Bauer Jones Financial Journal

Bauer Jones Financial Journal

The Privatization of Mexico’s Energy Resources Last December, a special all-night session of the Mexican legislature passed an energy reform bill that ended the monopoly of state-owned firm Petróleos Mexicanos | Page 5

The Hazards of Shipping Oil by RailChevron Site in FlamesOxydental Petroleum Moves to Houston

Bauer Jones Financial Journal | 1

Table of ContentsHazards of Oil Shipments.......................................................................2

After major accidents and spills occur all around the nation, is it time to rethink how we ship oil by rail?

Chevron Appalachia Site in Flames.......................................................3

After burning for several days, Lenco leaves questions for operators and regulators

Engineering Leanness..............................................................................4

OXY moves its global headquarters to Houston as part of a major restructuring plan

Privatization of Mexico’s Energy Resources.........................................5

After landmark move by Mexico, foreign companies once again consider entering the region

Domestic Refiners Gain in Changing Landscape................................6

As domestic crude becomes cheaper, refiners are profiting by exporting their products


On December 30th, a large train derailed in Casselton, North Dakota. 400,000 gallons of crude oil were spilled. The Cas-selton incident was one of several train derailments in 2013. Most of the pub-licized derailments this past year have one thing in common; the major component of their cargo was oil. The Casselton in-cident, along with other remote instances, has led to a cry for stricter regu-lation of oil transport by rail. The shale boom, which began in 2008, al-most led to a serious lo-gistical problem across the US. The existing infrastruc-ture simply could not handle the volume that many shale formations were yielding. The pipelines that lead to major refining centers were, and still are, function-ing at full capacity. Oil that does not travel via pipeline has to be transported somehow and because these shale formations are all onshore, the only economic transpor-tation methods are pipeline, train, and truck. Railroads have since picked up the additional product that pipe-line companies simply cannot transport. Railroads ac-counted for the transport of roughly 1% of US oil field production in 2010, according to Association of Ameri-can Railroad. They were estimated to have carried near-ly 11% in 2013. The effects of putting 10% of US oil field production onto trucks would have resulted in exten-sive damage to infrastructure and contributed to a sig-nificant increase in automotive fatalities. With pipelines and trucks unavailable or unable to transport another several billion gallons of crude oil, railroads have rap-idly grown their market share. This is a large gain for a previously marginal player in the midstream business. This significant growth in such a short period begs the question— are railroads growing at the expense of our safety?

Even with a record year for spillage in 2013, (1.15 mil-lion gallons of oil, reports the US Pipeline and Hazard-ous Material Safety Administration) railroads lost only .01% of their oil freight. In the face of these numbers, the American Petroleum Institute claims that there is still room for improvement. API President Jack Gerard says that his group supports the manufacture of “next generation tank cars that exceed federal standards.” Mr. Gerard predicts that these rail cars will make up as much as 60% of all oil-transporting rail cars by 2015. With considerably high safety marks, railroads have proven to be an incredibly practical partner in shale development. Unlike pipelines, rail routes are rel-atively inexpensive and quick to construct. This makes them ideal for the exploration business, which is very scattered. Railroad companies are delivering oil with what some would call no statistically significant risks. There are products commonly moved by rail that can cause much more detrimental effects than crude oil.

The Hazards of Oil Shipment by Michael Scheinthal


Chevron Appalachia Site in Flames

Massive flames erupted at a natural gas well operated by Chevron Appalachia in southwestern Pennsylvania following an early morning explosion on February 11th. The site, Lanco, experienced the first explosion at the 7H well before a later fire spread to well 6H. A third well was present on-site, which for-tunately failed to catch fire despite some damage. Wells 7H and 6H continued to burn through the week as an initial crew of 50 people worked to con-trol and put out the fire. Chevron, local emergency of-ficials, and a third party contractor, Wild Well Control, fought the blaze until both burned out on February 16th. In the midst of the chaos one worker, 27-year-old Ian McKee of Cameron International, died and another was injured. Records from Pennsylvania’s De-partment of Environment Protection (DEP) show the site was first drilled during March of 2012. Located in Greene County, Pennsylvania, records also show the site had yet to produce any gas. In fact, at the time of the explosion, workers were just beginning to prepare for natural gas production. Currently, there’s no offi-cial word on whether this played a factor in the events that followed. Going forward, officials know safety precau-tions must be high. With Lanco 6H and 7H still leak-ing gas, both the Pennsylvania DEP and Wild Well Control (a Houston based contractor) built up supplies of water on-site. This was a precaution in the event of another fire occurring before the wells could be capped. As of Sunday, February 23rd officials had capped off Lanco 7H, with attempts to cap 6H still occurring as of the date of this writing. Chevron plans to assess the third on-site well for its structural integrity. Following this, Chevron also plans to send the wellheads of 6H and 7H for off-site analysis for their leaks. The total cost of these events to Chevron is cur-rently unknown, though it will have effects beyond just the one site of the fires. State records list Chevron as owning 447 active wells across the state, which sits atopof the Marcellus Shale. The Marcellus Shale is a hugedeposit of gas that runs beneath much of the state andAppalachian Basin. Since 2008, the shale has generatedmuch economic growth in the area, as well as contro-versy.

This is due to safety concerns over the hydraulicfracturing method of well completion needed to accessthe gas. Chevron officials have been quick to state that this process was not occurring at the time of the blast.Nonetheless, the explosion still affected Chevron’soperations throughout the shale, with the companydeciding to cut back operations to dedicate resourcestowards the Greene County site. Chevron has also iden-tified 27 more of their wells in the state which they con-figured like Lanco 6H and 7H. This occurred followingan assessment request from DEP officials. Many haveconcerns on the similar wells’ ability to handle highpressures following an event like February 11th. Asof February 24th, seven wells have ceased productionoutright though no additional wells have been cappedat this time.

By Julio Diaz III


Strategic reconstruction is the name of the game for upstream energy company Occidental Petro-leum (NYSE:OXY). In a multi-phase plan to increase shareholder value, OXY is streamlining assets, leaning out its balance sheet, and focusing on domestic pro-duction. The first step in this strategy is to increase stock price and shareholder value through a share buy-back program and dividend increase. On this phase CEO Steve Chazen comments, “The dividend increase reflects our commitment to growing Occidental’s dividend annually, and we will continue to make share repurchases as opportunities arise… These actions demonstrate our confidence in the Company’s finan-cial strength and future performance.” On February 13, Occidental announced the sale of midwest-asset Hugoton Field. The excess liquidity- an estimated $1.4 billion from the 1.4 million acre asset- positions Cha-zen employ cash flow in this repurchase program. With this stake in the middle United States liq-uidated, the next step for Occidental was to separate its California-based segment into a wholly independent, publicly traded company. This new California compa-ny has the largest production of gas and oil equivalent units in the state and holds more oil and gas and min-eral assets than any other entity in the state with 2.3 million acres. In tandem with OXY’s restructuring, and in light of this segments strong performance in 2013, Occidental’s capital expenditures in California assets are expected to rise to $2.1 billion from last year’s 1.7 billion. In accordance with the OXY’s track-record (and the low-interest economic environment), this growth will be aggressively funded by debt, expanding the balance sheet to as large as $5 billion in 2014. Although these western assets have proven

profitable, OXY seeks to separate the high-cost pro-duction environment resulting from California’s political climate. With the Occidentals southern assets isolated; the lean, new OXY will be primarily invested in its most attractive asset, Texas. Developing the south Texas fields of Vicksburg, Frio, Wilcox, and Eagle Ford will fuel future growth for Occidental, while OXY’s profitability will come from West-Texas’ Permian Basin. With the developed infrastructure and competi-tive environment that now exists in the region, drill-ing costs declined by 24% and operating costs by 17% last year, driving up margins and increasing returns. Higher demand coupled with these decreased costs has further improved margins for the company moving forward. The new Oxy will also seek to capitalize on Texas’s tax incentives as it plans to relocate its head-quarters to Houston. The move to the “energy capital” offers many other benefits for Occidental as well. The increased proximity and decreased transportation cost to wholly owned mid-and-down-stream subsidiary OxyChem in Dallas, will cut costs further. On top of these tangible benefits, the human capital in Houston will add more value to the company as the best and brightest in the world continue to flock to the oil and gas Mecca. Occidental will continue its South American and Middle Eastern exploration and production from the new corporate headquarters in Houston; however, their stakes in the middle-east may also be for sale in the future. These sales would increase liquidity by as much as $20 billion, and could further fund OXY’s dedication to increase shareholder value through re-purchases, dividend growth, and capital gains.

Engineering Leanness by Jack Reader


Privatization of Mexico’s Energy Resources

Last December, a special all-night session of the Mexican legislature passed an energy reform bill that ended the monopoly of state-owned firm Petróleos Mexicanos (PEMEX) over the Mexican hydrocarbon industry. Although publicly-owned petroleum ventures have succeeded in other countries, nine years of falling profits at PEMEX have forced Mexico to open the mar-ket to private competition. PEMEX’s failure can be attributed to govern-ment mismanagement. Since 1938, when Mexico leg-islated the state-ownership of all oil and gas resources, the company has been treated as an exploitable source of revenue rather than as an autonomous corporate en-tity aiming for profitability. With PEMEX’s profits taxed at 90%, there is little money for innovation or reinvest-ment into the company’s future; in fact, the firm is over

30 billion dollars in debt, since there is little money to sustain operations. Furthermore, endemic corruption in Mexico has further retarded growth. In addition to privatization, the bill seeks to correct some issues with-in PEMEX itself as well. The 5 members of PEMEX’s board that come from the corrupt oil workers’ union have been removed, reducing the board to 10 members. The introduction of private companies could prove revolutionary for the Mexican oil and gas indus-try. Unlike PEMEX, these entities have the capital and expertise to access hard-to-reach oil with techniques such as shale fracking and deep water drilling. With only 5 shale gas wells in the country today, Mexico’s sig-nificant natural gas reserves (4th in the world as esti-mated by the US Energy Dept.), are being overlooked in favor of shallow basin wells, since PEMEX does not

have the capital required to invest in these proj-ects. This is critical given that the more easily accessible deposits, such as those in the Yucatan basin, have already been accessed and extracted. For example, the supergiant Cantarell field hit its peak in 2003, dropping from 2.1 million barrels per day to four hundred thousand barrels per day in late 2013. Enrique Ochoa Reza, the Mexican energy ministry’s undersecretary of hydrocar-bons, acknowledged the declining production. “Oil production had been declining. Gas pro-duction had been declining as well. We used to be self-sufficient in natural gas, and now we’re importing a third of our consumption from the U.S. We are importing 50 percent of gasoline in Mexico”, said Reza. With a scant two months since the bill was passed, planning is already underway for imple-mentation and investment, with late 2015 to be the conservative estimate on when bidding can begin. While PEMEX will retain right of first re-fusal, the legislation allows for both profit and production-sharing contracts, as well as oil li-censes. In fact, the wording of the bill even allows for some legal discussion on the possibility of oil concessions, the most liberal contract that can be awarded to private corporations.

This article is continued on Page 6.

By Ajinkya Patwardhan

Picture taken from www.ogj.com, Beyond US Border, Mexico primes shale potential


Domestic Refiners Gain in Changing Landscape

The energy landscape in the United States in the 1970s was characterized by great insecurity in the supply chain for crude oil. In this environment, Con-gress passed several pieces of legislation to preserve crude oil supplies: one was a severe restriction on the export of domestically produced crude. In the pres-ent day, the energy landscape is significantly different. Imports of crude oil have dropped while domestic pro-duction has grown, thanks to access to large reserves in the country’s many shale fields. This changing land-scape has caused many policy makers to examine the policy of crude oil export restriction and their effects on the industry. One concern held by opponents of crude ex-port restrictions is that the recent surge in domestic oil production has led to a supply glut of crude oil in the US market. This glut has caused a divergence to de-velop between American crude oil prices, linked to the WTI benchmark, and international prices, linked to the Brent benchmark. The WTI-Brent spread has been increasing since the third quarter of 2013, demonstrat-ing the effect of the domestic supply glut. The oppo-nents contend that this supply glut will decrease prices of domestically produced oil and dissuade further exploration and production in the United States. Unlike the market for crude oil, no such export restriction exists on refined petroleum products and because of this, markets for these products generally track the Brent benchmark. This relationship has creat-ed an arbitrage opportunity for domestic refiners, who can purchase cheaper crude on the American Market, refine it, and sell those refined petroleum products in global markets. As the cost of domestic crude has decreased, the refining margins of domestic refiners have increased. A prime example of such a beneficiary is Valero Energy Corp., a major U.S. refiner. In their third quarter 2013 filing, the management discussion and analysis states that “we [Valero] benefit when we process crude oils that are priced at a discount to Brent Crude Oil… for the fourth quarter of 2013, discounts on light sweet and sour crude oils have widened to date compared to the third quarter, and we expect this trend to continue…”. The stock prices of Valero and other major refiners have reflected this changing land-scape and have increased significantly relative to those in other areas of the energy industry in recent months.

Not surprisingly, many refiners are ardent supporters of Crude export restriction. They argue that refining crude oil domestically has created capital investment and jobs in America, and the removal of crude export restrictions will eliminate some of these benefits and transfer them to foreign countries.

Privitization of Mexico’s Energy Resources Cont. With 10.3 billion barrels in proven reserves, opening the Mexican oil and gas industry to private interests allows for the capital and technology required to access difficult oil such as the Chicontepec field. With estimates rating the field at containing 139 bil-lion barrels of oil, Chicontepec represents the future of the Mexican hydrocarbon industry; however, PEMEX doesn’t have the capital required to commit to the project. With an estimated 13,500 wells needing drill-ing to properly access the field’s potential, the hope is that giants such as Exxon and Shell can pick up where PEMEX could not. With a 1 million barrels per day loss in out-put over the last 10 years, some of the highest energy prices in the world, and the possibility of becoming a net importer if production isn’t improved, the Mexi-can government is focusing on improving their energy policy. This new legislation is a step in that direction, but with a conservative 3 year estimate until significant private capital can begin to invest in Mexican oil and gas, time will tell whether this new direction is the cor-rect one.As Reza conceded, “There are indications benefits won’t accrue for 3-5 years, yet the government went ahead anyway because it felt it was necessary. These reforms, while impressive, won’t do the entire job...”

By Jason Mishaw


The Investment Banking Scholars Club would like to thank the C.T. Bauer College of Business for supporting our mission to enrich our fellow students’ knowledge of investment banking and the financial world that surrounds us. IBSC would also like to thank the University Advisory Board and sponsors

for their continued support.

Thank You!

Documents

Bauer Jones Financial Journal