Today’s Blog – Thursday 24th March 2016

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Many observers on the US tight oil patch have noted the strong degree of resilience in that sector since the oil price demise of the last ~18 months.  Finance industry parties in particular have attributed a goodly part of this strength to the obtaining of significant “productivity” improvements.

Our view has been that although there have been genuine productivity gains in areas such as greater abilities to put more fracks, more accurately targeted, into horizontal wells, some part of the gains have cyclical not secular gains – particularly the procurement of cost cuts from the service sector that will not prove to be sustainable.

At a conference earlier this week, the CEO of the daddy of the oil service sector, Paul Kipsgaard of Schlumberger, made some stark points which supported this view.  It is worth quoting him at some length:

“The apparent cost reductions seen by the operators over the past 18 months are not linked to a general improvement in efficiency in the service industry. They are simply a result of service-pricing concessions as activity levels have dropped by 40-50% and most service companies are now fighting for survival with both negative earnings and cash flow. The unsustainable financial situation of the service industry together with the massive capacity reductions mean that the cost savings from lower service pricing should largely be reversed when activity levels start picking up.”

If this view is correct, then the “medium term” re-bound in oil prices that is almost universally considered as being inevitable will not necessarily be constrained at the upper end by views on tight oil cost structures derived from current practices.

Commodity prices

Crude prices fell overnight, largely in response to poor “numbers” from the EIA’s weekly report.  Both Brent and WTI were down around 3%, with the former closing at US$40.53 and the latter at US$39.83.

Views from analysts earlier in the week that US inventories would increase by around 3 mmbbls were wrong by a factor of 3 – the actual build was 9.4 mmbbls.  This was partially offset by a gasoline draw of 4.6 mmbbls (although distillate increased by 0.9 mmbbls).

News from the Middle East – it appears that none of the many Libyan Governments will be attending the upcoming OPEC/Russia meeting in Doha.  Although the country is a mess, it does have 1 mmbbls of shut-in oil production that could readily return to markets if political solutions were found.

Henry Hub fell ~4% overnight to US$1.78.  Following the very mild winter in the US, gas storage inventories are nearly 1 Tcf higher than would normally be the case at this time of year.

Low gas prices are expected to prevail until this excess inventory is cleared, which will be aided by declining production from pretty much everywhere outside the Marcellus, growing exports (by pipe and boat) and gas taking coal power generation market share.  In our view, the rebound after that could be strong (but we do note that we have been disappointed US gas price bulls before).

LNG and international gas

Yesterday’s announcement by Woodside Petroleum (WPL) of the deferment of the Browse LNG project has been the subject of a number of articles in the likes of The Australian Financial Review (AFR) today.  These have focused on political, joint venture and project design issues.

In our view the very simple reason why this project is now mothballed is that customers have not signed up to it – if they had, the other issues would have been resolvable.

Customers do however still have appetites for gas in some niches:

  • The US based Jordan Cove project has just announced that it has entered into a “preliminary” agreement with Japan’s largest LNG buyer, JERA, for 1.5 mtpa of capacity.  This supports the view that smaller parcels of gas and smaller projects are finding it easier to find homes than the mega-projects that are now coming on line.
  • News just out from Iraq of a gas pipeline from Iran to supply a power station.  Cross border pipelines are never easy – but this one could be called The Power of Shia.

Company news – Santos (STO)

STO today announced that its largest shareholder, Asian investment house, Hony Capital, had agreed to sell its ~12% interest in the company to large Chinese downstream gas company ENN.  The deal is subject to ENN shareholder approval which seems highly likely to come.

The price per share that is being paid is somewhat hard to calculate – but it is a premium to the current STO share price (why STO did not state this figure in their announcement is puzzling).

Surprisingly (to us anyway) the STO share price has not reacted positively to this news.  If a local industry player – say WPL – had emerged as a >10% STO shareholder this morning one can imagine the frenzy that would induce – but so far the market is just yawning.

This may be because this is considered to be the successful – and arguably cheap – acquisition of a blocking stake by an energy firm – a very different type of investor than Hony.  If others (e.g. last year’s STO predator, Scepter Partners) still have an interest in the company, they will need to consider their next moves differently given a fiscal investor has been replaced with a strategic one.

ENN has stated the acquisition of this STO share block is part of a strategy of gas industry vertical integration.  This statement from the company’s largest shareholder could have the effect of requiring the company to change what appears to be STO’s new CEO’s strategy: cut costs, sell non-core assets, wait for the oil price to rebound.

Readers may recall that ENN recently struck a deal with Origin Energy (ORG) to buy LNG from the latter (outside its APLNG venture).  The company clearly has an eye on Australia.

We would expect its strategy to be patient – but it is starting from a good foundation.

Company news – Beach Energy Ltd (BPT)

Demonstrating the power of patience, BPT’s largest shareholder, Seven Group, is inching up the company’s register within the allowed “creep” positions – it has just moved from ~20% to ~23%.

Quote of the day

The STO Board might want to look up the >2,000 year old writings of Sun Zhu, which includes the following piece of advice:

“When the enemy is close at hand and remains quiet, he is relying on the natural strength of his position. When he keeps aloof and tries to provoke a battle, he is anxious for the other side to advance”.

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