Today’s Blog – Thursday 16th June 2016

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Editorial

Our promise to dig a little deeper into BP’s annual review of world energy has been delayed a bit this week due to other commitments.  The key item that we (and others) have drawn from this year’s report is the deteriorating competitive position of coal, which saw an unprecedented ~2% decline in consumption in 2015.

China’s slowing economy (which had a total energy demand growth of only 1.5% last year) would have struck many as the primary cause for coal’s weakness.  In fact, by far the largest contributor was falling coal demand in the US.

The US’s large and flexible energy market(s) – and a large electricity generation fleet which can switch fuels – provided a substantial opportunity for cheap gas to directly out compete coal – and that is what happened.  Elsewhere in the world, gas is not as cheap, markets are not as liberal and generation kit is not as flexible.  So in the short term anyway this was pretty much an American phenomenon.

If we are correct in our persistent view that US gas prices will rise (and they have already done so from a low base in the last month), then coal could rapidly re-capture market and 2015’s losses could be reversed.

A “golden age of gas” has oft been proclaimed (and we like many of our Australian readers are personally invested in this in some shape or form such as investments and employment) – but has never really delivered to date.  The events in 2015 appear to be encouraging to this thesis, but if we are correct in our analysis above, the foundation’s for gas’s strong performance last year are not that solid.

Commodity prices

Crude prices continued to fall overnight – for a 5th straight day in a row.  Brent was down ~2% to US$48.66 whilst WTI fell a similar quantum to US$47.49.

The weekly EIA inventory report was a bit lack-lustre – crude was down only 0.9 mmbbls, gasoline was down a handy 2.6 mmbbls but distillate was up 0.8 mmbbls.

We think that the market is struggling to find direction at the US$50 level – with conflicting data moving things one way and another round this current pricing point.  The following quote captured this zeitgeist well:

“It’s ‘reverse Goldilocks’ – it’s not hot enough and it’s not cold enough.  If you’re bearish, it’s not low enough for the bears and it’s not high enough for the bulls.  Ergo, ($50) is the one number you don’t stick at.” – Paul Hornsell, head of commodities research at Standard Chartered

Henry Hub was flat overnight at US$2.60.

LNG and international gas

Shell’s CEO, Ben van Beurden, is due to meet with senior Russian Government and business officials in Moscow today (possibly including the current Tsar, Mr Putin, himself).  On the agenda is a possible partnership that Gazprom is pushing – to develop liquefaction facilities near St Petersburgh in order to export gas to Russian Baltic enclave Kaliningrad – and other markets in Europe.

We presume Mr BvB will desperately try to avoid a firm commitment to any such obviously political rather than commercial proposal – maybe he can get away with signing a MOU before the “Nostroiva!” starts.

Gazprom would love to add a Western LNG export arm to its current Eastern Sakhalin operations and on the margin such a project would add greatly to its trading operations – but at a very high cost.

Company news – Exxon (XOM) and BHP

Yesterday we noted media reports about the above selling down their Bass Strait assets offshore Victoria – when, somewhat bizarrely, Schlumberger was quoted talking about a previously unheralded sales process.

The companies themselves have now gone public, saying they will explore the divestment of late life oil assets (whilst keeping gas assets/infrastructure).  To date no public disclosure about any advisers to the sale process has leaked out and the whole disclosure looks a bit botched.

Various numbers have been bandied about in the media as to the worth of these 19,000 boepd assets – from the hundreds of millions to the billions of dollars.

We think the sale of assets that are nearly 50 years old will come with very substantial and complex abandonment issues (and hence Government involvement in their sale).  Therefore the net sale price could be much lower than estimated above – and the parties who might be interested and qualify as potential buyers might be quite limited.

There are also no doubt some complex taxation issues – involving Australia’s petroleum resource rent tax – which could be driving the divestment strategy.  This is an opaque area to say the least.

A partnership between a nimble operator and a well financed (e.g. Japanese?) non-operator would be a logical purchasing combination.  And if I was the Government I would keep the extremely well financed vendors on the clean-up hook.

Company news – Oil Search (OSH) and InterOil

InterOil’s AGM yesterday passed all the resolutions put to it – but by margins less than some observers expected.  This puts more pressure on OSH’s takeover offer to InterOil’s shareholders – which requires a 2/3 affirmative vote (but without being an expert on Yukon corporate law – the company’s jurisdiction – no doubt there could be some hostile options open to OSH).

We think this deal will still go through – the price is full, the strategy compelling and the alternatives few.  The extent of the negative votes at the AGM could well have reflected a zero cost complaint against the ridiculous CEO remuneration at InterOil rather than anything more fundamental.

Quote of the day

Rosneft’s Igor Sechin, echoing the views of the IEA – and finding his porridge to be “just right”:

“The market is reaching its balance quicker than analysts had predicted.”

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