ENRAM · Energy Resource Americas 

           
Perspective: Russia-Ukraine Still Impacts Energy Firms, Markets, Prices (BP, Shell)
           
Brian Blazina, Energy Resource Americas (ENRAM)
         
Published article 8/17/2022 (only headline changed, but situation not changed much, other than energy prices easing as expected); updated 4/5/2022; originally posted 3/4/2022.
             
Chicago – Well Houston, do we have a problem, many problems, or just what do we have? BP, and other energy companies face quite a situation. This article focuses on BP specifically; its exit from its Russia/Rosneft shareholding; sanctions' impact on world/US markets for oil, gasoline, and natural gas; a suggested BP-Shell merger; and the US shale industry's apparent inability to deliver oil from once-touted always-ready supply, especially at $100+ per barrel oil - a missed opportunity for hydrocarbons as economic security.
              
While some degree of self-sanctioning is in order, like energy companies' Russia (RU) exit plans, and US stopping RU imports; as long as RU oil gets to market somewhere, then world energy prices should moderate. The last thing we need is RU getting higher energy prices, based on ill-advised actions. We suggest here, not yet sanctioning RU energy IN TOTAL, because world economies may get more volatile, perhaps triggering recessions, or worse. Confusing messages about RU roil economies and markets - ultimately harming some 190 million Ukrainians and Russians. So what's going on?
              
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BP Write-Down?
               
While oil prices go over $100 per barrel (nearly double in last 6 months), BP's stock price, which typically rises and falls with oil prices, dropped nearly 10% in the first days of invasion. BP announced pulling out of interest in Rosneft, the Russian national oil company, following Russia’s unprovoked invasion of Ukraine.  The announcement put BP's equity price on a roller coaster beginning with a loss of 6.3%, a gain of 5.4% next day, then -5.0%, -2.5%, +5.7%, -4.6%, -2.5% in subsequent days - net change of -9.8% in 7 trading days after the announcement. 
             
Many people salute the bold move by BP, but the information available to shareholders was pretty confusing.  BP has already mentioned a possible write-down of the investment.   See BP website link here for more information – original press release was 2/27/2022 (current may be updated):  https://www.bp.com/en/global/corporate/news-and-insights/press-releases/bp-to-exit-rosneft-shareholding.html
              

          
If the situation is clear to you after reading the BP press release, then stop here.  Unfortunately, due to confusion out there, speculation is running wild about $billions in write-downs, as if BP may walk away from the investment, or RU government might steal it for free.  More clarification of plans and other potential buyers is needed as soon as possible.  
          
Some investors may incorrectly run with a $25+ billion hit to total BP market capitalization currently fluctuating between $94 and $100 billion USD, or 25%+ lost market cap.  And where's the $0.6-1.0 billion annual dividend loss fit in?  The concern is not the decision, but the timing and execution.  Why not done in 2015-2021, after Russia invaded its neighbor in 2014, or maybe announced now as a phase-out over a year, is surprising.  The audience would still call a phase-out announcement, bold. 
            
While many think getting out of Russia investments is a required action for western companies, what about other countries, economies, shareholders, and pension plans invested in BP?  Should they get market value or zero out of this investment?  What about the Russian people, most of the 145 million being OK people, who knew little about the invasion until it was on.  Might they become just another failed state, like North Korea? - well on the way, with a pre-invasion economy smaller than Italy, NY, or CA - a near lowest GDP per capita measures in the world?
              
Read on for more in-depth discussion of BP-Rosneft investment market value; BP exit strategy, and poisoned executive; oil market implications of RU-Ukraine invasion, potential buyers of BP-Rosneft; BP-Shell merger benefits; Russia's future investment reputation; impact on oil, gasoline, and natgas prices.

         
Market Value of BP Shareholding in Rosneft?
      
Without going into too much detail, market value of the BP investment, can be: 1) Rosneft stock price (very depressed by war actions of Rosneft’s primary owner – RU government), times shares; or 2) a 10 to 20-year revenue stream based on oil and gas volume times market price of oil, then discounted to net present value (NPV), but also artificially high oil price based on RU actions; or 3) a NPV of 10-20 year revenue stream or stock price projection excluding current invasion fallouts - as if it never happened.
        
Obviously, a nearly $100 per barrel oil price is not the right number for NPV option, because RU’s invasion also caused most of that price increase.  However, a term level of $50-70 per oil barrel might be in order.  Any option should exclude the forex results from the ruble collapse due to new sanctions and other fallouts from invasion; and include impact of Rosneft dividends.
          
What Was BP Exit Strategy?
    
Did BP have an exit strategy such as above, thought through and agreed with Rosneft, when they traded their interest in BP-TNK (the BP-Oligarchs JV) to take a 19.75% interest in Rosneft, the RU national oil company – before closing the deal? 
       
Has financialization of industry, and thus, a tendency for some companies to continually trade discounted event risk for "benefits and rewards" of cost containment and highly-sculpted financial results - an overlooked problem with this and other industries?
         
If not, and if so, are answers to the above questions, then more serious questions need answered, because it’s not like the BP-RU relationship was on solid ground.  One example involved a “mysterious” poisoning of Bob Dudley, then working in the BP-TNK JV, who later became BP CEO, and a Rosneft board member.  He and current BP CEO, Bernard Looney, are resigning from the Rosneft board.  Then there is the 2014 RU invasion of Ukraine that should have been a major red-flag and event risk adjustment.
    
Future Russian Investment in the Balance
    
Any negative write-down, or zero value via RU acting like its oligarchs by stealing away the BP shareholding at cents on dollar, or similar interests of other companies, should be out of question, because no investor would trust or invest in RU ever again, especially with current leadership.  RU would lose foreign investment right when needed most to secure an optimistic economic future for its people and leaders.  RU would become a failed state, like North Korea, begging for handouts from other countries.    
            

Other Potential Buyers
    
Possible new investors are China, a Mideast (ME) national oil company (NOC), or wealth fund.  See EnergyVoice article speculating on potential buyers of the BP interest (original article was 3/2/2022) via following link:    
https://www.energyvoice.com/oilandgas/europe/391674/bp-could-look-to-china-as-it-tries-to-offload-stake-in-russian-oil-firm-rosneft/
    
China is going to be shy about taking an interest in Rosneft due to a feared worldwide reputation backlash; however, China needs a secure source of oil, and already buys oil from RU via the Siberian pipeline.  Additional pipeline volume would hardly get noticed.  Regarding the buyout of BP Rosneft shareholing, China should realize who does what in RU investments today, will be forgotten with time - especially if China also takes a leadership role in peace talks among western allies, RU and Ukraine - a benefit provided to the world in exchange for addtional oil.
     
By helping secure peace in Ukraine, China attains that world leadership banner coveted for decades - and associated long-term investment, goodwill, and economic power.  China could lock down a fair term oil deal through use of ownership leverage that nets out against transport logistics costs to China - a strategic, secure, long-term energy source for this net oil importer nation.  Even a feather in the hat for China, especially, by taking out a British company's shareholding in an allied nation. 
    
ME NOCs, with declining oil production profiles - the well hidden elephant in the room - could secure an ongoing revenue stream to finance their country budgets and economic transformations.  Only "crickets" heard from ME “friends”.  Sovereign wealth funds, while not bringing expertise in oil exploration and production, can invest in a steady revenue stream for their clients (more "crickets").
       
BP-Shell Merger May Now Make Sense
       
BP and Shell may see this an excellent time to merge, finding synergies to offset RU investment losses expected by both companies.  BP and Shell have a combined $300 billion market capitalization to offset their planned hydrocarbon portfolio shrinkage, and expansion of alternative, sustainable energy. 
         
Shell brings a massive natural gas portfolio, now clearly needed as bridging fuel to any net zero carbon emissions future - especially given new risks/values exposed by the RU-Ukraine invasion.  Shell also brings a substantial electrical power generation business.  BP contributes an extensive international supply and trading network to realize the highest global value from products and assets.  Similar business styles, aspirations, and experiences help, too.  Shell may also temper BP's tendency to take higher risks; and BP, the reverse - complementary governance.
       
All energy companies are reminded by this current near $100+ per bbl oil environment that while hydrocarbons are making great money today, and have a place in the energy transition, hydrocarbons can be priced and/or underfunded out of the market. That's why "energy" companies have to manage their portfolio to match future customer demand - whatever the mix. 
        
Showing some hydrocarbon reliability today, in a crisis, can bring needed longevity and funding for the alternative energy transition.  The coal industry ran out of funding before they could even consider bridging with natgas.  Both BP and Shell say the right things, and have goals in alternative energy, but they need their combined capitalization to make it happen.
    
Read on for more in-depth discussion regarding oil market implications of Russian-Ukraine invasion, impact on world/US oil, gasoline, and natural gas markets.

      
Market Impact of Russian Oil and Sanctions
    
The aforementioned potential deals assure RU oil still gets to market, keeping world oil prices more manageable; and does not drive-up US oil prices that would work their way into refining/retailing gasoline prices (as well as diesel, jet, other refinery bi-products).  It also assures RU oil exports do not get even higher prices to fund its war with Uktraine - due to an unnecessarily tight market.
     
RU exports about 5 million barrels per day (bpd) of oil…about 1.6 million bpd via Siberian pipeline to China, leaving roughly about 3.4 million bpd going to the water for oil tanker transport to refineries around world, including US (just canceled).  Some water tanker volume can slip scrutiny, leaving maybe 2-3 million bpd stranded for a period, due to trading companies and countries self-sanctioning.  Letters of Credit are required to finance the trading, so some financial institutions may back away, too.
        
World oil demand runs roughly about 100 million bpd, with the incremental 1-2 million bpd setting price for all the rest.  Existing producing fields decline over 4%+ per annum, making investment in oil exploration and production critical to the sensitive world suppy/demand balance.  If we get another 2-3 million bpd shortfall setting market prices, then that’s another 50-66% impact on incremental prices at the margins - massive beta increase in volatility.  The market is also in extreme backwardation (current prices much higher than future prices); however, that same backwardation can stay in place for months, just sliding forward in time. 
      
Before even considering sanctions on TOTAL RU energy, the US government should negotiate with anybody and everybody - no matter where we stand politically - to replace at least all RU oil exports (the full 5 million bpd).  Yes, this means OPEC, Iran, and Venezuela - whatever it takes to get more oil on the world market (not for import by US, necessarily).  Sometimes when properly motivated, both sides can quickly reach agreement on long simmering issues, so don't underestimate the value of needs and opportunities that might never get realized without a crisis.  Only after replacing the RU oil exports, should other refined products and chemicals exports be considered for replacement.  Again, the rationale is to not trigger world recession, or the remote WWIII.
      
The Oligarchs’ Way or a New, Improved Russian Govt Way
       
Of course, there’s always “The Oligarchs’ Way” – you know, how they always roll…”getting” assets for low or zero prices.  However, the last thing RU needs right now, is acting like the oligarchs of last 2+ decades, trumping up fake scandals, then stealing investments at cents on the dollar, because no country or fund would ever invest in Russia again, hastening its demise into North Korea type decline.  If hypothetically 1 million Russians are bad people out of about 145 million, then let’s not create another humanitarian crisis in RU, too.
        

            
Impact On US Oil Market and Gasoline Prices
          
The International Energy Agency (IEA) was formed in 1974 to deal with world energy issues, following the Arab Oil Embargo which quandrupled oil prices.  One of their first good ideas was to form the Strategic Petroleum Reserve (SPR) in 1975, where oil is stored, then released during a world energy crisis - like a supply shortage, embargo, or war. The inability for the normally efficient, reliable oil industry to deliver needed oil at this time, is a "supply shortage".  That's exactly what the SPR is being used for now. 
       
It does not matter what kind of oil is stored, and there's only minimal bottlenecks to ratable release from the SPR's four underground storage sites in Lousiana and Texas - close to the massive US refining and chemical complex along the Gulf Coast; and to water for trading one oil type for another more suitable to refinery kits in the area.  As long as it gets to market, ratably, the desired economic impact gets met.  It's really Economics 101, where additional supply balances more with demand, and prices stablize - just like toilet paper did later in the pandemic. 
        
The release of 180 mllion barrels (bbls) of crude oil from the US SPR, at about 1 million bbls per day (bpd) applies downward pressure on oil prices, and thus gasoline/other prices refined from oil, ultimately.  The prior release of 60 million bbls of oil - 30 million from US SPR, plus 30 million from other non-OPEC nation sources like Japan and UK - helped temper oil prices.  The US oil demand is about 20 million bpd.  If marginal prices get determined by similar percentage levels as world demand, then it’s not just “9 days demand has no impact on price”, but months of impact on that price for the incremental oil bbl – if volume ratably released from the SPR.
           
Also, high prices cure high prices, because US shale oil production turns on faster than any other type oil production - at least that was advantage once promoted, right?  Maybe US shale (tight oil) industry in the Permian Basin (TX and NM) can come to the rescue, after seemingly over-producing at all the wrong times in the last 5+ years; to point of cratering world prices and destroying value/investments in the energy industry.  Many people "pounded chests" about US as the #1 oil producer in the world, but then 400+ energy related bankruptcies happened due to low prices.  "Where was the help then?", the shale industry asks, although fallout mostly self-inflicted by industry, investors, and bankers.  We funded some of that pain - a real economic lesson about risk, hubris, and lack of discipline.
       

         
Oil economics are not rocket science, although political pundits, think tanks, and industry associations, like the American Petroleum Institute (API) - now carrying water (not oil unfortunately) for oil producers caught flat-footed by the strong US economic rebound - want you to think otherwise.  They have supply chain and labor problems, like other industries, but list demands, and heap blame on others - unlike other industries.  As a result, drawing quite a bit of incoming blowback - not reading the room well.  If the API wants more credibility, then see that oil producers produce more oil now, not in six months.  And hey, here's a thought - change your organization name to the American "Energy" Institute (AEI)...instead of doubling down like the coal companies once did, before they began to die.
             
There's some good reasons why Average Joe American can't understand why the oil industry, some pundits, and politicians now have lists of demands, want handouts (corporate socialism?), more leases on federal lands, and deregulation.  All while they control 9,000+ approved leases not yet drilled, with oil prices at $100+ per bbl.  But what happens when Average Joe American decides the "gasoline companies" can't solve his problem, and buys an electric car...or power companies get massive battery storage to support more solar and wind power production?  The oil industry must demonstrate reliability, especially with prices high and money to be made.
               
Lot of talk about Canadian oil to the rescue, while questioning negotiations with Venezuela and Iran to get more oil into world market.  Canadian oil has never been sanctioned or banned from US, like Venezuela and Iran.  If more OPEC, Venz and Iran oil gets into world market, then world oil prices go down.  The US does not have to import Venz or Iranian oil - just see it gets on the world market. 
       
Most people don't know this, but Keystone Pipeline was completed, bringing Canadian oil into the US daily.  It runs from the western Canadian Sedimentary Basin in Alberta to refineries in IL and TX; to oil tank farms and a pipeline distribution center in Cushing, OK.  The only thing canceled (for now) was Phase 4, the "XL" pipeline shortcut between states, to save construction costs, with minimal impact on oil volume or price.  Canadian oil ultimately gets all the way to the US gulf coast - some exported from there to China. It also moves via unit trains to Canadian and US destinations - a solution to any temporary bottlenecks. XL is currently not needed.
       
Expect gasoline prices to keep rising for a while, but not too long, because the refined products industry is incredibly efficient, and will produce at full capacity when gasoline (and other refined product) prices are high, to the point of surplus.  Surplus supply always triggers an eventual price drop, because storage terminals (connected to pipelines) must clear inventory to make room for new batches coming down the pipeline.  Lower terminal rack prices are the main tool to incentivize tanker truck lifting from terminal storage for delivery to your local gasoline station.  However, strong demand prolongs high prices because volume moves even at higher prices.
        

             
Impact on US Natural Gas Prices
         
The natural gas issue with Nordstream 2 pipeline from RU to the EU was not impacting US Natural Gas (natgas) prices before the invasion.  US natgas prices stayed in the $3 to $5+ per unit range - remarkable compared to Europe at many times those prices.  Abundant US natgas supply from the "shale revolution" (take a bow here industry), and high export infrastructure costs – often $20 billion+ for an export terminal – kept natgas prices in that rough range over last 5+ years (vs double digits $ per unit in early 2000s). 
        
Those low prices helped kill off most coal business as uitility companies got forced into switching to natgas powered equipment to generate electricity.  Now prices are rising into $6 per unit range, and could rise to higher single digits per unit depending how much US natgas gets exported on LNG water tankers to the EU.
       
Those low US natgas price levels keeps natgas production investment steady, demand strong, and manufacturing costs low.  In fact, today, with companies coming home to manufacture in the US, due to long, unreliable foreign supply chains and bottlenecks exposed by the pandemic, the US has the lowest natgas costs in the world – a main manufacturing cost component.  Low natgas costs and automation helps the US add manufacturing of less labor-intensive products, like computer chips, with associated high-paying jobs.
       
However, reckless export of currently abundant US natgas supply - such as replacing all RU supply to EU, will raise US natgas costs much higher.  You never want to become an energy extraction country, because that leads to economic and national security problems - one of the reasons why we said in 2016 that lifting the US Crude Oil Export Ban would hurt the future US economy.
                
Summary
       
Our hearts go out to both the Ukraine and Russian people, because nobody wins in war.  Putin made a terrible mistake, and should not make things worse by destroying Ukrainian and Russian people’s lives, economies, and futures; or by stealing investments in his country from former and future partners. Slava Ukraini!
        
Allow a fair and square market buyout of the BP interest in Rosneft, and of other energy companies’ RU interests, by China, Mideast national oil companies, or a sovereign wealth fund, before continued speculation starts to destroy value and markets.  Higher oil prices benefit the RU war versus Ukraine, and harms western economies.
                 
BP can then get on the fast track to their already stated goal of exiting 40% of oil hydrocarbon portfolio – a positive for ESG minded shareholders, many in the US.  However, BP must clarify plans and impacts on the bottom line.  Perhaps a BP-Shell merger can provide capital needed to make up for lost value, and speed up BP-Shell goals for smooth transition to a net zero carbon future.
       
The US should negotiate expeditiously with OPEC, Iran and Venezuela, to replace all RU oil exports, before sanctioning same; otherwise, a world recession could be triggered by this one event - as all recessions get triggered by a single final event.  The US does not need to import Venz or Iranian oil, but just get it on world market.  Again, RU should not benefit from higher oil prices.
              
Finally, our US Free Market Capitalist Economic System must sort out the problem - especially at $100 per barrel oil.   However, instead of "drill, baby, drill”, all we hear again, from our shale oil producers...is well..."crickets".  Texas, a place I love, and supposed energy center of the world, for second time in a year, is not producing enough energy.  Not a good look for economic security promoted by hydrocarbon industry - another self-inflicted wound.  Come on US Shale Cowboys - this is your opportunity to shine, like real Patriots - to make your case for oil as a reliable part of our energy future, and make real money, too!  Cowboy up!