Russian Oil

Over the past 5 years or so, Russia has provided roughly 80% of non-OPEC oil production growth. This initially was generated via Citibank research.

That said, Russia’s oil production peaked a few months ago and is now contracting - under the 10 million BPD average production rate of 2007. One can find multiple explanations for the decrease in Russian oil production: aging infrastructure, less Western oil company participation, high tax rates, or depletion rates are catching up with new production.

Here, obviously is a map depicting the various oil producing regions in Russia [old Soviet Union?]

The next table analyses data of proven reserves.

Russian reserves are large, the gap between SPE and Russian reserve accounting systems is growing smaller but also, most (over 80 Gb) Russian ABC1 reserves are in the mature and evermore difficult to develop regions of Western Siberia and the Volga-Urals basin

Some analysis;

What can be seen is that production has been falling due to depletion. The increased production in the data stems from new fields, as opposed to increased recovery, or increased production.

However, most new production from Western Siberia is coming from new fields like the Salym Group.

All three of the Salym fields, which are located in the Khanty-Mansiysk Autonomous Okrug in Western Siberia.

Development and production from Upper Salym has already begun, and Vadelyp production is due to start in 2006. The production from West Salym, the biggest in the Salym group of fields, is expected to peak with at least 120,000 barrels per day by 2009.

This is from J. Robinson West of PFC Energy;

THE RISKS in Russia are large and could mushroom. The impact of the Yukos affair, combined with under-investment and the poor management of the Russian petroleum sector in general, is serious. PFC Energy estimates that Russian production, now 9.3 million BPD, will peak at just over ten million BPD in 2008. Without a huge infusion of capital, technology and management for further exploration and production, Russian production may hit a lower peak and begin declining sooner. Billions will also be needed to expand export capacity. Without a stable legal and operating environment, Russia will fail to meet its production targets. This in turn could damage the Russian economy and the prestige of the Putin Administration.

Reading further into the research, it would seem that almost 100% of Russia’s current increases in production over the last 5yrs have come from one region, the Western Siberia basin in the Khanty-Mansiysk Okrug region.

Data from this region;

The production and increased recovery rates being generated by BP and LUKOIL are being driven via the following methodologies;

waterflood optimisation
hydraulic fractures
idle well recovery
electric submersible pumps (ESP)

The most current developments are found here;

All of these fields should now be producing oil.
Sakhalin 1&2
Vankorskoye
Verkhnechonskoye

Most of the studies and research quote four major threats to Russian production;
*Actual Reserves
*Geographic difficulties [lack of infrastructure]
*Investment
*Political

Certainly Russia under Putin has become increasingly confrontational vis-a-vis the United States, but also with Europe as the recent gas imbroglio can attest.

Russian production was estimated to be circa 9/10 million barrels per day, up until 2010, and then peaking, with the inevitable decline. This decline seemingly, has arrived two years early. Is the decline due to Peak Production, or simply political manouvering to either conserve Russian wealth in the ground [assuming higher prices in the future] or the inability via investment or technological prowess to access the increasingly difficult reserves?

 

Russian oil…

From The Economist;

WHEN the price of oil reached another record on May 6th, of over $122 a barrel, analysts pointed to attacks on pipelines in Nigeria and turmoil in Iraq as the immediate causes. Even small disruptions to supplies from such places can cause the price to jump, since only Saudi Arabia has the capacity to replace the lost production, and it does not seem inclined to do so. But to understand how supplies became so scarce in the first place, one must look at the state of the oil industry in Russia, the world’s second-biggest producer.

Over the past seven years, according to Citibank, Russia accounted for 80% of the growth in oil production outside the Organisation of the Petroleum Exporting Countries. The increase in its output in the early part of the decade matched the growth in demand from China and India almost barrel for barrel. Yet in April, production fell for the fourth month in a row. It is now over 2% below the peak of 9.9m barrels a day (b/d) reached in October last year. Before that, the growth in Russia’s output had been slowing steadily, suggesting that the drop is not a blip. Leonid Fedun, a vice-president of Lukoil, a local oil firm, says Russia’s production will never top 10m b/d. The discovery that Russia can no longer be relied upon to cater to the world’s ever-increasing appetite for oil is naturally helping to propel prices to record levels.

Oil and gas have been the foundation of the regime of Vladimir Putin, Russia’s outgoing president, and are also a preoccupation of his successor, Dmitry Medvedev, who was chairman of Gazprom, the state-controlled gas giant. The flow of petrodollars has created a sense of stability, masked economic woes and given Russia more clout on the world stage. Yet the malaise afflicting its most important industry is almost entirely man-made. “Geologically, there is no problem,” says Anisa Redman, an analyst at HSBC, a bank.

In principle, Russia’s bonanza could continue for years: it has the world’s seventh-biggest oil reserves, at 80 billion barrels, according to BP, a British oil firm. And oilmen reckon there are 100 billion more barrels to find—“the biggest exploration prize in the world”, in the words of Robert Dudley, the boss of TNK-BP, BP’s Russian joint venture. But Russia has regulated the industry so poorly that production is falling despite the soaring oil price.

“Tax is the major impediment,” says Ms Redman. The government levies an export duty of 65% at prices over $25 a barrel. Add to that various corporate, payroll and production taxes, oilmen complain, and the state creams off as much as 92% of profits. Executives at TNK-BP have argued that rising costs across the oil industry will make many investments in Russia unprofitable unless the tax regime is changed. As it is, TNK-BP accounts for a fifth of BP’s production, but only a tenth of its profits.

The government does offer tax breaks on production from older fields. So oil firms, naturally, have been concentrating on squeezing as much oil as they can out of those. Until recently, that was an obvious priority anyway, since fields that had fallen into ruin after the collapse of the Soviet Union in the early 1990s could be revived relatively easily and cheaply. By mapping existing fields more precisely, installing new pumps and injecting water and chemicals into wells to maintain pressure, private oil firms were able to raise Russia’s production from 6m b/d to almost 10m b/d, mainly from western Siberia. In 2003 alone, output jumped by 12%.

But this strategy is now yielding diminishing returns. Mr Fedun says the western Siberian fields have reached their natural limit. To keep production at today’s levels requires ever more investment. To get Russia’s output growing again, firms must make huge investments to develop new fields in remote provinces such as eastern Siberia and the Sakhalin region.

There has been some growth in these areas, mainly thanks to the less heavily taxed projects, called “production-sharing agreements”, that the government offered briefly in the late 1990s but has since curtailed. Strip out the production from these projects, and Russia’s output has been in fitful decline since August 2006, according to analysts at Citibank. Worse, the output from these projects declined last month too. The government’s ill concealed expropriation of various prize assets over the past few years has only added to the reluctance to embark upon big new projects.

Lukoil, for example, is investing $10 billion a year, but roughly 30% of that goes into gas production, which is now more lucrative than oil, given rising domestic prices for gas and lower taxation, says Mr Fedun. It has also been investing in refining, since the export tax on petrol and diesel is lower than that on crude oil. It is still projecting 4% annual growth in its output over the next 15 years, but the figure would be much higher if the government eased the tax burden, says Mr Fedun. Rosneft, the state-controlled oil champion, took on so much debt buying the plum divisions of Yukos, a private firm bankrupted by the Kremlin’s zealous tax collectors, that it has little leeway for expensive new projects. Other firms are hoarding their profits and waiting for the tax regime to change.

The government did provide some $4.5 billion in tax breaks last year. But this, the oil companies argue, is barely enough to keep production stable. In his inaugural speech to the Duma as prime minister on May 8th, Mr Putin said that taxes on the industry must be reduced. However, new fields can take a decade to develop. The Kremlin has also failed to hand out exploration rights in the Arctic—the region oilmen consider most promising. And it says that in future the foreign firms with the expertise to tap offshore fields beneath frozen seas will be limited to minority shareholdings in big projects. “Oil production will be whatever the government decides it to be,” says Mr Fedun.

Meanwhile, Russia today is more dependent on oil and gas than it has ever been, argues Chris Weafer, a long-time Russia watcher and chief strategist at Uralsib, a bank. The share of oil and gas in Russia’s gross domestic product has more than doubled since 1999 and now stands at above 30%, according to the Institute of Economic Analysis, a think-tank. Oil and gas account for 50% of Russian budget revenues and 65% of its exports. Yet the government has put at risk the goose that lays these golden eggs.

 

Peak Oil…further evidence

What does it mean that crude oil is peaking? Essentially it means that the world has used half the oil available to extract and will enter a permanent decline, even as world energy demand is rising, with new economic powerhouses China and India growing at an alarming rate. Peak oil does not mean we are on the verge of running out of oil; the overriding implication is that we are entering a period of relentlessly rising prices and ultimate shortfalls. This is ominous for economies and for individuals facing a seeming perfect storm of hardships financial and otherwise.

The idea that oil companies are somehow ‘to blame’ for record oil prices and rising fuel costs is seductive but absurd. For all their power and profits, the international oil companies are in fact in trouble. They may still be swimming in cash, but no longer in oil. Despite vast investment in exploration and production, these days they generally fail to replace the oil they produce each year with fresh discoveries, or even to maintain current levels of output. Shell’s oil production has been falling for six years, BP’s seems to have peaked 2005, and this week even the mighty Exxon was forced to admit its output dropped 10% in the first quarter of the year.

None of this should come as a surprise since all the evidence now suggests the world is rapidly approaching “peak oil”, the point when global oil production goes into terminal decline for fundamental geological reasons. Annual discovery of oil has been falling for over forty years, and now for every barrel we find we consume three. Oil production is already shrinking in 60 of the world’s 98 oil producing countries – including Britain, where output peaked in 1999 and has already plunged by more than half. When an individual country peaks it only matters for that country – Britain became a net importer of oil in 2006 – but when global supply starts to shrink the effects could be ruinous for everybody.

Saudi Arabia, the swing producer, the single most important producer of oil via ARAMCO a private company. Their fields, super-giants have been for decades over-produced. The reality is now becoming increasingly difficult to hide.

Production is dropping precipitously. With oil prices where they are, and have been for a while now, should the theory of “plenty of oil left in the ground” be true, now would be the time to capitalise some of it surely?

As can be seen revenues from the high prices are delicious. The problem is that Revenues are quite flat compared to what they could be, had production remained constant. The fact is that for a variety of reasons, Saudi fields were overproduced in earlier decades, and they are now paying the price [and so are we]

Even with the advancements in drilling technology claimed by Saudi ARAMCO, the water cut is a major problem, and this type of problem trends from good to bad.

 

Oil…news just gets worse

The oil story continues to deteriorate;

Declining production rates coupled with spiraling industry-related inflation curbing real investment could not come at a worse time. The IEA now expects global demand growth for crude oil to rise 2.0% in 2008, that despite a slowdown in the U.S. The following figure below shows that Asia’s 2008 demand growth exceeds the demand decline in North America by an 8.8 ratio, indicating Asia’s is consuming 8.8 barrels more for every one barrel less coming from North America. What is also astonishing is the rapid growth in oil consumption in the Middle East, with the Middle East consuming more than four barrels for every one barrel decline in North American consumption

The Middle east is also one of the largest investors in alternative energy. Now, when the worlds marginal oil producer sets this course…what should that imply to the rest of the world?

France, is energy independent.

Thats right, the damn Frenchies have broken the OPEC cartel monopoly and are energy independent, basing their supply on reuseable nuclear fuel. As soon as the electric car, or whatever is next, the French will be out from under the rock.

 

Oil Production

Oil prices have increased, foxing even Mr T.Boone Pickens. Common wisdom dictates that in a recession, consumption falls, to date that has not been the case.

Production levels are part of the problem, and this ties directly into peak oil.

As can be seen, production is static, even falling in key areas, in the face of record prices, even after adjusting for inflation.

Under normal circumstances, the rogue states, Nigeria, Russia, and Venezula, amongst others, due to their cash starved governments tend to increase production when prices are high, to capitalize the windfall profits.

Their greed however, has done them in. By increasing their tax rates, seizing control of assets, and generally being short-term in their outlook, they now find themselves in the interesting position of having overproduced their existing fields, and lacking the expertise and cash to bring on line potential new fields.

Some examples from J.Jubak;

Russia’s older west Siberian fields are in decline, following the path of such fields as the North Sea. Russia has promising fields in eastern Siberia, but developing those is expensive. The fields are hundreds of miles from anywhere, making it costly to get workers and equipment to the fields and then support them in one of the world’s more hostile climates. And then there’s the additional cost of getting the oil and natural gas from remote wellheads to market.

How expensive is expensive? Leonid Fedun, the vice president of Lukoil (LUKOY, news, msgs), Russia’s largest independent oil company, recently estimated that Russia needs to invest $1 trillion over the next 20 years to keep production in the range of 8.5 million to 9 million barrels a day.

It’s never easy to find $1 trillion in investment capital, but the Russian government has made it hard for its oil industry to attract even a small part of that capital. The Kremlin has structured taxes so that most of the extraordinary rise in oil prices flows into government coffers, not oil-company profits.

When oil rises above $27 a barrel, the Russian government takes 80% of any additional revenue in taxes. That means at $67 a barrel, an oil company gets just $8 more a barrel in revenue than at $27. If the price climbs to $107 a barrel, the oil company’s revenue increases by just $16 a barrel from what it was at $27 a barrel.

In Nigeria, a third of the country’s oil output by 2015 is at risk, energy advisers to Nigerian President Umaru Yar’Adua have warned, because the government hasn’t been paying its share of the costs of joint ventures — about $3 billion to date — with Royal Dutch Shell (RDS.A, news, msgs), ExxonMobil (XOM, news, msgs), and Chevron (CVX, news, msgs). If the government’s failure to pay jeopardizes the joint ventures, Nigeria can kiss plans to double its production goodbye. Instead, total oil and gas production will fall 30% by 2015.

Where has the money gone that was supposed to go into the joint ventures? It’s in the pockets of just about any Nigerian government official with any clout.

Mexico faces a similar shortfall in investment capital. The country’s massive Cantarell oil field in the Gulf of Mexico is dying. Production fell 12% in 2006 and 18% more in 2007, according to data from the national Energy Ministry.

Mexico’s total oil production, which peaked at 3.4 million barrels a day in 2004, fell to 3.08 million barrels a day in 2007. If trends continue, Mexico, the fifth-largest oil exporter in the world, exporting 1.9 million barrels a day, could become a net oil importer within 10 to 20 years.

Mexico does have ways to replace this production, but it will take money and technology. Developing the massive Chicontepec onshore field in eastern Mexico will require drilling 13,500 to 20,000 wells at a cost of $30 billion to $38 billion over the next 15 years, according to Pemex, the Mexican national oil company, because the oil occurs in isolated pockets

In the meantime, China, and increasingly India, continue to require ever increasing amounts of an increasingly limited resource.

 

Alon Energy [ALJ]

Alon Energy is a potential investment opportunity within the Oil Refining industry, which was highlighted as an industry that potentially had some longer term macro-fundamentals working in their favour. This is just a preliminary fact finding post, the in depth analysis will be posted later.

I particularly like the fact that Alon processes sour & heavy crude.
Also, the diversity within the business; refining & marketing, asphalt & retail.

Alon USA Energy, Inc. is an independent refiner and marketer of petroleum products operating primarily in the Southwestern and South Central regions of the United States. The Company’s business consists of three segments: refining and marketing, asphalt and retail. In the refining and marketing business, Alon owns and operates four sour and heavy crude oil refineries are located in Texas, California and Oregon and have a combined throughput capacity of approximately 170,000 barrels per day (bpd). It refines gasoline, diesel fuel, petrochemical feedstocks, asphalt and specialty blended asphalts. Alon primarily markets gasoline and diesel under the FINA brand name at approximately 1,200 locations. In the retail segment, the Company operates 206 branded 7-Eleven convenience stores in West Texas and New Mexico, which offer merchandize, food products and motor fuels under the 7-Eleven and FINA brand names. Substantially all of the fuel sold by these stores is produced by Alon’s refinery.

Financial Highlights
Sales 4.32 Bil
Income 165.78 Mil
Net Profit Margin 4.06%
Return on Equity 47.05%
Debt/Equity Ratio 1.26
Revenue/Share 92.26
Earnings/Share 3.54
Book Value/Share 9.17
Dividend Rate 0.16
Payout Ratio 5.00%

Beta 1.78
Dividend & Yield 0.16 (0.98%)
Earnings/Share 3.54
Forward P/E 6.60
Market Cap. 718.04 Mil
P/E 4.40
Return on Equity 47.05
Total Shares Out. 46.81 Mil

So far so good.

 

Oil

Peak oil is seemingly a fact that if not already arrived, certainly not too far off. With increasing world demand, primarily from China, the price of oil is also seemingly set to rise.

Projected demand;

The useage that oil is currently put to use broken down by %

What are the reserves?

The chart indicates that the vast majority of the proven reserves lie in Saudi Arabia.
Saudi Arabia has for some 40yrs been considered the marginal or swing producer.
There has also been much speculation as to the veracity of their [Saudi Arabia] claimed reserves.

Why is this?
Due to their secretive, closed shop approach to the international oil community.

World production figures tell an interesting story;

We can see that Saudi Arabian production has been in decline for three years now.
There is some very interesting research that would account for this fall-off in production.

This first picture was actually generated by Aramco;

The highlighted section illustrates this larger, more detailed image;

Here we see the massive depletion in the centre picture, compared and contrasted to the original oil levels on the far left. The far right picture adds gas caps, which further reduce the recoverable oil.

Quite scary, but consistent with the falling production, and further announced production cuts.Thus if you accept that Saudi Arabia is misleading the oil community with regard to proven reserves, oil could become an interesting investment opportunity.

Let’s look at US Refining capacity [oil to gasoline]

We see that US capacity has fallen from a peak.
This is due to the extreme age of the refineries, and investment required via CapEx to bring back capacity, and the lack of any new refining capacity.

US gasoline demand however is constant/growing;

Thus, are the current refiners an investment opportunity?
According to Ford Equity Research, the answer is yes.

An index composite of seven refiners is shown below using Ford Equity Research’s Custom Graphs. The figure below shows the index plotted in the top clip against their 5-year price-to-earnings (PE) band, with price-to-earnings to growth ratio (PEG) shown lower clip. The index of the seven refiners shows the group is near the 5-year PE low and the PEG ratio of 1.22 is currently one standard deviation below its 5-year average of 1.55, indicating the group remains an attractive investment.

I will have a look in detail of a possible candidate[s] in a later post.