Friday, July 15, 2005

“Worldwide Spiraling”

It’s good to know inflation is tame—at least, that’s what anybody buying ten-year bonds with a 4.20 yield are telling us.

But that’s not what Royal Dutch/Shell is telling us, according to today’s WSJ:

“Shell said costs in the second phase of the massive Sakhalin II natural-gas project…may double to $20 billion, and it expects the project to be delayed by half a year.”

The Sakhalin II project is a huge Liquified Natural Gas development off Sakhalin Island near Japan, designed to supply “the growing economies of Southeast Asia,” as described on the Sakhalin web site.

According to the folks at Shell, the sudden, overnight increase of $10 billion in the cost of this project owes itself partly to Sakhalin-specific issues, including environmental costs and pipeline-laying complications; and partly to “a world-wide spiraling of commodity and project costs,” as per the WSJ.

“We do not see these pressures decreasing in the near to midterm,” the Shell CFO told listeners on a hastily-organized conference call.

Just last week, in “But They Won’t Drill With It...Not For Now, Anyway,” I wrote about the fact that despite the doubling in oil prices this past year and the resulting massive increase in cash flows to the major oil companies, those same oil companies maintained cautious drilling plans—preferring to return much of the spare cash flow to shareholders via hefty dividends and share repurchases.

Looks like there’s going to be at least $10 billion less spare cash flow—either for returning to shareholders or for the drilling and exploration that the world is going to need to avoid another energy crunch.

Could be a long, cold winter for the bond market.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.


qtse said...

That's not good news, let's hope it doesn't keep up. Though it's tough enough to predict commodity trends, it's easier to let financial experts do all the work :P. I've been relying on for all my info, which ones do you recomment?

mamis said...

Jeff, 2 questions:

1) I understand your reluctance to offer stock picks, but let me ask this: if one were to agree that there's a coming energy crunch, and if one were to agree that oil has to go higher in order to induce the integrateds to should one play that thesis through stocks? E&P? R&M? Drillers?

2) A macro thesis I've been playing with; would be curious to hear your thoughts:

a) The USA uses oil more efficiently than developing economies.

b) WW GDP growth has been centered in developing economies in recent years.

c) Therefore, an energy crisis hurts developing economies much more than the US...

d) So growth slows and inflation grows more in developing economies than in the US...

e) And the conventional wisdom on yuan revaluation, dollar depreciation, spiralling US trade deficits, bad US equity returns relative to emerging markets, etc. is wrong.

Jeff Matthews said...


1. You're right, I am reluctant to offer stock picks because this site is not about picking stocks. However, I do think that until the majors lay off the focus on returning cash to shareholders, buy into the $60 a barrel number and really ramp up drilling, you win owning either the majors or the drillers--but the drillers will have the real spike-move.

2. I am not a macro guy, but an energy crisis hurts everyone eventually: as Asia's costs go up (and many Asian countries subsidize oil products prices to consumers) then our cost of imports goes up so inflation hits the U.S. just as hard as anywhere else, although Asian stock markets probably react worse.

As for the trade deficit, I was taught that economies that produce particular goods and services the cheapest should be allowed to do so, for the benefit of all. So I don't think the trade gap with China is all that big a deal. For what that's worth.

gvtucker said...

Just because the majors aren't investing the money in exploration doesn't mean money isn't getting spent elsewhere. When my group started in '99, there was only 1 other private equity fund in the exploration business. The amount of money chasing deals was in the low hundreds of millions.

Now, there are literally hundreds of private equity funds competing for deals, and the amount of money chasing those deals is in the tens of billions. And that doesn't even count the macro funds that are devoting cash to energy deals. You're seeing many independents starting their own oil service subsidiaries so that they can build new rigs rather than pay the higher contract costs to the service companies.

The market is solving this issue, slowly but surely.

Jeff Matthews said...

Yes, the market is solving the issue slowly...very slowly.

The North American rig count was up 7.7% this week, and the overall world rig count has risen the last few years.

But for an idea of how far we have to go before all this new activity translates into active exploration, compare the 2,580 rigs working around the world in June of 2005 with the 3,455 working in June of 1985...and the June 1981 boom-era count of 5,515.

We still have a long way to go.

RichL said...

You are looking at the energy shortage/high price question entirely too narrowly. There is a great deal of investment going on to reduce the use of energy with very high ROEs. The price solves the problem in the not too long-run.

If you have a spare 2 hours, this link to Rice Univ. has a speech by Amory Lovins on Winning the oil endgame. at -

It is not the conventional wisdom and worth the time.

Kevin H. Stecyk said...

Just commenting on RichL's comment: For those interested, you can read the executive summary of the book Winning the Oil Endgame (PDF version) (or even the entire book) by Dr. Amory B. Lovins et al to get a quick impression of his message.

It should be noted that Lovins is cofounder and CEO of Rocky Mountain Institute.

I completely agree with Jeff's analysis and I am a suspect of Lovin's and his follow author's analyses and conclusions. But others can read for themselves and arrive at their own conclusions.

Its_strange said...

Oil up $30 barrel and no inflation , no complains and the stock markets is just fine.......Heating oil up big, gas up over a $1.00 a gallon and no inflation, no complains and the NYSE is just great !.Just think what the oil companies wwould have done had they known ....!!!........right

gvtucker said...

Five years ago, all of the fundamental issues facing the energy markets were the same. Chinese demand was growing rapidly, the rig count was much lower than it is today, Hubbert's Peak was a concept that had been published decades ago. Nothing was different, except one thing--the price of energy. Back then, the only people that talked about prices anywhere near current levels were in the oil and gas business, and if you listened to them, all the logic that is used now will sound like old news.

Now, all of a sudden as the price of energy has increased sharply, people look for reasons and find all the things that Jeff has been talking about.

As the rig count grows, Chinese and US demand starts to decline (or at a minimum grow less rapidly), people will start to look for reasons why the price of energy is declining.