• A House Divided

      March 28, 2012 4:34 PM by Aaron Ball

      Is energy policy dividing the country in the same manner as the divergent commodities and manufacturing economies of the pre-Civil War United States?

      Now, more than ever, lines are being drawn around the fundamental concepts of how to (literally) fuel our economy. States who have placed their land and shores "off limits" to drilling are populated by the same voters who decry American involvement in the Middle East, advocate the use of alternative fuels, complain about the high price of gasoline, and advocate ending so-called tax "breaks" for oil companies.

      Policy aside, these divergent views represent fundamentally different views of the role of government and private enterprise--and the chasm seems to widen every day. A Secretary of Energy whose goal is to drive gasoline prices as high as possible is acting not as a referee in the market, but judge, jury and executioner. The same may be said for an administration for which government, not the market, decides which energy sources will grow through subsidies, while others are saddled with taxes and regulation, with the ultimate goal to drive the fuels of "yesterday" into the ground.

      Even more alarming is that the government led view is simply not supported by facts, but dogma and religious-like zeal matched only by the Taliban. This should be an alarm to all Americans who value the liberty of the free market system, since once government controls energy, it controls the economy.

      Lower gas prices reduce spending, slow production, and bring out problems in poorly constructed legal relationships

      January 13, 2012 3:05 PM by Aaron Ball

      Natural gas stocks are getting hammered.

      Gas prices down to just $2.77 per MMBtu and some analysts predict a fall to $2.50 per MMBtu is possible.

      Add to that the fact that the Marcellus is just about the only area in the country where break-even prices are below $4.00. 

      It’s tough out there from a cash flow perspective, especially for companies who modeled their development on higher gas prices. This means look for reductions in capital expenditures and slowed production. Hopefully, this also means that prices will eventually rise and the market will sort out the problem. 

      However, thinly capitalized companies, with more exposure to short term price swings, might not survive the pain of such an adjustment. This includes many “low cost” producers who charged into the Marcellus on peak prices. 

      From a lawyer’s standpoint, these adjustments, shake outs, or whatever you wish to call them, have a way of bringing forth the flaws in old bargains to produce litigation.  Low-cost producers were attractive a year ago, but some of them, and their counterparties, acted with more expediency than common sense in crafting the legal aspects of their relationship. Unfortunately for those companies, this was a “pay less now versus pay much more later” scenario, with cash flow problems stemming from lower prices compounded by the distraction and expense of litigation.

      It may be time to dust off those contracts.

      Looking to 2012: What are the major challenges occupying the minds of energy company senior executives in today's market?

      December 21, 2011 11:34 AM by Aaron Ball

      A number of challenges, such as changing geopolitical relationships, the emergence of new competitors, changes in supply and demand dynamics, social and environmental pressures, and demographic shifts, are transforming and reshaping the oil and gas industry.

      But there is one indisputable fact that affects not only our industry but the world as a whole: Global demand for energy will continue to increase dramatically, driven in large part by population growth and the strong desire of developing countries to achieve economic prosperity. Experts may disagree about the rate of growth, but there is no dispute that growth in the demand for energy is inevitable.

      For non-NOC executives we have spoken to over the past year, the major challenges are, and will remain:

      (1) Access to resources (reserve replacement),

      (85%). [ISI 2011]

      (2) Cost (finding and development costs per barrel) and availability of services,

      BP ($12/BOE), Shell ($14/BOE) and ExxonMobil ($14/BOE) hold the lowest future development costs per unit of undeveloped reserves. Marathon ($36/BOE), ConocoPhillips ($25/BOE), and Hess ($20/BOE) hold the highest future development costs. [ISI 2011]

      Industry organic finding and development costs were $17/BOE during 2008-2010 which compares to $17/BOE during the previous 5-year period. The result falls to $14/BOE when including reserve additions from oil sands, which were considered mining activities before 2009. Total replacement costs, which include reserve additions from oil sands and acquisitions, were $15/BOE for integrated oils during the period. Organic finding and development costs which exclude the impact of acquisitions and oil sands bookings were best at BP ($9), Shell ($11/BOE), and ExxonMobil ($13/BOE). The highest or worst organic replacement cost performance emanated from Marathon ($29/BOE), Chevron ($25/BOE), and Hess ($21/BOE). [ISI 2011]

      (3) Availability of skilled personnel.

      Global geopolitical forces are creating a highly volatile, rapidly fluctuating crude oil and gas market. Global competition for depleting resources continues to drive the need to lower operating costs and increase finding and recovery rates. The number of skilled resources continues to decline. Shareholders are pressuring companies for a return on their investments that is commensurate with other long-term investment strategies.

      Integrated Oil Performs Well, but what's next?

      November 9, 2011 5:28 PM by Aaron Ball

      While there is definitely a range on performance, profits remain near record levels for "Big Oil" and the larger independents are growing larger. In E&P, both cash on cash returns and production income are up. Current integrated oil financial expectations and valuations are higher than they have been in a decade. Integrated oil companies in particular have outperformed S&P Energy and matched the S&P 500. For example, BP, COP, CVX, and OXY continue to hold strong investment potential.

      ConocoPhillips (COP) is a good example of the current strength of integrated oil companies. COP equity leads its peers over the past few years, and the company appears poised to perform at even higher levels through 2012. COP’s major businesses are both high quality performers and well positioned from a competitive standpoint in their respective markets. COP's balance sheet appears strong with pro-forma dividend yields at 5% and 3% for E&P and R&M.

      Investors will, however, want to avoid/sell under-funded gas focused companies (i.e., those with a poor gas/oil/NGL mix) due to what I consider to be the almost certainty of pain from a future "Marcellus fallout." Under-funded companies with greater gas exposure will find the markets less hospitable for obvious reasons.

      So, in general, things look good for integrated companies and larger independents.

      But what's next?

      Virtually all current global oil demand growth emanates from non-OECD countries, led by Latin America, the Middle-East and Asia in 2011-2012. However, in the short term, even non-OECD demand projections fell in the past few months due to higher fuel prices, and slower economic growth. Chinese oil demand picked up by six percent in August, but was offset by weaker overall global demand. Slow economic growth, lower coal prices, heavy rains (which means lower agricultural demand and increased supply of hydroelectric power) and the release of stored inventory through "destocking" have all contributed to recent demand growth projections. Global oil demand growth is projected to slow to 0.9 and 1.3 MMBPD in 2011-2012. Non-OECD demand growth remains positive but, of course price increases will certainly impact demand in Asia, Latin America, FSU countries and Africa. These non-OECD areas represent approximately 80% of projected global demand growth in 2011-2012. Lower consumption in these countries would be negative for crude oil prices.

      What strategies are best for dealing with these variables? How do companies weather the new challenges that arise every day?

      I would like to hear from you, the reader, with your opinions on prospects for companies considering the current market.

      What are your predictions for 2012?

      A Foreigner'€™s Perspective on Labor in the Brazilian Oil & Gas Industry

      September 28, 2011 10:50 AM by Aaron Ball
      Due to the breakneck speed at which the pre-salt discoveries have fueled growth in Brazil, most companies, Brazilian and foreign alike, know it is difficult to procure all of the skilled labor required for operations.

      The lack of qualified employees owes in part to the historically deficient Brazilian public education system. This system produces few candidates qualified to become petroleum engineers, geologists, geophysics, technicians, etc. As a result, many companies are obliged to create their own training centers to educate employees. Petrobras, for example, established an eleven-month-long training program for newly hired engineers to strengthen their knowledge before releasing them into the field.

      Another solution is outsourcing through the importation of foreign employees. According to the Brazilian Labor Ministry, the number of authorized foreign workers rose 30% in 2010 alone. This number, however, does not mean the skilled labor shortage will be solved anytime soon since demand far exceeds even this dramatic growth. The reason for this is that Brazilian work visas can be a challenge to obtain and procuring permanent visas requires even more lengthy and expensive immigration procedures.

      The burden for an "importer" of foreign labor does not end with the visa process. Foreign workers need to pass through an acculturation program and require relocation support which is extremely burdensome to the hiring company. This, together with the higher salaries paid to skilled oil and gas workers, substantially increases payroll and general operating costs.

      The fun does not stop there.

      Many foreign companies who have experienced light labor regulation in other Latin American countries are often surprised by the relatively onerous and inflexible Brazilian labor laws and the influence of powerful labor unions. The current, protectionist labor laws are derived from the "corporatist" labor code of the fascist government of Benito Mussolini. In fact, the Brazilian labor code is so pro-employee that a collective bargaining agreement may prevail over both the Labor Code and the Constitution if it is more beneficial to the employee. It should be no surprise then, that employee termination is also extremely difficult, with expensive severance provisions common.

      To say Brazilian unions are powerful is a gross understatement. In Brazil, workers automatically "join" a union, defined by the region the worker works in, and his field of work. A worker, by law, must pay dues to that union (one day’s salary per year). In Brazil there are around 18,000 labor unions, all deeply rooted in their respective sectors, with guaranteed dues to fund their operations and enormous political influence.

      This clash of labor culture may make life difficult for foreign companies doing business in Brazil. Those who fail to put this critical element into the mix when developing a plan to enter the Brazilian market, place the success of their entire venture at risk.