Musings In The Oil Patch: Saudi Arabia, Libya And Venezuela

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Includes: BNO, DBO, DNO, DTO, DWT, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, SCO, SZO, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, WTID, WTIU
by: Open Square Capital
Summary

Yesterday, Saudi Arabia guided March 2019 production and export figures lower.

Libyan oil production to remain unstable despite El Sharara field recapture.

Venezuelan production unlikely to recover in 2019 even if Maduro regime falls.

Investing in oil often means nothing happens for days, and then everything (including things you'd never think of) happens within days. The beginning of February is turning out to be one of those times. Here's a few of our musings as the first few weeks of February progress.

On Tuesday, Saudi Arabia, more specifically Saudi Energy Minister Khalid al-Falih, announced that Aramco plans to reduce crude production to 9.8M bpd and exports to 6.9M bpd in March. This follows the back-to-back declines in production and exports in February and January, and reconfirms Saudi Arabia's commitment to aggressively rebalance the market after flooding global inventories in anticipation of the Iranian sanctions.

Couple this reduction with recent declines in Libyan (315K bpd) and Venezuelan (~300K bpd to potentially +700K bpd) production, as well as the participating Non-OPEC+ cuts we're beginning to see, and we're slowly creeping towards the previously feared scenario that began tightening inventories and spiking oil prices last-October (i.e., when Iranian sanctions had the potential to remove 2M bpd of oil supplies from global markets, sparking discussions about $100/barrel oil).

Now we know. We know oil watchers will say that Libyan oil production, driven by the El Sharara field closure, will come back online now that General Khalifa Haftar has gained control of the oil field and plans to transfer control back to the Tripoli (where the internationally recognized government sits) and that Venezuelan production will recover as President Maduro steps down, and the opposition government begins to repair the damage done. Perhaps, but we remain skeptical.

Libya

In Libya, we remain skeptical that General Haftar will willingly relinquish control of >25% of Libya's oil production without significant concessions. In fact, we're skeptical that he will even relinquish control to begin with, as his forces already hold the territory. Why deploy military forces to take control of a quarter of your country's oil production and then hand it over to an internationally recognized authority? Goodwill? Doubtful. If possession is nine-tenths of ownership, then possession by arms even more so. So the question remains what will he ask for and what will Tripoli agree to? Concessions will be made, but more importantly agreeing to those concessions will take time depending on how palatable they are. Certainly they need each other, as the El Sharara field comprises a large portion of Libyan production, and continuing the force majeure shut-in benefits no one. Tripoli needs not just the funding, but also the ability to deliver crude and preserve their relationships with the end-customers. In contrast, General Haftar needs the internationally recognized government (along with the export contacts/contracts) to help him bring oil to market. Regardless of any deal, we believe Libya will enter into a new phase of instability, one where Libya's government in the West will now face a stronger and more emboldened General Haftar for control. For Libya's NOC and the Western-backed government, General Haftar has now become your couch surfing acquaintance, entrenched and hard to move. As the demands increase, and why wouldn't they since he controls the oil, the relationship will become increasingly untenable. So even if a temporary agreement takes hold, we remain doubtful how long it can last.

Venezuela

For Venezuela, increasing production if/when President Maduro's regime falls will depend on capital infusions, both monetary and the human-kind. Monetary infusions (i.e., international and IMF loans) should come quickly if the opposition party takes over. We assume that production stabilizes and returns to the 1.2-1.3M bpd range within a month. Growing production, however, is another matter entirely. First, technically capable oilfield workers, engineers, and geologists will have to be coaxed back to the country, after many have already fled. In addition, investments will take time to ramp as international oil companies will need to see political stability before committing capital. Remember these investors will likely be the same companies that wrote off their Venezuelan investments in the past few years. So just imagine the boardroom conversations to come. Try convincing your board to allow you to commit millions if not billions to Venezuela shortly after a regime change. Tough sell given the lower hanging fruits that are already in your project pipelines, ones that can more easily hit your target IRRs with higher probabilities of success. Moreover, since oil prices are still low, there's even less tolerance for long-term and risky oil investments. Ultimately, we'd anticipate real production recovery to be years out (at the very least until 2020) even if President Maduro were to step-aside today.

Saudi Arabia

Sure we're handicapping the two scenarios above, but it's all a probability based analysis isn't it? Pull the thread and see what happens to oil supplies. For now though, Saudi Arabia is helping you pull. Actually their tugging like the 800lb gorilla. Tanking production and exports is effectively crystallizing either the Libyan outage (if El Sharara restarts) or recent Venezuelan declines (if it recovers to pre-sanction levels) into March. In turn, this also means that we can expect an even tighter oil environment come April and May when the lower exports coincide with higher refinery demand as refiners exit turnaround season. For now, the market doesn't care though. For now, it'll focus on a potential US government shut-down, US/China trade issues, and Brexit, but if we emerge at the end-of-Q1 without the world self-talking its way into a slowdown, this is about to get interesting. Today, the Saudis are daring producers to cover the shortfalls, and that's increasingly more difficult to do. More likely though, after being burned in Q4, they've already decided... let it burn.

As always, we welcome your comments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.