This is the first part of a two-part transcript in which Fool.co.uk's David Kuo welcomes back Malcolm Graham-Wood from VSA Capital to chat about the state of the oil sector. They look at the outlook for oil prices and dissect the latest results from Royal Dutch Shell
EDITOR'S NOTE: What follows is a lightly edited transcript of David Kuo's conversation with Malcolm Graham-Wood.
David Kuo: This is Money Talk, the weekly investing podcast from The Motley Fool. I am David Kuo, and my guest was so popular the last time he was on the show, we simply had to invite him back. He is, of course, oil and gas veteran Malcolm Graham-Wood from VSA Capital. Welcome back to The Motley Fool, Malcolm.
Malcolm Graham-Wood: Morning.
David: Good morning to you. Now we'll have a look at some of the oil minnows that we talked about six months ago, but before that I'd like to talk about oil prices, if I may, and the oil price is currently around $100 again, having been at $130, then it fell to about $90, and now it's $100. So what is going on with oil prices, Malcolm?
Malcolm: Well, it's $110 today -- it's been running quite a lot in the last few days. But the first thing you must remember about oil prices is, they always exaggerate the moves on the upside and on the downside. So when it got up to $127, $128, it was too high, and likewise when it got to $88 at the end of June, it was probably too low. At the high level, we had all those geopolitical influences from Iran in particular, and the only way to sort that out was to actually put more product onto the marketplace, which Saudi Arabia did -- they increased by two-and-a-half million barrels a day, which is almost what Iran were producing. Other people produce a little more, like Russia and so on, and of course the market suddenly realized there was a lot of crude around, and the price came down. It came down too far, and of course when it got to $88 to $90 at the end of June, suddenly people realized that the forces were working in the other direction. Even the Saudis were caught a little bit short on that front, and they certainly started to cut back their production. Then we had one or two other things, little things which always add to the tension, like Sudan and south Sudan, and activities, shut downs in the North Sea and the Gulf of Mexico and so on.
David: Some people might say these are exciting times for oil companies, but at what price does it no longer become viable for the oil minnows to say, I'm going to start drilling for oil, I'm going to stop drilling for oil?
Malcolm: Well, the ideal price is probably almost where we are at the moment, between $90 and $110 being a broad range, and around $100 is good for pretty much everybody. The Saudis don't like it below $90. People like the Venezuelans and so on don't like it below $100 or $110. In terms of companies, it depends what sort of crude and where you're operating. If you're operating on shore in the US, or somewhere else where it's relatively cheap, it doesn't really matter -- I mean, anything at about $20 a barrel works. If you're operating in Canada, it's probably $80 a barrel, and anything below that you'd stop investing, or you'd delay things. The more difficult, the more harsh the area, or the tax regime or whatever, but around $100 works for pretty much everyone.
David: Well, you may say that, but recently we had results from Shell, and they were moaning that oil prices were a little bit lower, which has this operational gearing effect on the company itself, and I think Shell's profits didn't quite come in as high as people expected, primarily because of the oil price. So what did you make of Royal Dutch Shell's results in general?
Malcolm: The oil price, a little bit to begin with -- there were two specific things for Shell there. The first thing was that, like all the other companies, that that quarter, as I said at the end of June, the price was at its worst, so it had come down from $125 to $90 in the space of the quarter, and they'll never that back this quarter or the next quarter -- it'll reverse itself out, and even today they'll be doing that much better. The second thing is that they reminded us that in Canada, because of the pipeline products in North America, there is nearly a $15 gap now, and the Canadians would just love to be able to export, either over to the west coast or through up to the east coast refineries, so that was their specific problem.
The Shell figures were poor. I thought that they hadn't explained away quite enough things, routine stuff like maintenance, outage of some of the upstream end and some downstream work. In most areas, they were a little bit light of expectations.
David: So what did you make of its decision to abandon its decision to buy Cove Energy
Malcolm: No, no -- I mean, the situation around Cove is clear and simple. They want to be in East Africa, they want to be in the big gas finds, they want to be in LNG -- they're the world leader in it. The other people in East Africa want Shell to be there as well. Once they'd put a guideline price down and then increased it once, Shell are not known for overpaying for assets. You must bear in mind that there are a whole bunch of assets in that area which Shell can still go and buy. Within the same licence that Cove was in, there are two Indian companies who own 10% each, one of which is Videocon, which isn't an oil company, so that's 10%, so that's a bigger stake than the eight-and-a-bit percent that Cove had, so Shell could go and buy that one. I've been saying for some months now that I think that, I wouldn't rule out the fact that Shell hadn't gone to see Anadarko. Now, they're the operator, and they own 36.5% of this licence, and I would have said it might have been a very smart move to go to them and say, can we buy all, or probably half, of that stake, and so get yourself 18% or something like that of the thing in one go. What you'll do is, you'll do it at the correct price. If Shell had increased the bid for Cove, that increases the value of all the assets around in the area, and if you're going to be going on to buy those assets, the last thing you want to do is to set the marker high. So I think Shell will buy assets in the area, either Anadarko or Videocon, or the other Indian company, or they'll farm in with somebody else somewhere, but they haven't forgotten about East Africa -- they're still very interested indeed.
David: OK, now, staying with Shell just for a few minutes longer, in the case of Shell, it's listed here on the London Stock Exchange. It's also listed in Europe, and recently it said it was pulling funds out of Europe. What did you make of that?
Malcolm: Well, Shell is a massive business. It's probably sort of the 30th-biggest country in the world by assets. If it was a country, Shell and Exxon
David: OK, so there's nothing for investors to be too worried about?
Malcolm: Nothing at all.
David: OK, so as far as Shell was concerned, you thought the results were a little disappointing, so what did you make of BP's results? Hugely disappointing?
Malcolm: Truly awful, I think is what I said at the time -- absolutely dire. They disappointed -- were miles wide of the mark in pretty much every area that they operate in -- upstream, downstream. They had write-offs, they had tax losses in Russia -- every single place that you could name. They've had an awful set of figures. I suppose the only good thing you can say about it is that, at the moment, people aren't looking at the actual numbers, because BP have got so many other problems on their plate. They're looking at the Gulf of Mexico, they're looking at TNK, they're looking at the 7.2 billion that they haven't got out of Argentina, which they messed up at the end of last year, and so they've got a whole lot of other things. It was always going to be a bad quarter for everybody, it was always going to be a bad second and third quarter for BP. They've got a lot of planned maintenance in the Gulf of Mexico, and in the North Sea. So the time when people weren't expecting too much, they really did take the opportunity to put the kitchen sink in there, and they did it. They were awful.
David: So are you saying we have to wait until the fourth quarter before we see anything concrete coming out from BP?
Malcolm: Oh, absolutely. I think the fourth quarter of this year for BP is going to be crucial. I think the third-quarter figures that we're in at the moment will be awful, so they'll be reported in the fourth quarter, but that's not the point. I think the fourth quarter, sometime in October is the due date for AAR to decide whether they're going to be involved in buying or selling, or whatever they're for.
David: What is going to happen there, Malcolm?
Malcolm: Well, nobody knows what is going to happen. What I think BP would like to happen, and if you're a shareholder of BP, what you would really like to happen, they want to get out of the clutches of AAR, who are the other investors in TNK BP, because they can't do anything sensible while they keep on obfuscating the matter, and they did it last week on the day of the figures, they said that they wouldn't agree to the dividend payment, which they said was due to the world conditions and everything else. But TNK is there to pay out what they make, and that's because there's a director short on the TNK BP board, and they can't agree on who the new director is going to be -- it gets worse.
David: It's comical, isn't it, really?
Malcolm: It's completely comical, and that's why BP need to get out of it. I mean, the biggest name in the frame is Rosneft, and President Putin wants to get back and get into state control quite a lot more of the assets that are in Russia. What I would like to see is perhaps Rosneft buying out BP. They might or might not buy out AAR as well. But if they were to buy out BP, and the sort of figure to look for is about $25 billion; if it was more than that, they've done well; if it's less than that, it's a little disappointing. But if Rosneft were to buy them out, and maybe pay some of it in cash and some of it, they can take an investment in BP, you might find that BP could have $10 billion or $12 billion to pay back to investors in special dividends, and they might have a 5% holding in Rosneft. If Rosneft end up being on the shareholder list of BP, Rosneft will be wanting to make sure that BP do well. Then, I think that, where there is further exploration to be done in the Arctic, or investing in Russia, which is still one of our big frontier areas, BP will want to be there, so that's a way of sort of having it all right at the end, out of the clutches of AAR, cash on the table, and taken away from the TNK BP investment, possibly Rosneft being a friend of yours afterwards.
David: Now, the thing is, if BP wasn't a multinational company, most people looking at BP would say, this is a takeover target, given that the mess that it is in at the moment. Do you believe that it's a takeover target?
David: Really? You've heard it here first.
Malcolm: I would buy BP ... it's absolutely at its most vulnerable. Everything has gone wrong for BP. The senior management lacks credibility in a big way, and they've messed up. Last year they messed up the Rosneft, the Arctic deal; they messed up the Argentinean deal. They've got a court case going on from Macondo, TNK we've just discussed, but the point is, they're in a very, very vulnerable state. BP really is a great operating business, but the best bit about BP is its Gulf of Mexico operation, which will become, and kicking in in 2013 and '14. You buy it now, you buy it on the cheap -- there's no doubt about that. BP's market cap is only 90 billion pounds -- say, or is it $120 billion -- and Exxon will spend $60 billion a year minimum on capex. So it wouldn't be a big buy for them, and of course you can get rid of, if you take on BP, you don't have to take on the whole thing. You can sell off bits of it, there's still quite a lot of exploration areas, where you could sell to other people, you could just develop some bits, and just take it on for the Gulf of Mexico. I've said for years that they should have got rid of that downstream business, all the refining and marketing, and you could go to any number of US or international refiners and say, take it off our hands. They've been putting money in like it's going out of style. There are other people who run refineries and do downstream much better than BP do, so lots of options.
David: So is there any chance that Tony Hayward could make a comeback and replace Bob Dudley?
Malcolm: No, I don't think so. I'll come on to Genel later on, and I think Tony's got a very exciting opportunity there. I don't think, if the thing you're buying BP for is the Gulf of Mexico, you want Tony Hayward running it. I mean, it happened on his watch -- that's what happened, and he made it worse by one or two of the inappropriate comments that he made at the time. The only trouble is that Tony Hayward was actually, was a really good businessman, and he ran BP very well with that exception. Bob Dudley doesn't come into that category unfortunately, so BP have got a chairman and chief executive who are subpar.
David: OK, so let's have a look at Britain's number three oil and gas company, which is BG. Now, in the case of BG, what did you make of its figures?
Malcolm: I'm a big fan of BG, and Frank Chapman in particular. I think he's got a fantastic operation there. The numbers themselves, like the others, they disappointed a little. Like some of the others, they had to take a write-off on their shale operations, their shale gas operations in the States, but in general terms I think that things went pretty well. I mean, there were three probably really good stories about BG -- there's the Brazilian operation, the acreage there; there's Australia, and there's the LNG operation. The interesting thing is that BG would split actually quite naturally, for someone. It's not easy to set up an LNG operation. It's massively profitable, particularly at the moment, with almost all the nuclear, or all the nuclear in Japan, out of action at the moment, they're big buyers of crude oil and of LNG. The biggest seller to them of crude oil has been Iran, so they're forced buyers of LNG and have been throughout the year. So that business will make three billion dollars' pre-tax profit for BG this year, and of course Brazil, and some people, one of the worries about BP is that some people just don't realize, it's a long-term thing, but if we're still here, we'll look back in a few years' time, and we'll see them producing hundreds of thousands of barrels a day out of Brazil, and it's a long, slightly longer term game than most. But I think BG is significantly undervalued. Whether that changes in the very short term, I'm not sure. Frank Chapman is due to retire in June of next year. There's some good-quality people behind, so it's not as if it's going to be a worry, but I'd love to know what's going to be, there will be one more thing he does before June of next year. Either way, BG is undervalued at the moment.
David: Could that one more thing that he does be a merger with BP? I mean, putting my analyst hat on, I would say that the merger of BG and BP seems to make an awful lot of sense?
Malcolm: It would make some sense. I mean, it would be one hell of a merger to put together, and I think a bit of hand-warming in the investment banks of Canary Wharf if that happened. But actually, it would make some sense -- you could have a fantastic operation with the Gulf of Mexico and Brazil and the operations of LNG and Queensland gas and all the stuff in Australia. You'd have to do an awful lot of trimming around the edges; a lot of the BP and BG peripheral exploration stuff would have to go. But if you're out of Russia, you could end up with the most fantastic company, with governments, so Brazil, Australia, supplying LNG. Don't forget BG are in Tanzania, so they've got an LNG operation in East Africa facing toward the Far East. The only big question would be: Who is running it? As long as the BP guys weren't running it, and screwing it down to the ground, trying to keep Frank Chapman back for another year or two, and pay him enough to defer his retirement.
That was the first part of a two-part transcript in which Fool.co.uk's David Kuo chats with Malcolm Graham-Wood from VSA Capital about the state of the oil and gas sector. They look at the outlook for oil prices and dissect the latest results from Royal Dutch Shell, BP, and BG Group.
In the second part of the transcript, Malcolm offers his opinion on a number of popular oil explorers that include Rockhopper Exploration, Falkland Oil & Gas, Gulf Keystone Petroleum, and Ophir Energy. Just click here to continue reading.
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