The Weekly Report: Energy in 2012 – Part I

10 January 2012


Two weeks ago, we summarized some of the events and notable developments in the energy sector during 2011. This week, we’ll try to give a broad outlook of what 2012 might have in store, both here in T&T as well as globally. For this post, we’ll delve into what is in store for the local energy and commodity industries in our twin island republic.

Upstream

The upstream sector showed strong momentum in 2011, which will spill over into 2012. We are not even halfway through January, and one new exploration well was successfully drilled by Range Resources, a U.S. based independent oil firm.

A big driver of increased upstream activity is Petrotrin’s (and the Government’s) need for more crude. This is just one way they can reduce the 3 billion TT fuel subsidy bill, as they have to import increasing amounts of crude from Africa, Russia and South America to make up for falling local production.

Every barrel of foreign crude costs substantially more than locally produced crude, and that increased cost is absorbed by the government through the subsidy and not passed on to the consumer. Additionally, while natural gas has become the bedrock of Trinidad’s lucrative world class petrochemical industry, the T&T government’s royalties on crude oil are higher than on “natty” so increased oil production has a double benefit for the nation.

This partially explains why between 2009 and 2011 we have seen a veritable Canadian invasion, especially on onshore blocks which were the sole domain of Petrotrin.

Petrotrin is also expected to make a decision regarding the Soldado field in the Gulf of Paria, which will lead to an outcome where increased activity and production from that field is unavoidable. Lastly but definitely not least, SOOGL Antilles Ltd, the subsidiary of Chinese global energy giant Sinopec, is expected to expand its drilling program considerably as it looks to spend $1 billion USD over the next 3-4 years on upstream activity.

Services

After posting a 17% growth rate in 2011, according to the Central Bank, the services sector is on track to have another solid year due to the upstream activity summarized above. What remains to be seen is how it will stack up compared to 2011 which saw a veritable flurry of activity.

Most of 2011’s services activity was in the upstream sector but in 2012 and beyond, downstream services activity may pick up with the potential start of construction of another AUM (Ammonia-Urea-Methanol) complex at Methanol Holdings (MHTL), as well as the Carisal caustic soda plant. According to the Energy Chamber, at their peak, both projects will generate a cumulative 3,650 construction jobs, as well as more than 500 jobs once they are completed.

This would be a reversal for the downstream services/construction sector, which suffered an even sharper decline since 2008 than upstream services did.

Downstream and Petrochemicals

2012 could shape up to be a good year for the downstream and petrochemicals segment. The refinery upgrade projects at Point-a-Pierre would have finally been completed – fingers crossed. This will help Petrotrin reduce a huge drag on its profit and financial health, and ultimately make the refinery more competitive globally.

Gas supply constraints related to maintenance and platform upgrades by several producers will also be eliminated or mitigated, allowing petrochemical producers, Atlantic LNG and Phoenix Park to work at higher capacities, thereby bringing more revenue in for their respective shareholders.

Additionally, two shovel ready projects, the Carisal plant and second AUM complex at MHTL may start construction which will lead to jobs and contracts for service companies. There are also strong prospects of seeing the construction and completion of the first melamine moulding compound plant, which if successful could attract additional investment in the plastics manufacturing sector in T&T.

On the retail marketing front, this year could see the government’s CNG project finally gain momentum, which would pave the way for changes in the fuel subsidy regime. CNG can be provided as fuel to the local market (especially commercial fleets and maxi taxis, who are major fuel users) at an unsubsidized cost that is comparable to local subsidized rates for diesel and gasoline. Additionally, the impact on the country’s gas reserves would be minimal.

The government has failed in the past to implement CNG on the scale that it would have liked, but as crude prices seem likely to persist at a level that would make the subsidy bill quite exorbitant, the urgency is forcing them to go about it in a more systematic and deliberate way than before.

Impact of Global Events

2012 may also be a year of momentous global events, which would inevitably affect Trinidad. In particular, two scenarios could produce pricing shocks in global energy markets: sovereign defaults in the Eurozone, and military conflict with Iran.

The impact of any sovereign default in the Eurozone, whether a peripheral or core economy, could conceivably cause a 10-25% decline in the price of oil in less than two weeks—barring decisive and quick response from the ECB, IMF or another multilateral institution. A sovereign default would affect the value of the Euro currency, would wreak havoc in the European banking system, and ultimately cause a severe recession all of which will inevitably affect demand for oil and energy globally, as Europe is a major consumer and importer.

Because methanol and ammonia prices are highly correlated with crude, any sudden drop in crude prices would bode ill for the T&T petrochemical sector, which is a major global-scale exporter of both those products (as an example, Trinidad and Tobago is responsible for 25% of global ammonia exports, according to PCS). If 2008-2009 is any guide, this can be a very debilitating blow not just to the petrochemical sector but to the overall economy. Additionally, it is unlikely to recover as quickly as it did in late 2009 through 2011, as the severity of the shocks in this event would be much more widespread than the Lehman collapse of 2008.

On the other hand, military conflict with Iran could conceivably cause a 10% to 20% spike in energy prices in a 2 week time frame, with that amount going up substantially depending on how protracted the conflict becomes. Ultimately this may be a short term positive for Trinidad’s energy and commodity sectors, but in the medium and long term, high pricing could lead to demand destruction, and with the global economy already fragile, exceedingly high prices would ultimately be very negative for any kind of recovery.

Conclusion

This is a highly speculative write-up, but is meant to be exploratory, as unfortunately we do not have a crystal ball here at Firstline (although I heard there are good second hand ones for sale on Charlotte Street). Nevertheless, we do offer the opportunity to make relatively safe and low risk investments in the local energy sector where you can earn 6.50% on a one year tenor.

For more information, contact me at michael.cooper@nullfirstlinesecurities.com or give the office a call at 628-1175.

Michael J. Cooper
Trading & Strategy Consultant

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