Tuesday, July 29, 2008

What is Going On in the Oil Markets? OPEC Appears to be in Control

Oil prices are generally very volatile, but this year has been an exceptional roller coaster. What is going on in the oil markets currently? Note that over the long term, oil prices tend to be determined to a greater degree by fundamental factors (supply and demand) verses technical factors (financial speculation). This article will focus on fundamental factors, making the assumption that supply and demand factors fundamentally determine oil prices.

In the author's view, the effective consensus view on oil prices from approximately 2002 onward prior to July, 2008, was that demand would increase significantly going forward, while supply would stagnate, leading to continued high, and even higher, oil prices. The new "market consensus" since the beginning of July 2008, appears to be, in the author's opinon: slightly higher supply (we are finally seeing a supply response) and only slightly higher demand (developed countries' oil consumption will go down, developing countries oil consumption will go up, but at a lower rate). The new consensus appears to imply a slightly higher supply than demand, going forward, resulting in significant downward pressure on the current and future price of oil.

The reassessment since July 2008, has mainly been driven by two new pieces of information, which are being digested -- world supply in the past few months increased, albeit slightly (by approximately 500,000 bpd from a world average production of 86M bpd, also note that exportable oil has so far not shown increases in supply), and total world consumption slowed significantly, driven mainly by consumption declines in the United States (offset by continued consumption in the developing world, mainly China).

It is argued in this article that this new, as of July 2008, "market consensis" is not exactly accurate -- the supply response in 2008 is not a fundamental change regarding future production, due to the fact that all the increased supply in 2008 has been from OPEC countries, who have an interest in relatively high oil prices. But the demand response in 2008 is likely a fundamental change, meaning that world oil demand will likely slow significantly going forward. The new market consensus is therefore close on demand, but off on supply. If supply is actually being effectively controled by OPEC, but demand is moving at a lower rate, the net result will likely be current pressure on the oil price, but a long term, supported reletively high oil price, in line with OPEC's interests (note OPEC has stated that they are comfortable with long oil prices around $100, if over the short term in the $80's).

The risk to the author's view of the current oil situation -- which is can be summed up by the title "OPEC controling prices" -- is a worldwide economic recession and/or a very large conservation movement in both developing and developed countries, that decreases demand to a higher degree than OPEC effectively can cut supply. In this case, the price of oil would decline significantly.

Oil Prices: Dominated by OPEC Currently

There have been notable developments on both the supply side and the demand side in 2008 in the oil markets -- namely, there is a small overall supply increase in total oil and condensate production in 2008, and on the consumption side, most notabily, oil consumption in the overall world has increased only very slightly (under 500,000 barrels per day) -- with a surprising 5% decline in 2008 in the United States, the world's largest oil consumer, for the past three months (May, June and July).

On the supply side, OPEC is engineering this supply increase, by removing all restrictions by members towards oil production by OPEC members in 2008. The removal of OPEC production quotas, (by a senior OPEC official, reference) has not been reported widely in the media. The king of Saudi Arabia stated in July 2008, that he is "very disappointed" by the increase in the price of oil. This move has been initiated by OPEC in order to support the flagging OECD economies by lowering oil prices, and alleviate pressures on the developing world's economies, according to comments by OPEC officials.

Near term supply increases are determined mainly by Saudi Arabia, currently, as the only country with stated high (over 1 million barrels) of unused oil capacity. Saudi Arabia has promised new oil production in 2008 and so far has delivered between 200-500k of new production (depending on the source, different info from governmental sources the EIA and IEA). The key new oil capacity as most of the new announced projects are very old oil fields, from the 1960's. However note, the political will to increase prices by SA down to below $60 is assessed as "very low" as the King of Saudi Arabia, despite the comment above about being "very disappointed" in another July 2008 interview signalled confidence that reletively high oil prices will continue:

"Prices will continue to soar as the economy flourishes because energy is a vital resource in development. Thanks to the Almighty, our region has a strong oil reserve that can meet future demands."

The apparent paradox of King Abdullah wanting to increase production while supporting a reletively higher price of oil can be solved by Abdullahs observation that (from the July 2008 interview) that: "Our enthusiasm to protect the interests of the international community, in terms of oil, is on par with our eagerness to protect national interests."

It should be noted that since about 2005 Saudi Arabia and OPEC have signaled a willingness to act to support signifcantly higher oil prices -- higher than the 1990's normalized levels of $10-$30 per barrel. In 2006, when the price of oil briefly dropped below $50, Saudi Arabia cut back production which was a major factor towards oil prices re-starting their trend upward. Quote from March 26, 2006:

"OPEC's unity may keep oil from dropping below $50 a barrel for years to come, energy experts say.``They've learned their lessons,'' said Daniel Yergin, author of the Pulitzer-winning history of the oil industry, ``The Prize: The Epic Quest for Oil, Money & Power.'' ``They like this band from $50 to $60 and they prefer the upper part of the band rather than the lower part,' `We are happy with the level of compliance,'' Mohamed al- Hamli, president of the Organization of Petroleum Exporting Countries, said in an interview in Bangkok on March 22. (2006)"

Further, OPEC has currently removed all restraints on oil production from all countries. OPEC has lifted all quotas as of early 2008 on OPEC production due to the run up in oil prices which threatens the world economy.

"A senior OPEC delegate said Monday that OPEC ceilings and quotas had become largely irrelevant and that OPEC had a "tacit" understanding that those members capable of boosting crude production should supply as much oil as world oil markets needed."

With OPEC producing all out, we get a very small move up in overall oil production. (which actually can be interpreted as a reason for long term concern in terms of oil productive capacity for the world as a whole over the long term -- does OPEC really have potential for significant future output increases if maximum current output increases total output by less than 1 million barrels?)

Which other countries besides SA can increase oil production and oil exports significantly with a moderate probability over the intermeidate term? Almost without exception, they are OPEC member countries. Of non SA production, the two main countries with the most potential are Iraq -- which is quietly increasing production -- and Iran. Lower probability of future significant increases exist from Brazil, Venezuela, Nigeria, Angola and Kazakhstan -- these total the only countries with moderate probability for potential of significantly higher (over 1 million) of future production increases over the intermediate term. But note, these countries, with the exception of Iraq, Kazakhstan and Brazil are in OPEC -- although both Kazakhstan and Brazil have signaled they are interested in joining OPEC.

Note that non-OPEC production is flat, without significant prospects for increases over the intermediate to long term, according to IEA (International Energy Agency) president Faith Birol. The most notable current development is the fact that Mexican oil production declined at over 30% last year without prospects for reversal of that decline this year (that is to say, is continuing to decline at near 30%) and North Sea production is declining at 20% per year. These moves are offsetting any new production -- from for example, Canada or deepwater Gulf of Mexico.

In summary, overall, on the supply side, the current supply increase is likely a deliberate response by OPEC, and it is likely future supply increases are controlled by OPEC. Going forward, without significant world "demand destruction," it is likely OPEC will continue to move to support a long term, relatively high price of oil.

What is Occurring With Demand? Real Demand Destruction in Developed Countries, Developing Countries Still See Demand Increases

The key question on the consumption side: is it possible that overall consumption of oil can decline going forward? This would require, in the developed world, continued declines year to year. Further, this would require, in the developing world, oil consumption to increase little or not at all. The most obvious solution to lower world oil demand is that recession will lower oil demand in both developed and developing countries. The probability of a collapse in China is beyond the scope of this analysis, as is a "Second Great Depression" in the United States. If the US continues to experience a slight recession while China continues to grow, OPEC would still appear to have the upper hand in determining long term oil prices.

One more "risk" to the above theory, that OPEC controls the intermediate price of oil. Can the world move away from oil use in the intermediate term, without economic impacts? It is noted that demand in the United States dropped by approximately 5% so far in 2008, Denmark's oil demand peaked back in 1998, and Japan's oil demand hasn't moved significantly since the 1980's, despite economic growth there (more specifically, in Japan, economic growth in the 80's, followed by stagnation in the 90's).


- lower oil consumption is related to either 1) lower rate transport of goods and persons and/or 2) more efficient transport of goods and persons. 1) is more correlated with lower economic activity (recession), while 2), efficiency, is more correlated by mass transport -- both Denmark and Japan have very good public transportation. Will both the developing and developed world move massively into public transport? The rate of this increase is also beyond the scope of this analysis, but will be addressed in a future analysis.

Tuesday, July 22, 2008

Gazprom Neft and KazMunaiGas Left Out of the Forbes Global 2000 and the PIW 50?

Both the Forbes Global 2000 and Petroleum Intelligence Weekly 50 do not include either KazMunaiGas or Gazprom Neft in their rankings of the world's largest firms. In future years, as the financial and journalistic community gains knowlendge of these firms, based on the size of these firms reserves and expected production of oil and natural gas, both KazMunaiGas and Gazprom Neft should place in the Forbes and PIW rankings.

Energy firms are very well represented among the largest public firms in the world, according to the Forbes Global 2000, which can be found here: http://en.wikipedia.org/wiki/Forbes_Global_2000#2008_list The Forbes Global 2000 ranks firms in terms of size according to a formula that includes revenues, market capitalization, profitiability and assets, amoung other factors. The Forbes Global 2000 includes 3 private oil firms as of 2008, Exxon, BP and Shell in the top 10. (interestingly, has three banks in the top 3 spots -- with the current lower market capitalization of the financial sector due to the ongoing 2008 credit crisis, it is likely the Forbes 200 2009 version may drop financials from the top three spots). The Forbes Global 200 ranks publicly-held and privately-held firms only.

It should be noted that in the energy world, the largest energy firms are mainly national oil firms -- otherwise known as "NIOCs", 100% owned or partially owned by governments. Saudi Aramco, the national oil company of Saudi Arabia, is by far the largest oil firm in the world, according, to the Petroleum Intelligence Weekly top 50 (PIW 50), which can be found here: http://www.energyintel.com/documentdetail.asp?document_id=218175 Saudi Aramco's #1 ranking in terms of size in the PIW 50 is based on Saudi Arabia's massive size as an oil producer: Saudi Aramco expects to produce over 9M barrels per day of oil and natural gas liquids in 2008, and boasts oil reserves of approximately 250 billion barrels, a full quarter of known conventional oil reserves. In comparison, the privately owned Exxon Mobil produces approximately 3M barrels per day of oil (including natual gas in terms of oil equivalent barrels) and boasts reserves of approximantely 21 Billion barrels, including affliates. From these measures, it is clear that Saudi Aramco is the largest oil firm in the world in terms of energy production.

If the Forbes Global 2000 included both government-owned firms in addition to publicly held firms, it is likely that Saudi Aramco would be number 1 in the Forbes Global 200 list, as it is clearly a larger energy firm than Exxon Mobil.

Other national oil firms also boast very high oil and gas production numbers. The majority stated owned Gazprom -- the equity of which can be purchased as the government only holds a majority share, and the rest trades -- produces approximantely 9.5M barrels per day oil equivalent in natual gas, not counting Gazprom's oil production subsidiary. Oddly, according to Forbes' Global 200 ranking, Gazprom places only 19th in 2006, even through in the energy world it is one of the heavy weights (PIW has been steadily increasing Gazprom's ranking in the top 50).

The relevence of this discussion is the fact that KazMunaiGas and Gazprom Neft are not currently on the radar of either the PIW 50 or the Forbes Gloabl 200. These firms are not very well known in international circles. However, KazMunaiGas boasts very high reserve numbers, as mentioned in the previous article - over 2 Billion barrels of oil equivalent. In comparison, Marthon Oil, which is ranked 34th on the PIW 50, has reserves of approximately 1.2 Billion barrels of oil equivalent. Gazprom Neft also has reserves over 2 billion barrels, and, as argued in both previous articles, both KazMunaiGas and Gazprom Neft and growing rapidly in terms of reserves and production, while most western oil firms are struggling to maintain production. Going forward, it is expected that both KazMunaiGas and Gazprom Neft should gain recognition on both the Forbes Global 2000 and the PIW 50, which should boast investor recognition and probably market capitalization.

Thursday, July 10, 2008

Kazakhstan's Flagship Oil Company "KazMunaiGas" E&P Expected to Significantly Increase Reserves and Production

KazMunaiGas Exploration & Production ("KMG E&P", ticker (GDR) KMG.L) is the publicly held subsidiary of National Company (NC) KazMunaiGas, the national oil and gas company of Kazakhstan. KazMunaiGas E&P went public on both the London Stock Exchange and the Kazakhstan Stock Exchange in 2006, and, at the current date of the writing of this article, has a market capitalization of slightly under $US12Bn (and enterprise value of approximately $US9Bn, with approximately $US3Bn in net cash) and a P/E ratio on market capitalization of approximately 8x. KMG E&P produced approximately 242,000 bpd of oil in the first quarter of 2008, up 26.4% year over year. KMG E&P's proved and probable reserves of oil and gas were approximately 2.1 Billion barrels of oil equivalent at year end 2007, an increase of 43% year over year.

The key question for interested investors is, will the public KazMunaiGas E&P serve as the government of Kazakhstan's main acquisition vehicle for Kazakhstan's domestic oil and gas industry? This question is relevant in that if the answer is "yes," then KMG E&P has a higher probability of being equivalent in Kazakhstan to, for example, Petrobras in Brazil and Gazprom in Russia -- both public, majority state owned oil and gas firms which have increased substantially in market capitalization over the past few years due to their country's large reserves of petroleum wealth. This article will argue that there is a high probability that KazMunaiGaz will be the major acquisition vehicle for onshore Kazakhstan, and has a moderate probability of serving as the main acquisition vehicle for offshore Kazakhstan.

Oil and Gas Potential in Kazakhstan:

The oil and gas potential within Kazakhstan has been well documented -- Kazakhstan contains the second largest area of oil reserves outside of OPEC according to the EIA -- so only a few brief points will be included here. Kazakhstan as a whole has 24 fields according to the EIA with reserves close to 1 billion barrels or more, which are shown at this page at the EIA. Kashagan -- the offshore oil development which has very large reserves (over 20 billion, with close to 9bn barrels estimated recoverable) but has been repeatedly delayed -- and Tengiz -- operated by Chevron -- are largest and the most well known oil fields within Kazakhstan, but there are several other areas of large potential oil and gas reserves within Kazakhstan. Kazakhstan's section of the Caspian Sea is estimated to hold the largest reserves of any country around the Caspian, and the Caspian Sea is estimated to be one of the largest oil reserve regions in the world. Overall, more reserves are estimated to lie in offshore Kazakhstan than onshore, but both areas are expected to produce large volumes of oil. Kazakhstan is not a mature oil producing country by any means, with production only starting up on a large scale in the early 2000's. Historical and projected oil production to 2009 is presented in Figure 1 below.

Source: EIA

In the future, Kazakhstan holds very good potential for new oil and gas discoveries, as Kazakhstan is as large in terms of territory (as large as Western Europe and/or three and a half times the size of Texas), and the country is relatively lightly explored.

Overview of Kazmunaigas E&P:

KazMunaiGas E&P is 61% owned by KazMunaiGas National Oil Company, which, in turn, is 100% owned by the Kazakhstan government. KazMunaiGas National Oil Company (the parent of KMG E&P) was formed in 2002 by the combination of Kazakhoil (Kazakhstan's state owned upstream assets prior to 2002) and NC Oil and Gas Transportation (Kazakhstan's state owned downstream oil assets prior to 2002). KazMunaiGas E&P's ownership structure is potentially somewhat more confusing than, for example, Petrobras' ownership structure, as there is an additional firm between the government ownership and the public oil company. That is to say, Petrobras is directly, 55.7% owned by the government of Brazil, while KazMunaiGas E&P is 60% owned by KazMunaiGas NA which is owned by the government. Currently, there is only one state owned national oil company of Kazakhstan -- KazMunaiGaz NA -- and only one publicly owned, majority state owned national oil Company in Kazakhstan, KazMunaiGaz E&P.

As KazMunaiGaz NA (the parent firm) is well entrenched as the national oil company of Kazakhstan, the one of the main questions for investors -- above stated above -- is the extent to which KazMunaiGaz E&P (the public subsidiary) will own the current and future holdings of KazMunaiGaz NA. KazMunaiGas NA, by law within Kazakhstan, must hold a percentage of all oil and gas projects in Kazakhstan, and therefore future oil and gas reserve growth at the parent level is very likely. There are several indications that KazMunaiGaz E&P will hold a large percentage of future oil and gas fields from the parent company. The evidence for this assertion is presented as follows.

In KazMunaiGaz's investor relations sector of its website, in the May 08 KMG E&P investor presentation titled "Acquisition Strategy Strong Foundation for Future Growth" KMG E&P comes close to outright stating that it will be able to acquire assets with certainty from the parent. The presentation states at the end that KMG E&P will be the "producer and developer onshore" with an "interest offshore" and mentions an "Article 71" in Kazakhstan oil and gas law that states that KMG E&P first rights to "request" to bid on any of the parent's existing or future assets. The language of this Article 71 is taken by the author to encourage but not outright guarantee future transfer of assets from the parent KMG NA to the public KMG E&P.

Further, in the KazMunaiGas E&P's 2007 annual report, the chairman of KMG E&P Uzakbay Karabalin stated that the publicly held KazMunaiGaz E&P is the "flag carrier of the oil industry in Kazakhstan" and indicated that one of its main strategies is to acquire oil and gas properties within Kazakhstan from the parent firm. Further supporting the relationship between the national oil company and KMG E&P, on page 12 of the Annual Report, KMG E&P stated that it has a "strong relationship with its parent company, NC KMG, which gives KMG EP preferential access to onshore assets in Kazakhstan."

KMG NA and KMG E&P have stated that there role model firm is the Norwegian Statoil (ticker STO), which is majority owned by the Norwegian government, but the majority operator of Norway's oil and gas reserves. According to Rice University (large pdf warning) the government's purpose in making KMG E&P public in 2006 was for the government to "realize the value" of KMG's oil onshore assets. As such, this implies a sensitivity to market valuations by Kazakhstan's government for its oil and gas reserves. Also note, that several analysts, including the Economist's Intelligence Unit, have compared KMG E&P with Rosneft -- both went public in 2006 -- and both are majority owned by their respective governments but strong forces in the consolidation of the country's respective oil industries. These factors suggest a large role for KMG E&P in the future oil and gas industries of Kazakhstan.

Kazmunaigas E&P Producing Fields:

KMG E&P mainly holds two major oil fields - Uzenmunaigaz (where the majority of reserves and production occurs) and Embamunaigaz. Over the last year Kazmunaigas E&P has acquired 50% ownership in Karazhanbasmunai and Kazgermunai -- which are both currently relatively minor oil producing regions , but with solid reserves Uzen and Embamunaigaz are both relatively mature production areas, although outlook appears for relatively stable production over through 2013. KMG E&P also acquired two additional oil operations within Kazakhstan in 2007, a 50% share in
Kazgermunai in April and a 50% share in CCEL(Karazhanbasmunai) in December. The impact of of the 2 acquisitions was an increase in production by 25% and an increase in proved and probable reserves of 20%, according to KMG E&P's 2007 annual report.

KMG E&P Potential Acquisitions:

Going forward, KMG E&P has specifically targeted several acquisitions within Kazakhstan, which are explored in this presentation dated May 2008. KMG E&P has targeted a 33% stake in PetroKazakhstan for the second half of 2008. PetroKazakhstan, partially owned by PetroChina, produced approximately 123,000 bpd of oil in 2007.
In the Feb 08 investor presentation, KMG E&P has targeted "Kazakholl Aktobe" which has proven reserves of 275M barrels of oil equivalent, but according to the EIA link above has reserves of a bit more than 1 billion barrels, and is starting up production. Potentially the strongest acquisition target for KMG E&P by production and reserves in the near term is Mangistaumunaigas, which produced 174,000 bpd in 2007, and which, according to the EIA, holds 1.4 billion barrels of recoverable oil equivalent of reserves.

Table 2: Near Term Acquisition Targets for KMG E&P:

Firm Name

Reserves (est)

Production (2007)

KMG E&P Ownership Percentage


1.4 Billion BOE

114,000 bpd


Kazakholl Aktobe

275M BOE

20,000 bpd



550M BOE

144,000 bpd




7,000 bpd


Will KMG E&P Move Into Offshore Projects in the Caspian Sea?

In an interview with CEO Askar Balzhanov of KMG E&P in October 2007 (reference: Kazmunaigas E&P Looks to Tap into Caspian Offshore, NEFTE Compass, October 11, 2007), Balzhanov stated that he is targeting offshore work in the Caspian Sea, and will present this idea formally to KMG NA. Originally KMG E&P was set up to target onshore oil and gas fields in Kazahkstan. Askar Bakzhanov previously was the CEO of the parent KMG NA's offshore oil activities before his appointment to the CEO position of KMG E&P, and knows offshore Kazakhstan's oil fields very well. The acquisition by KMG E&P of the offshore activities of KMG NA would be a natural fit according to Balzhanov.


The main risk for investors is the relationship between the parent company KMG NA and KMG E&P, as discussed above. The risk exists that KMG NA could deny oil and gas projects or even create a completely separate oil and gas company to represent the state's interests in Kazakhstan's oil and gas sector. This risk is partially mitigated by the factors discussed above.

Taxation issues represent another risk to the operating performance of KMG E&P. In early 2008, Kazakhstan issued new oil taxes, which represent approximately 12% of the revenue from oil at $130 per barrel. The taxes were motivated by the government to increase revenues to support Kazakhstan's domestic spending and country credit rating. It is possible, with a downturn in economic activity within Kazakhstan, that the country could continue to increase the tax burden on the oil sector to bring in revenues. This risk is partially mitigated by the fact that Kazakhstan's economy is currently performing strongly, with approximately 8% growth in 2008. Further, Kazakhstan's debt to GDP is a relatively low 14% in 2007.

The third risk is risk of a lower oil price, which is a risk shared by KMG E&P with almost all other upstream oil and gas firms. According to KMG E&P's 2007 Annual Report, the Company does not hedge its exposure to oil and gas prices.


KMG E&P represents the flagship oil firm of Kazakhstan, and, as such, represents a strong long term buy at the current market capitalization of $US12Bn. KMG E&P has made statements that it has a first priority on future onshore oil and gas activities in Kazakhstan, and has a good chance to move into offshore oil and gas projects in the Caspian Sea. As Kazakhstan holds high reserves of oil and gas, KMG E&P will benefit alongside Kazakhstan's oil and gas industry. Risks include political risk, including the risk of a change in the relationship between KMG E&P and the government of Kazakhstan, but this risk is mitigated by the Oil and Gas law of Kazakhstan, which specifically states that KMG E&P has a first right of refusal for oil and gas projects in Kazakhstan, and the stated relationship by KMG E&P and KMG NA management on the close ties between the two companies. Taxation risk is partially mitigated by the relatively strong growth and debt position of Kazakhstan.

Note on Purchasing GDR's by US Citizens:

KMG E&P trades as a GDR in London, and almost all GDR's (Global Depository Receipts) have restrictions on their purchase by individual investors who are US citizens. American institutions can buy GDR's -- and in fact, approximately 9% of the total float of KMG E&P is owned by American institutions. Interested individual American investors in KMG E&P (and other GDR's) are encouraged to ask several brokerages to find one that has the capability to purchase GDR's.