by Tyler Durden on 11/03/2014 23:42
Two years ago, in hushed tones at first, then ever louder, the financial world began discussing that which shall never be discussed in polite company – the end of the system that according to many has framed and facilitated the US Dollar’s reserve currency status: the Petrodollar, or the world in which oil export countries would recycle the dollars they received in exchange for their oil exports, by purchasing more USD-denominated assets, boosting the financial strength of the reserve currency, leading to even higher asset prices and even more USD-denominated purchases, and so forth, in a virtuous (especially if one held US-denominated assets and printed US currency) loop.
The main thrust for this shift away from the USD, if primarily in the non-mainstream media, was that with Russia and China, as well as the rest of the BRIC nations, increasingly seeking to distance themselves from the US-led, “developed world” status quo spearheaded by the IMF, global trade would increasingly take place through bilateral arrangements which bypass the (Petro)dollar entirely. And sure enough, this has certainly been taking place, as first Russia and China, together with Iran, and ever more developing nations, have transacted among each other, bypassing the USD entirely, instead engaging in bilateral trade arrangements, leading to, among other thing, such discussions as, in today’s FT, why China’s Renminbi offshore market has gone from nothing to billions in a short space of time.
And yet, few would have believed that the Petrodollar did indeed quietly die, although ironically, without much input from either Russia or China, and paradoxically, mostly as a result of the actions of none other than the Fed itself, with its strong dollar policy, and to a lesser extent Saudi Arabia too, which by glutting the world with crude, first intended to crush Putin, and subsequently, to take out the US crude cost-curve, may have Plaxico’ed both itself, and its closest Petrodollar trading partner, the US of A.
As Reuters reports, for the first time in almost two decades, energy-exporting countries are set to pull their “petrodollars” out of world markets this year, citing a study by BNP Paribas (more details below). Basically, the Petrodollar, long serving as the US leverage to encourage and facilitate USD recycling, and a steady reinvestment in US-denominated assets by the Oil exporting nations, and thus a means to steadily increase the nominal price of all USD-priced assets, just drove itself into irrelevance.
A consequence of this year’s dramatic drop in oil prices, the shift is likely to cause global market liquidity to fall, the study showed.
This decline follows years of windfalls for oil exporters such as Russia, Angola, Saudi Arabia and Nigeria. Much of that money found its way into financial markets, helping to boost asset prices and keep the cost of borrowing down, through so-called petrodollar recycling.
But no more: “this year the oil producers will effectively import capital amounting to $7.6 billion. By comparison, they exported $60 billion in 2013 and $248 billion in 2012, according to the following graphic based on BNP Paribas calculations.”
In short, the Petrodollar may not have died per se, at least not yet since the USD is still holding on to the reserve currency title if only for just a little longer, but it has managed to price itself into irrelevance, which from a USD-recycling standpoint, is essentially the same thing.
According to BNP, Petrodollar recycling peaked at $511 billion in 2006, or just about the time crude prices were preparing to go to $200, per Goldman Sachs. It is also the time when capital markets hit all time highs, only without the artificial crutches of every single central bank propping up the S&P ponzi house of cards on a daily basis. What happened after is known to all…
“At its peak, about $500 billion a year was being recycled back into financial markets. This will be the first year in a long time that energy exporters will be sucking capital out,” said David Spegel, global head of emerging market sovereign and corporate Research at BNP.
Spegel acknowledged that the net withdrawal was small. But he added: “What is interesting is they are draining rather than providing capital that is moving global liquidity. If oil prices fall further in coming years, energy producers will need more capital even if just to repay bonds.”
In other words, oil exporters are now pulling liquidity out of financial markets rather than putting money in. That could result in higher borrowing costs for governments, companies, and ultimately, consumers as money becomes scarcer.
Which is hardly great news: because in a world in which central banks are actively soaking up high-quality collateral, at a pace that is unprecedented in history, and led to the world’s allegedly most liquid bond market to suffer a 10-sigma move on October 15, the last thing the market needs is even less liquidity, and even sharper moves on ever less volume, until finally the next big sell order crushes the entire market or at least force the [NYSE|Nasdaq|BATS|Sigma X] to shut down indefinitely until further notice.
So what happens next, now that the primary USD-recycling mechanism of the past 2 decades is no longer applicable? Well, nothing good.
Here are the highlights of David Spegel’s note Energy price shock scenarios: Impact on EM ratings, funding gaps, debt, inflation and fiscal risks.
Whatever the reason, whether a function of supply, demand or political risks, oil prices plummeted in Q3 2014 and remain volatile. Theories related to the price plunge vary widely: some argue it is an additional means for Western allies in the Middle East to punish Russia. Others state it is the result of a price war between Opec and new shale oil producers. In the end, it may just reflect the traditional inverted relationship between the international value of the dollar and the price of hard-currency-based commodities (Figure 6). In any event, the impact of the energy price drop will be wide-ranging (if sustained) and will have implications for debt service costs, inflation, fiscal accounts and GDP growth.
Have you noticed a reduction of financial markets liquidity?
Outside from the domestic economic impact within EMs due to the downward oil price shock, we believe that the implications for financial market liquidity via the reduced recycling of petrodollars should not be underestimated. Because energy exporters do not fully invest their export receipts and effectively ‘save’ a considerable portion of their income, these surplus funds find their way back into bank deposits (fuelling the loan market) as well as into financial markets and other assets. This capital has helped fund debt among importers, helping to boost overall growth as well as other financial markets liquidity conditions.
Last year, capital flows from energy exporting countries (see list in Figure 12) amounted to USD812bn (Figure 3), with USD109bn taking the form of financial portfolio capital and USD177bn in the form of direct equity investment and USD527bn of other capital over half of which we estimate made its way into bank deposits (ie and therefore mostly into loan markets).
More ( here )
And so on, but to summarize, here are the key points once more:
- The stronger US dollar is having an inverse impact on dollar-denominated commodity prices, including oil. This will affect emerging market (EM) credit quality in various ways.
- The implications of reduced recycled petrodollars has significant ramifications for financial markets, loan markets and Treasury yields. In fact, EM energy exporters will post their first net drain on global capital (USD8bn) in eighteen years.
- Oil and gas exporting EMs account for 26% of total EM GDP and 21% of external bonds. For these economies, the impact will be on lost fiscal revenue, lost GDP growth and the contribution to reserves of oil and gas-related export receipts. Together, these will have a significant effect on sustainability and liquidity ratios and as a consequence are negative for dollar debt-servicing risks and credit ratings.
Helix Energy Solutions Group, Inc. announced that it has been awarded its initial customer contractual commitments for the Helix 534. The Helix 534 was acquired in August from Transocean and is undergoing modifications and upgrades necessary for conversion into a well intervention vessel at the Jurong Shipyard in Singapore.
The Helix 534 is scheduled to sail from Singapore during the first quarter of 2013 and after transit to the Gulf of Mexico, is expected to be placed into service in late second quarter 2013. Backlog for the Helix 534 involves work in the Gulf of Mexico and extends into 2016.
Meanwhile, the Q4000 has extended its strong contractual backlog through 2014, with strong customer interest into 2016.
Helix also announced that the Skandi Constructor has also received its initial contractual awards. The Skandi Constructor is a chartered vessel and is expected to enter the Helix well intervention fleet in the spring of 2013. Its initial contract involves work in the North Sea and follows with a project off the eastern Canadian coast.
Helix’s two existing North Sea based well intervention vessels, the Seawell and the Well Enhancer, have been awarded customer contracts into the fourth quarter of 2013.
Owen Kratz, President and Chief Executive Officer of Helix, stated, “The recent contract awards for our two new additions to the well intervention fleet, the Helix 534 and the Skandi Constructor, as well as the growing backlog for our existing fleet, reflects the strong market demand for deepwater well intervention services as well as Helix’s market leadership for these services. Furthermore, customer interest for our newbuild semisubmersible well intervention vessel, the Q5000, remains high. The Q5000 is currently under construction at the Jurong Shipyard in Singapore and is scheduled to enter the fleet in early 2015.”
- Helix Updates Well Intervention Fleet Backlog (dailyfinance.com)
- A Day in the Life of Keith Schultz, Captain of Helix ESG’s Q4000 Well Intervention Rig (gcaptain.com)
The stars are aligned for the success of the ultra-deepwater (UDW) drilling industry. As crude oil prices remain substantially high, oil exploration companies are going farther offshore to obtain new supply sources, supporting the demand for UDW drilling. At the same time, the cost of purchasing UDW drillships remains low, as shipbuilders clamor for any sort of construction orders (rigs and ships) because of the extreme downturn in the shipping industry.
UDW drilling refers to drilling beginning at water depths of more than 7,500 feet. Companies in this field contract out their UDW drilling rigs along with the necessary equipment and work crew on a daily rate basis to drill wells for customers. The nature of the business is very specialized, meaning that it is difficult for a new entrant to replicate the business model and attempt to muscle itself into the picture. Furthermore, the business model is fairly simple. Companies aim to profit from the difference between the daily rates that they charge their customers, and the daily operating expenditures (“OPEX”) that they incur while servicing drillships. So long as daily rates remain high and OPEX stays low, UDW drillers will make a tidy profit.
Fortunately for drillers, the demand and supply dynamics of the industry is in their favor. A typical drillship scheduled for delivery in 2015 can be purchased at around US$650 million, while the ongoing daily rate of a typical UDW drillship is around US$600,000. Assuming daily OPEX of US$200,000, a UDW drillship should bring in about US$400,000 daily. Considering these assets cost an average of US$650 million each and estimated useful lives of around 25-30 years, this spread between daily rates and OPEX could potentially generate US$730 million for the rig owner in five years.
Following the 2010 oil spill incident by BP in the Gulf of Mexico, increased regulation and greater scrutiny has limited the entrant of new UDW players. These policies entrench the incumbent UDW drillers and support the daily rate that companies can charge oil exploration companies such as ExxonMobil. At the same time, prices of new drillships remain low as the global shipbuilding industry goes through a deep cyclical trough. This means that shipbuilding houses are more likely to charge lower prices to obtain any business possible to make up for lost orders from the shipping sector.
Here are some of the drilling companies that have a higher proportion of exposure to UDW drilling and could potentially profit from the demand and supply imbalance in the industry. (Click here to access free, interactive tools to analyze these ideas.)
1. Ocean Rig UDW
ORIG is a pure play that allows one to invest in the deepwater water drilling market as it derives all of its revenue from that particular niche sector. 75% of its rigs are contracted into 2015, thus ensuring some kind of cash flow stability over the next three years. It has six high-spec UDW rigs on the water and three newbuilds scheduled for delivery in 2013. Of its six UDW rigs, it has two semi-submersibles that can drill up to 30,000 feet and four drillships that can drill up to 40,000 feet. Daily rates of all six ships are at least US$450,000, and up to US$675,000.
Furthermore, in August 2012, two of the newbuilds have already been contracted at daily rates of around US$640,000. However, a potential investor might be concerned that its assets are pledged as collateral to loans that are beginning to mature from September 2013 onward. For example, its two semi-submersibles Eirik Raude and Leiv Eiriksson are pledged to a US$1.04 billion revolver that is maturing in 2013.
2. Pacific Drilling (NAS: PACD)
Pacific Drilling derives 100% of its revenue from deepwater drilling. As such, it is one of the only two pure-play UDW drillers on the market. It has a fleet of six UDW drillships, with four delivered and two newbuilds to be delivered by 2013. It has the youngest fleet in the industry. Similar to Ocean Rig, it’s poised to profit from the upturn in deepwater daily rates and a lack of near-term supply of such expertise. The contract backlog for Pacific Drilling is at around US$2.2 billion and consists contracts ranging from one to five years. Two of the rigs operate in Nigeria, one in Brazil and another in the Gulf of Mexico.
One of the concerns about the company is that it has a fairly small fleet and has all its exposure to the deepwater drilling market. Should crude oil prices turn south for a considerable amount of time, the company might run into trouble.
3. Atwood Oceanics (NYS: ATW)
ATW is an international offshore drilling contracted founded in 1968. It currently derives 83% of its revenue from deepwater drilling and has eight rigs on the water, with five semi-submersibles and three jackups. It also has five newbuilds that are ready for delivery by 2014. Given its smaller size compared to the other players in the field, roughly 75% of its revenue is generated from its three largest customers: CVX Australia, Sarawak Shell, and Kosmos Energy Ghana.
The company is poised to take advantage of the upturn in the industry with most of its rigs contracted for a number of years. Its earliest rig repricing will come in December 2012, and this will allow it to have a chance of renewing the contract at a higher daily rate. Furthermore, the company has pretty low leverage compared to its peers with its debt to capital ratio at 26%, far lower than the industry average of around 35%.
4. SeaDrill Limited (NAS: SDRL)
Seadrill derives 66% of its revenue from deepwater drilling in FY2011 and has a mix of deepwater floaters, high-spec Jackups, and newbuilds. A huge advantage in investing in Seadrill is its aggressive dividend yield, which is currently at 9%. Its fleet consists of 66 offshore rigs, with 19 of them being newbuilds. It also has stakes in other offshore drilling companies such as Archer Limited (40%), SapuraKencana (6%), Varia Perdana (49%), Asia Offshore Drilling (34%), and Sevan Drilling ASA (29%). Its EBITDA margin and operating margin over the last two years has also been above those of its peers at 53% and 41%, respectively. However, similar to Ocean Rig, Seadrill has a tremendous amount of debt with its debt to capital ratio over 60%, while its peers are averaging around 35%. While in a rising daily rate environment Seadrill will do well with its leverage, it will suffer if and when the industry suffers a slowdown.
5. Noble Corp. (NYS: NE)
Noble Corp is a leading player in the offshore drilling industry with an existing fleet of close to 70 rigs. The fleet consists of nine drillships, 16 semi-submersibles and 43 jackups. In FY2011, it derived 61% of its revenue from deepwater drilling and will be a benefactor from the uptrend in daily rates of ultra deepwater drilling rigs.
In terms of geographical reach, Noble Corp is everywhere. It has 19 rigs in the Middle East, 12 rigs in Mexico, 10 rigs in Brazil, 10 rigs in the Gulf of Mexico, nine rigs in the North Sea, two rigs in the Mediterranean, one in Alaska, and five in other regions.
6. Transocean (NYS: RIG)
Transocean currently derives 59% of its revenue from the deepwater drilling sector. Unfortunately for the company, it was involved in the Macondo oil spill in the Gulf of Mexico in 2010. As a result, there is a lot of uncertainty surrounding the company. However, Transocean is definitely a force to be reckoned with in the offshore drilling market. It has the largest fleet of offshore rigs, with 130 rigs on water and five newbuilds. Furthermore, it has a large cash pile of close to US$4.0 billion and generates close to US$2.0 billion in cash from operations every year. This makes it a prime target to renew and upgrade its existing fleet of UDW rigs to take advantage of the latest uptrend in daily rates. Unfortunately, the Macondo event and its ensuing troubles will probably keep its share price depressed for the foreseeable future.
- South Korea: Samsung Yard Bags $ 600 Mln UDW Drillship Order (mb50.wordpress.com)
- Ultra Deepwater Drilling Poised to Take Advantage of Supply Demand Imbalance (fool.com)
- South Korea: Samsung Yard Bags $ 600 Mln UDW Drillship Order (appliedagrotech.net)
- Seadrill is Keeping the Lights on at Samsung Heavy with Seventh, and Eighth, New Drillship Order (gcaptain.com)