The Silent Crash

This chart (click to enlarge; all graphics in this article at Carlo Magnifico's chartbook) illustrates how stocks began to underperform commodities as the recent commodity bull began. The methodology used here was to create a ratio by dividing the Dow Jones Industrial Average by the Reuters/Jefferies commodity index (the leading benchmark for commodities as an asset class). During commodity bear markets the Dow Jones Industrial average does well, while during commodity bulls it goes into the tank. The large symmetrical triangle has scary implications, explained below.

By Peter McKenzie-Brown

 In real terms, in recent years the Dow Jones Industrial Average has been in a "stealth correction" - or, less generously, a silent crash. Growth in M3 money supply is now hidden, so it is not obvious that the US Fed is printing money at the astonishing (estimated) rate of 17% per year.

One result is that, while in nominal terms the Dow has appeared fairly flat for the last couple of years, it has actually been in a tailspin. It's dropping in euro, pound, yen, yuan and Canadian dollar terms, to name a few. More importantly, it is dropping in terms of real money (gold bullion) and other commodities - products from underground and from land and sea, the value of which is independent of the printing press. Since 2001, putting your money into traditional US equities has mostly been investing in a silent crash.

 If you believe in technical indicators, that situation could get much worse. The chart explains this graphically. Technically speaking, its most important feature is that the two lines form a large symmetrical triangle. According to the massive classic on technical analysis, Edwards and Magee’s Technical Analysis of Stock Trends, roughly 75% of symmetrical triangles are continuation patterns – that is, they suggest a major turning point.

A breakout is a technical event in which a stock or commodity price “breaks out” above the high (or below the low) trading pattern lines that enclose other price points. Breakouts are used by technical analysts to predict substantial upside or downside movement. Think of them as a kind of tipping point. Critical mass creates unstoppable momentum.

 Until we see a major breakout, in theory the chart could go either way. However, for the reasons this blog has been discussing for about a year, I believe the slight breakout we are now seeing is the beginning of a big drop. I have covered many of the causes – for example, dollar weakness, peak oil and its ties to gold prices, developments in the natural gas markets, Asian growth, financial crisis and so on – in earlier posts. To understand the tremendous momentum behind the collapse in the Dow relative to commodities, you need to appreciate the strength of the commodity rally. The chart above illustrates the power behind this commodity bull. The blue lines show the long, drawn-out collapse in commodity prices from 1980 to 2002. The red and green lines show a bull of tremendous virility – perhaps, if we can believe the recent breakout, one that is getting stronger still. My last chart compares the performance of the Dow to those of proxy indexes for shares in oil (the XOI), natural gas (the XNG) and gold (the XAU). The strength is there. Like the commodities whose prices back up their profits, there is little sign of the commodity stocks slowing down.

Note: Donald Ross, a correspondent, offered an alternative interpretation to the symmetrical chart presented at the beginning of this post. He also sent comments which deserve to be quoted in full: 

I don't think that you (really Carlo) are correct in drawing a Symmetrical Triangle here. 

From Edwards & Magee (regarding Triangles): "'Remember that it takes two points to determine a line. The top boundary line of a price area cannot be drawn until two Minor trend tops have been definitely established, which means that prices must have moved up to and then down away from both far enough to leave the two peaks standing out clear and clean on the chart. A bottom boundary line, by the same token, cannot be drawn until two Minor trend bottoms have been definitely established.' "Simply extending the Major trend line to form the bottom of a pattern would only be accurate if the reversals from the Minor tops reached down to, and reversed up again, at the trend line. " 

I think that this chart is showing us a Descending Triangle, which is more often a bearish indicator than a Symmetrical Triangle. I've taken the liberty to draw on Carlo's chart. I'd like to know what you think. I must also point to the Edwards and Magee "caveat" at the end of the chapter on Triangles: "'..., but the coarse, triangular patterns which can be found on graphs of monthly price ranges, especially the great, loose convergences which can take years to complete, had better be dismissed as without useful significance.' 

"Your article, Peter, and Carlo's work, are extremely significant in my opinion. Ninety-five years of the un-Constitutional Fed's un-Constitutional activities have brought us to the end of the latest, and greatest, example of the fallacy of fiat currency." Donald's interpretation of this chart, the descending triangle, is even more bearish than the symmetrical triangle discussed above. Here it is.

The Gas Storage Cycle

Chart #1: This chart compares the amount of natural gas in storage (usually underground reservoirs) in the lower 48 states, over time. The shaded area indicates the range between the historical minimum and maximum values for the weekly series from 2003 through 2007. The pattern is normal, of course. Like squirrels with their nuts, we store natural gas when it’s plentiful and consume it when we need it most.

By Peter McKenzie-Brown

Last fall, the amount of natural gas in storage in the United States set a new five-year record. Since then it has plummeted, and it has dropped more dramatically than at any other time in the last 15 years. The severity of the drop is obscured by the impact of Hurricane Katrina, which distorted the cycle several years ago. As my correspondent Paul Stallion explains,

looking at the numbers you will notice that this winter approximately 30 per cent more natural gas was drawn down from storage than for any other year in the past decade and a half. This fact is somewhat hidden in the chart of seasonal highs and lows, because usage nevertheless stayed within the 5-year average. What isn't mentioned is that the short-term (5-year) average itself is skewed by the hurricane which devastated New Orleans (which is also the reason gas in storage in the last few years could so easily remain so close to the top of that average). Chart #1 is therefore misleading, in terms of how dramatic the recent drawdown has been - which is why no one has yet mentioned it...

The chart also illustrates a key trend. Over three winters, there have been progressively lower supplies as the winter ended. This post suggests that this year less gas in storage is likely to combine with other factors to drive natural gas prices much, much higher than you might expect.

The volumes of gas in storage vary every year. During warm winters we consume less, for example, and during cold winters, more. Sometimes gas production surges, as it has in the south-central United States (Texas, Oklahoma, Louisiana and Arkansas) for the last few years. The combination of warmer winters in ‘06 and ‘07 plus growing supplies help explain the high storage levels of the last few years. The relatively mild summers of the last few years have been another factor. When it’s really hot, you use a lot of gas to generate electricity for air conditioning. Also, last summer liquefied natural gas (LNG) from overseas was cheap, and the US brought in large volumes by the tanker load for storage.

In the last six months, that situation has reversed. This winter was unusually cold in eastern North America, so we have consumed a lot more gas than usual. Also, prices for LNG are now much higher in Europe and East Asia than in the US, so that supply is going elsewhere: US imports have dropped from 4 billion cubic feet (BCF) per day last July to less than half a BCF today. And while the surge in south-central gas supply continues - mostly in Texas - production is in decline everywhere else in North America except Alaska, which isn't connected to any serious markets.

Now, turn your mind to the following chart. In my view, it says important things about the state of natural gas.

Chart #2: The purple line shows NYMEX natural gas prices during the last decade; the brown line shows the performance of the natural gas index (XNG) on the Amex. The XNG is a weighted share price index of the 15 largest players in the US gas business.

In the first half of the last decade, gas prices averaged perhaps $3.50 per thousand cubic feet. In the last five years, they have been around $7. A big increase, but compared to the price of oil, which has risen by a factor of five, not a big deal.

The odd part about chart #2 begins in the winter of 2002. Since that time natural gas prices have had lots of peaks and valleys, but the XNG has climbed steadily. My friend Carlo Magnifico, who provided the chart, puts it like this:

There’s been a steady accumulation of gas shares since 2002. The gas index has not had any really painful corrections like the price of gas has. It’s as though the price of gas doesn’t really factor into the price of gas stocks. Someone knows something. Gassy stocks are the place to be.

Last December this column anticipated the recent run-up in natural gas prices, and the balance of this article supports that call. We are now in a commodity bull market. During those cycles, commodity stocks rise while industrial stocks drop. In another article, I called this the great divergence.

Before I summarize the case for natural gas prices continuing to rise, a comment on one likely cause of this commodity bull. Harvard economics professor Jeffrey Frankel suggested in his blog that a decrease in real interest rates (“real” rates exclude inflation) increases the demand for storable commodities. In his thought-provoking comment, he writes,

If strong economic growth is not the explanation for the large increases since 2001 in prices of virtually all mineral and agricultural commodities, then what is? One wouldn’t want to try to reduce commodity markets to a single factor, nor to claim proof of any theory by a single data point. Nevertheless, the developments of the last six months provided added support for a theory I have long favored: real interest rates are an important determinant of real commodity prices. High interest rates reduce the demand for storable commodities, or increase the supply, through a variety of channels:

• by increasing the incentive for extraction today rather than tomorrow (think of the rates at which oil is pumped, gold mined, forests logged, or livestock herds culled)
• by decreasing firms’ desire to carry inventories (think of oil inventories held in tanks)
• by encouraging speculators to shift out of spot commodity contracts, and into treasury bills.

A decrease in real interest rates has the opposite effect, lowering the cost of carrying inventories, and raising commodity prices, as happened in the 1970s, and again during 2001-2004. It’s the original “carry trade.”

Professor Frankel makes clear that this is only one factor, but I think it's a point worth noting. Keeping that idea in mind, here is the case for a continuing bull market in natural gas prices. Such a market is probably the event that the steady upward performance of the XNG (Chart #2) is anticipating.

1. We are in a bull market for commodities (partly for the reasons Frankel suggested), and a rising tide raises all ships.

2. The gas industry must put enough gas in storage to meet demand next year, and the gas needed will be much greater than it was a year ago. As Chart #1 shows, volumes in storage are now well below last year’s volume, so demand will be much stronger. More to the point, this spreadsheet shows that this winter 30 per cent more natural gas was drawn down from storage than for any other year in the past decade and a half. As Paul Stallion's comments explained earlier, Hurricane Katrina's impact on supply obscures this statistic because it so dramatically dropped the bottom end of the 5-year average.

3. Gas production has been increasing in the south-central US. However, it is in decline elsewhere in the lower 48 states. Also, imports from Canada are unlikely ever to rise to the peak levels of a few years ago - partly because of declining production, but also because of greater domestic demand in Alberta and elsewhere.

4. Prices for LNG have more than doubled since last summer. Some countries are willing to pay $20 per thousand cubic feet, compared to the $9 and change that Americans now pay. This means we are far less likely to see low-cost LNG unloaded at American gasification terminals in the near future. Cargoes will continue to be redirected to higher price destinations, like East Asia.

5. The last factor to consider is the weather - to a large extent an imponderable, but something meteorologists are getting better at forecasting. The US National Weather Service predicts a hotter-than-normal summer this year. On a related note, the usually accurate Colorado State University forecast team "expects an above-average Atlantic hurricane season and may raise its prediction of 13 tropical storms and seven hurricanes when it updates its outlook" this week, according to Reuters.

Either of these factors could have an additional big impact on gas supply. High temperatures mean more need for air conditioning, and therefore more gas demand to fuel electrical generation. Hurricanes could mean shut-in production in the Gulf and in Texas and Louisiana.
Forecasting prices is a mug's game, and I will stay out of that. But I think natural gas prices are going way up from where they are today. To hedge against it, I put a little money here.

Note: Just two days after I wrote this came news of a major natural gas outage at the Independence Hub in the Gulf of Mexico. For several weeks, this will take one BCF per day out of production, worsening the situation described above.

Last of a Breed

This article first appeared in the April 2008 issue of Oilweek.

By Peter McKenzie-Brown Jim Kinnear makes it sound compelling. During the last couple of decades, “the trust took over the mid-cap end of the market. The junior companies are the explorers. The independents are doing the large projects – EnCana and CNRL (Canadian Natural Resources). Then there are the super majors. This type of vehicle (the trust) is ideal to fit that part of the market. It’s a difficult business model – how much should we reinvest, how much should we distribute to our unit holders. (The trust) is a very efficient way to reallocate capital. If you acquire an interest in an oil and gas asset, there’s good margins and good cash flow. You’re buying a good income stream. Our concept was to buy a cash flow stream. I’m a financial analyst. BSc – very general degree – then became a financial analyst. These assets provide cash flow, part of which is depletion of assets. You put up $100, get $20 back per year for five years, say, then you own the property. You can get a 15-20 per cent rate of return each year.” These notes give you an idea of the depth, intensity and direction of Kinnear’s thinking. Trusts evolved out of managed limited partnership (MLPs) for the wealthy and professionals. They are a financial vehicle developed to answer the question, “Can we expand the closed-end trust?” Trusts and MLPs combine the cash flow business model with a tax ruling that exempts them from tax. Pengrowth: Kinnear’s Pengrowth was the third trust; the first two were Enerplus and Royal Trust Energy. Kinnear remembers when Marcel Tremblay started up Enerplus in the mid-1980s. “He started his first fund with less than $10 million,” Kinnear says. “He got a comfort letter saying that he could distribute all this cash to his unit holders without paying tax. His unit holders would pay the tax on all the net revenue, not the trust. If unit holders lived in another jurisdiction, like the United States, they would pay tax in that jurisdiction.” Companies and corporations pay tax, but royalty trusts do not. They began as vehicles which pass oil and gas cash flow through to investors, and they still serve this purpose. Pulling out a writing pad, Kinnear draws a graphic showing how trusts work. With an expensive-looking fountain pen he draws a graphic showing cash flow coming from operations and being dispersed to individual investors. “You’re buying a cash flow stream,” he says. “We called it financial engineering. It’s like a REIT, except instead of owning buildings we owned revenue-generating oil and gas properties.” Taxes would be paid by investors, who could purchase trust units through stock exchanges. This very clever model enabled taxpayers to defer and avoid taxes – for example, by holding their trust in RSPs. The trust/RSP combination postpones taxes, sometimes almost endlessly. During a shift as an oil and gas analyst in Calgary, Kinnear acquired some petroleum interests. He incorporated Pengrowth in 1987. The year was significant because, in the dramatic first two months of 1986, oil prices had dropped precipitously from $26 per barrel to ten dollars. The drilling industry was flat on its back. Large projects were being cancelled and postponed. Oil and gas companies were earning negative rates of return. In Alberta, housing prices crashed. Yet the larger Canadian economy was doing well. “I felt like a turd in the fruit bowl” said the president of a major Calgary-based oil company (not Pengrowth) after addressing a business conference in Toronto in 1987. There seemed to be rising prosperity almost everywhere else – partly because energy prices were so much lower. Lower prices benefitted most of the country, but Alberta suffered. In those days, the late 1980s, oil and gas properties were there, in the gloom, for the asking, and that’s when Kinnear began to buy properties for Pengrowth. Pengrowth is one of the largest and most profitable energy trusts in Canada. Now 20 years old, the trust is worth about $5 billion (total assets). Enerplus and Pengrowth have both become major players in the energy trust business, and they are close in size. In 2006 Enerplus had $2.7 billion in net equity on the balance sheet, compared to Pengrowth’s $3 billion. Marcel Tremblay left Enerplus quite abruptly in 2001. Pengrowth Manager: Kinnear has created an organization on which, to a much greater degree than is common, he leaves indelible marks – especially in the area of corporate branding. Pengrowth is one of a declining number of income trusts which still has a one-person manager – essentially, a management contract with the founder and CEO of the company. Pengrowth Management Ltd. is owned 100% by Jim Kinnear, and it puts millions of dollars into not-for-profit events and charities each year. This arrangement means that Jim Kinnear’s management fees and bonus include millions of dollars for philanthropic sponsorship. Pengrowth’s major sponsorships tend to be high-profile events: The Pengrowth Saddledome, the Duke of Edinburgh Awards and the Canadian Open – the world’s third oldest open golf tournament. “For all (Pengrowth’s) community endeavours the money comes from the manager,” Kinnear explains, “and I am 100% owner of that.” Since the trust’s purpose is to pass cash flow on to investors, as a trust Pengrowth can’t sponsor charitable events directly. “When we invest in these programs, we don’t just give money, though. We get involved. We help make these organizations better. We really feel we can make a difference.” Kinnear has an encyclopaedic knowledge of the business and of the energy industry as a whole, especially from the perspective of a dealmaker and a salesman. He brings an analyst’s mind, a quick tongue and a great deal of charm to an interview. How has the report of Alberta’s Royalty Review Panel affected his trust? “We don’t have all the details, but it seems to be only 4-5 per cent. What is really important for us is the maintenance of credits for EOR (enhanced oil recovery).” Of more concern to him was Jim Flaherty's Scary Halloween Trick. Also known as the Halloween Massacre, federal finance minister Flaherty announced this new tax on October 31, 2006, and it will start taxing trusts in 2011. The tax, which will impose a 31.5% duty on the net income of energy trusts, has a catchy acronym, SIFT. The word stands for “specified investment flow-through tax”. As a result, the price of Pengrowth units “has declined by about 20 per cent on the markets and (the new rules have) made it more challenging to do our business.” Besides SIFT, Kinnear gives a litany of problems facing the Canadian industry. “The high dollar has affected costs and adversely affected margins. Over the last two years costs have really skyrocketed. They are now twice what they were in 2001. Globally, everything is way up, construction costs, drilling costs, everything. The cost chart in the last two years has become parabolic. Then there was the royalty review in Alberta. The gas market in North America has had major problems and there’s talk of recession. Stock markets around the world are volatile. We call it piling on. What more can happen?” Outlook: Given all that piling on, Kinnear seems sanguine about Pengrowth’s future. “We have a number of potential development projects down the road that can offset our depletion over the years,” he says. And “we have a huge accumulation of tax pools, we have about $2.5 billion in tax pools, and we can use those to offset this new tax. We continue to be a high-yielding Canadian energy trust. We want to deliver as much cash as we can to our unit holders before we become taxable.” He argues that a flight to quality in the industry has driven a lot of investors to Pengrowth. “We have a lot of heritage assets. Judy Creek, Sable Island, Swan Hills and the Weyburn field in Saskatchewan. Weyburn,” he adds parenthetically, “is currently the world's largest carbon capture and storage project.” Producing these assets during this period of high-priced oil means high rates of return. “In 2006 we were among the top ten oil and gas property acquisitors in North America. We can double the size of our assets under the SIFT rules.” He also notes with satisfaction that the federal government expects to have Canada’s tax rates at the lowest level in the G-8 by 2012. Asked about the price outlook, he says “We’re not very good at calling prices. We think there will be recovering gas prices over the next year or so. Storage in Canada is closer to the five-year average than it was, and gas drilling is down” both in Canada and, recently, the US. Will oil prices climb or collapse? Kinnear is just back from a CERA (Cambridge Energy Research Associates) conference in Houston. One speaker was Matt Simons – author of Twilight in the Desert, and a fierce sceptic of Saudi Arabia’s ability to increase or even maintain oil production capacity beyond the next few years. In a recent pronouncement, Simons proposed that the world reached maximum production two years ago. The apparent increase in supply since that time has been essentially a drawdown in global inventory. The interview turned to a discussion of peak oil. Peak Oil: Peak oil is the notion that the world has produced about half its producible reserves, and that implied demand will soon outpace available supply. Kinnear begins in a humourous way. “You usually see a peak in oil prices in the spring, and the low point for oil demand is usually in December.” It is not clear whether he understood the question until he adds this: “In the second half of last year something very interesting happened. Look: we have $90 oil, and most companies are still missing their production targets. Maybe the oil just isn’t there.” He warms up to the topic. “It took about 250 million years to create all this oil, and we have used about half of it in the last three generations. It’s amazing. Whether you do or don’t believe in peak oil, there just hasn’t been sufficient reinvestment in the business. There’s been a classic cycle of underinvestment. What are the major companies doing with their cash flow? Spending some of their cash on new development and buying back stock to increase shareholder value. Some major companies are replacing as little as 15% of their reserves.” This underinvestment has several causes. For one, 80% of the world’s reserves are national oil – owned by countries where alien companies can’t invest directly. These countries are mostly not known for their efficient use of capital: Venezuela, Sudan, Saudi Arabia. Other known reserves and resources are located in places that are difficult and undesirable to explore, like the Arctic. Kinnear echoes a century-old refrain: “It’s a capital-intensive business. You’ve got to keep offsetting depletion and there’s a massive amount of capital required just to maintain production. And suppose there’s not enough investment to both offset the decline and grow production in the near term. What’s going to happen if India and China continue to boom and expand their requirements for energy?” That is a good question. After listing a number of large producing basins and giant fields in decline, Kinnear points out that “the only country that has the potential to grow production over the next 5-10 years is Canada, because of the oil sands.” He returns to his central theme: “Whether you believe in peak oil or not, there is not enough money going back into the oil industry to offset production. It’s a huge issue.” There is an irony in this. Trusts like Pengrowth do not take large exploration risks or develop such megaprojects as oil sand plants. Instead, they acquire producing assets from other firms, and often operate them directly. For firms with that business model, the risk of peak oil can create an ideal business environment. Under peak oil, energy trusts would generate increasing cash flow as a result of rising energy prices. Those funds would come from existing operations, and they would fund future distributions and expansion. While not involved much in the hunt for new fields, trusts like Pengrowth provide an efficient way to harvest known reserves. This is a profitable business model.

India Beckons

This article appears in the April 2008 issue of Oilweek; image from this site.

By Peter McKenzie-Brown

With the head of an elephant and the body of a man, Ganesh is one of the most revered deities in the Hindu pantheon, and certainly the most easily recognizable. Ganesh is the patron of arts and sciences; the god of intellect and wisdom; the remover of obstacles; the propitiator of business.

On one of the coldest days of winter, Ganesh seemed to arrive in Calgary, offering to remove obstacles for companies prepared to help unlock India’s petroleum wealth. The occasion was a travelling road show hosted by the government of India and advertised under the bureaucratic name NELP VII.

For the E&P sector, the prizes on offer are huge: 57 blocks of land in highly prospective but poorly explored sedimentary basins. As the presenters quickly made clear, the financial rewards can be high, and the geological and geopolitical risks are low. There are also excellent opportunities for the service sector.

NELP stands for New Exploration Licensing Policy, and it reflects the reform and liberalization of the country’s economy – a process which began in the early 1990s and has gathered steam ever since. Under the policy, which went into effect in early 1999, the government has held six rounds of bids, awarding 162 production sharing contracts. As a result, the country’s petroleum industry has grown from two companies producing from three basins in 1990 to 49 companies producing from ten basins today. There are 26 basins in the country in total, only 15 of which have been explored. India’s sedimentary basins (more than half of them offshore) total more than 3 million square kilometres in area.

The seventh round of NELP will likely be the most successful yet. On April 11, companies from around the world will submit bids on 57 exploration blocks – 19 in deep water, nine in shallow water and 29 onshore. Whether from government or industry and whether Indian or foreign, all of the road show’s speakers agreed that the bids will be evaluated through a transparent, competitive process with single-window clearance.

According to Les Kondratoff, whose Canoro Resources was successful in the last round of bidding, “going to India today is like coming to Alberta was in the 1940s” (because of the low drilling density). “Why wouldn’t you go there?” he asks. “The risk is lowest.” He points to his company’s Amguri field on a 53-square-kilometre exploration block. He believes it may be a 70 million barrel field. “In Canada, we’d be popping Champagne with that big a field. In India, big discoveries are not too uncommon.”

Indeed, according to information provided by the irrepressible V.K. Sibal, director general of India’s Directorate of Hydrocarbons, Indian gas reserves are growing more quickly – 6 per cent a year during the last seven years – than in any other part of the world. Because of the huge market in India, he stresses the potential for monetizing gas discoveries within India. “Our vision is that we can take gas from everywhere (in India) to anywhere, from anywhere to everywhere.”

Calgary-based NIKO Resources has been the greatest Canadian success story in India. Since the company was awarded exploration blocks in 1999, its stock has risen from $3 per share to a peak above $100, and one of its biggest Indian successes is yet to come on stream. The company and its partner, Reliance Industries, plan to bring a deepwater gas field on stream this coming June; production is expected to peak at 80 million cubic metres (2.8 billion cubic feet) per day.

You have to be a bit cautious when looking at the numbers which the Hydrocarbon Directorate’s Sibal uses in his presentations. The country’s “prognosticated resources” in the 15 basins explored to date, he says, are 205 billion barrels of oil and equivalent. Of those, 66 billion barrels have been identified as “in place reserves,” including 15 billion barrels discovered in the last seven years. However, pending further evaluation and appraisals, so far his directorate has only assigned 4.73 billion barrels of in-place reserves to this century’s 49 Indian discoveries.

Sibal offers compelling exploration numbers. During the first nine months of the 2007-2008 reporting year (it ends in March), the industry drilled 35 exploration wells in poorly explored basins and came up with 17 discoveries. In the previous three years, the success rate for discovery was an excellent though less eye-popping 18 per cent.

Resources Needed, and Available: Speaker after speaker at the NELP conference raved about the opportunities India presents. However, in addition to the obvious opportunity offered to the E&P sector, there was an undercurrent of opportunity for the service sector. Although there are already many service providers in India – international companies like Weatherford International and domestic ones like Jindal Drilling – opportunities for the service sector are clearly outstanding.

Getting the equipment and services needed to explore and develop are slowing down the country’s exploration effort. According to Jindal Drilling’s Naresh Khumar, “There is a huge demand for all kinds of services. Companies are asking for drilling holidays because they cannot get rigs to drill.” From cementing to wireline to workover services, from marine logistics to jack-up rigs, the situation in India is dire.

Frankly, this explains India’s highly attractive NELP energy policy. The country expects demand for both oil and gas to more than double by 2025, leaving huge gaps between consumption and domestic supply despite large anticipated increases in production. National security and trade balances make this problem paramount. The country is anxious to develop a world-class petroleum industry, with much greater capacity in the areas of service and supply.

Weatherford Tools’ David Reed – his company (a US-based international oilfield service provider) is growing rapidly in India – is impressed with the “ease of entry, access and equity” which players encounter there. It is “at the top of the scale” as a country to work in, yet “standards for service providers are very high. There are no compromises in India.” He is also smitten with the people. “There is a tremendous skill-set in India, and you would be crazy not to leverage that for your business.”

The skill-set Reed is referring to represents one of India’s many paradoxes. While 40 per cent of Indians are illiterate, the country has the world’s second-largest pool of trained scientists and engineers. Those skilled masses enable India to develop more computer software than any other nation in the world – worth $22 billion last year in export income.

Doing Business in India: The story barely begins with the skilled workforce. Now firing on all cylinders, at 9.4% last year India’s economic growth rivals that of China. Since 1991, when the country began its program of economic reform, annual growth has averaged 8%.

India speaks 23 major languages and 22,000 distinct dialects but, stresses Canoro’s Les Kondratoff, “the language of business is English.” India boasts the 12th largest economy in the world – $1 trillion last year, with net exports of $127 billion. The country has large and diversified infrastructure, including 15 international airports and 449 domestic ones.

Indians practice many religions. Hindu is the most important, but the country also has the world’s second largest Muslim population. Despite inevitable tensions, the great diversity of Indian people is held together by the largest and noisiest democracy on the planet.

India’s use of British-style common law means contracts signed in India are honoured. According to the Hydrocarbon Directorate’s Sibal, “production sharing contracts are sacrosanct to us.” He cites “attractive, competitive and transparent bidding terms,” a positive climate for investment, efficient infrastructure, expanding domestic oil and gas markets, higher returns and lower risk than in other developing countries. He then throws out a challenge: “Compare us to the world’s best. We come out on top.”

One India hand is Don Whelan, who went there in 1996 with the late Bill Olsen, the founder of NIKO Resources.

A real fan of the small company in India, Whelan is now creating a Mumbai-based petroleum service company called Today’s Petrotech. “Little companies, as NIKO was when we went there, are more adaptable,” he says. “The first two years were a real learning curve. After we got over that hump, it became easier and easier. Now it seems like second nature.” He warns, though, that the Indian demand for paperwork sometimes seems endless.

Having married since moving to India, Whelan has no intentions of returning to Canada. For him, the expat life in Mumbai is just fine. “Our maid, our driver, our gardener – their wages are about $100 per month each.” He worries, though, that Mumbai’s infrastructure isn’t keeping up with changing times. The streets are increasingly gridlocked, and that is going to get worse in the fall when Indian automaker Tata Motors begins selling its long-awaited People’s Car, with a sticker price of about $2,500.

Amarjeet Singh, a KPMG partner, is headquartered near New Delhi. He says the comparisons between investing in India versus investing in China favour India every time. “If you just look at the experience of all big multinationals going to China, most of them will vouch that they are still struggling to make money. In India there are many roadblocks, but if you are doing your business properly, if you understand the market, if you adapt yourself to Indian conditions and frame of mind you will make as much money as a domestic player.” But he cautions that “you have to have a long-term view. If you have a long-term view you will always make money.”

Singh recommends that entry-level players in India “outsource all of the functions – accounting, administration, all of those things. Those are not your core business.” Singh admits that taxation in India is complex, but says “it’s complex in Canada, too. If you plan well, if you handle it well, taxation is not a roadblock to doing business in India.”

According to Singh, “The fiscal regime which is applicable to exploration in India is at least as aggressive as in any other part of the world. There are tax holidays, you are permitted to set off losses in one block against income in another, you can aggregate all your expenses against aggregated production and so on. The government has carved off benefits for the E&P industry that are far above those in other countries and other industries in India. And once you have a production sharing contract, you can operate any way you want.”

Canoro’s Les Kondratoff echoes those sentiments. “Projects aren’t ring-fenced and there’s a seven-year tax holiday from the time you begin commercial production. Royalties are low and you are entitled to full-cost recovery.” He adds that there is enormous demand for bottled propane, and refineries want ever more crude. There are opportunities all around to monetize petroleum assets.

His company had a devastating experience in Russia. Canoro’s Russian partners, he says, abrogated contracts. Canoro had no viable recourse before Russian courts, so Kondratoff particularly appreciates India’s long experience with common law. India, he says, “has all the ingredients for success.”

Ganesh-like, NELP seems to be removing obstacles to that success. The next step is the bidding, and the journey is to unlock India’s considerable petroleum wealth. For those who miss out on NELP VII there will be other rounds, and India will remain an investment destination.