This year has seen US land drilling activities fall to the lowest levels on record. Globally we are seeing a very nuanced and regional reaction to the current oil price downturn. Examination of the global land rig fleet (which Douglas-Westwood tracks on a rig-by-rig basis) reveals some key themes.
Having dominated the global land drilling market for living memory, the number of US rigs drilling has been eclipsed by activity in other regions. In terms of absolute rigs working, Eastern Europe and the Former Soviet Union now occupies the top spot.
In terms of rate of growth (or otherwise) there are other bright spots of activity. Activity in the Middle East has remained robust and a 2% growth is expected in 2016. This compares to a 49% decline this year in the US. The comparative robustness of NOC spend is also evident in the rig data. We see that current NOC operators are responsible for 34% of the identified fleet vs 31% a year previously.
Like the operators, rig contractors themselves are focused on free cash flow. Efficiency of operations and uptime are critical, and key rig components are being recycled from one rig to another to minimize spend on new hardware. Where new rig components are required, our clients are reporting a trend towards increasing adoption of Chinese-manufactured parts. Efficiency and safe operations are also boosted by the continued uptake in automated rig equipment.
Older and less efficient rigs are being scrapped. Our data suggests that 16% of the North American fleet has been scrapped since January 2015.
Whilst we do not expect activity levels to return to the highs of 2014 anytime this decade, we do anticipate recovery from the present levels (just over 3,400 rigs) at a compound rate of 8% to reach over 4,700 by 2020.
Michael Green, Douglas-Westwood London
Canadian Differentials Remain Strong Post-WildfiresCanadian oil sands supplies partially recovered in June, with production volumes approaching normal in early July. Canadian, Bakken and Rockies differentials remained strong, supported by the reduced supplies. A small Cushing crude stock draw in June will be followed by another small draw in July.
Gazprom is offering Ukraine’s Naftogaz somewhat lower gas prices than European suppliers for the third quarter, the head of the Ukraine's national oil and gas company Naftogaz has said. "The price offered by Gazprom is somewhat lower as of today than the one offered by European suppliers, though the market is very volatile and the price on the European market has started to lower," Andriy Kobolyev told reporters. Gas supplies from Europe are sufficient to provide Ukraine with reserves for the winter season.
Warmer weather so far during July has added 2 GWs of demand in Italy, with the week starting also with extra cooling needs of roughly 4 GWs. Day-ahead prices have, however, been generally in line with expectations so far in July, with maximum hourly prices also under check, most likely as thermal demand is being undermined by a weaker economy, generally healthy hydro levels, and more favorable gas pricing.
Coal pricing was mixed last week, although the fact that the market was able to hold onto sizeable gains posted in the prior week despite weaker oil prices illustrates that the market has found a vein of structural strength. Interestingly, deferred pricing for API#2 (Northwest Europe) and API#4 (South Africa) strengthened relative to the prompt, while the opposite was true of FOB Newcastle (Australia). PIRA continues to assert that 2017 prices are undervalued, although we are doubtful that prices can maintain the recent run in pricing. While China's thermal coal imports have turned positive year-on-year, India's imports remain notably below prior-year levels and do not look poised to emerge any time soon, particularly during the monsoon season.
The U.S. EPA finalized designations for the 2010 SO2 NAAQS, classifying 61 areas, compared to 66 areas from February’s proposal. The five areas where EPA has backed off for now (no final action is being taken) include four in Texas and one in Oklahoma — all of which had been targeted in February’s proposal (contrary to those states’ own recommendations). EPA’s final four non-attainment regions include areas with coal plants in Illinois, Maryland and Michigan. All but one of EPA’s finalized designations for Texas agree with state recommendations, bearish for longer-term gas demand and power prices in ERCOT, though Regional Haze regs still await the outcome of legal challenges.
With pollination in full swing for many, weather forecasts offer something for both the bull and the bear. Expected hot temperatures this week will be somewhat offset by additional precipitation for almost everyone in the Eastern Belt. Those west of the Mississippi River are forecast to receive even more rain on top of last weeks’ very impressive totals.
Production was over 1 MMB/D for the third time in four weeks. Corn prices tumbled after bearish USDA reports, boosting manufacturing margins. 2016-D6 RIN prices soar.
PIRA’s analysis of resource control policies around the world suggests a marked trend towards more investor-friendly policies in the upstream oil sector. Most notably, Saudi Arabia, Russia, and Nigeria all announced plans to sell stakes in state-owned upstream operators, and improved contractual terms could soon materialize in major producers, including Iran, the UAE, and Venezuela. The moves are being partially offset by prohibitive tax increases in some countries, in an attempt to support government revenues. But if prices remain below the levels of the past decade, as PIRA forecasts, we would not be surprised to see more widespread implementation of policies favorable for foreign or private investment.
This week’s economic developments highlighted the global economy’s resiliency as well as its potential vulnerabilities. The U.S. jobs data for June were constructive: they showed healthy gains in payrolls, but did not point to overheating in the labor market. The latest data on Chinese foreign exchange reserves were also positive for the outlook. At the same time, the U.S. dollar continued to strengthen, a fallout from the Brexit decision two weeks ago. In addition, the European banking sector remained under pressure.
Crude stocks drew just 320 MB/D this past week, about one third the level PIRA expected. We believe floating stocks in the Gulf of Mexico were reduced to support the high import level. With floating stocks now likely more normal, PIRA expects July imports to reflect FOB cargo loadings, which imply lower than June imports and larger stock declines. For next week, we have crude stocks falling 620 MB/D with imports at 7.85 MMB/D.
The prospects for heavy summer cooling loads should favor a market “buying the dips,” despite prices retracing last week’s gains. Indeed, a sea change in sentiment has been on display as of late, whereby expectations for expanding cooling degree days (CDDs) have positively colored speculative positioning and price. Certainly, the latest snapshot of open interest in NYMEX/ICE futures encapsulates the shifting environment, which has seen Henry Hub (HH) prices rally ~30% month-on-month. Most notably, the long-to-short ratio between non-commercial longs and shorts continues to push deeper into new high ground, rising to ~1.1, the highest level since 2014.
In recent months, several utility-scale solar PV projects have been announced at ultra-low prices, raising questions about downside risk to natural gas and other power sources. As a result, PIRA recently raised its 2025 U.S. solar generation outlook 41% above the previous outlook from fall 2015. However, PIRA does not see substantial downward medium-term flexibility for U.S. utility-scale solar PPA prices below current subsidized levels, assuming a link to fundamental economics. Nevertheless, in regions with strong insolation and meaningful incentive mechanisms, solar will continue to pressure other power sources as it continues to grow from its small base.
California carbon prices were up in June vs. May, but remained below the auction floor. Declines in open interest suggest that market players are not switching to the secondary market for procurement, but rather refraining from taking new positions altogether. There is little incentive to purchase allowances at the August auction. Re-offering of unsold consigned allowances raises the auction quantity and will require a higher bidding volume to clear. PIRA does see pricing once again exceeding the auction reserve this year. Cap-and-trade regulatory amendments will be released July 12th, addressing post-2020 caps and allocations, linkages and also unsold allowances.
Inventories build by 390 thousand barrels the week ending July 1. PADD V received approximately 2.9 million gallons of imported ethanol from Brazil, only the second week this year in which imports were reported.
The 2016/2017 corn and soybean acreage numbers have turned into “knowns” for the July WASDE, but higher-than-expected old crop corn and soybean supplies in the Quarterly Stocks report just a few days ago may have more than a few scratching their heads at the World Board. Add to the mix these extremely fragile markets, and Tuesday’s outcome is far from a certainty in PIRA’s opinion.
Financial stress continues to lessen post-Brexit. On the week, the S&P 500 flirted with record highs, while volatility declined and emerging market debt prices rose sharply. The dollar retains a mixed upward bias. It has continued to strengthen against the British pound and some of the Eastern European currencies. However, it has weakened against a host of Asian currencies.
Crude runs rose on the week as maintenance continues winding down. Crude imports moved higher by 0.9 MMB/D and crude stocks built 1.5 MMBbls. Finished product stocks built 1.1 MMBbls, with increases in all the products other than gasoline. Gasoline demand was relatively strong and stocks drew, while gasoil posted a significant stock build on lower yield and exports. Refining margins have remained soft with little barrel support other than fuel oil and naphtha.
Even with send-outs sputtering into the N.W. European market during the shoulder months of the late second and early third quarters, the need for access to the liquid pricing hubs at the Dutch Title Transfer facility (TTF) U.K. NBP has never been more pronounced. The Atlantic Basin market stands poised to absorb some 90-bcm/yr. of new supplies by 2020 (not including Yamal), and sellers are extremely active in securing a portion of this total.
The horizontal oil rig count reached a trough in mid-May. Despite this, shale production is not expected to immediately return to growth. PIRA expects the rig count to continue increasing at a gradual pace for the balance of the year and beyond. An estimated 400 horizontal oil rigs are currently needed to maintain production, which is 128 rigs higher than the current count of 272. Production is expected to shift to growth by 2Q17. On an annual basis, PIRA expects shale crude and condensate production to decline 330 MB/D in 2016 and 60 MB/D in 2017. This represents a 70 MB/D upward revision in 2017 versus our June Reference Case.
After gas demand in the U.K. finally grew last year for the first time since 2010, many hailed it as a case when demand finally bottomed out. Gas burn is now getting strong support in the U.K. in the form of a £18.08/ton carbon floor and coal-fired power stations are getting shut down. Future growth prospects hang on power sector growth, but the upside appears to be limited, particularly from the perspective of National Grid.
Mont Belvieu propane prices narrowly beat out broader energy markets by declining 5.7% on the week to settle near 50¢/gal (August). Butane futures fell in line with WTI (-7.3%) while ethane prices dropped nearly two cents to 21¢, the lowest level since May.
The overall global equity market was unchanged for the week, with U.S. market gains offsetting weakness elsewhere. Gains in the U.S. market were broad based across most of the tracking sectors, except energy. Housing, retail, and consumer discretionary were the strongest performers. Internationally, the performance was mixed and tended to be weaker. Asia and Europe both displayed aggregated declines on the week of 1.2-1.5%.
Oil prices fell $3.70/Bbl this past week with time spreads getting crushed on both sides of the Atlantic. There was not a specific story to point to but just a host of negative news. PIRA's outlook for the week ahead is that the market will continue to be range bound and should therefore find support within a couple of dollars from here.
In June 2006, PIRA put forward a simple model to approximate the method used by some major oil companies to evaluate long-term investment projects. We have updated the results and not surprisingly prices are a lot lower.
The information above is part of PIRA Energy Group's weekly Energy Market Recap - which alerts readers to PIRA’s current analysis of energy markets around the world as well as the key economic and political factors driving those markets.
Reducing drilling and development spend has largely been the focus of services and equipment providers in the Gulf of Mexico – with the aim of lowering costs at the most capital intensive period of asset lifecycles. Often overlooked, Opex costs have grown in line with other upstream costs – 7% CAGR from 2010 to 2014 in the Gulf of Mexico. The North American offshore market has some of the highest overall MMO costs per barrel – more than twice the global average.
Historically, offshore Opex has been largely ignored as a critical driver of deepwater project economics, yet this is beginning to change. The current rate of growth combined with the overall operational cost in the Gulf of Mexico is not sustainable. Operators are deferring and cancelling many historically routine operational objectives as long as they stay within safety and regulatory guidelines. Budgets for maintenance and modification projects are now being revisited and contractors will feel the impact. Within our offshore support sector clients, many firms typically point to the large proportion of revenue that is production-linked, implying that this insulates from the effect of oil price cycles. Whilst this may be true up to a point, the effect of the current prolonged downturn clearly reaches far further than exploration and development activities.
Mergers and acquisitions are likely to be a result of this operational spending compression, but there are still many efficiencies to be shaken out. Practices such as consolidating projects and optimising contracting processes are already producing results in many cases. With breakeven economics at $70 per barrel or higher at some Gulf of Mexico prospects, recognition of operational costs and streamlining the value chain can no longer be overlooked.
Andrew Meyers, Douglas-Westwood Houston
Laden by corruption scandals and falling oil prices, Petrobras is struggling to repay $130 billion (bn) worth of debt – nearly $24bn will mature by 2017. Efforts to sell non-core assets (pipelines, powerplants, bonds etc.) have been slow going and any attempt to divest upstream operations impeded by red tape. Mandatory operatorship (30%) for Petrobras in the pre-salt basin not only limits the company’s options for raising cash from existing upstream assets but also increases the NOC’s capital outlay. Foreign investment in upstream operations has been made less appealing due to Brazil’s unitization rules, which can make outside operators susceptible to additional financial risks.
Offshore Brazil was once known as a “safe haven” for oil field service companies, yet almost half of all indigenous companies are now facing insolvency issues according to KPMG (e.g. Queiroz Galvao, OGX). Macro-economic factors, inefficiencies (low quality of goods and services, failure to fulfil contract deadlines etc.) and stringent local content rules have created a number of obstacles to growth in the sector.
However, despite these challenges, new opportunities may emerge as the national government and Petrobras re-think the O&G industry’s growth strategy. In early 2016, the government launched the ‘PEDEFOR’ program – relaxing local content rulings and incorporating new financial incentives for foreign companies. The response from industry participants has been largely positive – with Aker Solutions opening another subsea manufacturing center in April 2016.
As Petrobras puts upstream assets (Bauna, Golfinho and Tartaruga fields) into the market, it appears further amendments to pre-salt requirements and licensing methods may take place. If implemented, these changes could lead to another wave of foreign investment. Drawing parallels to the mooted IPO of Saudi Aramco, NOCs are beginning to reevaluate their relationship with both national governments and foreign E&P investors. In the current price environment, experimenting with various options and methods of collaboration is likely to be the most sensible approach to dealing with the challenges of today’s oil & gas market.
Chen Wei, Douglas-Westwood Singapore
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