TOM NELSON and CHARLES WHALL, portfolio managers at Investec Asset Management, explain why they believe the oil price is unlikely to stay this low for an extended period of time.
The sell-off has been driven by Opec’s surprise actions and not, as popularly believed, a ‘supply glut’.
We believe the oil price is unlikely to stay below the industry’s cash operating cost for too long.
We expect the recovery in the oil price will likely surprise investors in its speed and scale.
ANIMAL SPIRITS OF TRADERS AND CHANGING SAUDI BEHAVIOUR Oil prices have fallen steadily since the Opec meeting on 27 November 2014. The realisation that Saudi Arabia would not moderate production to support oil prices has let loose the animal spirits of traders who continue to sell oil aggressively. Brent crude oil is hovering at $50 per barrel (bl), WTI is in the high $40s, and energy equities continue to underperform. As a reminder, the average price of Brent oil in 2014 was $99/bl. We must not lose sight of the fact that the collapse has been in near-term prices as evident through the longer-term futures price which is currently trading at $78 today.
The Opec meeting was a significant negative surprise to us and to the rest of the market. The change in Saudi behaviour cannot be overstated, and far outweighs the demand weakness which we expect to be transitory. Saudi Arabia has decided to defend market share at the expense of price for the first time since the 1980s, which will cause oil prices to fall excessively – beyond a level which rational supply/demand economics would dictate.
Without a market moderator to smooth the supply/demand balance – a role Saudi Arabia had played skilfully for a number of years – the traders can sell oil with impunity, at least for now. Opec’s decision has changed the way oil markets will function in the short term. This new era of volatility will cause a material slowdown in spending and investment which will balance the market – and this will lead in time to an oil price overshoot to the upside. Neither scenario is helpful for major oil producers: the net effect will be less investment, at a time when the sector is already struggling to combat steeper production declines and a startling lack of exploration success.
However, reflecting on the Opec meeting, we are at least now clearer on Saudi intentions, namely to slow down supply from key non-Opec producers: US shale oil and Russia. To recap, Opec had expected nonOpec supply to increase by 1.4 million bl/day in 2015. We think this scenario is optimistic.
HOW LOW CAN OIL GO? The rational, if unanswerable, question at the moment is ‘how low can oil prices go?’. We base our oil price analysis around the four pillars of supply, demand, marginal cost and Opec – but recognise that short-term trading momentum, driven by financial speculation, is still to the downside.
Opec: The next meeting is scheduled for 5 June 2015, but we should not discount the possibility of an emergency meeting being convened before that date. Brent was trading at $78/bl when they met in late November. In our view, Saudi Arabia is waiting for clear evidence of a slowdown in US shale oil production, which could come towards the end of the first quarter.
Marginal cost: At $50/bl Brent oil we are already well below the marginal supply cost, defined as the cost of pumping the last and most expensive barrel required to satisfy demand, for the industry. Spending is being reduced, projects are being delayed, and investment in the sector is falling. We estimate the marginal cost for US shale to be around $75/bl.
Demand: 2014 was a weak demand year, but still a year of demand growth. We believe that 2015 demand will be stronger, stimulated by lower oil prices (the traditional cure for low oil prices). To reiterate, the oil price collapse has not been caused by a collapse in demand, which was only 0.5% less than estimated. Chinese strategic buying of oil – for which there is ample storage capacity – could surprise the market in 2015.
Supply: 2015 is the most difficult year to model since 2008 due to the sharp slowdown in spending. Regarding US shale oil: we calculate that spending by US shale oil producers will fall by 30%. Most importantly, we estimate that US shale oil production growth – which has been 1 million bl/day for each of the last three years – will fall to less than 0.5 million bl/day. The challenge is pinpointing the delay between reduced drilling and reduced production. Such is the efficiency of drilling and tying-in wells, this lower spending will be evident with a drop in production growth coming towards the end of the first quarter in our view.
Outside US shale oil, 2015 is expected to be a lean year for new conventional field start-ups, as we have written before. The changing tax regime in Russia has incentivised Russian producers to boost production in December and January, but the effect of sanctions and underinvestment could pull Russian production materially lower in 2015.
OUR OIL PRICE FORECASTS FOR 2015 With all of this in mind we forecast that Brent oil will average $60/$70/$80/$85/bl in the four quarters of 2015, to give a full-year average of $70-75/bl, representing 40-50% upside in the commodity price from today’s level. We model no premium for geopolitical risk but note that Saudi Arabian succession, Venezuelan debt default and Nigerian elections stand out as supply-side risks.
CONCLUSION Overall, we are positioning the portfolio for a recovery in the oil price in 2015, as described above. We believe the sell-off has been driven by Opec’s surprise actions and we expect the equities to recover in anticipation of a move higher in the commodity price. The recovery is likely to surprise investors in its speed and scale, just as the sell-off has, and we fundamentally believe that we are approaching the bottom in terms of sentiment, investor positioning and valuation. We believe the oil price is unlikely to stay below the industry’s cash operating cost for an extended length of time.
The Bulb World Chief Executive Officer (CEO) and entrepreneur, Ketshephaone Jacob has been selected as a 2021 Top 50 Africa’s Business Hero.
Jacob was chosen from a pool of 12,000 applicants – many of whom are highly-skilled and accomplished entrepreneurs.
Africa’s Business Hero, sponsored by technology entrepreneur, Jack Ma, aims to identify, support and inspire the next generation of African entrepreneurs who are making a difference in their local communities, working to solve the most pressing problems, and building a more sustainable and inclusive economy for the future.
The initiative is as inclusive as possible and applications were open in English and French to entrepreneurs from all African countries, all sectors, and all ages who operate businesses formally registered and headquartered in an African country, and that have a 3 year-track record.
Every year, finalists are selected to compete in the ABH finale pitch competition and participate in a TV Show that will be broadcast online and across the continent.
The finalists will compete for a share of US $1.5 million in grant money.
The Bulb World, is home grown LED light manufacturing company, which was partly funded by Citizen Entrepreneurial Development Agency (CEDA) at the tune of P4 million, to manufacture LED lighting bulbs for both commercial and residential use in 2017.
The Bulb World operate from the Special Economic Zone of Selibe Phikwe. Early this year, The BulB World announced its expansion to South Africa, setting in motion its ambitious Africa expansion plan.
During the first quarter of 2021, production in Botswana’s economic nucleus- the mining sector contracted by 12 percent. This is according to Mining Production Index released by Statistics Botswana this week.
The country’s central data body revealed that Index of Mining production stood at 74.4 during the first quarter of 2021, showing a negative year on-year growth of 12.0 percent, from 84.6 registered during the first quarter of 2020.
The main contributor to the decline in mining production came from the Diamonds sector, which contributed negative 11.7 percentage points. Soda Ash was the only positive contributor in the mining production, contributing 0.1 of a percentage point. However Soda Ash’s contribution was insignificant to offset the negative contribution made by Diamonds.
The quarter-on-quarter analysis by Statistics Botswana experts shows an increase of 16.3 percent from the index of 64.0 during the fourth quarter of 2020 to 74.4 observed during the period under review.
Diamond production decreased by 12.1 percent during the first quarter of 2021 compared to the same quarter of the previous year. The decrease was as a result of planned strategy to align production with weaker trading conditions mostly linked to Covid-19 protocols restrictions.
Botswana’s diamond sector is underpinned by Debswana, the country’s flagship rough producer- a 50-50 joint venture between government and global mining giant De Beers Group. The other producer is Canadian based Lucara Diamond Corp through its wholly owned Karowe Mine which is a relatively small but significant production that has made a name for itself worldwide with rare diamond recoveries of unprecedented carat size.
On the other hand, quarter-on quarter analysis shows that production has improved, registering a positive growth of 17.5 percent during the first quarter of 2021 compared to the preceding quarter – 2020 Q4.
Though production was significantly lower in the first quarter, the two producers ended Q2 with rare diamond recoveries. Debswana early last month found the world’s third largest gem diamond – weighing 1098 carat at Jwaneng Mine, its flagship gem quality diamonds producer, also regarded the world’s richest diamond mine.
A week later Lucara announced its second biggest recovery, the 1174 carat clivage near-gem dug from its Karowe Mine. The diamond is the world third in carat size after the plus-3000 carat Cullinan found in South Africa back in 1905 and the 1758 carat Sewelo unearthed at its Karowe mine in 2019. Debswana and Lucara are investing billions of pulas in underground mining projects to extend the life of its mines, Jwaneng & Karowe respectively.
In terms of Gold which is produced at Mupani mine near Botswana’s second city of Francistown output decreased by 17.9 percent during the first quarter of 2021 compared to the same quarter of the previous year.
Similarly, quarter-on-quarter analysis reflects that production decreased by 21.4 percent during the first quarter of 2021, compared to the preceding quarter. The decrease was as a result of the deteriorating lifespan of the mine as well as the impact of COVID-19 which slowed down the mining activities.
Soda Ash production increased by 11.1 percent during the first quarter of 2021 compared to the same quarter of the previous year. In terms of quarter-on-quarter Soda Ash production also showed an increase, picking up by 2.1 percent during the period under review. The increase in production is attributable to the effectiveness of the plant following refurbishment which occurred in the third quarter of 2020.
Salt production decreased by 34.0 percent during the first quarter of 2021, compared to the same quarter of the previous year. Similarly, the quarter-on-quarter analysis shows that salt production registered a decrease of 32.9 percent during the period under review. Both salt and Sodash are produced by partly government owned Botswana Ash (BotsAsh) operating from Sowa town near Makgadikgadi pans.
Coal production decreased by 11.2 percent during the first quarter of 2021, compared to the corresponding quarter of the previous year. The decrease was attributed to the reduced demand from Morupule B Power Station following the remedial works being undertaken, as one boiler was in operation during the period under review.
Although production fell, Statistics Botswana says there was no shortfall in supply of coal due to stockpiling. On the other hand, the quarter-on-quarter comparison shows that coal production increased by 20.4 percent compared to the preceding quarter.
Botswana’s flagship coal producer is Morupule Coal Mine; a wholly state owned mining company located in Palapye producing primarily for Botswana Power Corporation (BPC)’s power generation plants Morupule A & B.
The other coal producer is Botswana Stock Exchange listed Minergy which operates a 390 MT Coal Resource mine in Masama near Media in the southwestern edge of the Mmamabula Coalfields.
Department of Mines in the Ministry of Mineral Resources, Green Technology & Energy Security has awarded mining licence to Tshukudu Metals-a subsidiary of Aussie firm Sandfire Resources ,giving the company a green light to start piecing the ground at its Motheo Copper Project near Gantsi.
Lefoko Moagi, minister in charge of mineral resources in Botswana confirmed to weekendpost on Tuesday. Minister Moagi revealed that “the licence has been approved , but Sandfire Resources as a listed company will report to its shareholders and investors then make an official public statement” he said.
Based on a forecast copper price of US$3.16/lb (reflecting current long-term consensus pricing) the Base Case 3.2Mtpa – Ghantsi copper project is forecast to generate US$664 million (over P7 billion) in pre-tax free cash-flow and US$987 million (over P10 billion) in EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation), at a forecast all-in sustaining cost of US$1.76/lb over its first 10 years of operations.
In December 2020, the Board of Sandfire Resources approved the commercial development of the Motheo Copper Mine located in the Kalahari Copper Belt in Botswana, marking a key step in its transformation into a global, diversified, and sustainable mining company.
Tshukudu Metals Botswana (Pty) Limited (Tshukudu) a 100% owned subsidiary will be the owner and operator of the Motheo Copper Mine which is scheduled to produce up to 30,000 tonnes per annum of copper in concentrate over a 12 year mine life.TMB is targeting development of its Motheo Copper Mine in 2021 and 2022, with its first production in 2023.
GOVERNMENT NOT TAKING UP 15 % STAKE ON OFFER
Beginning of this year presentations were made to the Department of Mines as part of the Mining Licence approval process and to the Ghanzi Regional Council, additional information was requested by Department of Mines in April and was duly supplied by the company.
As part of the Mining Licence approval process, the Government of Botswana has a right to acquire up to a 15% fully contributing interest in all mining projects locally. Quizzed on whether government through Mineral Development Corporation Botswana (MDCB) would be taking up stake in the project Minister Moagi said, “No consideration is being made on that regard”.
“Government is not considering taking up a stake in the Ghantsi Copper Mine project, every opportunity is assessed on all risks, but Government makes money all the while from leases, taxes and royalties, remember if you take stake you are liable for liabilities of the project as well,” Moagi said.
Last month Sandfire announced that it has awarded over P5 billion worth mining contract to African Mining Services (AMS), a subsidiary of Perenti, to deliver the open cast operation.
The contract, which has an estimated value of US$496 million (over 5 billion), is the largest single operational contract for the new Motheo Project covering a period of 7 years and 3 months, with provision for a one-year extension.
The contract according to Sandfire Resources was awarded following a competitive 3-stage tender process which saw a number of key factors taken into consideration when selecting the preferred contractor.
These included Citizen Economic Empowerment, safety culture, equipment suitability and availability, commercial terms and identified improvement opportunities. Under the terms of the contract, AMS has agreed to form a 70:30 Joint Venture with a suitable local Botswana partner or partners.
The JV is expected to be finalized ahead of commencement of mining in early 2022. African Mining Services has been operating in Africa for over 30 years. AMS’ parent company, ASX listed diversified mining services group Perenti, already has a presence in Botswana through Barminco, their underground mining division, at the large-scale Khoemacau Copper Mine located 200km north-east of Motheo.
Last month Sandfire executives said the award of the open pit mining contract represents another key milestone in advancing the Motheo Project towards production, with all components of the contract in line with the key parameters outlined in the December 2020 Definitive Feasibility Study (DFS).
The company said full-scale construction of the US$279 million (over P 3 billion ) mine development is expected to commence immediately upon receipt of the Mining Licence, with mining scheduled to commence in early 2022 ahead of first production in early 2023. This week Sandfire Resources advertised over 10 positions in calling on applications from geologists, mining engineers and geotechnical engineers.
The Motheo mine has an initial mine life of 12.5 years based on production from the T3 pit. The initial development is expected to generate approximately 1,000 jobs during the construction phase and 600 direct full-time jobs during operations, with at least 95% of the total mine workforce expected to be made of up of Botswana citizens.
Later in the week Sandfire Resources announced in the company website that it has received the licence. Sandfire’s Managing Director and CEO, Mr Karl Simich, said the award of the Mining Licence represented a major milestone that would see a significant increase in construction and development activities on site.
“We are absolutely delighted to now be in a position to move to full-scale construction at Motheo, with our construction crews expected to mobilise to site over the next few days. I would like to thank the Government of Botswana for their support throughout the approvals process, which will see Motheo come on-stream in 2023 as one of very few new copper mines commencing production globally.”
Simich said the project is expected to generate approximately 1,000 jobs during construction and 600 full-time jobs during operations, and represents the foundation for Sandfire’s long-term growth plans in Botswana.
“Our vision is that Motheo will form the centre of a new, long-life copper production hub in in the central portion of the world-class Kalahari Copper Belt, where we hold an extensive ground-holding spanning Botswana and Namibia,” he said.