Oil Producer CDS: Bullish and Bearish Factors

One of the truly fascinating things about the market (and by “market” I mean the sum of the equity, fixed income and commodity markets) is that at any given point in time a set of factors can be considered bearish and at another point in time the exact same set of factors can be considered bullish.

The case in point is oil. Last year at this time we were seeing the WTI Crude futures contract trade at over $140/bbl, the USD, represented by the DXY index was trading in the low 70s and we were peering into the abyss.

Oil is trading at about half of last year’s peak but up close to 70% from its lows earlier this year, the DXY is trading at 80+/- down 11% from it’s early March high and yet the equity market is moving higher, albeit in fits and starts with almost every letter in the alphabet being used to describe the shape of it’s recovery.

One of the reasons given for the latest push above the $70/bbl number for crude is a supply disruption in Nigeria as Royal Dutch Shell (RDS.A) said that militants had forced the shut down of a pipeline facility.

At the same time and as a possible counter to the Nigerian issue, Iraq, this week, is planning to auction off contracts to foreign firms to help revive production at six developed fields that are under-producing as a result of the war. With 115BN barrels of proven reserves, Iraq’s supply is thought to be among the worlds largest but production is just 2.4MM/bbls/day when it has been as high as 4MM/bbls/day in the past. At current prices that’s $112MM/day the country is missing out on.

Now before you go shorting the NYMEX contract out the wahzoo understand that there are some issues to be considered. The contracts run for 20 years and are “serviced-based” which means the winners will not be able to count Iraq’s reserves as their own. Additionally, there has been a “request” for $2.6BN in “soft loans” (a little money “under the tent” as it were) from the government to those who should be lucky enough to win the opportunity to invest in a project where suicide bombings occur with the same regularity as the 3:10 to Yuma and a shaky legal structure persists despite three years of debate regarding petroleum resources.

With that said there were about 120 companies that expressed interest in the project and 35 of them qualified to bid including Exxon Mobil (XOM), Royal Dutch Shell, Lukoil (LUKOY.PK) and Sinopec (SNP). All but XOM trade in this country as ADR’s as well as their home exchanges but only XOM and RDS have CDS contracts.

XOM’s CDS levels have come down dramatically from their peak last December 16th of 115bps to a recent low of 36bps on June 3rd and closed at 40bps last night. The stock price has traveled a less smooth road moving off its high, also on 12/16 (unusual because of the positive correlation) to a low of $62.22 on March 5th of this year when the CDS closed at 70bps. Since March the stock moved higher while the CDS moved lower but the most recent high in the stock ($74.05; 6/11/2009) has not been bested during oil’s latest move higher. XOM closed at $70.58 last night and bounced off of what appears to be support at around the $68 level on June 24th.

RDS’s stock price peaked at $59.65 last November 4th just a day after the CDS bottomed at 72bps. There has been a higher degree of positive correlation between the equity and CDS market for RDS as both declined from late last year until late April of this year when they both went their separate ways again. Like XOM, the CDS level has exhibited less volatility and a steadier move lower while the stock also peaked in early June and has yet to regain those highs.

The auctions in Iraq were scheduled for the 29th and 30th of June. We will have to wait to see if a winning bid in the auction results in more bids for the stocks of those in the oil business.

Enjoy the short week.