Oil Markets Aren’t As Bad As They Look

Friday November 4, 2016

In the latest edition of the Numbers Report, we’ll take a look at some of the most interesting figures put out this week in the energy sector. Each week we’ll dig into some data and provide a bit of explanation on what drives the numbers.

Let’s take a look.

1. Venezuela’s cash reserves running out

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- The two Bloomberg charts depict the increasingly dire situation in Venezuela. Cash reserves plunged to a 14-year low of $10.9 billion in October, as its economy descends deeper into crisis.
- Fortunately, the state-owned PDVSA managed to convince investors to extend repayment on $2.8 billion in bond payments that were due next year.
- That bought Venezuela some time, reducing the risk of default. But with few resources left, Venezuela won’t be able to kick the can down the road forever.
- Based on credit-default swaps, Bloomberg says that the market is pricing in a 91 percent chance of a Venezuela default within the next five years.
- Oil production has already declined by more than 10 percent this year, and will continue to deteriorate.

2. China’s oil production falling

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- In addition to countries like Venezuela, China is also losing oil production. China’s three main oil producers – PetroChina, Sinopec and Cnooc – saw their output fall by a combined 9 percent in the third quarter from a year earlier.
- Low oil prices damaged their finances, leading them to cut spending by about half so far this year compared to last.
- China has some mature and depleting oil fields, which require investment in order to maintain production levels. “Low crude prices led to lower spending, and lower spending caused the lower output,” Tian Miao, a Beijing-based analyst at North Square Blue Oak Ltd, told Bloomberg. “The only thing that can change the game is a substantial rebound in crude prices.”
- Sanford C. Bernstein analyst Neil Beveridge believes that China’s oil production might stop falling with crude prices holding steady at $50 per barrel, but output won’t rebound until prices hit $60.

3. Transportation CO2 emissions surpass power emissions

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- In February 2016, the U.S. hit a milestone – CO2 emissions from the transportation sector surpassed those of the electric power sector for the first time since 1978.
- U.S. CO2 emissions have declined by 25 percent since 2008 due to efficiency, renewables, and an ongoing switch from coal to natural gas for electricity generation.
- At the same time, transit emissions are rising as cheap gasoline has fueled an uptick in driving.
- Power sector emissions will continue to fall as more renewable energy comes online, but transportation sector emissions will be harder to cut into. Until EVs make deeper inroads, CO2 emissions from transportation will remain stubbornly high.

4. EVs might not break oil demand

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- The oil industry has been the subject of a growing number of analysts predicting its permanent decline. The plunging cost of battery packs will lead to a sharp rise in the adoption of electric vehicles, recent forecasts say.
- EVs could become cost competitive with conventional gasoline and diesel powered vehicles as soon as the early 2020s. Royal Dutch Shell just admitted that it sees peak oil demand within the next 5 to 15 years.
- But the IEA is not so sure, because there is much more to oil demand than just passenger cars. “The oil demand growth is not coming from cars, it’s from trucks, aviation and the petrochemical industry and we don’t have major alternatives to oil products there,” the head of the IEA Fatih Birol said at a conference in Paris this week. “I don’t buy the argument that electric cars alone will cause a peak in oil demand at least in short and medium term.”
- Less than half of every barrel of oil is used for gasoline. Other uses include heating oil, jet fuel, propane, natural gas liquids, petrochemical coke, asphalt, lubricants, and so on. EVs will not kill off overall oil demand growth alone. The IEA’s comments are likely encouraging for oil investors and industry executives.

5. BP still not covering dividends

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- BP reported an underlying replacement cost profit of $933 million, half of $1.8 billion profit earned in the same quarter in 2013.
- In the first nine months of 2016, BP had $13.3 billion in underlying cash flow. But it spent $11.5 billion on capex and dispersed $3.4 billion to shareholders in the form of dividends.
- BP trumpeted its cost reductions in its report to investors this week, arguing that it is on track to reduce cash costs by $7 billion by next year.
- But because it is still not covering its dividend with cash flow, its debt is rising. BP’s gearing ratio – a ratio of debt to equity – rose from 20 percent last year to 26 percent at the end of September.

6. World’s most expensive natural gas

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- Natural gas prices have been rising in the U.S. as demand continues to expand due to more gas-fired power plants, and supplies have contracted as drilling has ground to a halt. Henry Hub prices are now trading just under $3/MMBtu.
- But natural gas prices are highly seasonal. Henry Hub prices crashed last winter due to unseasonably warm temperatures across the country, dropping as low as $1.50/MMBtu, the lowest price in years.
- The upcoming winter is expected to be much colder. New England in particular could see natural gas prices spike, both because of cold temperatures but also because a lack of pipeline capacity tends to lead to bottlenecks and shortages.
- Traders from ConEdison Energy said this week that New England could temporarily see natural gas prices spike as high as $20 to $25/MMBtu this winter if the weather gets exceptionally cold.
- At those prices, New England could be home to the highest natural gas prices in the world. That will likely result in an uptick in LNG imports into the region.

7. M&A activity picking up

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- Stable oil prices and improved credit conditions over the past few months are leading to an uptick in M&A activity, according to the EIA.
- Many of the deals are located in the Permian Basin, the hottest shale region in the U.S. right now. Rigs have returned to the field, money is pouring in, and oil production is rising. The Permian is the only onshore area where output is expected to rise in the near-term, the EIA says.
- In the third quarter, there were 93 M&A deals accounting for $16.6 billion, which works out to an average of $179 million per deal. That is the highest average deal since the third quarter of 2014, and is illustrative of high valuations for Permian acreage.
- Moreover, there were 71 deals valued at $1 billion or more since 2011 in the U.S., and nine of them have taken place in the second half of 2016 alone, compared to only four in the full year of 2015.

That’s it for this week’s Numbers Report. Thanks for reading, and we’ll see you next week.