Energy Finance

Forecasters say Gustav — still a tropical storm this morning as it moved off Jamaica — will likely grow into a major hurricane over deep, warm Gulf of Mexico waters this weekend, and that the center of the storm could reach the U.S. Gulf Coast on Tuesday.

Gustav is forcing shutdowns of some offshore oil operations, causing hikes in global crude prices. Wholesale gasoline prices are rising in the Gulf region, forcing filling stations to raise pump prices ahead of Labor Day weekend.

The Gulf has 4,000 oil rigs and half of America’s refining capacity. Hundreds of offshore workers have already been pulled out and analysts said the storm could send U.S. gas prices back over $4 a gallon.

Merrill Lynch & Co.,  Wachovia Corp., Lehman Brothers Holdings Inc. and other lenders are about to find out how expensive credit has become.

Banks, securities firms and lenders have a record $871 billion of bonds maturing through 2009, according to JPMorgan Chase & Co., at a time when yields are at their most punitive when compared with treasury notes. Increased yields could cost lenders as much as $23 billion more in annual interest versus a year ago, according to Merrill Lynch data.

High refinancing costs will reduce banks’ borrowing flexibillity in the capital markets, which could further reduce both commerical and consumer credit availability, curbing what is already the slowest growing economy since 2001.

As of June 30, Standard & Poor’s has given a negative outlook to almost 50% of the 50 highest-rated financial institutions in the U.S., the biggest slice in 15 years.

Investors are demanding bank-bond yields of 4.14 percentage points more than treasury yields, up from last year’s 0.76 percentage point in January, according to Merrill Lynch data. Spreads on investment-grade rated bonds are averaging about 3.14 percentage points.

Also, bank-to-bank interest-rate derivatives show that banks are becoming hesitant to lend to each other amid the flood of maturing debt.  Banks are charging a premium of 78 basis points more than that predicted by traders for the Fed’s daily effective federal funds rate average during the next three months, up from 24 basis points in January. Some forecasts predict a widening to 85 basis points, or 0.85 percentage point, by mid-December, thus approaching record levels.

Financial firms, which have incurred $504 billion of writedowns and credit losses since the start of 2007, are selling mortgage securities and collateralized debt obligations (CDOs) at fire-sale prices to pay down looming maturities.

For example, last month Merrill Lynch agreed to sell $30.6 billion of CDOs at 20% of face value. Lehman is said to be exploring the sale of all or part of its asset-management business, Neuberger Berman LLC.

Australia’s Queensland state has implemented a ruling to ban shale-oil mining for 20 years, thus blocking a plan by Brisbane-based Queensland Energy Resources Pty. for an oil-sands stripmine to be constructed about six miles away from the nation’s Great Barrier Reef. 

Closely held Queensland Energy was formed in 2004 by U.S. investor Sandefer Capital Partners LP to buy most of the shale-oil assets of Australia’s Southern Pacific Petroleum NL.

The ruling interrupts plans by the E&P, owner of the McFarlane deposit, to dig up about 400,000 tonnes of rock for testing. The company plans to mine more than 1.6 billion barrels of oil from the play during the next 40 years.

Meanwhile, Queensland’s government will spend the next two years researching whether shale oil deposits can be produced in an environmentally acceptable way.

Beyond the land-based effects of stripmining the shale, Queensland officials are concerned that the proposed mine would create as much as 40 million tonnes per year of greenhouse gases.

According to the Queensland Resources Council, a mining industry association, the ruling will erode Queensland’s standing as a destination for exploration investment.

Currently, only one lease exists to mine shale oil in Queensland. That development is near the coast at Gladstone, about 550 kilometers by road from Brisbane.

Elsewhere, Canada’s Pembina Institute, based in Alberta, has also challenged government permits granted to companies with oilsands projects because of the effect on the environment. It is urging the province to slow the pace of oil-sands development.

Two gas traders were sentenced to prison yesterday for reporting false gas trading data to industry publications in order to control gas markets.

Michelle Valencia, a former Dynegy trader, faces a 57-month sentence on seven counts of wire fraud. Greg Singleton, formerly with El Paso Corp., received a 28-month sentence on a single count.

Valencia and Singleton were charged with violating the Commodity Exchange Act by trying to influence gas markets through false price reporting to Platts’ Inside FERC’s Gas Market Report and Natural Gas Intelligence. The data is used in indexes used to calculate the value of gas transactions.

Meanwhile, a Russian court today rejected jailed oil tycoon Mikhail Khodorkovsky’s request for early release from an eight-year sentence for tax evasion and fraud.

Khodorkovsky, who headed the Yukos oil company and was once Russia’s richest man,  has spent almost five years in jail. He was sentenced in 2005 to an eight-year term and has been eligible for parole for the past 10 months.

Khodorkovsky was ineligible for parole because he had refused to undertake professional training at his prison, which specializes in sewing. 

The super-majors dominated the western GOM Lease Sale 207 as interest in deepwater exploration continues to be robust.  Super-majors accounted for over half of all bidding. Lease Sale 207’s $487 million in high bids translates to a record $267 per acre. This was the largest western GOM sale since 1998.

Anadarko Petroleum Co. was the largest bidder among domestic oil and gas firms and was the sixth largest bidder overall. ExxonMobil Corp., BP Plc, Royal Dutch Shell, Chevron Corp., ConocoPhillips and Total SA dominated the sale, accounting for over half of all high bids. With over 130 high bids, ExxonMobil by itself comprised over a third of the total.

Foreign firms were also active, primarily those from Europe. The highest bid belonged to StatoilHydro, which bid $61 million for Alaminos Canyon 380. Bidding by Asian firms was limited. With the exception of Anadarko, Hess Corp., and Devon Energy Corp., independents sat this sale out.

Anadarko was also one of the most active bidders. This time it placed 28 bids (including one listed under Kerr-McGee) for $30 million. Twenty were high bids totalling $20 million. Most of the company’s bidding centered around NW Nansen (EB 558, 602). The company was high bidder on a handful of blocks toward the southwestern corner of the Gulf, which is likely to be prospective for the lower tertiary trend.

There were bids on 319 blocks out of 3,412 up for lease. Typically about 8% to 10% of the blocks up for lease receive bids. The bulk of the bidding occurred in the deepwater, especially around the southwestern corner of Garden Banks. Over 50 companies placed bids.

The next lease sale is Central GOM Lease Sale 208, which is likely to be held in March 2009.

Fear wins the battle but greed will win the war,” says Mark Urness, analyst at Calyon Securities USA, referring to oilfield service stock values. While industry fundamentals remain strong and companies continue to exceed consensus earnings estimates, the recent decline in oil and gas prices has led to panic and fear among investors, he says.

It seems investors are currently ignoring the strong fundamentals and while fundamentals will eventually win, valuations may remain low.  To reflect this, Calyon is reducing its target price-to-earnings multiples across the sector by an average of 1 to 2 multiple points.

“We believe that oil service fundamentals remain highly compelling. The independent E&P companies plan to spend aggressively in North America and the national oil companies have been very aggressive in the Eastern Hemisphere and Latin America. We believe that the visibility is nearly unprecedented and the growth over the next couple of years is pretty much locked in, provided crude oil stays above $80 per barrel and gas above $7 per thousand cubic feet,” he says.

According to Urness, U.S. land rig utilization rates are running at high levels. Offshore rig utilization is around 90% and all the newbuilds are finding work right away. There is still a healthy level of offshore rig building activity with 189 offshore rigs under construction. For every rig that gets delivered, another one gets ordered, says Urness.  Most oilfield service and drilling companies either achieved or exceeded consensus earnings estimates in the second quarter.  Also, Calyon expects E&P capex to grow 20% in 2008 versus an earlier estimate of 12%.

“We expect rig counts, activity and spending to continue to move up despite what the stock market seems to be indicating, which is that it’s all going to come to an abrupt end,” he says. “We believe that the market has been driven by panic, fear, negative sentiment and psychology rather than fundamentals, because fear and panic has pervaded the market as the credit crisis continues.

“When commodity prices decline as rapidly as they have, there is a rush for the exits and many investors aren’t focused on fundamentals or valuations.  We believe that the energy mini-bubble has burst, which will lead to a more healthy market environment with less speculation. Eventually, strong fundamentals will prevail.”

Oil prices rose yesterday as the dollar weakened and investors worried that a predicted fall in gasoline supplies could cause refineries to step up crude use. U.S. crude for September delivery rose $1.66 per barrel to settle at $114.53. Prices were volatile during the day, falling below $112 in the morning, then topping $116 in the afternoon before falling back a bit.

Crude jumped after industry analysts predicted a 3 million barrel decline in gasoline stocks for last week and an increase in refinery utilization of 0.4%. A rise in refinery production would drive up demand for raw crude. A decline in gasoline stocks would indicate that refiners had cut production too much. 

Meanwhile, oil was also pushed higher as weaker U.S. economic reports drove the dollar down against the euro and yen. Oil contracts are traded in dollars, and a lower dollar makes them more affordable for foreign investors.

Also, concerns about the Georgia conflict, causing supply disruptions through a vital pipeline link between Europe and Asia, grew after NATO Secretary-General Jaap de Hoop Scheffer said Russian troops in Georgia were not following a cease-fire agreement brokered Monday.

Also adding to supply concerns were comments by an oil official from Libya who yesterday said oil prices would probably rebound. Libya spokespeople also said the oil cartel was not likely to change production levels when it meets next month. 

Hence, while worries about permanently lessening demand have driven oil prices down from a July 11 record high of $147.27, some analysts say crude’s sharp slide may be nearing an end, bottoming out at around $110 to $112 per barrel, before climbing to a new price plateau.

Yesterday, Barack Obama met with longtime conservationist and oilman T. Boone Pickens. They met to discuss strategies for developing alternative energy.

Obama reportedly praised Pickens as a legendary entrepreneur, and said, “One of the things I think we have to unify the country around is having an intelligent energy policy. … That’s what we’re going to be talking about.”

Pickens is bankrolling a wind energy campaign. A critic of U.S. dependence on oil and a champion of wind power and other alternative energy forms, he has vowed to spend $58 million to promote his “Pickens Plan,” which calls for the U.S. to generate 22% of its power through wind generation and other sources.

Pickens also met with McCain in Colorado last week to discuss his plan.

If Pickens becomes this election’s new Chaney…will be be Dem or GOP? 

The annual U.S. inflation rate soared to 5.6% in July - its highest in 17 years - according to recent reports. Rising inflation could force the Federal Reserve to start raising interest rates.

Interest rate cuts in Europe and a rate hike by the U.S. Fed could help strengthen the already-rising dollar. Rate hikes in the U.S. usually bolster the dollar because higher rates increase returns on dollar-based assets.

Going forward, analysts say that the dollar rally “could have some legs.” In a recent research report, Goldman Sachs analysts, led by Thomas Stolper, say the lows the dollar hit earlier in the year “are almost certainly behind us.”

However, an oil price surge, a decline in U.S. exports, or increasing signs of U.S. economic weakness could derail the dollar’s rebound, Goldman Sachs analysts say. For now, they expect the euro to fall to $1.45 against the dollar over the next three months, and even to $1.40 a year from now.

I don’t know about you, but I’m saving up for some Milan shopping in 2009.

The mood at EnerCom’s oil and gas conference in Denver has been positive, if slightly frustrated, says Jeb Armstrong, analyst at Calyon Securities (USA). With gas prices over $8.00 per million Btu and oil still in triple digits, producers are pulling record profits and unprecedented rates of return. But the energy stock price index has risen only 5% this year and many E&Ps are in negative territory, he says. Undervalued stocks are a bargain, but the timing of recovery is uncertain.

“There continues to be some disagreement over whether oil and gas prices have reached a near-term floor.  Opinions vary from the current level of slightly above $8.00 per million Btu down to $7.00. Widening basis differentials, primarily in the Rockies and to a lesser extent in the Midcontinent, is already impacting the economics of more marginal plays,” he says.

Also, industrial demand for gas, which appeared to evaporate when gas surged to $13.50, may be coming back. The price of gas in the U.S.  is 25% to 40% lower than in much of Asia and Europe, providing the domestic petrochemicals industry a competitive advantage while at same time keeping liquified natural gas imports away.

Meanwhile, Armstrong reports that capital spending plans for this year are not threatened by $8.00 gas and $115 oil. Companies generally stress test the economics of their drilling programs down to $7 to $7.50 gas and $70 to $80 oil.  Mid-year increases in capital budgets are mostly the result of exploration success, rising steel costs and the acceleration of existing and highly economic drilling programs.