Summary of the main points in Research note (dated Feb 2010) by Goldman Sachs:

• Recovery in Oil has been led by Emerging Markets and in particular China, offsetting weak demand from the US

• Higher long-term Crude prices required to motivate new supplies – marginal projects require $85-$95 / bbl under currency cost environment
• Pace of economic recovery will determine length of time until demand once again pushes against limited crude oil production capacity.  Economic macro factors such as China tightening policy, potential Sovereign defaults in Europe and US policy will weigh down on sustainability of recovery.
• Strong Industrial Production data from US as well as colder weather added to draw on US total inventories contributing to recoevry in WTI
• Tightening of supply-demand balance will likely lead to oil at sea (Storage) to decline in January

• Chinese demand was largely driven by “Other” Industrial related products and exceeded expectations and set a new high of 5 mmb/d for first time in Dec

• Loading of Arab Gulf & West Africa Crude continue to head East

• OPEC spare capacity will be exhausted by 2Q2011 and will bring OECD invesntory levels to fall below 10 – year average and lead to demand rationing
• Volatility in the Front months has come down in line with volatility in equities but volatility in longer-dated WTI has remained high, indicating the risk of future supply shortages
• Non-OPEC supply will be disappointing with fewer big projects and higher declin rates due mainly to sanction delays and poor execution
• OPEC capacity to increase only 1-2% pa in coming years (mainly due to Saudi, Qatar & Iraq) and to reach full capacity within 2 to 3 years and Iraq production will be much required to avoid demand rationing

Related articles

• China, setting the world’s oil prices (alneft​.com)

Research paper by Barclays Capital on Global Energy Outlook. In summery:

1.                  Crude oil, coal and carbon pricing are expected to strengthen on a 12-24 month horizon; natural gas and US power prices may take longer to recover.

• BarCap expect price of WTI to average $85 / bbl in 2010 and $ 97 / bbl in 2011 vs avg of just $62 / bbl in 2009. Uncertainty from Nigeria, Iran and Iraq weighing in.
• Projected fall in non-OPEC supply (even though it has been a mixed bag of weak /strong) this should facilitate OPEC’s market management drawing closer the prospect of severe supply tightness in the market – adding to upward move on prompt prices.
• Lower Power sector demand will weigh in on Natural gas – forecast for 2010 Henry Hub is $ 5.25 / MMBtu.
• New Liquefaction Trains will come on stream adding 4.5 – 5.5 Bcf/d in growth production in 2010 – Even though Non-OECD demand is rising, Europe / US will still need to absorb 2 Bcf/day. Market will remain oversupplied and thus pressurizing spot LNG prices with prices converging to trade closely together in 2010.  Price forward differentials will favor US ports, making Atlantic Basin LNG spot cargoes increasingly sail west.

2.                  A preference for crude oil and upstream biased investments, relative to natural gas and downstream oil. We see price support for crude in 2010 and even more so in 2011 as demand recovers, inventories return to balance and new supply slows. We like the commodity and oil biased E&P investments in credit and equities.

• BarCap is positive on US integrated Oil Compnies in medium term but sees uncertainty in long term. Highlight ExxonMobil and Chevaron. They are Neutral on European Integrated Co but sees ENI as particularly undervalued – implying a 45% upside potential.

3.                  A clear negative view on downstream oil profitability, and investments sensitive to oil product margins. We expect refining capacity additions to exceed demand growth at least until 2012. We are negative on independent refiners in credit and equities.

• Negative on both US & European Refiners – Sunoco is cheapest to its peers but Valero is their choice in short term given its geographical diversity.  In Europe focus is on complex efficient refiners like Saras, GALP, Hellenic Petroleum and Motor Oil.
• Land Rigs will improve shareply in 1H of 2010 and expect long up-cycle in exploration & production spending. Barcap favors large cap like Weatherford, Schlumberger & Transocean.

Related articles

• LNG: Wind of Change (Barclays Capital) (alneft​.com)
• Oil Refining Drags on Earnings (WSJ​.com) (alneft​.com)
• Shell Disappoints, Freezes Dividend – Analyst Blog (benzinga​.com)
• Exxon Profit Hurt by Refining (online​.wsj​.com)

NCB Capital Petrochemical Tracker (Saudi Arabia)

Related articles

• Gulf Gap in Davos Belies Booming Saudi Arabia Economy (Update2) (businessweek​.com)
• Saudi Oil Flows East: China’s Ever Increasing Appetite for Oil (seekingalpha​.com)

The debate as to why we don’t use a particular type of fuel to heat out homes or fill in our cars especially with regard to Biofuels / alternative energy,  can be clearly seen  from this analysis by The Oil Drum. Consumers are driven by convenience, cost and availability of supply.  Oil Drum compiled list of all major fuels and compared cost on a BTU equivalent basis. They compared the cost per one source / fuel that is needed to raise temperature of one pound of water y 1 degree Fahrenheit. They took into account the cost of subsidies wit regard to Bio/alternative energy.

Bill Gross, the legendary head of PIMCO (the largest fund managers with over $ 1 trillion under management) and nicknamed Mr. Bond for his influence on the Bond / Fixed income market, is out with his eagerly awaited outlook letter to investors.

Some of the highlights of Mr Gross’s letter :

• He mentions a Mckinsey study that analyzed historical data and concludes that Governments facing banking crisis usually double their outstanding debt within 3 years and an increase of 7% in unemployment rate and remains elevated for five years. Once debt reaches 90% of GDP, its economic growth slows by 1%.

• In what he refers to as a “Ring of Fire” are those countries (in Red) where their debt may exceed 90% of GDP within few years time while the yellow and green are the most conservative.
• He also cites another McKinsey study that shows that countries that start deleveraging,this phase usually 2 years after the crisis (2008 in this case), and last for 6 to 7 years. In 50% of the cases, a period of belt-tightening exert drag on GDP growth. On the other half, outright corpoarte defaults or acceleration of inflation will emerge. … Continue Reading

If demand rises, profits for oil tankers could surge. The big winners would be companies, like those listed here, with vessels available for spot deliveries.

• Oil Tankers Trucking Along (blogs​.wsj​.com)
• A Year of Global Shipping Routes Mapped by GPS (wired​.com)
• Jefferies Believes In The Oil Tanker Business (FRO, NAT, OSG) (benzinga​.com)

The impact of high oil price can be seen clearly from the graph. In 2000, Jet Fuel constituted 14% of total airline cost. This climbed to 32% in 08 and forecasted at 26% for ’10 (according to IATA). This has contributed to US$ 49.1 billion losses in the airline industry during the last decade (source).  This is US$ 5 billion loss per year.

According to Scarce Whales, the global airline industry is estimated to lose US$ 5.6 billion if oil prices average US$75 per barrel (basis ICE Brent crude) during 2010.

Recent changes in accounting rules with regard to hedging have also distorted financial picture by Airline Industry. Airlines using forward contracts, write off the difference between higher contracted forward price and prevailing lower spot against income.  In ‘Out of the Money‘ ‘effective’ hedging, the non cash loss of hedging is marked-to-market and is written off against reserves while ineffective have to realize loss against their income.  IATA estimate that if these ‘Marked-To-Market’ losses are taken into account, the industry net losses in 08 will rise from $ 8 billion to $ 16-17 billion.

On the positive, narrowing of cracks between Fuel Oil and Jet Fuel, as well as recovering Ocean Fright rates, have slowed loss of market share of Air Freight to Ocean transport.

A weak US dollar (declined by 15% against Euro in 09) have had a slight positive impact on Jet Fuel cost for non-dollarised airlines.

Overall, the airline industry have combated the rising cost related to Fuel with improved efficiency in non-fuel cost in particular labour productivity. Between 2000 – 06,  Airlines improved labour efficiency by 56% taking total non-fuel cost as percentage of total cost from 28.5% to 23.3.% (IATA source).

Nevertheless, the Industry is still facing difficulties as capacity is not falling in line with demand (only USA have been able to shrink capacity in line with demand) even as research has demonstrated no correlation between size and profitability for airlines. (actually, most profitable airlines are those that serve niche market or routes). Weighted load factor achieved of 60.4% remains below Break-even of 61%.  The latest IATA traffic growth numbers (Nov 09 + 2.1% on last year compared to +0.5% in October 09) is indicating strong recovery particularly in Middle East, Asia Pacific and Latin America.

Cost of Capital for majority of airlines (average rating BB+) remains at 8% even as interest rates are at historical lows.  As a result, losses will persist and with Return on Invested Capital (ROIC) at 2 % – in short – an Industry that is hemorrhaging value for even the bravest of investors.

Middle East Airlines in 2010

2010 will see the regions airline recovering growth momentum of 12.2 % and 73.9% load factor aided by regional routes & attracting long haul connectivity via regional hubs. Emirates, Etihad and Qatar Airways continue to take market share from other regional airlines and long haul from international airlines.

Regional hubs such as Dubai has achieved stellar average annual growth in passenger traffic of 15% and 9% for Abu Dhabi. Between 1997 and 2007, passenger traffic for the two airports trebled (source InterVISTAS).

According to IATA, the sector will lose $ 300 m (majority of losses incurred by legacy Gov. owned airlines).

There is scarce information with regard to Jet Fuel hedging by regional airlines but majority have hedged around 30% -45% of total fuel consumption at good levels, taking advantage of low oil price during Q1 – Q2 of 2009.  Emirates fuel cost accounted for 35.1% (AED 14.4 billion or $ 4 billion) of total cost in 2008-09 compared to 32% in previous year.

A Goldman Sachs reports shows extensive list of world’s top 280 energy project that will have a major impact on world’s energy market.

FT Alphaville » The world’s top 280 energy projects.

New additional capacity from Saudi is causing margins to be depressed.

• Zawya : SICO Petrochem update report Jan 2010

From Early Warning, a good scenario analysis of Iraq Oil Production.  The analysis project Iraq Oil production to 2017.

The best case scenario has medium term target of reaching 3.5 m bpd by 2012 (iraqi plateau legacy production) and then IOG investment will kick in to take production to 12 m bpd by 2017.

The low / worst case scenario, assume volatility of production and political upheaval / civil unrest after the March elections, production to hover around the 1 m bpd. In between the two scenarios lies the possibilities.

In our opinion, a lot of parameters are still uncerain such as :

• Kurdistan Oil Production (good results from the likes Gulf Keystone) add to possibiitiy of upwards surprise (potentially Kurdistan can produce 1 m bps.
• Kirkuk – who’s in charge and effect on Arab-Iraq-Turkish relationship with Kurdistan
• Infrastructure – will take much longer to develop required oil infrastructure in riskier environment compared to country like Saudi and continued disruption by insurgency
• Potential Political Upheveal regrading distribution of resources will also impact production (Central Gov / Kurdistan)
• Limiting new contracts / production by Gov as additional oil on the markets depress prices while IOCs will want to continue production to take back investment.
• Iraq membership of OPEC – again a question mark – looks likely that they will likely stay on as an observer – but additional production will have impact on OPEC quotas / influence over oil price. This will need to be assessed with regard to politics / relationship with Saudi & Iran

Ref : Tariq Shafiq on Iraqi Oil Reserves

Platts: Top 250 Home.

• Insightful analysis and predictions for 2010.

Story in process -Oil Contango and its Effects on Oil Prices.