts?

After all, the consensus is for crude oil prices to rise next year as global economic recovery strengthens. US crude prices are expected to trade at $76.85 a barrel by the end of next year, according to the latest analysts’ poll published by Consensus Economics. In the futures market, the Nymex December 2010 contract was trading above $82 a barrel, whereas the January 2010 contract (the front-month) was trading at about $73 a barrel.

Agustin Carstens, Mexico’s finance minister, has almost certainly put his job on the line in taking a more conservative view than the market consensus. But Mexico probably started to plan the deal more than six months ago when there was more uncertainty about the outlook for the global economy. Securing a price that would fit a target for government revenues would have been more important than outright profit maximisation. This does not mean that Mexico believes that oil prices will fall as low as $57 a barrel—this is only an insurance policy and the deal is all about managing risk.

Choosing a strike price of $57 a barrel will have reduced the cost of the put options (rights to sell) for Mexico. The further away the strike price is from market expectations, the cheaper the option is to buy. Further hedging is likely to take place by producers keen to take advantage of the fact that forward oil prices are currently trading substantially higher than spot oil prices. Oil producers could implement the same strategy as Mexico at almost half the cost, as premiums for put options have fallen since September 2009.

The deal is also an opportunity for investment banks such as Barclays, which acted as counterparties to Mexico. The banks can offer over-the-counter calls (rights to buy) that can be customised for client needs rather than mere standardised contracts.

Options market positioning suggests Mexico’s strategy sits comfortably within the current range of expectations. For December 2010, put options are concentrated at $60 a barrel (numbering 40,634 lots) and $40 (36,398 lots) while the bulk of call options are about $100 a barrel (currently 60,661 lots).

An oil price at $80 a barrel is clearly inconsistent with supply and demand dynamics, inventory levels and the current macroeconomic environment. But I expect:

* Risk appetite and cheap liquidity will continue to support the market

* Dollar will remain weaker and EUR/USD could reach155 in three months time

* OECD forward-demand cover will drop to 54-56 days

* Opec will not slip further on compliance or hike production at its forthcoming meeting

The glut of liquidity flowing all over the world due to ultra-loose monetary policy followed by governments could lead to renewed speculative interest in oil until it reaches a level that may lead to demand-destruction. It’s deja-vu, all over again!

Source: Financial Express
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Some things have gotta give - III

Oil prices have finally broken the $60-74 a barrel range that we have seen since the beginning of June and WTI oil is now trading at approximately $76 a barrel. The Chinese dragon is also blazing a trail under the crude oil market. After sliding to a five-year low of under $33 a barrel in December 2008, oil prices staged a steady climb upward to $82 recently, aided by Chinese stockpiling. On January 5, Zhang Xiaoqiang, deputy of China’s National Development commission, said he’s ‘actively’ involved in the global competition for crude oil, natural gas and minerals to satisfy the country’s thirst for raw materials. Beijing has $2.25 trillion in foreign currency reserves at its disposal, to invest in “infrastructure facilities in key countries which hold resource deposits and have a friendly relationship with China,” Zhang said.

A key component of Beijing’s strategy is to guarantee access to Persian Gulf oil, especially from Iran and Saudi Arabia. China is the top importer of crude oil and natural gas from Iran, and the two allies are bound by energy deals with a total value of $120 billion and growing. China and Japan have been involved in a bidding war over a major pipeline deal to deliver Russian oil from Eastern Siberia.

In Africa, Beijing has invested $8 billion in joint exploration contracts in Sudan, including the building of a 900-mile pipeline to the Red Sea, which supplies 7% of China’s oil imports. Beijing has also concluded oil and gas deals with Argentina, Brazil, Peru and Ecuador. But its main interests are focused in Venezuela, and ambitious oil deals in Canada, the fourth largest and top-most oil suppliers to the US.

Boosting autos sales has been a key ingredient of Beijing’s stimulus programme. China has overtaken the US as the world’s top buyer of automobiles, not surprising since its population of 1.3 billion persons is more than four times that of the US. Roughly 12.7 million cars and trucks were sold in China last year, up 44% from the previous year and far surpassing the 10.3 million sold in the US.

To meet its growing industrial and transportation needs, China imported 17.1 million tonnes ofcrude oil in November, up 28% from a year earlier, emerging as the world’s third largest importer after the US and Japan. But China’s demand or oil could double in the next.

10 years, according to the IEA, if its economy continues to expand at a growth rate of 10%.

It is widely believed that at some point, the growth in Asia and world demand for oil would exceed the available supply, leading to triple digits for oil prices.

On December 25, Saudi Arabia’s King Abdullah told a Kuwaiti newspaper, “Oil prices are heading towards stability. We expected at the beginning of the year an oil price between $75 and $80 per barrel and this is a fair price,” he said. The Saudi kingdom has about 2.5 million barrels per day of excess oil capacity, and could dump more oil on the market, to prevent prices from climbing above $80 a barrel.

However, speculators in the oil markets are putting Riyadh to the test, betting that the kingdom would allow a rally to $85, against the backdrop of a steadily improving V-shaped recovery in global stock markets. Abdullah hinted at this when he said, “Oil prices might rise reasonably,” keeping pace with other asset markets.

The recovery in oil prices we witnessed over the last six months can partially be explained by the cyclical recovery in the global economy. But still, it is quite obvious that the rise in energy prices has gone closely hand in hand with rising equities and a weakening of the dollar. The close relationship between oil and other asset classes has once again fuelled the old discussion about whether oil is higher because of fundamentals or because of speculation.

One way to illustrate the change in demand and demand expectations is to look at the IEA forecast for 2010. Since the first oil demand forecast for 2010 was presented in July, the forecast has been revised higher by the IEA in all the following monthly reports. Oil demand is now expected by the IEA to rise by 1.4 to 86.1 million barrels a day in 2010 after falling by 1.7 million barrels a day in 2009.

I do not think we have seen the last IEA upward revision of global oil demand for 2010 as I am more positive on the 2010 outlook relative to the IEA, which uses the more downbeat IMF economic forecasts in its baseline scenarios. We have also seen upward revisions in 2010 demand forecasts by other official bodies like Opec and the US Department of Energy

Hard data has also shown an improvement over the last couple of months. Implied demand from the US—derived from the weekly EIA data—has witnessed a clear turnaround. Implied gasoline demand has improved. The four-week moving average is now running at 4.4% YoY and total products supplied are up by 0.5% YoY.

Rebound in manufacturing could support distillates are still very weak, down by 11.5% YoY. But, all in all, we are now moving towards a situation where global oil demand is rising on a yearly rate for the first time in two years. At the same time, one should be careful not to put too much weight on 2009 data compared to 2008. The so-called base effect is very strong at the moment, as demand almost collapsed in the aftermath of the Lehman bankruptcy. If we look at the two-year change in implied demand in the US, it’s clear that demand is still well below the level seen two years ago. Distillate demand still has a long way to go before reaching 2007 levels.

Furthermore, we should not forget that US stocks are still abundant with distillates way above the five-year average, without clear signs of a decline. Gasoline stocks, on the contrary, are close to normal and crude oil has in fact shown a declining trend during the autumn. The latter is very encouraging and one of the first signs that the global glut of oil is currently being worked off.

Although distillate stocks are abundant, higher distillate prices could be expected ahead of the winter season. The heating oil crack is still very low, and is in my view quite sensitive to a recovery in manufacturing demand and perhaps a cold winter. But the market is still fighting a huge stock overhang. And that is the main reason we doubt that we will see triple-digit oil any time soon—it’s simply different from the market that pushed oil close to $150 a barrel last year. We should not forget that the cartel is now stuck with a significant 4-5 million barrels a day of spare capacity, according to the US Department of Energy. Opec puts spare capacity even higher at 6-7 million barrels a day.

It seems that Opec is ready to hike production if oil continues to drift higher. Recently, the Opec secretary-general El-Badri said that the cartel was not comfortable with oil prices returning to $100 a barrel. The secretary general has also said that the cartel would be ready to boost oil production if the global recovery is sustained.

There is little doubt that Opec production cut-backs have been a major factor behind the stabilisation in the oil market since the beginning of the year. For the first couple of months, Opec showed a remarkable compliance rate of 80%. But compliance has dropped lately. According to the IEA, it was running at a modest 62% in September, down from 66% in August. But when we compare Opec compliance over 2000-08 to the current cycle, it remains high in this historical perspective.

Opec production cuts have had the rather surprising effect of pushing residual oil higher. The crack spread for fuel oil has tightened from approximately $30 a barrel to around $10 a barrel. This is rather surprising considering that demand for fuel oil has been under strong pressure due to the 20% drop in global trade. But the combined effect of Opec cutting back mainly on heavy oil and more effective refineries has dominated the market. Tightness is expected to stay in the market for the foreseeable future, as we doubt Opec is about to put out new heavy oil.

If we had to focus on just the current stock situation and current demand, prices ought to be lower. The market, however, is forward-looking and is factoring in a tighter market which is in my view one of the main reasons why oil was able to test $80 a barrel with OECD forward demand above 60 days. This cover is expected to continue lower for the next 3-6 months towards 54-56 days, only slightly above the 52-54 days preferred by OPEC.

Source: Financial Express

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Some things have gotta give - II

The People’s Bank of China (PBoC) ordered its banks to power a V-shaped recovery through an explosion of credit—a record CNY 10 trillion ($1.5 trillion) in new loans, or double the 2008 total. Roughly a quarter of the new loans were channelled into the Shanghai red-chip stocks and property markets, designed to inflate their values.

The combined fiscal and monetary stimulus—equal to 45% of China’s GDP—spurred the juggernaut economy to an estimated 10% growth rate in the fourth quarter, up from 6% growth in the first quarter.

China’s economic growth is set to return to double digits in 2010, with booming factory activity driving its Purchasing Managers’ Index (PMI) to a reading of 56.6 in December from 55.2 in the previous month. South Korea, Asia’s fourth-largest economy, said its exports to China were 75% higher at $54.2 billion during the month of December (comparable statistics from China are awaited).

However, China’s accelerating economy is also increasing worries among some of the People’s Bank economists that the consumer price deflation experienced through most of 2009 will quickly flip to rapidly escalating inflation in 2010.

China’s voracious appetite for agricultural commodities, crude oil, base metals, and other industrial raw materials is transmitting inflationary pressures worldwide, with the epicentre located in China itself and in neighbouring India.

The PBoC finds itself far behind the ‘inflation curve’, and hasn’t yet gone beyond meaningless ‘open mouth’ operations in order to tame budding pressures lurking beneath the surface. The Dow Jones Commodity Index made a stunning U-turn last year, rebounding sharply from an annualised rate of decline of 52% in July to an annual inflation rate of 23% in December, 2009.

With key commodity prices expected to extend their advance in 2010, an outburst of escalating inflation lies on the horizon for the Chinese economy.

This could invite policy actions from the PBoC from time to time, similar to the ones witnessed recently on January 8 and 12. As and when these happen, the rally in commodity prices could get temporarily derailed.

Yet, considering the glut of liquidity all over the world, the outlook for commodity prices in 2010 is positive.

Steel

The LME steel contract was introduced in April last year. After falling off a cliff in fall 2008, prices rose more or less consistently over 2009. The price of steel stalled in October 2009 despite the fact that stocks had come down after...

peaking at the start of the year.

Indeed, a considerable slowdown in the de-stocking process is currently taking place. Since the end of 2008, inventories have been run down as production and imports for consumption alike have fallen rapidly.

Recently, world production has started to bounce back, albeit from historical lows. In light of our relatively optimistic global growth forecast (given very loose monetary policies which I believe will stay in force across the world for most of 2010), I would expect steel demand to recover soon. ISM and US steel production have co-moved closely in the past, and I forecast that ISM will reach 60 mark in early 2010—this bodes well for steel demand and could thus put upward pressure on prices.

The futures curve remains in contango but no open interest exists for contracts further out than January 2010. Slope and curvature are broadly unchanged since last year but the curve has seen a downward level shift over the past month. Overall, we see steel prices rising alongside other base metals during 2010.

With nickel and zinc being important inputs to steel production, a virtuous circle of rising prices for this set of metals cannot be ruled out.

On a wider global scale, however, one needs to remain more cautious as demand has not yet shown clear signs of recovery, and in the near term price movements will most likely depend on the amount of furnace restarts.

Copper

Construction activity in the US has started to show signs of recovery: new home sales have witnessed a turnaround and building permits have risen, albeit from historically low levels. Together with the rebound in Chinese imports, such figures may have been supportive for copper prices lately.

Copper production has risen somewhat, but in contrast with aluminium where overcapacity could become a crucial factor, falling ore grades at a range of mines implies that copper supply could surprise on the downside going forward. If global demand simultaneously picks up noticeably, this could exert some upward pressure on copper prices.

The copper market performed notably better than aluminium in 2009, boosted by relatively low inventories. Copper stocks saw a considerable draw over the summer as Chinese stockpiling gained pace. However, imports fell back somewhat in August before bouncing back in September, 2009, and China remains a net importer of the metal by a large margin.

However, one can still see copper stocks being at elevated levels, which surely does not justify the sharp rise we have seen in copper prices of late.

Chinese macroeconomic news has generally surprised on the upside recently: real GDP growth came in at 8.9% YoY in Q3, and retail sales and industrial production alike have continued to rise after bottoming out at the start of 2009.

Although the OECD Composite Leading Indicator for China remains below the 100 boom/bust level, recent data hints that the Chinese economy is gaining momentum. This, in turn, bodes well for demand for copper—and metals in general—going forward. CFTC data on non-commercial positioning in copper has turned net long lately, suggesting that bets on rising prices are now outnumbering the bets against. Again, I must reiterate that all this is happening against the backdrop of rising copper inventories, which makes things difficult to reconcile.

Source: Financial Express

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Some things have gotta give - I

Commodity prices have rebounded despite high inventories caused by weak demand during the recession. This price impetus came from a perception that the worst of the global recession was over. Rising demand from an expected global recovery will require extra capacity in many commodity sectors. Commodity prices were surprisingly buoyant in 2009, and are expected to increase further in 2010 as world activity expands after the global crisis.

The commodity rally has gone hand-in-hand with a weak dollar and an increasing risk appetite in financial markets fuelled by, among other things, better-than-expected Q3 earnings reports. Cheap and abundant liquidity has flowed into all risky assets from equities to credits and clearly into commodity markets as well.

However, it would be wrong to dismiss the rally as a pure consequence of cheap liquidity and a weakened dollar; strong fundamentals have contributed as well. The recovery in the business cycle has continued and we see more and more signs that commodities demand both within and outside the OECD area has improved.

Global recovery

Chinese growth continues to power ahead, fuelling an almost insatiable need for commodities. This is reflected in the continuously strong imports of copper into China. Indeed, positive demand revisions have continued with the IEA, EIA and OPEC alike continuing to revise their forecasts for 2010 oil demand upwards. We have thus moved from a situation with negative demand revisions last year to positive ones.

It is hard not to notice, however, that returns in the current recovery phase have been much stronger than witnessed previously in this phase of the business cycle. This commodity price rally at the early stage of the recovery in global industrial production (and ahead of global economic growth) differs dramatically from past experience. After previous global industrial downturns, prices typically continued to fall or rose at very modest rates, far below the increases recorded this year.

What explains the early rally in commodity prices? As for prices of the most risky assets, the initial impetus came from the perception that the worst of the global recession was over and that wide-ranging public interventions had succeeded in lowering uncertainty and systemic risks in the financial sector. Against this backdrop of expected improvement in near-term outlook, commodity markets benefited from increased incentives to hold inventories. At the same time, improving financial conditions provided for increased credit availability for inventory financing at more normal costs while rising inflows into commodity funds likely facilitated the hedging of inventory positions.

The additional forward-looking demand for inventories, and some stabilisation in stock build-ups as end-user demand bottomed out, allowed for easier absorption of the continued excess supply (current supply minus current end-user consumption). Downward pressure on spot prices eased as a result.

I believe the global recovery still has substantial steam left (considering there is more stimulus spending of governments to come in 2010 and beyond) and expect the all-important ISM indicator to hit the strong expansion level of 60 soon enough. However, considering the business cycle sensitivity of commodities, we should expect to see a lot of nervousness and price volatility in markets during 2010. The market is simply different now, with much more spare capacity and a significant positive output gap in the global economy, which would have to close in order to create the same degree of upside pressure on prices. Although, at times, the extra liquidity around the world would clearly overwhelm fundamentals as the chief driver of commodity prices in 2010.

Looking ahead into 2010, the prices of many commodities are likely to increase further. The demand side should generally be the main source of upward pressure, as global activity is widely expected to expand at a faster pace. Information about expected future spot prices derived from key commodity futures options confirms that investors anticipate higher prices in 2010.

Looking at commodity price prospects from a longer-term perspective highlights how prices are expected to remain high by historical standards. The effects of the crisis have been to reduce prices somewhat below their 2008 peaks, but demand is expected to continue rising at a solid pace as industrialisation continues in emerging and developing economies. Accommodating this demand will eventually require further capacity expansion in many commodity sectors, with some need to tap higher-cost sources.

China has been on the lookout for resource companies around the world to feed its voracious appetite and I expect this trend to continue in 2010. As the stimulus spending of China continues unabated, upward pressure on commodity prices is expected to continue in 2010. Small attempts to tighten monetary policy in China will have only a temporary negative effect on commodity prices.

International hedge funds are also expected to continue to invest in commodities to take advantage of the all-time low interest rates currently prevailing in the US, thus creating a nice feedback rally for commodities in 2010.

Base metals

Leading indicators suggest that base metals could rise further as global growth and demand improves. I favour copper over aluminium as the fundamental picture has deteriorated further in the latter with idle production capacity being re-started in a period of elevated stocks. Demand for base metals is likely to get a further boost as factories based in G-7 nations rebuild their inventories.

Base metals have rocketed sharply higher despite a large build-up of inventories stocked in warehouses in London and Shanghai. Aluminium inventories held at the London Metals Exchange are bulging at near record levels of 4.6 million tonnes.

Global output of aluminium is running at 38.4 million tonnes per year, exceeding demand at 35 million tonnes. Yet, aluminium futures in Shanghai rose to 17,000 yuan per tonne, up 60% from a year ago, with Chinese factory output running 19% higher.

Japanese buyers paid premiums of $30 per tonne over the spot price for longer-term contracts, after a European trading house bought over a million tonne from Russia’s Rusal, the world’s biggest aluminium producer. Investment bankers are utilising new and creative ways of lending money to base metal producers, with nearly 70% of the supply of aluminium sitting in LME warehouses tied up in such financing deals, and therefore, not available for delivery in the spot market.

Bankers are buying aluminium on the spot market and selling forward at a profit. The metal is stored in a warehouse until delivery. Bankers are financing the deals by borrowing dollars in the Libor market at 0.25%, thus creating artificial demand for aluminium. However, there’s always the risk that such quasi ‘carry trades’ could be unwound in a violent way when the Fed begins to lift Libor rates.

Still, base metals are buoyed by Chinese demand, absorbing 43% of the world’s supply last year. China imported 1.45 million tonnes of aluminium in the first 11 months of 2009, up 1,225% from the previous year, and 3 million tonnes of copper, up 136%. The cash price for iron ore doubled from its March lows, to $118 per tonne, as Chinese steel mills imported 566 million tonnes, up 38% compared with the same period last year.

The story of aluminium remains one about large LME stocks. Aluminium inventories at LME have surged during the past year and are currently running at record highs. Aluminium prices have, along with prices of other commodities, plunged since the global recession took off last year. Still, prices are up almost 25% this year. A range of countries have introduced stimulus packages to support car sales, which have helped boost demand for aluminium.

Although LME stocks have continued to build over the summer of 2009, cancelled warrants on aluminum, i.e. stocks booked for delivery have simultaneously surged. This could partly reflect the effects of Chinese imports but may also be a sign that demand is finally picking up.

On the face of it, it should not be a problem for the market to satisfy an increase in demand given record-high stocks.

However, with the market in contango and thus having an incentive to sell aluminium forward, a fair amount of stocked metal may be tied up in financing deals and thus not be accessible for instant delivery.

Lately, prices have capped some of the gains seen in 2009 and cancelled warrants have witnessed a setback. This could be a worrying sign given the bulky inventories. However, producer stocks of aluminium have simultaneously declined, albeit by less than their LME counterparts.

After plummeting in late 2008, aluminium seemed to receive some support as US durable goods orders picked up over the summer. This may partly be attributed to base effects and partly to, for example, the cash-for-clunkers programme, which likely released some pent-up demand. But sales fell back a little in September 2009, suggesting that the expansion may not prove sustainable. In addition, with China seemingly on track to become a net exporter of aluminium again, OECD demand would need to pick up swiftly in order to avoid the stock situation weighing on prices.

Source: Financial Express

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A mixed year for upstream oil and gas sector

Despite major discoveries, NELP VIII met with lukewarm response.

Pat for India

Govt received 76 bids for 36 blocks out of 70 put on offer under NELP-VIII

26 bids for eight blocks out of the 10 offered under the fourth round of Coal Bed Methane

The Petroleum Ministry maintained that the successful completion of the bids in the face of global recession was in itself a major achievement

It was a clear case of ‘you win some, you lose some' for the oil and gas exploration and production activities in the country. In 2009, the segment experienced its moment of glory with the gas flowing from what is tipped as world's largest discovery of 2002 in the East Coast, and crude oil production from the tough terrain of Barmer fields, Rajasthan.

But, this really did not result in attracting the investors to bid for the latest and most ambitious oil and gas auction round (NELP VIII). The auctions evoked a lukewarm response with only 36 of the 70 blocks offered receiving bids.

The subdued participation was attributed to the ongoing gas dispute between the Ambani brothers that has questioned the sanctity of the production sharing contract (PSC), coupled with the impact of the economic slowdown.

The Government received 76 bids for 36 blocks out of 70 put on offer under NELP-VIII and 26 bids for eight blocks out of the 10 offered under the fourth round of Coal-Bed Methane (CBM-IV). For 16 deepwater blocks, 15 shallow water blocks and three on-land blocks, no bids were received.

However, the Petroleum Ministry maintained that the successful completion of the bids in the face of global recession was in itself a major achievement. “The response of bidders when compared to similar offers elsewhere in the world was one of the best during the year,” the Ministry argued.

In the upstream exploration and production activities, production has been nearly stagnant for over a decade. During the current financial year (2009-10), the production is expected to increase significantly, oil by 11 per cent (mainly due to production from Rajasthan and the Krishna-Godavari Basin deepwater block) and gas by 53 per cent (due to natural gas production from the KG Basin deepwater block) over the previous year.

Reliance Industries Ltd (RIL) operated Krishna Godavari Basin D6 block was put on production from April 1. This is expected to nearly double the supply of natural gas from the domestic sources, which excluding D6 production is close to 70 mscmd (ONGC fields and joint venture fields) currently.

At present, the gas production from D6 is 52 mscmd, which is expected to touch 70 mscmd in January, reach 82 mscmd in March and maintain the natural gas production in the range of 82-89 mscmd up to March 2012.

Imports

Today, the country's dependence on imports of meeting its crude oil requirements is more than 70 per cent. There has been a constant rise in import of crude oil during the last five years from 95.9 million tonnes in 2004-05 to 132.8 mt (provisional) for 2008-09. Cairn India's Barmer fields, Rajasthan, which commenced production from August 29, 2009, is projected to produce 2.2 mt of crude during the current financial year.

At peak production, it is expected to produce 8.9 mt a year of crude oil during 2011-12, which will account for about 25 per cent of the total domestic crude oil production, and reduce the country's crude oil import bill by about 8 per cent, at current crude prices.

Besides, carving out more areas for exploration for offer under various rounds of NELP and CBM, several measures have been taken by companies such as ONGC to accelerate hydrocarbon exploration and production. This is a continuous process, and not just restricted to 2009.

Tax holiday

Oil India Ltd made a successful listing at domestic equity browses. But, on the policy front, the sector was still left with lot of questions unanswered. Though for NELP VIII and CBM IV the Government clarified on the issue of seven year tax holiday for commercial production of gas, it has not indicated anything for the future rounds. In fact, the delay in providing clarity on tax holiday did have an impact on investors' sentiments in NELP VIII and could do so in future rounds.

The issue of gas pricing continued to haunt the Government in 2009 as well. With an intention of bringing more transparency in the existing gas pricing regime, it is examining a uniform domestic price for natural gas, which is now sold at rates ranging from $1 to $6/mBtu, depending on the source. The Government has asked GAIL (India) to undertake a study on pooling of prices of natural gas in the country. GAIL has engaged Mercados EMI Pvt Ltd to undertake the study.

The end of 2009 saw the Government beginning hunt for a new Director General for the Directorate General of Hydrocarbons after the unceremonious exit of Mr V.K. Sibal. On October 31, it appointed Mr S.K. Srivastava as the interim head of DGH after Mr Sibal was denied extension.

Source: Hindu Business Line 

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