Oil and Gas

Natural Disaster

The good news is oil should average $67/barrel for the rest of 2009; the really bad news is natural gas prices may fall further. Six months into 2009, the oil and gas industry finds itself reeling from what we can now call the “crash of 2009.” Oil and gas industry executives are in a challenging period, closely watching their companies’ assets, trying to have some understanding of what oil and natural gas prices will do and just how far the domestic rig count will drop.

This is by no chance the industry’s first “rodeo.” The domestic oil and gas industry has had its share of good times and bad, which have been different in their own way, but have shared some commonalities. The invasion of Iraq in 2003 caused oil prices to climb; the Asian economic collapse in 1997-98 sent prices to $10 per barrel; the Iraqi invasion of Kuwait sent them up above $20; and of course the severe economic downturn took place from ’85-’86 when prices plunged to near $12 after OPEC flooded the market with surplus production. Each of these global incidents took their toll on the oil and gas industry by impacting global supply and demand.

Is the “crash of 2009” any different from the incidents in the past decades? One could argue that it is. The global oil supply and demand factor is common in all of the past peaks and valleys; however, there are other factors making the “crash of 2009” more profound, such as the world economic meltdown; the U.S. recession; the collapse of vital capital lenders; and the election of a biased, anti-oil and gas industry administration in Washington. All of the ingredients for the perfect storm.

What is the current crude oil short-term outlook?

As of the middle of June, oil prices have recovered to above $72 per barrel from a low of $35 in February. The Energy Information Administration estimates the price of West Texas Intermediate crude oil to average $67 per barrel for the second half of 2009, which would be a $16 per barrel increase over the first half average.

Of course gasoline prices are seasonally climbing along with rising oil prices, which puts pressure on a struggling economy. The oil and gas industry will once again be blamed for hindering the financial recovery of the world’s economies.

What many do not understand is that the domestic oil and natural gas industry cannot sustain itself with prices below its cost. According to a 2006 study, the finding cost for a barrel of oil in the Gulf of Mexico is $63 per barrel, making it the single most expensive finding cost in the world. In a recent Bernstein Research study of 100 E&P companies in Texas, Oklahoma, Kansas and Arkansas, the average break-even price for a company to sustain itself without any growth is $45 per barrel.

In spite of the continued decline in domestic crude oil production and the continued decline in the number of rigs drilling for oil (a mere 183 rigs), U.S. crude oil production is projected to increase by 150,000 barrels per day in 2009. The increase is due to the 400,000 barrels per day of new production coming online from major deepwater projects in the Gulf of Mexico, such as Thunder Horse.

The world is awash with oil. Inventories are full, pipelines are full and there are nearly 100 million barrels in ships on the high seas looking for the right price and time to unload. For most purposes, OPEC has the price of oil in the middle of its suggested range of $60-$80 per barrel, and I would look for OPEC to maintain its current production quotas in the August meeting in Vienna. OPEC will have to be sensitive to world economies struggling to recover.

The short-term outlook for natural gas, however, is bleak.

The natural gas industry is also swollen with surplus production. U.S. working natural gas in storage is 17 percent above the five-year average. EIA predicts natural gas stocks to reach 3,659 billion cubic feet at the end of the 2009 injection season (October), roughly 94 Bcf above the previous record of 3,565 Bcf reported for the end of October 2007.

According to EIA, “the monthly average Henry Hub natural gas spot price is expected to stay under $4 per thousand cubic feet (Mcf) until late in the year as abundant natural gas supplies converge with weak demand driven by an 8 percent decline in industrial sector consumption.” The electric power industry will take advantage of the low natural gas prices and, using cogeneration, will switch from oil to natural gas for its energy source, offsetting some of the 8 percent decline from the industrial sector.

Unlike the oil sector of the industry, natural gas prices are predicted to remain in their current posture with little to no increase until late 2009. EIA suggests natural gas spot prices will average $4.13 per Mcf in 2009 and $5.49 per Mcf in 2010. The Bernstein Research study suggests the mean break-even price for the Mid-Continent marginal gas producers surveyed was $4.66/Mcf, well above recent prices in the range of $3.80/Mcf.

One year ago there were 1,504 rigs drilling for natural gas in the United States; today there are 685, a 54 percent decline. Consequently, the total U.S. marketed natural gas production is expected to decline by 1.1 percent in 2009 and by 2.6 in 2010.

Some analysts believe the need for the natural gas rig count to climb to the levels of 2008 to sustain production levels may not be necessary, pointing to the technology of the unconventional “resource plays.” Wells being drilled in plays like the Haynesville Shale in north Louisiana come on line as barnburners; however, the high rate of production falls off in 12 months and then levels off for several years. I don’t pretend to be an expert, but I do believe the 28 percent production depletion rate will eat away very quickly at the 4 Bcf per day surplus production, and the industry will need to scurry to stay up in the year to come.

In Acadiana we know how to adjust to the peaks and valleys of the industry caused by supply and demand. Right now, however, the focus of most industry executives is on the uncommon ground of politics in Washington, D.C. Proposals before Congress, if passed, will literally throw the fundamentals out the window.

Don Briggs lives in Lafayette and has been president of the Louisiana Independent Oil and Gas Association since 1992. To comment on this column, e-mail indbox[email protected] .