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Market Update: Oil & Gas - July 2017

Market Update: Oil & Gas - July 2017

A closer look at Asian middle distillate storage markets and private equity in exploration & production.


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Tightening in Asian Middle Distillate Storage Markets

The current low crude oil price environment, in conjunction with the response from Asia's refineries, has bolstered refined product inventories. In contrast, strong buying interest from India, combined with tighter Chinese export quotas has seen a short-term jump in demand in South East Asia. With the above market conditions reflected in the middle distillates forward curve, the recent sustained backwardation has become more pronounced.

Many traders have responded by moving their volumes out of landed storage tanks, as the spreads have been overtaken by their inability to recoup their storage costs.

This comes at a time when alternative storage options are being considered: the trend of traders using oil tankers due to their relatively low cost (as a result of the compression in freight rates) and intrinsic flexibility.

With many traders contemplating reducing the storage lease volumes/tenors, or not renewing their storage contracts, tank owners and operators are likely to continue to face downside pressure on storage rentals rates. With the negative carry in the forward curve, tanking companies, especially those who have recently completed new storage projects in the Singapore-Malaysian Straits, will need to carefully manage their funding arrangements, to avoid running out of cash in a funding environment that is still cautious of oil-linked industries.

- Oliver Hsieh, Director, Commodity & Energy Risk Management, KPMG in Singapore

Private equity in exploration and production

The first half of 2017 has seen a boom in exploration and production (E&P) deal activity, with M&A spend reaching levels not seen in recent years, with a general view in the market place that assets are being picked up by the right buyers; with challenging assets moving to specialist operators in the North Sea, and oil sands moving to companies with specific technical expertise in the US. Private Equity (PE) has played an important role in re-igniting this deal activity, providing the much needed competitive tension, and innovative deal structures, which has helped to close the buyer and seller expectation gap, and deliver the finance needed to ensure deals are done.

“Within the North Sea specifically, we have seen the market has started to understand the attraction of E&P to Private Equity, and therefore we have recently seen PE succeed in a number of deals, most notably Shell's $3.8billion sale of their North Sea package of assets. PE's approach into E&P appears to be less about the high leverage, cost cutting and quick exit model that they often used in other industries. It is more of a longer term bolt-on model to build balanced, complimentary portfolios of assets and strategic plays, with cash extracted through exit rather than in the `ownership' years. During 2016, we saw over $60 billion of equity capital raised for natural resource deals across 74 funds, and this alongside the longer term build and buy strategy suggests that PE will be around, at least in natural resources, for many years to come.”

- Natalie Wansbury, Director, Oil & Gas Practice, KPMG in the UK

The Australian Response to the Paris Agreement and its Energy Future

Australia is fully committed to the Paris Agreement climate accord, however like the USA and other countries, Australia is struggling to agree how to best meet these targets. Pressure is increasing on the Federal Government to prioritise jobs and industrial growth for Australia, over non-binding international targets, now that the USA has publicly withdrawn. At the time of the Paris accord, Australia’s Energy and Environment Minister Josh Frydenberg stated “We reiterate our full commitment to the Paris Accord…We believe that the targets we agreed to, the 26% to 28% reduction in emissions by 2030 on 2005 levels are reasonable, are achievable.”

For Australia to deliver sustainable environmental results a structural change needs to occur to our energy policy. One of the steps in this process has been the commissioning of an independent review by Australia’s Chief Scientist, Dr Alan Finkel. Dr Finkel has produced a report titled “Blueprint for the Future: Independent Review into the Future Security of the National Electricity Market” on June 9 2017. The Australian Federal Government has endorsed 49 of the 50 recommendations, stopping short of agreeing to the 50th recommendation - a Clean Energy Target. This Clean Energy Target is seen to be the foundation to addressing the triple challenge of providing reliable and affordable energy while meeting Australia’s emissions targets.

In terms of supply, Finkel makes recommendations specifically with regard to gas, which have been broadly supported by the Australian upstream community. State and territory governments are urged to lift the current moratoria on unconventional gas exploration and development. This will provide opportunities for multiple stakeholders, gas producers to develop accessible Australian resources close to market, land owners given the opportunity to benefit from agreeing access rights and fair compensation, and end users benefit from a larger domestic supply. The Finkel Review recommendations have also been supported by industry leaders such as Peter Coleman, CEO Woodside, who has stated “Only by ¬rewarding the states that encouraged companies to develop untapped resources could the country ensure it had appropriate access to cheap gas reserves”.

Similar issues related to onshore gas development are being experienced across the globe. Many sovereign nation states, all on similar but different journeys, are each impacted differently by technology developments in this area. The USA is furthest progressed on the domestic production of shale, with few issues from landowners who are well compensated, but frequent issues with environmental groups and those who feel they are impacted by these developing industries. The UK is progressing its fracking program with mixed public responses, as are countries across mainland Europe. China is beginning a vast onshore fracking program, with less public dissent. Across the globe, progress is being made to increase the production of gas and confirm its position in the global ‘energy mix’ as a lower carbon fossil fuel it is a vital part of the solution to fulfilling the promises of the Paris Agreement.

So back to Finkel….Ted Surette, KPMG Australia’s Energy & Natural Resources Leader stated “The Finkel Report is being lauded as a ‘once in a generation’ energy review. If implemented well, it has the potential to bring value to consumers, enable security/reliability and meet our emission obligations. All stakeholders need to take time to understand the blueprint’s recommendations and its implications. Let’s not waste this opportunity. This is not a report that can go on the shelf”

So for Australia the debate continues.

- Jonathon Peacock, National Oil & Gas Leader, KPMG in Australia

Analyst estimates: oil

  2017 2018 2019 2020
Min 45.1 53.1
Average 55.4
Median 56.0 58.8
Max 64.9 80.0 80.0 80.0
  2017 2018 2019 2020
May Avg 57.1 63.3
June Avg 55.4
May Median 56.8
June Median 56.0 58.8 65.0 70.0

Analyst estimates: gas

  2017 2018 2019 2020
Min 2.5 2.8 2.9 2.9
Average 3.2 3.2 3.2 3.3
Median 3.2 3.1 3.2 3.3
Max 3.4 3.7 3.5 3.5
  2017 2018 2019 2020
May Avg 3.2 3.2 3.3 3.5
June Avg 3.2 3.2 3.2 3.3
May Median 3.2 3.1 3.2 3.3
June Median 3.2 3.1 3.2 3.3

Note: The forecasts/analyst estimates identified are an indication based on third party sources and information. They do not represent the views of KPMG.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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