Easwaran Kanason

Co - founder of NrgEdge
Last Updated: June 6, 2022
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Business Trends
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At the start of January 2022, Brent crude was trading at nearly US$80/b. At the time, that was considered strong and a better level of pricing for the industry in general. So strong, in fact, that major importing nations were starting to complain. By the end of March, after Russia invaded Ukraine and OPEC+ held fast to its gentle supply easing strategy – Brent was trading at US$104/b, having seen a recent peak of US$123/b on March 8. Over the same time, natural gas prices saw an even larger quantum of increase, driven at first by Europe and East Asia’s competition for spare volumes and then the EU’s choice to wean off Russian gas. Those high prices have been a windfall for all energy companies across the spectrum, with some declaring their best financials ever in Q122. But not everyone is pleased. The backlash is beginning.

To recap, the financial results of the five largest integrated energy companies in the world were actually mixed. On one hand, you had triple digit crude prices boosting revenue and profits against a carefully-cultivated basis of cost discipline inherited since 2015. On the other hand, the public relations nightmare caused by Russia’s invasion of Ukraine led to almost all international energy companies quitting the country. Some of those divestments were huge.

It hit BP the worst. As one of the earliest aggressive investors in Russia post-breakup of the Soviet Union, BP’s stake of nearly 20% in state energy firm Rosneft has long been a benefit to its books. But that position was no longer tenable as of 24 February, with BP being one of the first to announce its retreat from Russia. That led to a US$24 billion write-down, resulting in a net loss of US$20.4 billion. But beyond that headline number, actual fundamentals were sparkling. Its replacement cost profit, BP’s proxy for net profit came in at US$6.2 billion, the highest level in more than a decade. Brushing off the Rosneft loss, BP remains eager to appeal to its old and new generation of shareholders. It maintained its dividend and accelerated share buybacks to US$2.5 billion, while boosting investments in clean energy including a major partnership with ADNOC and the UAE’s Masdar to develop green hydrogen power and technology sites in the UK and the UAE. That balancing act is setting up BP for the future; a review by the Poynter Institute for Media Studies concluded that BP’s investment in low-carbon activities was as high as 20% of total investment, compared to 0.16% for ExxonMobil.

BP’s European supermajor peers also took hits from their Russian exit, though nowhere near the size of the Rosneft loss. Shell announced a comparatively modest US$3.9 billion post-tax impairment. Its Q1 net profit was a stellar US$9.13 billion that was its best quarterly performance ever, as Shell benefited from both high crude prices and its canny trading division – a strategic combo that BP also possesses. And like BP, that paired its Russian exit with a ‘Buy British’ stance by planning to invest US$22.5 billion in UK energy though 2030, Shell also announced similar plans. That would involve a US$33 billion injection in the UK through 2032, appealing to the new home of its headquarters after quitting a complicated dual-home structure between the UK and the Netherlands. That overture may not have worked, but more on that later.

Over the English Channel, TotalEnergies also took a write-down of some US$4 billion to cover its holdings in Russia’s Arctic LNG 2 project. That didn’t stop it from reporting strong net profits of some US$4.9 billion, and matching BP in clean energy ambitions. In Q1 22 alone, TotalEnergies has invested in wind farms off the US East Coast and Poland, acquired the solar power business of California’s SunPower and partnered with Japan’s ENEOS to developed decentralised solar power grids in Asia. And in May, it acquired 50% of America’s fifth largest renewables player Clearway Energy Group, as well as launching a multi-source carbon capture project at Cameron LNG in Louisiana with Sempra, Mitsui and Mitsubishi.

On the other side of the Atlantic, financials were strong as well. Chevron, which has the least exposure of all the supermajors to Russia, saw its net profit nearly quadruple to US$6.5 billion. Its focus on the short-term will heed the Biden administration’s call to increase production, with Chevron pumping 10% more US oil than a year ago in Q1 and planning additional LNG investments. The Russia situation, however, forced ExxonMobil to write off some US$3.4 billion after discontinuing its Sakhalin-1 project in Eastern Russian. Even with that impairment, ExxonMobil’s quarterly net profit tripled to US$8.8 billion after a massive 53% jump in revenue to US$90.5 billion.

After being blindsided by Covid-19, the supermajors and their compatriots are back to bumper profits. And even Chevron and ExxonMobil are starting to plough some of that money back into clean energy projects after rewarding shareholders. At its recent AGM, 98% of Chevron’s shareholders heeded the recommendation of its Board to strengthen its methane emissions measurements. But those high oil and gas prices are wrecking economic havoc beyond the boardrooms, and a fantastic financial quarter has just made the energy industry a bigger target.

Rising energy prices means rising prices across the board. And coupled with wars and droughts curtailing food supply, the world is facing unprecedented levels of inflation in the 21st century. Europe and the USA, in particular, have been hit hard, with European households facing a massive increase in their heating and power bills, while US gasoline prices have hit some US$6 per gallon in some states. Some governments are appealing to their producing industries. The Biden White House is trying to revive mothballed refineries to ease fuels supply but some leaders are pursuing a more aggressive strategy. Italy, for example, decided to increase its oil windfall tax from 10% to 25%, to fund its exit from Russian reliance. Similar rumbles have been seen across European capital, but the biggest salvo has come from the UK, where Chancellor of the Exchequer Rishi Sunak imposed a 25% windfall tax on energy firm profits for an unspecified amount of time. The move could raise as much as US$6.3 billion, which would be channelled to ease a major cost-of-living crisis in the UK.

As a short-term measure, this makes sense. But this does burn up a lot of political goodwill on both sides of the spectrum. On the left, a provision that some of the levy could be avoided by making new investments in UK oil and gas extraction to offset as much of 80% of new capital expenditure breaks a pledge by the host of COP26 to no longer subsidise fossil fuel production. On the right, the industry is predictably not supportive of the measure, warning that it will challenge investment in home-grown energy, especially after BP and Shell’s announcement to pivot to the UK after their Russian exits to accelerate clean energy adoption. And Sunak might not stop there, reportedly planning to target big power generation companies like EDF and RWE with similar measures. But with profits being that high and set to be even higher in Q2, it is difficult for the energy and power industry to do much but grin and bear it. Italy and the UK might be the first, but the world’s energy and food crisis will not be solved anytime soon, and expectations are now high that energy companies must do more to give back to society. 

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OPEC And The Current State of Oil Fundamentals

It was shaping up to yet another dull OPEC+ meeting. Cut and dry. Copy and paste. Rubber-stamping yet another monthly increase in production quotas by 432,000 b/d. Month after month of resisting pressure from the largest economies in the world to accelerate supply easing had inured markets to expectations of swift action by OPEC and its wider brethren in OPEC+.

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The increase will be divided proportionally across OPEC+, as has been since the landmark supply deal in spring 2020. Crucially this includes Russia, where the new quota will be a paper one, since Western sanctions means that any additional Russian crude is unlikely to make it to the market. And that too goes for other members that haven’t even met their previous lower quotas, including Iraq, Angola and Nigeria. The oil ministers know this and the market knows this. Which is why the surprise announcement didn’t budge crude prices by very much at all.

In fact, there are only two countries within OPEC+ that have enough spare capacity to be ramped up quickly. The United Arab Emirates, which was responsible for recent turmoil within the group by arguing for higher quotas should be happy. But it will be a measure of backtracking for the only other country in that position, Saudi Arabia. After publicly stating that it had ‘done all it can for the oil market’ and blaming a lack of refining capacity for high fuel prices, the Kingdom’s change of heart seems to be linked to some external pressure. But it could seemingly resist no more. But that spotlight on the UAE and Saudi Arabia will allow both to wrench some market share, as both countries have been long preparing to increase their production. Abu Dhabi recently made three sizable onshore oil discoveries at Bu Hasa, Onshore Block 3 and the Al Dhafra Petroleum Concession, that adds some 650 million barrels to its reserves, which would help lift the ceiling for oil production from 4 to 5 mmb/d by 2030. Meanwhile, Saudi Aramco is expected to contract over 30 offshore rigs in 2022 alone, targeting the Marjan and Zuluf fields to increase production from 12 to 13 mmb/d by 2027.

The UAE wants to ramp up, certainly. But does Saudi Arabia too? As the dominant power of OPEC, what Saudi Arabia wants it usually gets. The signals all along were that the Kingdom wanted to remain prudent. It is not that it cannot, there is about a million barrels per day of extra production capacity that Saudi Arabia can open up immediately but that it does not want to. Bringing those extra volume on means that spare capacity drops down to critical levels, eliminating options if extra crises emerge. One is already starting up again in Libya, where internal political discord for years has led to an on-off, stop-start rhythm in Libyan crude. If Saudi Arabia uses up all its spare capacity, oil prices could jump even higher if new emergencies emerge with no avenue to tackle them. That the Saudis have given in (slightly) must mean that political pressure is heating up. That the announcement was made at the OPEC+ meeting and not a summit between US and Saudi leaders must mean that a façade of independence must be maintained around the crucial decisions to raise supply quotas.

But that increase is not going to be enough, especially with Russia’s absence. Markets largely shrugged off the announcement, keeping Brent crude at US$120/b levels. Consumption is booming, as the world rushes to enjoy its first summer with a high degree of freedom since Covid-19 hit. Which is why global leaders are looking at other ways to tackle high energy prices and mitigate soaring inflation. In Germany, low-priced monthly public transport are intended to wean drivers off cars. In the UK, a windfall tax on energy companies should yield US$6 billion to be used for insulating consumers. And in the US, Joe Biden has been busy.

With the Permian Basin focusing on fiscal prudence instead of wanton drilling, US shale output has not responded to lucrative oil prices that way it used to. American rig counts are only inching up, with some shale basins even losing rigs. So the White House is trying more creative ways. Though the suggestion of an ‘oil consumer cartel’ as an analogue to OPEC by Italian Prime Minister Mario Draghi is likely dead on arrival, the US is looking to unlock supply and tame fuel prices through other ways. Regular releases from the US Strategic Petroleum Reserve has so far done little to bring prices down, but easing sanctions on Venezuelan crude that could be exported to the US and Europe, as well as working with the refining industry to restart recently idled refineries could. Inflation levels above 8% and gasoline prices at all-time highs could lead to a bloody outcome in this year’s midterm elections, and Joe Biden knows that.

But oil (and natural gas) supply/demand dynamics cannot truly start returning to normal as long as the war in Ukraine rages on. And the far-ranging sanctions impacting Russian energy exports will take even longer to be lifted depending on how the war goes. Yes, some Russian crude is making it to the market. China, for example, has been quietly refilling its petroleum reserves with Russian crude (at a discount, of course). India continues to buy from Moscow, as are smaller nations like Sri Lanka where an economic crisis limits options. Selling the crude is one thing, transporting it is another. With most international insurers blacklisting Russian shippers, Russian oil producers can still turn to local insurance and tankers from the once-derided state tanker firm Sovcomflot PJSC to deliver crude to the few customers they still have.

A 50% hike in OPEC’s monthly supply easing targets might seem like a lot. But it isn’t enough. Especially since actual production will fall short of that quota. The entire OPEC system, and the illusion of control it provides has broken down. Russian oil is still trickling out to global buyers but even if it returned in full, there is still not enough refining capacity to absorb those volumes. Doctors speak of long Covid symptoms in patients, and the world energy complex is experiencing long Covid, now with a touch with geopolitical germs as well. It’ll take a long time to recover, so brace yourselves.

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June, 12 2022