June 21, 2019

Probes and squeezed profits change the oil Even state-run firms have felt the pinch. Azerbaijan's trading game Socar Trading closed some refined products desks and shrank others. For the world's biggest oil traders, it feels like a return Other companies aim to adapt by scaling up and boosting to the 1980s when earnings were diluted by an profits by trading bigger volumes. Swiss-based abundance of crude. ArrowMetals said last month it was buying AOT Energy. After three decades of stellar expansion and booming Increased transparency thanks to ship tracking and revenues, profit margins at , , , satellite imagery of key infrastructure, such as refineries Gunvor, Mercuria and other merchants have been and storage, has eroded the amount of proprietary squeezed by a market again awash with crude and information trading firms could once rely upon to give them amid stiff competition from national oil firms. an edge. A raft of high-profile U.S. probes into trading activities "Traders traditionally live on imperfections of the market. are also shaking up the business, echoing the Digital technologies are erasing a lot of these transformation that followed the 1983 U.S. indictment opportunities," Tornqvist said, although he said technology of Marc Rich, the godfather of global oil trading. boosted efficiency. Veteran executives, many of whom learned the trade Trading houses are now investing in artificial intelligence in the Marc Rich era, say only the fittest firms will and other technology to process the enormous amount of survive the new crisis. data available. "I've been hearing arguments about the death of Vitol, the world's biggest oil trader, lifted traded volumes by trading for the past 30 years. But the reality is: there a third in the last five years but added just 15% more staff. are those who adapt and those who disappear," However, IT staff numbers rose by 60%. Gunvor CEO Torbjorn Tornqvist said. "Classical research just isn't enough," said Gerard Delsad, He said companies have always had to change with Vitol's chief information officer. the market, such as adapting to the development of RIVALS BEEF UP futures. But last year was particularly tough. Adding to the challenge, state-owned firms, scarred by the Vitol, Mercuria, Gunvor, Trafigura and the oil trading oil price rout between 2014 and 2016, want a bigger share division of Glencore made a combined net profit of of oil sale revenues. National firms in Saudi Arabia, Iraq, about $3.2 billion in 2018 on the back of $747 billion Abu Dhabi and Algeria are all working to expand their in revenues, compared with a combined profit of $5 marketing arms. billion in 2015 on revenues of $511 billion. Some oil majors also eye the action. U.S. giant Consulting firm Oliver Wyman said trading margins ExxonMobil is beefing up its trading division. BP and fell more than 20% last year from a peak in 2015. Shell are already major rivals to the trading houses. "We estimate margins could likely decline by at least Meanwhile, old business ways, such as relying on agents, another 15% over the next five years as also known as intermediaries, to set up contracts between markets become more stable and more transparent state suppliers and buyers, have become a focus of and competition becomes more intense," it said in a investigations. report this year. U.S. Department of Justice, securities regulator CFTC and Executives say consolidation is inevitable, as rising the Federal Bureau of Investigation (FBI), as well as Swiss market transparency means companies have fewer and Brazilian prosecutors, have opened a range of probes opportunities to exploit quality or timing dislocations into the use of intermediaries by several trading houses. between producers and end-users to win deals The companies say they are cooperating with the outside of exchanges or futures markets. authorities. FEELING THE PINCH The extra scrutiny has encouraged more investment in While bigger trading firms can absorb the weaker compliance. profits, smaller companies are racing to find savings "You have to audit the intermediaries as if they were in and cut staff. your own companies if you want to be compliant with the Monaco-based Galaxy Energy has quit the crude guidance from the U.S. Department of Justice," said a trading business, while mid-ranking ECTP exited oil senior trading executive with decades of and most metals trading. Castleton Commodities experience. International closed its physical metals business Gunvor said it had reduced the number of agents it uses globally and reduced its London oil desk. by a third since 2018. Trafigura Chief Executive Jeremy Gunvor Group, one of the top five independent oil Weir said this year the firm had also cut the number of traders, lost money for the first time last year although agents it uses. it was back in the black in the first quarter of 2019. It "The industry and others have beefed up compliance," is considering asset sales. Mercuria Group Chief Executive Marco Dunand said. June 21, 2019 (continued)

"Investing in IT makes it easier to control potential legal OPEC source said. issues." has been under pressure from its domestic oil "We educate people with monthly programmes," he said, companies to let them pump more. adding Mercuria spent $10 million to $15 million a year Iran and Venezuela, both OPEC founding members, are on compliance. under U.S. sanctions that have hit their oil production and Dunand also said his head of compliance sat next to him, exports. adding it was no help if compliance officers "are miles U.S. President Donald Trump has called on Saudi Arabia away." and OPEC to boost output to compensate for the Probes and thinning margins are spurring leadership reduction in Iranian oil supply, but Saudi sources say that transitions at many companies, executives say. though the kingdom will always respond to its customers "The new generation now have to make money. That's needs, there has been no demand for extra crude to why they want to take over. They want the rich old dogs justify them increasing their production. out of the way," said a large shareholder at a major trading house. Trump orders review of controversial biofuel waiver program - sources producers to maintain output within OPEC target in July- sources U.S. President Donald Trump has directed members of his Cabinet to review the administration’s expanded use Gulf OPEC producers will keep their July oil production of waivers exempting small refineries from the nation’s within their OPEC target despite the current global supply biofuel policy, after hearing from farmers angry about the cut pact expiring at end of June, OPEC sources said on issue during his recent Midwest tour, according to three Thursday, a signal that the Gulf exporters are reluctant to sources familiar with the matter. boost supply. Trump's move underscores the rising political importance Saudi Arabia, the top global oil exporter's crude output in of the U.S. Renewable Fuel Standard, a more than June will be around the same level of its May production, decade-old law which requires refineries to blend corn- and its July output will remain within its obligation under based ethanol into their gasoline to help farmers, but the OPEC-led supply cut deal, the sources said. which also provides waivers to small refining facilities that Saudi oil output in May was 9.67 million bpd, according can prove compliance would cause them financial harm. to OPEC figures. Riyadh has been pumping below its Since Trump took office, the Environmental Protection 10.3 million bpd target under the OPEC pact for the past Agency has more than quadrupled the number of waivers months. it has granted, saving the oil industry hundreds of millions Key OPEC producers Kuwait and the United Arab of dollars, but enraging another key constituency - corn Emirates are also keeping their output in July within the growers - who claim the move threatens demand for one OPEC target and will not be raising their production, the of their staple products. sources added. Trump heard from disgruntled farmers and their political In May, Kuwait pumped 2.709 million bpd, and the UAE's backers on the issue earlier this month when he visited oil production was 3.055 million bpd - both below their the Midwest to tout his administration's decision to lift a OPEC's supply target. ban on summer sales of higher ethanol blends of The moves indicate that the powerful Gulf oil producers gasoline called E15. Farmers welcomed that move but block wants to keep the existing output cut by OPEC warned Trump it was negated by the surge in small unchanged for the second half of the year. refinery exemptions. The Organization of the Exporting Countries The sources said Trump, upon returning from his trip, plus Russia and other producers, an alliance known as asked the heads of the EPA and the U.S. Department of OPEC+, have implemented a deal since Jan. 1 to cut Agriculture to find solutions to address the farmers’ output by 1.2 million barrels per day (bpd) for six months. concerns. They said the EPA is now considering limiting "All the talk now is about an extension of the same cuts, use of the waivers or forcing larger refiners to make up or a rollover, until the end of the year," one OPEC source for the exempted gallons - or a combination of both. said. "I think Trump realized he may have a political problem OPEC meets next in Vienna on July 1 to decide on its and told (EPA Administrator Andrew) Wheeler to fix it,” output policy, and will meet with its non-OPEC allies, led said one of the sources, a refining industry lobbyist who by Russia, on July 2. was briefed on the matter and asked not to be named. But Russia still has not said whether it would agree to The EPA, in a statement on Thursday, said the "EPA will keep the existing cuts in place or push to increase in the continue to work with the White House, USDA, members second half of 2019, the sources said. of Congress and other stakeholders to ensure the "Russia is the only country that is yet to decide," another Renewable Fuel Standard's continued stability."

2 June 21, 2019 (continued)

The USDA and the White House did not respond to While the company has drilled wells and made requests for comment. discoveries in Mexican territorial waters in the deepwater Any move to alter the small refinery waiver program Gulf, and has a joint venture partnership in one such would face resistance from the oil industry, already stung project with Australia's BHP Billiton, it has yet to produce by the administration’s expansion of E15 sales. any oil or gas there. They view the government support for biofuels as a Pemex's current crude production averages just under competitive threat to petroleum, and argue that the 1.7 million barrels per day (bpd), down nearly a half from waiver program is now being run as Congress intended. peak output of about 3.4 million bpd in 2004. "The president has made promises to refiners, too. He Mexican President Andres Manuel Lopez Obrador has promised to keep refineries competitive and he made pledged to raise Pemex output to 2.5 million bpd by the promises to keep regulatory costs down, and we hope he end of his term in 2024. keeps those promises," said, Derrick Morgan, senior vice Velazquez expressed confidence that the company's near president of the refining trade group American Fuel and -term focus will prove successful. Petrochemical Manufacturers. "The most important thing is we're convinced of what Trump's expansion of the waiver program has become we're doing," he said. an unlikely talking point for several Democrats vying to Pemex, the world's most indebted oil company, has faced defeat him in the 2020 presidential election, including mounting pressure to improve its finances and invest Senators Amy Klobuchar and Elizabeth Warren, who more in its profitable exploration and production business. believe it can help turn farmers already stung by the Earlier this month, Fitch Ratings downgraded Pemex's trade wars against him. roughly $80 billion of bonds to speculative grade - or The EPA granted 35 exemptions for 2017, up from seven "junk" status. A second downgrade from another ratings in the last year of the Obama administration, according to agency would trigger forced selling from funds whose agency data. That included waivers for refineries owned mandates prohibit them from holding such assets. by profitable majors like Exxon Mobil Corp and Chevron Among many fixed-income investors, Pemex debt is Corp, as well as one owned by billionaire investor Carl already trading like a junk asset. Icahn. Velazquez added that Pemex's expects to invest between The exemptions represent more than 2 billion gallons of $13.2 billion and $13.7 billion (250 billion-260 billion potentially lost demand for ethanol, the biofuel industry pesos) annually in exploration and production over the says. However, the extent of the actual demand next few years. destruction, if any, is a matter of intense debate. Pemex's exploration and production budget this year is The EPA has delayed action on the 39 pending around $14.2 billion. applications for the 2018 calendar year. Mexico's Pemex to stick to areas it knows best, pass on EXCLUSIVE-Chevron Phillips Chemical in bid to deepwater -CFO acquire Nova Chemicals -sources Petroleos Mexicanos will focus on shallow water projects and onshore plays, and avoid investing in its deepwater Chevron Phillips Chemical Company, a joint venture riches for now, as the ailing Mexican state-run oil between Chevron Corp and Phillips 66, has offered to company seeks to turn around a 14-year slide in crude acquire Nova Chemicals Corp for more than $15 billion production, a top official said on Thursday. including debt, people familiar with the matter said on Chief Financial Officer Alberto Velazquez outlined the Thursday. approach the state-owned oil company known as Pemex Chevron Phillips Chemical, one of the world's top will take at a conference in the colonial city of Leon on petrochemical producers, would gain scale and expand Thursday. its footprint through the acquisition of Nova Chemicals, He emphasized that Pemex has no plans to invest in whose expandable polystyrene and resins are used in a costly and technologically complex deepwater projects in range of industries, from construction to packaging. the , but will instead focus its exploration Abu Dhabi's sovereign wealth fund Mubadala Investment and production budget on the country's shallow water Co, the owner of Nova Chemicals, has been exploring a and onshore potential. sale of the Canadian plastics maker since the start of the "We are not going to invest in those types of year, and there is no certainty that it will accept the offer developments," said Velazquez, referring to deepwater from Chevron Phillips Chemical, the sources said. projects. Another bidder for Nova Chemicals may yet emerge, The vast majority of Pemex's current production comes some of the sources added. Mubadala could also decide from shallow water areas clustered around the southern to keep a stake in Nova Chemicals in a deal, one of the rim of the Gulf of Mexico, off the coast of the states of sources added. Veracruz, Campeche and Tabasco. The sources asked not to be identified because the

3 June 21, 2019 (continued) negotiations are confidential. Nova Chemicals, refineries slowed down, East Asian market sources said, Mubadala, Chevron and Phillips 66 did not immediately as they continued to digest inventories purchased in respond to requests for comment. previous months. Headquartered in Calgary, Nova Chemicals was founded "May data has thus far pointed to sluggish demand, with in 1954. Over the years, it has diversified its business imports contracting sharply -- and this is before the new beyond foam packaging and insulation to foam beverage round of bilateral (U.S.-China) tariffs kick in," consultancy cups and containers. Energy Aspects wrote in a note, which still put demand Nova Chemicals reported earnings before interest, taxes, up at 500,000 barrels per day on the year despite the depreciation and amortization of $271 million in the first weakening outlook. three months of 2019, down from $418 million a year China ramped up imports of Iranian oil in April before earlier, according to its website. cutting them off due to tougher U.S. sanctions, and Abu Dhabi acquired Nova Chemicals for $500 million in Energy Aspects said it expected new commercial storage 2009 using its stated-owned International Petroleum to come online. Investment Co (IPIC), saving it from a financing "The global economy and trade issues are a bit macro for restructuring due to its large debt. Since then, the us," one Chinese buyer said, noting July purchases company's business has grown rapidly, taking advantage closer to home than Angola such as from Gulf producers. of the shale-driven natural resources boom in North "But anything signalling lower growth and demand, none America. of this geopolitical stuff is good." Two years ago, Abu Dhabi merged IPIC with Mubadala, POOR MARGINS, FEWER BIDS which manages over $225 billion in assets. The Margins on the kind of refined products made from emirate has looked into consolidating its holdings and heavier Angolan crude such as jet fuel plunged to a six- retrenching from some overseas businesses. week low of $12.93 a barrel over crude at the end Founded in 2000, Chevron Phillips Chemical has 31 of May before recovering to $14.50 this week. production facilities located in the , The premium of to Dubai also reached its , Saudi Arabia, Qatar and Belgium. It had total highest levels in over a year, making Middle East oil a revenue last year of $12 billion, according to its website. more attractive prospect, before settling down again. China's lack of interest became clear early in the trading Angolan oil struggles to sell on demand fears, weak cycle as Chinese state oil trader Unipec declined to make margins any bids, setting the stage for a price slide that has now prompted somewhat buying by Chinese state and Angola, a key provider of oil to China, has suffered its independent refiners. slowest trading month this year as poor refining margins, More worrying for sellers, China repeatedly sought to sell high freight rates and subdued demand amid the trade West African cargoes it was assigned through long- war between and Washington curbed its sales. standing agreements with producers via the publicly Angolan crude had been selling out easily each month, visible Platts Window instead of shipping them home, but with heavier grades especially coveted since similar attracted little enthusiasm. Iranian and Venezuelan varieties evaporated due to U.S. All last week Unipec offered a cargo of Mostarda from sanctions. Angola's new offshore stream and finally discounted it to But a surplus of 8 cargoes struggled to find buyers as a dated Brent minus 80 cents, a plunge from offers for the new August programme was released on Monday -- the grade of around $1.20 in late May. first overhang of the year, traders said. "Sellers are nervous about Angolan (oil), as they sensed China typically purchases about two-thirds of Angolan the lower demand from the Chinese was not fake ... but barrels each month, making Africa's second-biggest oil rather a real pull-back", a West African trader said. exporter an important barometer of the Chinese market. Differentials for some top Angolan crude grades like Dalia Industrial output growth in China unexpectedly slowed to remained near all-time highs, but attempts by sellers to a more than 17-year low and investment cooled, official push them higher in the absence of Iran and Venezuela's statistics showed on Friday, and crude oil imports slipped barrels and new shipping fuel standards set for next year 8% in May from an all-time high the month before. have floundered. Asked if signs of slowing growth in China and a sluggish "Sellers got too greedy," the trader added. global economy were stinging demand, a top seller of Angolan oil said: "That's inevitably part of it." Druzhba oil pipeline flows to Poland resume after "The longer the trade war drags on, demand will shutdown -operator inevitably be hit. Then again, a resolution to that could lead to a speedy turnaround," the source added. Oil flows to Poland through the Druzhba pipeline resumed Crude purchases especially among Chinese independent on Thursday after being suspended on Wednesday

4 June 21, 2019 (continued) evening due to the discovery of contaminated oil, Polish then, their share has been on a downward trend, which pipeline operator PERN said on Thursday. shows no sign of reversing. Russia suspended west-bound flows through the pipeline OPEC's combined production was up by just 2 million in April due to excessive levels of organic chloride in the barrels per day (5%) in 2018 compared with 2008, while crude, but PERN confirmed on June 9 that clean oil non-OPEC output climbed by 9.6 million bpd (29%) in the supplies from Russia had been partially restored. same period. "This morning, after additional analyses of subsequent Saudi Arabia, OPEC's de facto leader, increased batches of crude oil and confirmation of its proper quality, production by 1.6 million bpd (15%), while Iraq boosted pumping was resumed," PERN said in a statement, output by 2.2 million bpd (90%). adding there was no threat to supplies for its customers. Outside OPEC, however, Canada raised output by 2 Russian pipeline monopoly also said million bpd (62%), and the United States boosted output contaminated oil had been found at a section of the by 8.5 million bpd (126%), mostly as a result of increased Druzhba pipeline from Belarus to Poland, causing the flows from onshore shale fields. shutdown on Wednesday, the RBC media portal Saudi Arabia's share of global output has remained stable reported. since the 1990s, but many of the organisation's other PERN said it had asked Belarussian pipeline operator members have seen their share erode as a result of war, Gomeltransneft for clarification regarding the issue, and sanctions, unrest and mismanagement. was told it was due to switching elements in the system. TWIN OBJECTIVES Belarusian state oil firm Belneftekhim said on Thursday Saudi Arabia emerged as the undisputed leader of OPEC no new contaminated oil had been found in tests on in the 1990s after war and sanctions crippled production Belarusian territory and it was looking into PERN's in rivals Iran and Iraq, and corruption, mismanagement discovery. and unrest hit output from , Libya and Venezuela. April's suspension of flows through the Druzhba pipeline Saudi Arabia's objective has been to maximise short-term affected refiners in Germany, Poland, the Czech export revenue, subject to the need not to jeopardise its Republic, Slovakia, Hungary, Ukraine and Belarus. long-term market position and protect its diplomatic relationship with the United States. U.S. efforts to cut off Iran oil revenue working -White In practice, the kingdom has alternated between periods House adviser when it prioritised the defence of prices (at the expense of market share) and protecting market share (at the White House trade adviser Peter Navarro said on expense of prices). Thursday that United States efforts to cut off Iran's oil In recent years, the kingdom's dilemma has sometimes export revenues through sanctions are succeeding. been eased when U.S. sanctions have restricted exports "What we're trying to do here, which is succeeding, is to from its regional rival Iran (and more recently from cut off their export revenues. They sell oil, they sell Venezuela). petrochemiclas, they sell iron and steel," Navarro said in Sanctions on rival producers have allowed the kingdom to an interview with Fox News. "It's certainly working - it's protect prices without sacrificing too much market share, working beautifully." so they serve both commercial and diplomatic objectives. But the limits of this strategy are now becoming evident COLUMN-OPEC's market share is in long-term with prices struggling to rise even as Iran and Venezuela decline: Kemp have been pushed almost entirely out of the market. Long-term trends in both oil prices and market share are The Organisation of the Petroleum Exporting Countries' adverse to the kingdom, complicating the government's share of the global oil market is progressively eroding as ambitious goals for social and economic transformation. it attempts to keep prices artificially high by restricting its U.S. SHALE BARRELS own production. U.S. shale firms and other non-OPEC producers, OPEC's share of global production fell to just 41.5% last including the major international oil companies, have year, the lowest since 2003, according to figures been the biggest beneficiaries of Saudi Arabia's and contained in the latest edition of the BP Statistical OPEC's efforts to restrict production and lift prices. Review of World Energy, published on June 11. By keeping prices higher than they would been otherwise, OPEC's share will almost certainly shrink even further Saudi Arabia's strategy of restricting output underpinned this year, to the lowest level since 2002, and before that the first shale boom (2011-2014) and the second one the early 1990s, given the organisation's output cuts and (2017-2018) in the United States. U.S. sanctions on Iran and Venezuela. In 2018, Saudi Arabia continued to restrict output during The organisation's members progressively increased the first six months, and ultimately raised production by their market share between 2002 and 2008, but since just 400,000 bpd for the full year, compared with a U.S.

5 June 21, 2019

increase of 2.2 million bpd, according to BP. joint venture in Australia, which produces liquefied natural By contrast, in 2015/16, the most recent instance when gas (LNG). KUFPEC is also investing in Canadian shale Saudi Arabia abandoned its price-defence strategy in gas and last month signed an oil concession in Pakistan. favour of market share, the kingdom's output rose by "We are no longer doing small acquisitions and we are no 400,000 bpd while U.S. shale output sank by 433,000 longer doing small deals. We will continue to look at and bpd. try grow our business in the places where we are already In the medium term, the kingdom's strategy of restricting strong." output to prop up prices is unsustainable; it is conceding KUFPEC is the foreign exploration arm of Kuwait, a key too much market share to shale and other non-OPEC Gulf OPEC producer which pumps about 2.7 million producers. barrels per day of oil and plans to boosts its crude oil Russia, which aided Saudi Arabia's efforts to restrict production capacity to 4.75 million bpd in 2040. supplies in 2017/18 and again in 2018/19, has already Kuwait's domestic oil expansion strategy will focus on expressed concern about the long-term consequences of offshore exploration and KUFPEC will be able to provide high prices and eroding market share. the knowledge and expertise needed to achieve that In the short term, the kingdom's policymakers are focused target, he said. on averting a renewed build up in inventories and slump "KUFPEC enjoys strengths in technology and know-how in prices as global growth and oil demand slows. in offshore drilling, and we work with our sister company, In the medium term, however, Saudi Arabia will have to KOC (Kuwait Oil Company), to help them apply our moderate its price goals and refocus on market share if it knowledge in Kuwait," he said. is to maintain its leadership role. "We also provide development opportunities for young Kuwaiti engineers to be trained with oil majors, so they Kuwait's KUFPEC eyes acquisitions as it boosts oil, can hone their skills and bring back that expertise to us." gas output - CEO Sheikh Nawaf is also the CEO of KPC Holdings Aruba, known as Kuwait Petroleum International (KPI), Kuwait's Kuwait Foreign Petroleum Exploration Co. (KUFPEC) is foreign energy investment arm. KPI plans to grow its looking for strategic acquisitions in the coming year and a retail business abroad, he said. The company has 4,700 half as it aims to boost its oil and gas production to petrol stations in Europe, under its trademark brand Q8. 150,000 barrels of oil equivalent per day (boed) by 2020, "We have just closed a deal to buy 75 stations in Belgium the company's chief said. and we are about to conclude an acquisition of another Sheikh Nawaf al-Sabah, acting chief executive of 96 stations in Spain," Sheikh Nawaf said. KUFPEC, told the state-run company will focus KPI is also a partner in an oil refinery in Vietnam, which on oil and gas exploration in countries such as in was commissioned in November last year and produces Malaysia, Indonesia, Pakistan and Australia. 200,000 bpd. The new refinery is designed to process "We are currently at 120,000 BOE (per day), and we mostly crude imported from Kuwait and will have a expect to be close to 150,000 BOE (per day) thanks to petrochemical plant connected to it. organic growth we foresee in our existing projects," Further expansion of the Vietnam oil refinery is possible, Sheikh Nawaf said in an interview in Kuwait City. he said. "We will consider the expansion, it is within the "We need one or two strategic acquisitions over the near mandate to look at it, we want to get into a steady state term to close the gap and reach a sustainable 150,000 and assess where we are and in due course take a BOE (per day) of production. If we get an opportunity in a decision on that," he said. new jurisdiction that fits within our strategy, we will take KPI has also partnered with Oman to build another that as well," he said. refinery in Duqm with a capacity of 230,000 bpd that will The company is also focusing on growing its producing also be a home for Kuwaiti crude, he said. assets in places such as Southeast Asia, Pakistan, KPI operates the 265,000 bpd Milazzo oil refinery in Sicily Canada, and Norway, he said. in a joint venture with Italy's . One of the company's main projects is its Wheatstone

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