Tag Archives: oil and gas

the view from Canada

January 22, 2015 By in Current Market Thoughts, Energy, Industry Analysis, Mining, oil and natural gas, Strategy Tags: , , , , Leave a comment

Yesterday the Governor of the Bank of Canada, that country’s central bank, announced it was lowering short-term interest rates from 1% to .75% as an “insurance” measure to help the Canadian economy adjust to lower oil and gas prices.  The move doesn’t come as a huge surprise, given that the oil and gas industry is close to 10% of the Canadian economy and has been accounting for about a third of its GDP growth.

In the words of Governor Stephen Poloz, “The drop in oil prices is unambiguously negative for the Canadian economy.  Canada’s income from oil exports will be reduced, and investment and employment in the energy sector are already being cut.”

To me, more interesting is the bank’s quarterly Monetary Policy Report, released at the same time, which deals with the global effects of lower oil.  It says:

1.  the Bank is assuming the oil price ultimately recovers to US$60 a barrel–no $100 oil anywhere in sight

2.  Canada gradually shifts focus to non-energy industries of the type which have been in decline during the energy boom years

3.  the net effect on world GDP growth of the oil price fall is zero, both in 2015 and 2016.  On an area by area basis, however:

–the US is a net winner.  It grows at a real rate of  +3.2% in 2015 (rather than the previously projected +2.9%) and +2.8% )+2.7%) in 2016

–China is, too.  It expands at +7.2% (+7.0%) and +7.0% (+6.9%)

–the EU, as well.  It advances at +0.9% (+0.8%) and +1.2% (+1.0%)

–Japan is up by +0.6% (+0.7%) and +1.6% (+0.8%)

–the rest of the world is a mild net loser, growing at +3.1% (+3.2%) in 2015 and reounding to +3.4% (+3.4%) the following year.

In the last category, Canada grows at +2.1% (+2.4%) this year before rebounding in mid-2015.

 

 

 

 

natural resources and economic growth

January 20, 2015 By in Energy, Gold, Industry Analysis, Long-term themes, Mining, Shaping a portfolio for 2015, Strategy Tags: , , , , , , 1 Comment

I ended up with my first stock market job, more or less by accident–and without any finance experience or training–in the late summer of 1978.  A few months later, the firm’s oil analyst was headhunted away and I took his place.  Within a couple of years (an MBA from NYU at night along the way) I had picked up a bunch of metals mining companies, too, and was in charge of the firm’s natural resources research.

The oil industry was (and still is) really non-intuitive–more about my early adventures tomorrow.  Today I want to write about the mining industry, which is a little more straightforward.

natural resources in the 1970s

I started out by reading the annual reports and 10-Ks of the major base metals mining companies for the prior five or six years.  What stood out clearly was that all the firms held very strongly a series of common beliefs, namely:

1.  that global economic growth would continue to be strong for as far into the future as one could imagine,

2.  that the availability of all sorts of base metals–lead for batteries, copper for wiring and tubing, iron ore for steel, and so on–was a necessary condition for this growth

3.  that, therefore, demand for base metals would grow at least in lockstep with GDP increases.

Implicitly, the companies also assumed that:

4. that oversupply was highly unlikely,

5.  that substitution among raw materials–like aluminum or PVC for copper–wouldn’t be an issue, and

6. that, because of 4. and 5., the selling price of output from future orebody discovery/development would never be a concern.

CEOs’ conviction was buttressed by reams of computer paper containing economists’ regression analyses “proving” that all this stuff was true.

a massive investment cycle…

Naturally, the companies, not risk-shy by nature, went all in across the board on new base metals mine development.

As I was reading these documents in 1979-80, the first (of many) massive new low-cost orebodies were coming into production.  This wave turned out to have been enough to keep most base metals in oversupply–and a lot of mines unprofitable–for the following twenty-five years!!!  Miners were also in the midst of a massive switch to exploring for gold, where high value deposits could be developed quickly and at low-cost–causing, in turn, a twenty year glut of the yellow metal.

…that didn’t work out

The mining CEOs turned out to be wrong in a number of ways:

–like any capital-intensive commodity business where the minimum plant size is huge, industry profits for base metals are determined by long cycles of under-capacity followed by massive investment in new mines that causes long periods of over-capacity

–although it wasn’t apparent in the 1970s, substitution of cheaper materials has been a chronic problem for base metals.  Take copper.  There’s aluminum for heat dissipation and wiring, PVC for plumbing, and glass/airwaves for audiovisual transmission.

–Peter Drucker was writing about knowledge workers as early as 1959.  Nevertheless, the mining companies and their economists weren’t able to imagine a world where GDP growth might not require immense amounts of extra physical materials.

I’ve been looking for a sound byte-y way to put this all into perspective.  The best I can do is a gross oversimplification:

–real GDP in the US has expanded by 245% since 1980.  Oil usage is up by about 10% over that period; steel usage is down slightly.  The supposed dependence of GDP growth on increased use of natural resouces simply isn’t true.

Why am I writing about this today?

…it’s because I continue to read and hear financial “experts” say that weak oil and metals prices imply declining world economic activity.  To me this argument makes no sense.

 

 

 

natural gas in the US: the “other” energy story

December 26, 2014 By in Current Market Thoughts, Energy, Industry Analysis Tags: , , , , , , Leave a comment

The US is now producing about 70 billion cubic feet of natural gas daily.  On a heat-equivalent basis, that’s equal to around 10 million barrels of oil.

When I was a starting-out energy analyst in the late 1970s, natural gas and crude oil sold for roughly the same amount per Btu.  In fact, in some instances, natural gas sold at a premium.  That hasn’t been true for a long time.  Up until July of this year, natural gas was selling for about $4.50 per thousand cubic feet (Mcf).  That’s the equivalent of $30 a barrel oil.

Why the huge price difference?

In the simplest terms:

–natural gas is a good substitute for oil as a heating fuel or for generating electricity, but it has made only small inroads in transportation, and

–because it’s in gaseous form, it’s harder to get from place to place.  Gas typically requires a pipeline, which is expensive and suffers from the NIMBY syndrome.

Even though the prices of crude and natural gas have going their separate ways for many years–with gas being consistently much cheaper than oil, natural gas, too, has had its own price collapse over the past six months.  Even at what should be a seasonal peak, natural gas is now going for $3.50 an Mcf (the equivalent of $23.50 a barrel), down by almost a quarter since summer.

The two price slides have one factor in common–an increase in production from hydraulic fracturing.  The other is mostly a gas thing–unusually warm weather in November and December  For what it’s worth, predictions are for continuation of the mild weather until spring.

The main effect of the natural gas price slide has been the obvious one–more money in the pockets of gas consumers.  But there have been several others.  Imports of natural gas from Canada are down.  Imports of high-cost liquefied natural gas (LNG) have dropped sharply.  The advantage that the EU’s petrochemical industry, which uses oil as its main feedstock, had achieved over its US counterpart, which uses gas, has abated.

my take

This is a situation where effects are asymmetrical.  The price decline is very bad for domestic natural gas producers. While it persists, demand for imported natural gas should be close to zero, although minimum “take” provisions of long-term contracts may force importers to buy at least some amount.  Bad for them, too, unless their customers ar contractually obligated to take the pricey stuff.

Because gas is hard to transport, this is a US phenomenon.

We use about 20 million barrels of oil in the US each day.  We use the equivalent of another 10 million in the form of natural gas.  On a dollar basis, though, gas amounts to only about 20% of overall hydrocarbon spending.  So the positive effect of the natural gas price decline will be much smaller than for oil and will be concentrated mostly in the Northwest and Midwest, where the weather is colder and where the pipelines terminate.

 

 

 

North Dakota, fracking and flaring

July 8, 2014 By in Energy, Industry Analysis, Mining, shale oil and gas Tags: , , , Leave a comment

My internet is working again!!!

 

Oil production in North Dakota, driven by hydraulic fracturing in the Bakken shale, has risen from 400,000 barrels a day to over a million over the past three years.  This has elevated the state to second place in oil output, trailing only Texas–and the coastal waters surrounding the US.  At today’s rate, North Dakota accounts for 15% of total national output of crude.

No wonder North Dakota has sailed through the recession without many bumps or bruises.

Part of this expansion has been enabled by the wasteful practice of allowing drillers to “flare,” or burn, associated natural gas at the wellhead.  Last week, the North Dakota legislature took a baby step toward controlling this activity.

what flaring is

Many underground hydrocarbon deposits contain both oil and natural gas.  So output that reaches the surface is a mixture of the two.  Even in a remote area where there are no pipelines, crude can be saved in holding tanks and periodically trucked away.  Not so natural gas, which requires either a pipeline or  complex (and expensive) cryogenic system to get it to market.  This lack of transportability is the main reason natural gas often sells at a steep discount to crude oil based on heating value.  It also makes the gas a liability.

A generation ago, the most common way of dealing with natural gas that came to the surface with crude oil was to divert it to a safe distance from the well and set it on fire.  In today’s world, the accepted practice is to require the driller to pump it back underground.  That way it can be recovered and sold once there’s a transport mechanism in place.

Not so in North Dakota, though, where about 30% of the natural gas brought to the surface is wasted and burned.  Statewide, that’s about $50 million worth a month–four times that in energy value using its crude oil equivalent.  The 30% compares with 5% of gas flared from wells in Texas.

Environmentalists have been squawking about flaring for some time.  Landowners, too, who see potential royalty payments going up in smoke.

So last week, the ND legislature acted.  It is forbidding new wells to flare natural gas–meaning they must have a way to pump gas back underground–but does very little to stop the practice in already-producing wells.

The obvious consequence of this action is to raise the cost of future drilling in North Dakota.  This will gradually lower the profit growth of companies drilling there.  My guess, however, is that it will do little to slow the growth of production, since the new legislation just removes “Free lunch” from the bar.

 

 

 

 

 

 

natural resource production companies: accounting quirks to watch for

January 15, 2014 By in Energy, Gold, Industry Analysis, Mining Tags: , , , , , , 1 Comment

mining

Mining is mostly about how a company develops resources that have already been discovered, sometimes very long ago.

1.  Metals orebodies can vary considerably from one part ot the next in the proportion of valuable minerals they hold.  Standard practice is to mine the highest-grade ore when prices are low, and the lowest-grade when prices are high.

Not a lot of operating leverage this way.  But the idea is to enable the mine to stay open even during the inevitable cyclical downturns.  Doing the opposite, which will likely boost the stock price in good times, can lead to disaster during the bad.  There’s no easy way for an outsider to tell, except by the reputation of company management.  In the case of gold, we may find out who’s been prudent and who’s been reckless when the 2013 financials are published.

2.  Same thing with site preparation.  Standard, and prudent, practice is to routinely spend money on things like removing overburden (layers of dirt covering the ore) in places where the company is not mining today, but plans to in the near future.  This activity can be quite expensive.  But it’s necessary.  On the other hand, a firm can make short-term profits look considerably better by not doing so.

oil and gas

Oil and gas is much more involved with finding new deposits, and how to account for those costs, than metals mining.

1.  Companies have two ways to account for the costs of buying mineral rights and doing exploratory drilling.  They are:

–successful efforts, where, as the name suggests, only successful fields are put on the balance sheet and gradually written of as oil and gas is produced.  The costs of unproductive areas are written off as expense as soon as they’re incurred.

–full cost, where all exploration costs, both for productive and non-productive projects, are capitalized and written off against production.

Successful efforts is more conservative, but normally results in lower earnings.

2.  Accumulated costs are written off pro rata as each unit of oil or gas is produced.  The amount expensed against the revenue from each unit is its proportionate share of the total cost of finding and developing all oil and gas (it’s a little more complicated than this, but this is basically what you need to know).  That proportion, in turn, is calculated based on periodic estimates by petroleum geologists’ of the total size of reserves.

Big oil companies use their own geologists; smaller ones hire outside consultants.  The important point is that this estimate–and therefore the amount of cost written off per unit produced–can vary a lot, depending on the particular consultant hired.  It may also depend on the tone, conservative or aggressive, company management sets.

Just as important, as I mentioned yesterday, oil and gas price changes can alter the size of total reserves.  The cost of recovery doesn’t change, but the amounts of hydrocarbons that can be brought to the surface at a profit can be.  Lower selling prices can raise the per unit amount expensed;  higher selling prices can lower the unit amount.  Potentially, lots of operating leverage–that’s completely out of management’s control.

3.  A minor clarification of #2:  subject to some limits, the company decides how to group reserves and associated costs into different “cost pools” for figuring out depreciation and depletion.  Artful grouping of these pools can help disguise an extended run of bad drilling luck.  Not usually a worry, except with small firms with limited history.

4.  As with any other capital construction project, when oil and gas companies explore and develop with borrowed money, they can capitalize (that is, put on the balance sheet rather than expense immediately) the interest expense on that borrowing.  The interest expanse becomes part of the general costs that are written off against oil and gas production.  For smaller companies with an ambitious drilling program, this can sometimes create the peculiar (and potentially disastrous) result that it shows positive earnings while it is suffering cash outflows.  This is because interest is being paid to creditors but these payments basically don’t show up on the income statement.  Check the cash flow statement!!