Oil and gas july issue (1)

Oil & Gas Issue (1) 07-2016Briefing

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Orient Oil and Gas

Orient Research Centre - Washington, D.C

Issue (1) 07-2016

Briefing


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Erdogan Makes himself Relevant Again

Following Erdogan’s apology to Moscow for shooting a Russian plane last year “by mistake”, Russia is reviving the shelved Turkish Stream Pipeline (TSP) project. And following signing a deal to end their rift, Israel is looking once more at Turkey as a potential rout to its natural gas trove in the East Mediterranean.

On June 27, Gazprom said it is ready to resume talks with Ankara on the construction of the Turkish Stream gas pipeline after Russia received the Turkish apology In 2014, Gazprom and Turkey’s Botas signed a memorandum of understanding for the construction of Turkish Stream. However, Moscow suspended negotiations on the project as part of other sanctions in response to Turkey’s shooting down of a Russian jet in Syria on November 24, 2015.In the case of Israel, Turkey restored its ties with the Netanyahu government without receiving the apology it always demanded for Israel’s attack of the Marmara ship carrying aid to Gaza.But moving to a dialogue on a possible rout for East Mediterranean to Europe through Turkey will not be easy.

In a parallel track, talks between Cyprus and Turkey allied Northern Cyprus are advancing, which would allow the plan to build a pipeline to Turkey to go forward.A pipeline to Turkey would be very risky.It is an economic question. If it can be financed and institutions feel secure they would get their mon-ey back with profits, then the project will go forward.However, due to global strategic considerations, the gas pipeline between Israel and Turkey will most probably go ahead fast.

Erdogan succeeded in opening a win-win bidding game between the West, which is enthusiast to develop the “Israeli Option” in order to reduce Europe’s dependence on Russian natural gas, and Moscow, which would like to keep its control over the European markets.The Leviathan partners started talks with European companies operating in Turkey.Strategy is the key to understand the rapid tempo of the Russian-Israeli race. Furthermore, ISIS activ-ity in northern Iraq prevents the import of gas through the region, the gas flow from Russia through Ukraine is inconsistent, and the Tran-Anatolian gas pipeline (TANAP) through Azerbaijan – scheduled to open by 2018 – will now only be ready at the end of that year. The “Egyptian Option”, from the point of view of the Israelis, has lost its appeal. Egypt is no longer an attractive destination for a number of reasons: in the past year oil and gas prices have fallen rapidly, making exports to an Egyptian LNG facility (which will then export the gas to Eu-rope) economically unsound; Egypt itself has discovered new gas reservoirs; and the price of natural gas in the country has risen, attracting international interest. If those reasons weren’t enough, Shell acquired BG – and it’s difficult to imagine the company would want to engage with Israel for such a large transaction.

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Iran-Russia: South Caucasus is the Birth Place of the Coming Game

Following lifting a good part of the international sanctions, Iran is becoming an active player in the South Caucasus, taking steps towards greater involvement in the region. Russia is not objecting, and even appears to be supporting these initiatives.Iran is also involved in another initiative with Russia, Armenia and Georgia. The four countries have agreed to build the North-South Energy Corridor, linking them to a unified electric grid.

Iran and Russia have been deepening their economic ties with all South Caucasus countries, securing reliable transit corridors while keeping other foreign competitors out of the picture. Iran has sought deeper energy cooperation with the South Caucasus for years. Under the terms of the 2013 agreement between Russian and Armenia, Gazprom has a monopoly on gas supply to the country. The Russian gas giant, who already owned 80 percent of Armenia’s main gas company, bought the remaining 20 percent of its shares.

Last March 2016, the Armenian government awarded a license to an Iranian company, Sanergy, to build a gas distribution network in the towns of Megri and Agarak, close to the border with Iran. Iran, Russia, Armenia and Georgia agreed to build the North-South Energy Corridor last April.Iran is now once again promoting itself as a transit option, and Russia supports this idea. For Iran and Russia, the South Caucasus region is important as a transit corridor that connects North and South, as well as East and West.

What is evident now is that Iran and Moscow have boosted efforts to foster not only political but also economic ties. They have been seeking to increase their influence in the region, leaving other exter-nal players with fewer chances for involvement.

Iran’s Oil Production is Losing Steam

A big portion of the fall in oil prices last year was driven by concerns over the rising production levels of Iran after the sanctions disappeared due to the Iranian nuclear deal.Iranian oil production has rebounded much faster than many analysts ever anticipated. At this point, Iran is roughly back to pre-sanctions production

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levels. Score one against analysts who expected the process to take years.The result is that there's probably very little additional crude that's going to come online from Iran. The country already is pumping as fast as it can, and frankly its post-sanctions export program has been at best minimally successful. Again, this is a ding on conventional wisdom that suggests Iran's production would have a significant impact on the market share of other major oil producers. This is probably a large part of what has driven Saudi Oil Minister that the glut is over. The slowing production from Iran is already hitting OPEC's crude production along with outages and issues in other OPEC nations. OPEC production declined marginally in May and may have done so again for June.

Fundamentally, though, Iran has other problems when it comes to production. Purchases by Europe as still far below where they were on a pre-sanctions basis. Italy, once Iran's best customer in Europe, took more than five months to accept its first Iranian oil tanker shipment, while purchases by Spain and Greece also remain far below pre-sanction levels.Instead, Iranian crude is mostly being sold to Asian countries - China, India, Japan and South Korea. The problem for Iran is that those customers are generally going to be more frugal and probably drive a harder bargain than corporate buyers in Europe. Overall, the takeaway for oil investors is that the Iranian threat is probably overdone. There's no in-dication that Iran has the capacity to keep ramping up production, and with oil prices as low as they are, the country would probably have to give ground; it can't afford to cede on price in order to take market share away from existing incumbents.

Brexit as an Additional Threat to Oil Prices

While the media & world focus on the fallout from Brexit, there is a more ominous challenge emerging concerning oil, as Chinese refineries are flooding the market with refined products like gasoline and diesel fuel, which is resulting in pressure on profits in the region.

The reason for the practice is primarily the glut as a result of reaching inventory capacity and a lack of infrastructure to move the oil.Brent and U.S. crude have been under pressure over the last several days, with Brent falling below $48 per barrel and WTI dropping below $47 in Monday morning trading. This has been partially from a knee-jerk reaction to Brexit, but also from concerns over Chinese demand, ongoing oversupplying of the market, supply from outages returning to the market, and concerns over a weakening global economy. In fact, Brexit is probably the least of oil's concern going forward.

Oil will continue to be volatile in light of Brexit, because it's going to take the market time to absorb

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what is happening, and to understand the limited effect a possible drop in consumption in the UK would have on demand.With Asia being the primary growth vehicle of oil, that will continue to be the key region to watch as to events there will have an impact on supply and demand.

Brexit on the other hand, will only have a temporary impact on the oil market, with not a lot of down-side left in it. Yet, the impact of Brexit would be felt indirectly as it may cause a slowdown in global economy and even trigger a recession that is waiting to happen. Refined products from China flood-ing the market is of much more concern for the potential consequences on prices in the short term.Contrary to a number of erroneous assertions, oil has already been re-balanced, the truth is closer to what U.S. Energy Information Administration administrator said recently that the market is still pro-ducing about 500,000 barrels a day above demand.

OPEC has also increased production, even as shale production in the U.S. has started to decline fur-ther, albeit at a slower pace than the market had been looking for. At the same time, low-cost U.S. shale producers are adding more production in the belief the worst is over for oil.In the short term supply will continue to exceed the pace of demand, but heading into 2017 that has the potential to change. Along with concerns over the flooding of the market with refined petroleum products from China, there are concerns over the effect the slowing global economy will have on oil demand.

Western economies are already overdue for a recession, and it is inevitable that it will come in the near future. Bexit may only be the trigger. The added supply could easily once again overwhelm de-mand once that happens.What is also important is Chinese refiners, supply from outages coming back to market, and the up-coming recession which will slow down demand at a time when supply is being added to the market in anticipation of growing demand.This is setting oil up for downward pressure in the short and long term, and brings into question the rebalancing narrative many in the oil market are considering a foregone conclusion.

Abu Dhabi to Build a Giant Energy Entity

Abu Dhabi’s proposed merger of two of its largest sovereign investment funds would create a global energy business that produces more oil than OPEC member Libya and with more assets than ConocoPhillips. The Persian Gulf emirate with about 6 percent of the world’s crude reserves will combine Mubadala Development Co. and

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International Petroleum Investment Co. to cut costs and boost efficiency, the state news agency WAM reported Wednesday.Like other oil producers in the region, Abu Dhabi is struggling to maintain state spending after crude prices fell by half since 2014. A union of Mubadala with IPIC would create an entity akin to integrated oil companies that pump oil and process it into fuel and petrochemicals used to make plastics and consumer goods.Middle Eastern oil producers have intensified their push into refining and petrochemicals over the last decade. Abu Dhabi, has also used Mubadala and IPIC to invest in assets that provide access to natural gas and technology needed to expand its manufacturing industries. Officials for both compa-nies declined to comment.

The planned merger indicates Abu Dhabi’s “strategy to have an energy-focused fund with its fingers in different parts of the industry.Mubadala Petroleum, has a stake in daily output of 411,000 barrels of oil equivalent. IPIC’s wholly owned Spanish subsidiary Cia Espanola de Petroleos SAU, known as Cepsa, produces about 130,000 barrels a day of oil, mainly in Algeria and Spain, according to the unit’s website.Their combined output is more than double that of Libya.

Mubadala pumps oil in Thailand, where IPIC too has a stake in energy concessions. Mubadala also produces gas in Indonesia and supplies the fuel to homes and industries in the U.A.E. and Oman.Mubadala’s renewable energy unit Masdar has solar and wind projects from Abu Dhabi to the U.K.IPIC’s Cepsa can process about 520,000 barrels a day of crude at its three refineries in Spain. The fund owns 21 percent of Japanese refiner Cosmo Oil Co. and a holding in 100,000 barrels a day of refining capacity in Pakistan at Pak-Arab Refinery Ltd. IPIC bought Canada’s NOVA Chemicals in 2009 and has a stake in Austrian chemical maker Borealis AG.

IPIC generates operating cash flow of $3 billion to $5 billion a year and has annual capital expenditure of $2 billion to $3 billion, Emirates NBD said Wednesday in a note. Mubadala has $1 billion to $2 billion in cash flow against capital investment of $3 billion to $5 billion, the Dubai-based lender said.

Oil Prices Heading Up

Oil prices rebounded in the second quarter after a historic two-year rout, boosted by a weaker dollar and a number of supply outages from Canada to Nigeria.Now, investors face an unusual predicament: They can’t agree on whether the market is facing a supply surplus or a deficit.U.S. oil prices rose $9.99, or 26%, in the second quarter to $48.33 a barrel on the New York Mercantile Exchange, the best quarterly performance on a percentage basis since 2009. Brent, the global benchmark, rose $10.08, or 25%, to $49.68 a barrel on ICE Futures Eu-rope.

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U.S. oil prices ended the quarter up 30% for the year.Natural-gas prices rallied, too. Nymex natural gas gained 49% to $2.924 a million British thermal units, logging its best quarterly performance on a percentage basis since 2005. It is up 25% for the year.Oil prices dropped 4.9% the day after the Brexit side prevailed and have been volatile since then. But some investors are already starting to look beyond the vote’s aftermath.Oil prices are hovering near $50 a barrel, roughly half the price of two years ago but a level that now spells relief for battered oil producers and their creditors. Investors piled into the oil market in the first half of the year as futures rallied from 13-year lows.

Market participants are divided about where prices are headed next.The bullish view is that daily production is barely keeping up with growing demand. U.S. output has fallen from its highs, and unplanned supply disruptions—due to Canadian wildfires, attacks on oil facilities in Nigeria and political unrest in Libya—removed millions of barrels of daily production from the market in recent months.

This sentiment prevailed in the oil market in the second quarter, pushing prices higher even after large producing nations failed to agree on an output freeze at a meeting in May.The opposite view is that global inventories still stand near record levels, keeping the market over-supplied even as daily production falls.

Many investors are looking past ample inventory levels. Analysts warn that Venezuelan production is increasingly vulnerable due to the country’s economic troubles and power outages.But wary investors point to 2015, when a strong price rally in the spring failed to hold. U.S. producers took advantage of the higher prices to put more drilling rigs to work, and U.S. output fell less slowly than expected.

But Prices of US Crude Going Down

US Oil fell on the end of June, pressured by returning Nigerian and Canadian output and as traders looked to book profits ahead of the long holiday weekend in the United States. OPEC's oil output has risen in June to its highest in recent history.Brent crude was down 89 cents a barrel, or 1.8 percent, at $49.72, having risen in the two previous sessions. US crude settled 3.1 percent lower, or $1.55, at $48.33 a barrel.

The more active Brent contract for September delivery traded down $1.19 at $50.13 a barrel. The glob-al benchmark rose in the previous two sessions, making up losses after a shock Britain exit from the European Union rattled markets across the world.

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In Norway, oil companies and trade unions began two-day wage talks in a bid to avert a strike that would initially cut the country's oil and gas output by 6 percent, the Norwegian Oil and Gas Associa-tion said.

Prices found some support after market intelligence firm Genscape reported an inventory drop of about 500,000 barrels at the Cushing, Oklahoma delivery hub for U.S. West Texas Intermediate (WTI) futures in the week to June 28, traders who saw the data said.Steady declines in U.S. output is adding to the rebalancing. U.S. crude stockpiles fell for a sixth con-secutive week, the U.S. Energy Information Administration reported.

ARAMCO Tries to Mitigate the Impact of Lower Oil

Saudi Arabian Oil Co. is leading a surge in borrowing by energy com-panies in the Middle East as they turn to banks and investors for cash after a drop in oil prices eroded their ability to pay for exploration and production.

Energy producers in the six-nation Gulf Cooperation Council tripled their borrowings in the second quarter from a year earlier to $12.9 billion, the most in 15 months, data compiled by Bloomberg show. Yanbu Aramco Sinopec Refining, a joint venture between Saudi Arabian Oil, known as Aramco, and China Petroleum & Chemical Corp. was the top borrower at $4.7 billion.

Lending rose as state-run companies including Kuwait National Petroleum Co. took advantage of falling borrowing costs. The J.P. Morgan Middle East Composite Index of the region’s debt yield, an indication of borrowing rates, is at the lowest since October 2015.

Cheaper crude squeezed revenue at oil companies, with the benchmark Brent contract dropping to a 12-year low of $27.10 a barrel in January from more than $100 a barrel two years ago. Saudi energy companies have borrowed $23.1 billion in the last 18 months, almost as much as the $23.4 billion they took in all of the previous eight years.

Debt will remain available to low-cost Gulf oil producers, albeit at higher rates as emerging-market credit is re-priced after the U.K. voted last week to leave the European Union, Sfakianakis said. "It’s nearly impossible for a national oil company to go bankrupt unless oil prices tank below $10, and I don’t see it going anywhere close to that."

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Qatar Anti-Smuggling Measures

The emir of Qatar, Sheikh Tamim bin Hamad Al Thani, has issued a new law envisaging fines of up to 1 million rials (US$275,000) and a prison sentence of up to 10 years for smuggling oil products.Oil product, in the law, includes everything that is produced in a refinery, including jet fuel, gasoline, lubricants, and more, the Peninsula daily reports. Qatar has been active lately in updating its oil production and ex-port policies. Local media recently reported that the emirate is considering setting up a new company to take care of marketing the country’s oil productions internationally.Currently, this is being done by independent company Tasweeq, which buys the oil and gas products from local refiners and then resells them. Under the new plan, this will pass into the hands of state-owned Qatar Petroleum in view of rising fuel production and consequently rising exports.The move could be seen as a lifeline for Qatar Petroleum, which has been hit hard by the oil price rout and has since 2014 undergone a major restructuring including asset sales and the divestment of its foreign investment unit.

Iran Slowly Regaining its Market Share

A supertanker with Iranian crude is heading toward Poland's Baltic Sea port of Gdansk, trade sources said and ship-track-ing data showed, as Iran continues to claw back market share after the lifting of Western sanctions.

It was not clear whether the buyer was Polish refiners PKN Orlen or Grupa Lotos, or whether the oil would remain in Poland or be shipped to Germany.Regardless of the ultimate destination, the cargo is the first Iranian crude sold into this part of the Baltic Sea market since January's lifting of sanctions, intensifying the battle for market share be-tween top producers including Russia and Saudi Arabia.

Both companies said they were also interested in running Iranian oil in their refineries.Saudi Arabia has been aggressively expanding its global buyer list and Iran has been hot on Riyadh's heals. Oil major Shell resumed Iranian oil purchases this month.Before sanctions, Iran was exporting about 2.2 million barrels per day (bpd). July exports are expected to be around 2.1 million bpd, up about 70 percent year-on-year.

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Saudis Offer Cheaper Oil

Saudi Arabia, the world’s largest crude exporter, cut all official selling prices for its crude sales to Asian and U.S. clients in August.State-owned Saudi Arabian Oil Co. lowered its official selling price for Arab Light crude to Asia by 40 cents to a premium of 20 cents a barrel above a regional benchmark.

Brent crude has dropped more than 35 percent since Saudi Arabia led a 2014 decision by the Organization of Petroleum Exporting Countries to maintain production to drive out higher-cost producers. The group decided to stick to its policy of unfettered production at its June 2 meeting in Vienna, with ministers united in their optimism that global oil markets are im-proving.

Middle Eastern producers are competing with cargoes from Latin America, North Africa and Russia for buyers in Asia, its largest market. Producers in the Persian Gulf region sell mostly under long-term contracts to refiners. Most of the Gulf’s state oil companies price their crude at a premium or discount to a benchmark. For Asia the benchmark is the average of Oman and Dubai oil grades.

Russia Wins the Competition with the Saudis Over China’s Market

Exports of Russian oil to China have jumped almost 42 percent to over 22 million tons from Jan to May.Most of China's crude imports now come from Russia. Saudi Arabia is its second biggest supplier with 21.8 million tons. The kingdom has increased oil exports to China by 3.9 percent in the 5 months to May.Russian exports to China have more than doubled over the past five years, up by 550,000 barrels a day. An International Energy Agency report showed that at the end of 2015 Russia also overtook Saudi Arabia as the biggest crude exporter to China.

Energy sales between the two countries have increased significantly. Two years ago Rosneft and CNPC signed a 25-year oil deal worth $270 billion under which the Russian company is expected to supply 360.3 million tons of crude to China.Last week during Russian President Vladimir Putin’s visit to Beijing, an oil supply contract was agreed, under which Russia could deliver up to 2.4 million tons of crude oil to ChemChina in a year's time.

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Natural Gas Dramatically Up in Second Quarter

Natural gas posted its largest quarterly percentage gain since 2005 on expectations that falling production and strong demand would shrink the glut of fuel. Prices rose 96.5 cents, or 49%, in the second quarter to $2.924 a million British thermal units on the New York Mercantile Exchange.

Producers added 42 billion cubic feet of natural gas to storage in the week ended June 24, the Energy Information Administration said Thursday, less than the 48-bcf injection that analysts surveyed by The Wall Street Journal had expected.

The natural-gas market remains over-supplied following a winter of sluggish demand, but the relative surplus of fuel in storage has shrunk in recent weeks due to declining production and rising demand. Prices have risen strongly in recent weeks on forecasts for hot weather, which can increase demand for gas-powered electricity to run air-conditioning units.

However, prices might not be able to hold gains above $3/mmBtu, because that level could prompt some power plants to switch from natural gas to coal, which is cheaper, and could encourage some producers to drill new wells.

Azerbaijan Gas Bonanza

The U.S. Energy Information Administration (EIA) has once again confirmed Azerbaijan’s importance in ensur-ing energy security both at regional and international scale.In its Country Analysis Brief report, EIA said Azerbaijan, one of the oldest oil-producing countries in the world, is an important oil and natural gas supplier in the Caspian Sea region, particularly for European markets.

Most of Azerbaijan’s natural gas is produced offshore.The contract for development of the Shah Deniz offshore field was signed on June 4, 1996. The field’s reserve is estimated at 1.2 trillion cubic meters of gas.

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A final investment decision was made on the Shah Deniz 2 field in Baku in 2013, envisaging producing additional 16 billion cubic meters of gas per year at the field.The proven gas reserves in Azerbaijan as of early 2016 amounted to 1.1 trillion cubic meters, which accounts for 0.6 percent of global proven gas reserves, according to BP’s estimates.The country holds over three trillion cubic meters of gas reserves which help develop the country’s export potential.

While the main focus is on the Shah-Deniz field with estimated gas reserves at 1.2 trillion cubic me-ters, Azerbaijan possesses additional significant gas fields such as Absheron, Umid, Babek and Nakh-chivan, of which Absheron field is projected to be commenced in 2021. The cited indicators ensure future development of the gas industry in Azerbaijan for a period exceeding 100 years.

The second-largest oil producer in the former Soviet Union, Azerbijan enjoys a potential to produce oil and gas from shale. Shale gas fields are located at the territory of Gobustan, Shemakhi and other regions. Earlier, ConocoPhilips conducted geological survey at Azerbaijani foothills in accordance with the agreement with SOCAR.

Meanwhile, the country recently announced that for the first time it hit a record in commercial gas production level in 2015.

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Oil and gas july issue (1)