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Evan Kelly

Evan Kelly

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Midweek Sector Update: August Off To A Shaky Start For Oil Markets

August started off on a dour note for crude oil, with prices tanking by around 5 percent on August 3. A slew of negative news from around the world weighed on prices. The Greek stock market plummeted on the first day of trading after being closed for five weeks. The Athens Index dropped by 16 percent on August 3 and continued its descent as of midday trading on August 4. Concerns over the Chinese economy once again reared their head as the government moved to put restrictions on short selling to stop the collapse of the stock markets. WTI fell below $46 per barrel and Brent briefly dipped below $50 per barrel before rebounding a bit on August 4.

Royal Dutch Shell (NYSE: RDS.A) will swap some assets with Russian gas giant Gazprom. The move will give Shell a stake in Gazprom’s Sakhalin-3 LNG project, on the island off Russia’s Pacific Coast. The project is perfectly positioned to serve the large and relatively fast growing LNG markets in China, Japan, and Korea. For Shell, it also offers a foray into a large gas producing region that has known costs, allowing the Anglo-Dutch company to book reserves at a time when it is difficult to find oil and gas reserves with reasonable production costs. According to Bloomberg, Gazprom produces a barrel of oil equivalent at about one-third the cost of Shell – $5.66 per boe for Gazprom versus $14.74 for Shell. The assets that Gazprom will receive in return are yet to be determined.

The move highlights the oil major’s need to find new reserves as it fights off stagnation. Shell’s output has actually declined 10 of the last 12 years, and now it is in the midst of a campaign to cut costs, lay off workers, and delay big projects. That would help shore up the balance sheet now, but also raises questions about the company’s ability to lift production over the long-term (and Shell is not alone). The purchase of BG Group (LON: BG) was an effort to acquire some very attractive gas prospects, and the swap with Gazprom is intended to do the same. Related: Recession Risk Mounting For Canada

The move also highlights that fears over western sanctions have eased in recent months. While the sanctions regime is still in place, the tense standoff between Russia and the West has quieted down. No doubt Russia’s assistance on the Iran nuclear deal has bought it some breathing room from western governments.

In a bit of good news for Shell, analysts at UBS upgraded the company to “Buy,” noting the large upside that Shell could gain from its purchase of BG.

An explosion struck the Shah Deniz gas field on August 4, Azerbaijan’s iconic gas project, and the country’s largest. The field had already been offline for maintenance, so production levels were not affected. For now, it is not clear who was responsible for the attack. The attack comes only days after Kurdish PKK rebels attacked two pipelines in Turkey, disrupting that country’s oil and gas imports. The Shah Deniz field is owned by BP (NYSE: BP), Statoil (NYSE: STO), and SOCAR, the Azerbaijani state oil company. Related: EIA Capitulates Under Cover Of Darkness

Speaking of the Kurds, the Kurdish Regional Government in Iraq announced plans to start paying international oil companies operating in the semiautonomous region for their oil production. The KRG had decided to move forward with oil exports on its own, after a deal with the central government in Baghdad has largely fallen apart. Private oil companies have not been paid for months, but the KRG hopes to remedy that beginning in September. The move highlights the fraying relationship between Kurdistan and the Iraqi government, and amounts to a step towards greater independence for the Kurds.

The Obama administration revealed its final rule on greenhouse gas limits for power plants this week. The regulation emerged slightly more stringent than its original proposal, requiring utilities to reduce their carbon emissions 32 percent below 2005 levels by 2030, instead of the 30 percent reduction proposed last year. However, the rule will also allow utilities two extra years to comply with the medium term targets, pushing the 2020 date back to 2022. The EPA predicts that the country will get 28 percent of its electricity from renewable sources by 2030, more than double the share from 2014.

The state of Oklahoma is imposing new regulations on oil and gas drillers in the state in an effort to cut down on the risk of earthquakes. The practice of disposing wastewater underground after fracking has been linked to the sudden spike in the frequency of earthquakes in Oklahoma, but new rules announced on August 3 will limit the volume of wastewater operators are allowed to inject underground in two counties. The Oklahoma Corporation Commission will require a 38 percent reduction in wastewater within two months, bringing the volume of wastewater below 2012 levels – the year when earthquakes started to pick up in earnest. Related: US Shale: How Smoke And Mirrors Could Cost Investors Millions

Market conditions for coal continue to deteriorate, with coal prices down by 10 percent so far this year. International coal miners have produced so much coal that prices are at their lowest levels in ten years, as the ongoing glut has depressed the market. But with an ongoing shift in the U.S. away from coal-fired electricity, as well as softening demand in China, the outlook doesn’t look good. In fact, China’s coal imports for the first half of 2015 were down by 37.5 percent from the same period a year ago, a jaw-dropping decline that could spread financial distress across the global coal industry if the trend continues. In a sign of the times, Alpha Natural Resources, one of the largest coal miners in the United States, will file for Chapter 11 bankruptcy protection, as the Virginia-based producer is unable to emerge from its mountain of debt.

Finally, NextEra Energy Partners LP announced plans to purchase seven natural gas pipelines in Texas for a combined $2.1 billion. The wind and solar division of NextEra Energy Inc., NextEra Energy Partners will acquire NET Midstream, giving it assets in the Eagle Ford Shale. NextEra will take on pipelines with the capacity to ship 3 billion cubic feet of natural gas per day. The pipelines also ship natural gas to Mexico, a market the company believes has strong growth prospects.

By Evan Kelly of Oilprice.com

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