OGJ Newsletter

April 12, 2004
As the Organization of Petroleum Exporting Countries' production quota reduction to 23.5 million b/d went in effect Apr. 1, Jefferies & Co. Inc. in New York raised its price forecasts for benchmark US crude to $31.25/bbl from $28/bbl for 2004 and to $28/bbl from $26/bbl for 2005.

Market Movement

Higher oil prices forecast

As the Organization of Petroleum Exporting Countries' production quota reduction to 23.5 million b/d went in effect Apr. 1, Jefferies & Co. Inc. in New York raised its price forecasts for benchmark US crude to $31.25/bbl from $28/bbl for 2004 and to $28/bbl from $26/bbl for 2005.

"Increasing global oil demand combined with OPEC's continued discipline—even with Iraq production ramping up and former Soviet Union oil production also rising—should provide a solid underpinning for oil prices for the foreseeable future," said Jefferies analyst Stephen D. Gengaro.

Gengaro expects world demand for oil to increase by 1.7 million b/d to 80.2 million b/d in 2004 and by another 1.6 million b/d in 2005, on top of an increase of 1.6 million b/d, or 2.1%, in 2003. "Based on current expectations for oil demand growth and non-OPEC supply, the call on OPEC crude appears to be down slightly in 2004 to 25.9 million b/d from 26.1 million [b/d] in 2003, but it should advance to at least 26.6 million b/d in 2005," Gengaro said.

Other factors that recently prompted several financial analysts to hike oil price forecasts include OPEC's limited excess production capacity, moderate-to-low commercial inventories of crude among member countries of the Organization for Economic Cooperation and Development, and what Gengaro described as "the positive implications of the weak US dollar."

Devaluation of the dollar "has two positive implications for crude prices: high crude oil prices do not appear nearly as high in the countries that are most price-sensitive, which has helped mitigate any potential demand destruction; and OPEC countries need high crude oil prices in US dollar terms to support their economies," he said.

Despite recent additions, commercial US inventories of crude remained relatively low, up only 4.9% from year-ago levels but 1.4% below the 5-year average as of Mar. 26. "However, adding in the US Strategic Petroleum Reserve, total [US] inventories are 7.4% above last year and 7.9% higher than the 5-year average—by no means high, but hardly supportive of $35-plus [West Texas Intermediate] prices. OECD inventory levels are essentially in line with historical norms," said Gengaro.

"We do expect [WTI] spot crude oil prices to retreat a bit more to close to $30/bbl by midyear as US crude stocks continue to build," Robert S. Morris at Banc of America Securities LLC, New York, reported Apr. 5. "The 2004 consensus outlook for WTI spot crude oil prices has increased to roughly $29.50/bbl from $27.62/bbl at the beginning of March," he said, "still below our full-year projection of $32/bbl."

The US Energy Information Administration on Apr. 7 reported a drop of 2.1 million bbl in US commercial crude inventories to 292.2 million bbl during the week ended Apr. 2. US gasoline stocks fell by 800,000 bbl to 200.1 million bbl, while distillate inventories plunged by 4.5 million bbl to 105.2 million bbl during the same period.

Meanwhile, armed resistance to US-led coalition troops in Iraq escalated in early April, with both Sunni and Shiite Muslims participating in what was described as the heaviest fighting since Baghdad fell a year ago. "The situation within Iraq has deteriorated significantly," said Paul Horsnell, head of energy research at Barclays Capital Inc., London, in an Apr. 7 report. "Iraqi oil output has been taken beyond sustainable levels and will slip back, andUrisks of more-serious outcomes appear to be growing," he said.

Refining margins

Meanwhile, Prudential Equity Group LLC, New York, raised its average US refining margin forecast for 2004 to $6.45/bbl from $5.35/bbl. "We expect margins to contract from their current level of $10.87/bbl," said Prudential analyst Andrew F. Rosenfeld. That increase reflects "high first quarter margins and, to a much lesser extent, our expectations for a slightly better-than-expected operating environment for the remainder of the year," Rosenfeld said. "Our US refining margin [estimate] averaged $8.19/bbl in the first quarter vs. $7.84/bbl" during the same period in 2003.

"Over the coming months, the gasoline supply situation should begin to ease from its perceived current tightness," he said. "While the refining industry is experiencing very strong fundamentals, we foresee a number of issues that should begin to put downward pressure on refining margins and thus share prices."

Commercial US gasoline inventories are expected to build as imports increase, refineries finish their spring maintenance, "and the secondary inventory system completes its restocking cycle," said Rosenfeld. "These factors have materialized over the past several weeks, and we expect these trends to continue for the next several months. These leading indicators should lead to a counterseasonal contraction in refining margins, which are currently at lofty levels."

Industry Scoreboard

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Industry Trends

The potential for a flurry of merger and acquisition activity in the exploration and production sector is not likely, even after Kerr-McGee Corp. on Apr. 7 announced plans to acquire Westport Resources Corp. in a multibillion dollar deal, according to RBC Capital Markets Corp. analyst Joseph D. Allman (see related story, p. 38).

"We do not think the Kerr-McGee-Westport transaction will spur a lot of M&A activity," Allman said last week in a research note. "A few additional transactions will likely happen, since companies have free cash flow and better balance sheets, but we do not expect much activity out of the ordinary," he predicted.

The E&P sector is "fairly valued at this point," Allman said, "so there are not a lot of bargains to be had, in our view."

Because of strong oil and natural gas prices, E&P firms are "enjoying cash flow, and they may not be willing to sell at this time," he said. Also, buyers might not be willing to cut deals during a time when commodity prices are close to their peak, he said.

In addition, Allman noted that company management "frequently like being managers of publicly traded companies and may not be so willing to give up their positions."

He added, "There has already been a lot of consolidation in the industry, so the menu of acquisition targets is not as big as it used to be."

US LAND DRILLERS and related services firms increasingly are benefiting from strengthening oil and natural gas prices, Raymond James & Associates Inc. reported.

Overall US drilling activity has risen by 313 rigs since Jan. 1, 2003, and the US land rig count is up by 334 during that same time, offset by losses in other categories, according to Baker Hughes Inc. statistics.

The increased land drilling rates were not apparent until recently because land rig utilization had not reached the point that would drive meaningful price increases and because land rig activity by some of the larger oil companies stagnated in mid-2003.

For example, both Anadarko Petroleum Corp. and El Paso Corp. reconfigured their drilling plans.

"Over the past several months, however, both of these negative issues have started to disappear. On the pricing front, utilization of land rigs, [fracturing] fleets, wireline units, tube mills, etc., have now reached the point at which the industry is starting to see meaningful price increases," said J. Marshall Adkins in the Houston office of the St. Petersburg, Fla.-based RJA.

Unlike last summer, both major and independent operators are contributing to the steady rig count climb, he said, adding that the majors are maintaining a "fairly consistent and improving market share."

RJA forecast a gradual US land day rate increase of $200-300/day/quarter in 2004 compared with day rate increases of more than $1,000/day/quarter for several consecutive quarters in 2000-01.

Government Developments

THE 2004 UK BUDGET that was approved last month contains scant incentives for oil and gas companies operating on the UK Continental Shelf, said Ernst & Young LLP analysts.

The removal of the petroleum revenue tax (PRT) on new shipments of oil and gas through pipelines and platform infrastructure built before 1993 is a positive change, the firm said (OGJ Online, May 5, 2003). But, there is debate on the appropriate level of cost disallowance, which will impact the measure's effectiveness.

Another budget measure is the exploration expenditure supplement (EES) to provide tax relief for companies not yet having enough tax liability to enable them to use the 100% capital allowances for exploration and appraisal expenditures under the research and development code. For these companies, the EES will provide a 6%/year uplift in the value of unused capital allowances due to qualifying E&A expenditures carried forward annually to 6 years.

The budget also initiated moves involving thin capitalization and transfer pricing. These are changes to PRT legislation that are designed to counter perceived tax avoidance. These measures will impact UK groups, partnerships, and joint ventures having more than 250 employees. They no longer will be able to make transactions to subsidiaries or partners at a loss in order to obtain a tax advantage.

Companies had sought to defer the effective date of the new rule in order to allow them more time to comply.

"It's disappointing that the new [rule] for UK transactions has been introduced so quickly before enterprise has had time to prepare," said Ernst & Young partner Sara Pickering.

The new budget also introduces disclosure requirements relating to certain tax schemes and arrangements. While these requirements will apply to anyone who promotes tax schemes as defined by UK's Inland Revenue, they also will require companies that implement such schemes to disclose them; more importantly, companies also are required to disclose all in-house schemes they devise.

A LOUISIANA STATE DISTRICT JURY has found that the former Chevron Oil Co. (now a subsidiary of ChevronTexaco Corp.) owes Louisiana $82 million in oil royalties dating back to 1987-99. The jury in Lafourche Parish also ordered the company to pay $20 million in legal fees.

Louisiana's Atty. Gen. Charles Foti said the verdict reached last month "sends a clear message" that corporations have to treat the state fairly.

Attorneys representing Louisiana argued that Chevron Oil's listed "posted price" was deliberately undervalued to avoid state royalty payments on leases in Bay Marchand field in the Gulf of Mexico.

ChevronTexaco denied that the company tried to avoid making royalty payments on its leases. Company attorneys are expected to appeal.

"We believe that the state's oil royalty payments during the time period at issue were based upon a fair price and that Chevron USA paid the state in accordance with the contractual agreements between the parties," a ChevronTexaco statement said.

During the time in question, the company said it paid $250 million in state royalties.

Quick Takes

PETRO-CANADA, Calgary, and partners Occidental Petroleum Corp. and London-based Petrofac Ltd. are negotiating a production-sharing contract (PSC) with the Syrian Ministry of Petroleum and Mineral Resources to develop gas reserves in Syria's Palmyra area for use in Syrian markets. Petro-Canada will be operator of the North and South Middle Area gas project, which is targeted for start-up in 2007. It involves appraising and developing as many as 15 gas discoveries found in two clusters: one east of Homs and the other southeast of Alleppo. Two gas treatment and separation plants also are planned. Devon Energy Corp., Oklahoma City, has signed a 5-year PSC to operate Block 242, off western Nigeria. Devon has a 75% working interest and Nigerian Petroleum Development Co. Ltd. 25%. Devon will conduct a 3D seismic survey in first quarter 2005 and will drill one exploratory well on the block, which lies on the Outer Toe Thrust trend in water 4,000-10,000 ft deep. The 575,000 acre lease is on trend with Ikija and Nsiku discoveries as well as Agbami field, now being developed. Devon plans to seek JV partners for developing the block. First Calgary Petroleums Ltd.'s fourth appraisal well in an MLE field, eastern Algeria, confirmed MLE southward extension over a large area on Ledjmet Block 405b. MLE-4 encountered five hydrocarbon zones with more than 56 m of cumulative net pay. On test, the well flowed 23 MMcfd of natural gas and 1,223 b/d of condensate from Carboniferous F1A. Development will begin following MLE-5 production testing. Production is to start in 2007. In late March, FCP spudded west of MLE field with LEC-1 and start drilling ZCH-1, the second Yacoub Block 406a well. Algerian state oil and gas company Sonatrach announced a natural gas and condensate discovery in the Brides region, 45 km from Gassi Touil gas field. The discovery followed the drilling of the Brides West well, Brdw-1, to 5,296 m, Sonatrach said. Appraisal drilling will determine the extent of reserves.

Gassi Touil is 150 km outheast of Algeria's biggest oil field, Hassi Messaoud. Companies are bidding to develop reserves, lay a pipeline, and develop new LNG export facilities at Arzew that would be supplied by Gassi Touil gas.

Vintage Petroleum Inc., Tulsa, said the An Nagyah 5 well in Yemen tested 44° gravity oil from the subsalt Upper Lam formation, extending the productive area of the An Nagyah structure to the west.

Vintage operates the 285,000 acre commercial development area within the S-1 Damis Block, holding 75% interest, while Trans-Globe Energy Corp., Calgary, has 25%. The Nagyah 5 well was drilled to 4,265 ft. A 23 ft interval was perforated at 3,455-3,478 ft and flowed at a stabilized, water-free rate of 1,150 b/d of oil and 440 Mcfd of natural gas with flowing tubing pressure of 300 psi. Vintage next will drill the An Nagyah 6 appraisal well, and preparation is under way for the An Nagyah 7 well. In Peru, Occidental Petroleum Corp. is reprocessing and interpreting 1,000 km of 2D seismic and performing an environmental impact study on Block 101, including geological studies. Oxy plans to drill the first of four wells in 2006. The block lies near Block 64 on which Oxy began work immediately following state oil firm Perupetro SA's lifting of force majeure Mar. 17 after a 6-year hold. A base camp for Block 64's Situche complex is under construction on the banks of the Morona River. Oxy expects to drill two wells back-to-back by yearend in Situche Norte and by mid-2005 in Situche Sur. It also has begun negotiations with Perupetro for exploration and production on nearby Block 103 in the Loreto and San Martin regions. CNOOC Ltd., the Hong Kong-based subsidiary of China National Offshore Oil Corp., successfully drilled two appraisal wells, BZ 34-1-5 and BZ 34-1-4, on its BZ 34-1 discovery in Bohai Bay off China. BZ 34-1-5 was drilled in 21 m of water and flowed nearly 400 b/d of 31-33° gravity oil through a 7.14 mm choke during the first drillstem test. The well also produced 537 MMcfd of natural gas through a 9.53 mm choke during a second drill stem test, officials said. The BZ 34-1-4, drilled on the same discovery, encountered gas pay zones of 16 m and oil zones of 38 m. CNOOC is operator with a 100% interest in the discovery. Talisman Energy Inc., Calgary, signed a PSC for Block PM-314 covering 2.3 million acres adjacent Block PM-305 off Malaysia where Talisman Malaysia Ltd. struck oil last year. Block PM-305 contains the South Angsi discovery (OGJ Online, May 15, 2003). Block PM-314 is 70 km off eastern Peninsula Malaysia in 30-70 m of water. The exploration term for Block PM-314 is 5 years, during which time Talisman Malaysia will acquire a 3D seismic survey and drill four wildcat wells. Talisman Malaysia is operator with a 60% interest. Petronas Carigali Sdn. Bhd., the exploration and production subsidiary of Malaysia's state owned Petroliam Nasional Berhad, holds 40%.

ELF PETROLEUM NIGERIA LTD., operator of Amenam field 19 miles off Nigeria, selected Stolt Offshore SA, London, for a $150 million fabrication and pipelay contract in the field's Phase II development (OGJ Online, Mar. 7, 2003). Stolt Offshore will perform engineering, procurement, fabrication, installation, and commissioning of a 640 tonne water injection platform, with 550 tonne topsides to be fabricated at its Globestar fabrication yard at Warri. Stolt Offshore in 2005 also will install a 60 km, 24-in. natural gas export line and 2 km of 18-in. pipeline to link the new water injection platform to a process platform in the field.

COMPANIES IN THE US employed 10 more rotary rigs the week ended Apr. 2—9 on land and 1 offshore—compared with the previous week. The 1,160 rigs drilling were up from 972 in the same period last year, according to an Apr. 2 Baker Hughes Inc. report. Gas wells accounted for 1,000 rigs. Texas (with 502 rigs), Louisiana (170), and Oklahoma (158) led the land drilling push, up 13 rigs among them. The Gulf of Mexico had 89 rigs working, vs. 97 the same time last year. Canada, however, idled 126 rigs while 194 rigs continued working vs. 221 the same time last year. Total North American rigs working dropped by 116 to 1,354.

PPM ENERGY INC.—formerly Portland, Ore.-based PacifiCorp Power Marketing Inc.—has begun development of its $74 million Waha Hub and salt cavern natural gas storage facility in West Texas. Development will take place in three phases during the next 6 years, with the first phase operational by 2006, reported parent company ScottishPower, Glasgow. The 7.2 bcf storage site, located near a major trading hub with good pipeline access, was part of the assets PPM acquired in December 2002 to expand its natural gas storage business.

OIL & GAS DEVELOPMENT CO. LTD. (OGDC), Islamabad, has started up its newly expanded membrane-technology natural gas processing plant in Qadirpur, Pakistan, the world's largest operating membrane plant in natural gas service. The plant's 235 MMscfd membrane capacity was expanded to 400 MMscfd of sales gas. UOP LLC, Des Plaines, Ill., which licenses the technology to OGDL, installed and certified a newly enhanced pretreatment system that included a chiller, a MemGuard unit, and an improved Separex membrane system using cellulose acetate- plus technology. UOP also delivered two new membrane skids that will enable OGDC to further increase sales gas production before yearend to 500 MMscfd.

ATP OIL & GAS CORP., Houston, began gas production Mar. 29 from Garden Banks 186 No. 1 well, which ATP operates with 80% interest. The remaining interest is held by NI Energy Venture Inc., an affiliate of Nissho Iwai Corp., Tokyo. A total of 15,660 ft of extended reach drilling penetrated a reservoir at 5,100 ft. ATP said it does not release production statistics for individual wells. ATP has commenced drilling a second well at Ship Shoal 358.

Fortuna Energy Inc., Calgary-based Talisman Energy Inc.'s Appalachian operating unit, expects to boost average production to more than 80 MMcfd of natural gas this year from 60 MMcfd in 2003. Fortuna Energy revealed two more high-volume Ordovician Black River gas completions in western New York. The Reed Hz 1 and Hakes Hz 1 were each drilled to 9,850 ft TD and steered horizontally across a seismically defined graben in the Black River formation. Reed flowed as much as 20.3 MMcfd of gas, limited by surface equipment capacity, at 2,323 psi wellhead pressure. Hakes tested 17.5 MMcfd of gas at 2,086 psi. Each is expected to have initial production capacity exceeding 20 MMcfd at pipeline pressure. The 2004, $85 million (Can.) Black River program calls for 11 horizontal wells.

QATAR PETROCHEMICAL CO. LTD. awarded Japan's JGC Middle East a lump-sum contract for design, procurement, construction, and services to expand an ethylene cracker in Measaieed to 720,000 tonnes/year from 525,000 tonnes/year. The contract, worth 20 billion yen, was signed Mar. 25, and completion is slated for second half 2006. Qatar Petrochemical said the expansion would improve operating efficiencies and utilize byproducts, which will be sent for processing to customers within the Mesaieed complex. Flint Hills Resources LP, Wichita, selected UOP's Unicracking technology to produce clean fuels at its refinery in Pine Bend, Minn. Detailed design of the new unit is under way, and commissioning is scheduled for second quarter 2006. The Unicracking unit will produce ultralow-sulfur diesel and naphtha. It will process a wide range of severities of several feed blends. It also will be able to operate briefly in a hydrotreating mode to enable more consistent overall refinery production while other units are offline for turnaround and maintenance. Esso SAF, an affiliate of ExxonMobil Corp., is studying new investments for environmental improvement at its Fos-sur-Mer refinery on the French Rivera, including improvement of the water purifying station, further energy conservation, and the reduction of sulfur dioxide and nitrogen oxides emissions. With a budget of about 30 million euros, Esso SAF in 2003 began preparatory work at the plant site for France's Auto-Oil2 specifications, required by 2005 (OGJ, Mar. 8, 1999, p. 29). That work began in March with construction of a new ScanFiner unit and the revamping and modifications of other units.

CHEVRON TRANSPORT CORP. LTD. will operate the North West Shelf venture natural gas project's newest LNG carrier, the Northwest Swan. The vessel will deliver LNG from the project's Western Australian operations to customers in Japan, South Korea, China and the LNG spot market. The carrier will feature a membrane containment system providing the ship a more-conventional profile, unlike the fleet's other eight ships with spherical tanks. The 287 m long vessel has a capacity of 138,500 cu m, compared with 125,000 cu m/tanker for the existing fleet. Woodside Energy Ltd. is operator for North West Shelf venture participants.

ENTREGA GAS PIPELINE INC., Denver, filed application with the Federal Energy Regulatory Commission to construct and operate a 327-mile pipeline in western Colorado and Wyoming to deliver new gas volumes from the Piceance and Uinta basins. The 1.3 bcfd pipeline would follow existing pipeline corridors from the Meeker Hub in Rio Blanco County, Colo., to the Cheyenne Hub in Weld County, Colo. Trigon-Sheehan LLC, Denver, will undertake project management, survey, right-of-way acquisition, engineering, design, procurement, construction management, and inspection for the pipeline. Entrega's targeted in-service date is fall 2005. Entrega is an affiliate of EnCana Oil & Gas (USA) Inc. BG International Ltd. awarded Stolt Offshore an $80 million contract to install 90 km of 24-in. natural gas pipeline from the Dolphin platform off eastern Trinidad to BG's onshore Beachfield, Trinidad and Tobago, facility. The contract includes an associated 12-in. infield flowline and well control umbilical. Stolt Offshore's DLB 801 lay barge will install these lines in the second half. National Gas Co. of Trinidad & Tobago awarded Stolt Offshore a $50-60 million contract to install 62.9 km of 36-in. gas transmission pipeline from BP PLC's Cassia B platform off Trinidad to the coastal city of Rustville in southeastern Trinidad. Stolt Offshore will employ its DLB 801 pipelay barge for the installation, which will take place in the second half.