Month of November, 2007

The oil majors who benefit from higher oil prices are seeing their profits erode as the cost to find new reserves increases too. Mind you, those profits are still pretty good! ExxonMobil today a $9.4billion quarterly profit today and BP reported lower quarterly earnings recently.

Funnily enough, the majors continue to buy back shares with their profits rather than invest it in exploration and infrastructure. In our book 'Energy & Environmental Hedge Funds: The New Investment Paradigm' (Wiley, 2006), Peter Fusaro and I pointed at 20-years of under investment and a demand-side surprise from China, India and USA as behind the rise in oil prices. We also noted that the oil majors continued to use more of their earnings to buy back stock than they did on exploring for more of the stuff. It will be the independents and minors who do the exploration, not the majors.

Additionally, I wrote an IssueAlert newsletter article for UtiliPoint International, Inc a couple of years back comparing the major's increased exploration budgets for the year against what commentators saw as necessary to replace reserves...it fell far short.

Everyone knows the theory that rising commodity prices should mean erosion in demand will occur and the price will stabilize and even fall as the supply/demand balance begins to change as a result. For the last 2-3 years, various analysts have been looking for that price effect on oil and other commodity demand. But it hasn’t actually occurred – not yet anyway. In fact, demand for just about all commodities appears to be rising despite increased prices and judging from some of the fundamental data, will continue to do so for some time to come.

The US Dollar

With all the interest in the current oil price I'm wondering why no one wants to give an opinion in our poll? Don't be shy, lets have your views.....

Everyone knows and is aware that China’s growing demand for energy and commodities in general remains a huge fundamental factor in assessing today’s and the future’s energy markets. According to the IEA’s World Energy Outlook 2007, China and India alone will account for 45% of the increase in global primary energy use through 2030 and will account for a disproportionate amount of the increase in coal use which it forecasts will grow by 73% in that period. It also states that “China’s energy needs will continue to grow to fuel its economic development is scarcely in doubt.” The report anticipates China will surpass the United States as the world’s largest energy consumer soon after 2010.

China’s demand is fueled by the rapid urbanization of the country, increasing wealth and access to consumer goods. For example, the IEA estimates that the vehicle fleet will grow 700% and points to strong growth in housing, the use of electric appliances and space heating and cooling in the country. Let’s just list a few other IEA report considerations regarding China to build the picture more completely;

1. China became a net coal importer in the first half of 2007 and coal imports into China will reach 7% of global coal trade by 2030;

2. Conventional Chinese oil production will peak at 9.3mbd in the next decade and oil imports will jump from 3.5mbd in 2006 to 13.1mbd in 2030 (note: Saudi Arabia’s production in 2005 was between 10.5 and 11mbd);

3. It needs to add more than 1300GW to its generation capacity;

Not one to usually get enthusiastic about online games but I just signed up to play this online trading game and wow - is it fun and a very professional site. And its FREE!.

The site resembles an online trading portal and looking at some of the links and information feeds its obviously designed to take players from a game to the real thing with one of the advertisers. But, the advertising is subtle and well done.

You start with $100,000 and basically you trade just like in real life. It feels and looks like a real trading platform with all the feeds, data and real-time prices you could ask for.

All players are of course ranked on their ability to make money and after the end of the trading competition the best trader wins $25,000.

Great fun.

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NRG recently announced that they are going to initiate a carbon capture and sequestration (CCS) project (in cooperation with Powerspan Corp.) at their WA Parish plant in Texas. The project, projected to be online in 2012, will capture a portion of the CO2 in the flue gases from one of the eight units operating at the facility, roughly a million tons per year, or about 5% of the plants total CO2 emissions. They’ll use a process developed by Powerspan that uses ammonia to absorb the CO2, a change from the typical methods employed which use amine.

The carbon capture part of the CCS equation appears to be at hand. What is not solved is the S or the sequestration. As of now, the plant doesn’t really have a home for the captured CO2, although NRG officials are hopeful that one of the ancient oil fields in the area could use the CO2 as part of a tertiary oil recovery project. I’m certain that they have done their homework and are aware of potential candidate fields for CO2 flood; however, these types of projects are extremely expensive and few fields can generate enough incremental production to offset the infrastructure costs associated with CO2 flooding - including new well tubulars/downhole equipment, distribution and gathering pipelines, compression, and the CO2 stripping facilities that will have to be built in order to remove the injected CO2 from the production stream in order to make the products saleable.

The price of crude oil reflects many factors – both fundamental and speculative. Exactly how much of each is anyone’s guess. This last two weeks though has been interesting when looking at the price of oil and the factors at work behind that price. Let’s look at some.

The most common tools of energy commodity risk management, namely Mark to Market (MtM) and Value at Risk (VaR), have become standardized metrics for any shop trading in the market. These metrics have their roots in the financial trading world, have transitioned well to energy commodity trading, and have become the most accepted measures of financial exposure.

For those holding and trading only energy commodities (physical, financial or both), not the production assets, these metrics work well. Mark to Market provides an objective measure of the commodity portfolio's value and VaR provides a measure of the risk associated with that portfolio over an assumed holding period (subject to a set of key assumptions). While other models are available for managing the risk associated with transacting in energy commodities, these are the two that have consistently been deployed in any shop that trades energy. So ubiquitous are these metrics that risk management software is generally defined as a solution that offers position management with MtM and VaR functionality.

Every two weeks Energy Viewpoints will host a number of articles from around the energy bloging world. Come back regularly to check out the articles...

I spoke at Commodities Week in London a few weeks ago. There were many great presentations and topics shared there but of all the presentations the one that interested me the most was by Ed Morse. Ed is Chief Energy Economist with Lehman Brothers and his presentation covered Oil supply and demand. His main thesis was that new refining capacity set to come onstream over the next few years will significantly change the supply side picture by the turn or just after the turn of the decade. In effect, by 2009, refining capacity additions should outpace demand growth by a factor of 2:1 he argued.

In making this assessment, Lehman has been conservative in looking at new refining capacity excluding projected refinery capacity upgrades in politically sensitive areas like Venezuela for example. Additionally, they see some strong political agendas to support the capacity build out that include;

• Saudi Arabia has a strong need to alleviate downstream bottlenecks which has in effect, reduced that country’s control over the oil market;

• Chinese self sufficiency;

• India’s plans to re-position as an export refining hub and its ability to bring the Reliance refinery onstream ahead of schedule; and,

• The need to process heavy oil in situ so as to get it to market more effectively in a number of producing countries.

Join this site and successfully invite a friend to be entered into our February 28th drawing for a free copy of this book by Petr C Fusaro and Gary M Vasey worth $130.

A couple of years ago I recall writing a piece for Energy Hedge about Royalty Trusts. Royalty Trusts were making a comeback as an investment in the sector and increasingly being used as a structure by those in both the midstream and E&P segments of the industry. Some tax law changes by the Canadian government put in slight ding in the attractiveness of the Royalty Trust but they remain popular and there are several hedge funds that focus on them.

I have also commented numerous times about how it is now easier to invest in energy – even commodities – as a result of new instruments and exchange clearing. For those of us that aren’t particularly wealthy but want some energy exposure nonetheless there is now the ETF.
A couple of years ago there were a small number of ETF’s in natural resources, utilities and energy. These Exchange Traded Funds were quite popular but only allowed investors to invest in an equity-oriented fund. Now that has all changed. Today, there are numerous ETFs and they appear to fall into three categories;

• Those that track an equity index;
• Those that track a commodity index; and,
• Those that ostensibly track the commodity itself.