Energy Earnings Arrive

Jim Brown
 
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After a bad two weeks for crude prices we will have earnings to take our focus off oil. Earnings should be decent for producers with WTI near $100 in early February. Next quarter could be a different story.

WTI in the May contract appeared to find support in the $86-$88 range ahead of expiration. The June contract is trading slightly higher at $88.30. For the June contract the $88 level should be support. However, the dollar continues to strengthen and global economics continue to worsen. It could be a rough summer for crude prices.

The WTI continuous contract has strong support at $85. If this is the bottom for the normal spring decline I would be thrilled.

WTI Continuous

Fortunately for BP they have the summer off from the liability trial. The liability portion concluded on Wednesday and judge Barbier gave the parties 60 days to file written briefs detailing their conclusions. He said "There is a huge amount of evidence for the court and parties to consider." That is code for "you better decide now if you want to settle before I reach a decision."

He congratulated the lawyers on all sides in the case saying the quality of "lawyering, professionalism and civility was exemplary. I know I appreciate it. You have made my job easier." The judge will decide the case. There is no jury.

The next phase of the trial begins on September 16th. That portion will focus on what all parties did to try and stop the flow of oil from the time the Horizon sank in April to the permanent seal on Sept 19th. The court will also try and determine how much oil was released into the ocean. The fines under the Clean Water Act will be based on the amount of oil released. The estimate is around 4.5 million barrels.

Unfortunately for BP their problems are still growing. Florida filed suit against BP and cement contractor Halliburton on Friday. The suit faults BP for not keeping up with required maintenance on things like the blowout preventer. The batteries needed to be replaced and may not have had enough power to perform its functions. Halliburton was sued for installing faulty cement that allowed the gas to slip by the well bore and make its way to the rig.

Louisiana and Alabama had previously filed suit and are participating in the liability trial that just ended. Mississippi filed suit last week against BP, Transocean, Anadarko and Halliburton. Atty General Jim Hood said he wanted to settle with BP but the company would nto even agree to waive the statute of limitations while we negotiated. The statute required suits to be filed before the third anniversary, which was Saturday April 20th. Under Mississippi law the state can fine each defendant $25,000 per day and Hood said the clock is still ticking with the bill at $27 million and growing. Hood wants additional cleanup work on areas that were damaged by oil. Of course they want punitive damages as well plus attorney fees, courts costs, etc, etc.

The statute of limitations has seen hundreds of new cases filed in Louisiana the past two weeks and dozens in Mississippi.

In other news BP said it was delaying the start of phase 2 of the Mad Dog project in the Gulf since "the current development plan?is not as attractive as previously modeled, due largely to market conditions and industry inflation." Could it also be due to the enormous liability and costs still growing for BP on the Horizon disaster? Their liability could be growing by $2 billion a month and they don't even know if the judge is going to find them liable for the disaster. I suspect the possibility of a $25 billion damage award on the Clean Water Act is causing them to second guess future spending. Lastly, they may decide to sell existing Gulf projects to raise money and abandon the Gulf for jurisdictions more favorable to BP. Chevron and BHP are partners in Mad Dog so we know who will cough up the development money if BP leaves. However, BP is the largest producer in the Gulf so leaving would be a major step. Thunder Horse, Atlantis and Mad Dog are the biggest producers for BP.

Schlumberger (SLB) posted earnings of $1.01 on Friday and beat estimates by two cents. Revenue rose +7.6% to $10.67 billion. The company said international drilling in Saudi Arabia, Iraq, Australia and China boosted growth and Canada offset declines in the USA. They said global production growth was on track but "the outlook for North America remains uncertain with lower than expected rig activity and continuing price weakness." Schlumberger has a bigger presence in the international market and Baker Hughes has the larger market share in the USA.

Speculators cut net long positions in natural gas by -19% last week. Analysts believe the gains may be coming to an end. That is the first time money managers cut back net long positions since February 19th. Produces raise their net short positions by +4% according to CFTC data. Producers are eager to sell into that price spike over $4.

Iran's oil minister, currently the rotating head of OPEC, said oil production was 1.5 mbpd more than demand and this oversupply was contributing to the decline in prices. OPEC meets in Vienna at the end of May to discuss production. The minister said the market could regain its balance later in the year as refineries come back online from spring maintenance and summer demand returns. Saudi Arabia burns an extra one million barrels a day in the summer to produce electricity for air conditioning.

Deutsche Bank warned that in increase in infections by the bird flu could reduce demand by 1.0 mbpd. The bank factored in the change in demand when SARS hit to come up with that number. The problem with this strain of the flu is that it is no evident in the birds so more people can become infected before anyone knows it is there. Currently the containment protocols have kept it from achieving pandemic status but this strain is just getting started. Researchers claim it has mutated dozens of times in the last month and anything is possible.

Aubrey McClendon, former CEO of Chesapeake Energy had a tiger by the tail and could not turn loose. McClendon had a sweetheart deal with the company where he had the right to a 2.5% interest in every well drilled. This "Founders benefit" may have sounded like a good deal but it was killing him when the price of gas imploded from the 2008 highs.

As part of the deal McClendon had to personally put up 2.5% of the cost and maintenance of each well. His portion of the costs to drill and maintain the wells exceeded $1.3 billion. However, with the drop in gas prices since 2010 he only received $573 million in return. The deficit he had to fund out of his own pocket and through loans and brokerage agreements was $770 million. The company estimates his current stake in those wells is only worth $335 million, which means he will have lost about $335 million in his sweetheart deal. It may have sounded good on paper when gas was $12 but at $3 it was bleeding him dry. When he left Chesapeake at the end of March his severance package was worth $19.3 million but at least he is free from the Founders Benefit upkeep.

The Utica Shale will never be an Eagle Ford. The outlook for the Utica Shale has fallen significantly after numerous wells in the oil window failed to produce commercial quantities of oil. There is plenty of oil there but there is no pressure to bring them to the surface. Acreage sales have fallen flat and prices are way down. Chesapeake just put 94,205 acres up for sale in the oil window. Apparently the gas portion of the play is commercial as CHK just upgraded guidance for year end of 330,000 Mcf per day, an increase of +340% from current levels. Natural gas liquids are also plentiful making gas/liquid wells profitable. The core fairway is going to be drilled but hopes for the outlying sections are fading fast.

Chesapeake has only connected 25% of their completed wells in the Utica. There is a shortage of pipeline infrastructure and gas processing facilities. There are several of these facilities expected to come online later this summer. That will boost gas coming to market from all sources in the play.

Market

The equity markets appear to be in rebound mode. S&P futures are up +7 late Sunday night. The critical support on the S&P at 1540 has held and we could see another move higher as we move into month end. Fund managers are still protecting their Q1 gains ahead of the busiest week of the quarter for earnings.

The energy earnings cycle kicks off strong this week with the most activity of the cycle. All the majors report this week with XOM, COP, CVX, OXY and TOT.

I doubt we will see any new highs on the S&P this week but anything is possible. Once into May all bets are off and stops should be tightened.

Jim Brown

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