Isaac Restart, Iran, BPT and Gas Prices

Jim Brown
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The restart of production in the Gulf is well underway with personnel now working on 377 of the 596 production platforms that were evacuated.

It will take several days for full production to resume because every link in the production chain must be inspected and then restarted. For the Gulf platforms that means a thorough inspection of the platform, inspection of the pipelines through which the oil and gas will flow to shore, the inspection and restart of the oil and gas processing plants and the pipelines from those plants to the main transmission systems. One problem in any of those components and the entire process remains offline. The inspection of the pipeline system is the most time consuming. Some storms can create underwater mudslides and create havoc with the pipeline system. Hurricane Ike was a storm that caused pipeline damage without a lot of damage to the platform system.

BSEE officials estimate that 94% of oil and 65% of gas production remains offline but is in the startup process. It will take 3-5 days for full production to resume. There are no reports of any major damage.

19 of the Gulf's 76 drilling rigs were still evacuated as of Saturday morning simply because of lack of available transport for the thousands of personnel heading back to offshore locations.

Crude prices rallied $2 on Friday as a result of the drop in the dollar after Bernanke seemed to indicate the Fed would add stimulus when it meets in two weeks. Now that the Labor Day driving is over and demand for fuel will decline the price of oil and gasoline should decline.

However, the headlines this weekend are again full of comments from Israeli officials and leaders from Iran. The IAEA said last week that Iran had stepped up production of highly enriched uranium at the underground Fordo facility. The IAEA said Iran had doubled the number of centrifuges at the Fordo site to more than 2,100. The site is underground and protected by 300 feet of rock. The Fordo machines are producing higher levels of enrichment compared to the more than 10,000 centrifuges at other Iranian sites that process to lower levels of enrichment.

Iran also caused new hostility at the IAEA when they covered the nuclear test building at the Parchin military base with pink tenting to keep spy satellites from seeing the reconstruction or destruction underneath. They have already razed two buildings here and completely removed any signs they were there. The scaffolding under the tarps suggests this tenting was built up over the building to hide any destruction until it is too late.

Parchin Test Site

A lot of investors like to own royalty trusts and master limited partnerships because of their high dividends and tax treatments. The grand daddy of them all is the Prudhoe Bay Royalty Trust (BPT) that was set up by BP in 1989. Owners of the trust are paid a 16.4246% royalty interest in the sale of up to 90,000 bpd of crude oil and condensate produced from the trust. The trust pays a 8% dividend.

At the end of 2011 the trust was estimated to hold 82.3 million barrels of oil and condensate. Estimated future revenues to the trust were $2.46 billion. Royalty payments were expected to continue through 2027 and then end.

The WSJ posted an article a week ago suggesting BPT and several other trusts were overvalued because investor demand for the shares had pushed the price well above the discounted value of the payment stream. Basically due to demand a trust share price may have been $50 when the expected royalties were only $30. If you held this example to maturity you would lose $20.

BPT was trading at $120 when the article was released and it fell to $76 over the next eight days. The WSJ said investors don't understand the trusts are depleting assets. They have a fixed amount of income and once the reserves are gone they will cease to exist. The increased share price was the equivalent of someone selling a $20 loan with payment terms of $1 per month for a year. You would not find a lot of investors willing to buy under those terms.

The BPT has rebounded to $88.50 and a market cap of $2 billion. However, the discounted payment stream allocated to the trust is only $1.43 billion today. Granted, oil prices can and probably will go up and increase the value of the payments over the next 15 years.

The article cost investors millions of dollars in a week and those investors probably would not have been the ones still owning the stock 15 years from now. It is unfortunate but it is a fact of life. When searching for maximum dividend yields you have to consider the fundamentals of the underlying entity.

BPT Chart - Weekly

The rig classification sector took a hit last week after a Reuters report analyzing their methods was published. The company in question was Smith Bits, a subsidiary of Schlumberger. Smith and Baker Hughes tabulate and publish rig data each week that is broken down by oil rigs and gas rigs. The report found that many of the rigs are misclassified. This is not a malicious error but one that is made more difficult by the horizontal drilling in the shale fields.

One group of 21 rigs run by Chesapeake in the Granite Wash Basin in Oklahoma was highlighted. The company applies for permits for oil/gas exploration. In some instances Smith and BHI rely on the permit applications to determine the rig type. In the case of Chesapeake, Smith Bits classed them as gas rigs because of the area they were drilling. A week later Smith changed their mind and classified them as oil rigs. This is important because of the weekly change in number of total rigs drilling for oil and gas. Analysts use those numbers to project future production. The reclassification was applied to 78 gas rigs that week. This would tell analysts there was a significant decline in active gas rigs and they would lower their estimates for future gas production and raise estimates on gas prices.

In practice the rigs did not move and nothing changed. Later when Chesapeake began reporting production results from the first Granite Wash well of 7.3 Mmcf and 314 bpd for a single well the classification of those 21 rigs were switched back to natural gas. For that week the rig report would have shown a decline of 21 oil rigs and an increase of 21 gas rigs even though there was no change on rig location.

Smith and BHI claim the mixed composition of shale wells makes it hard to accurately classify rigs before they drill. Shale fields can have multiple layers of gas, oil and condensate all stacked on top of each other. How the driller completes the well eventually determines the actual production. Some wells produce all three products. A well producing 50% gas, 20% NGLs and 30% oil could be considered an oil well because oil would be the biggest revenue for the hole.

Another problem for analysts trying to project production based on initial rig classification is that one gas rig in the Haynesville can produce as much gas as 50 wells in the Permian, according to Adarn Bedard a production tracker. He said there was an illusion that gas production was going to decline this fall due to a declining rig count for gas. He believes that is an incorrect assumption.

Baker Hughes defended their rig count methods saying they were closer to the source and depended on reports from the field for the majority of their data. BHI shares did decline -$3 on the news.

Natural Gas Chart

Jim Brown

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