Oil and Gas

The Price Is Right

The EIA releases its two-year pricing outlook for crude oil, a stable $80-$84 per barrel, and natural gas, which could swing from $3.88-$8.47.

When the fog lifts and all of the rhetoric clears, what is the realistic outlook for the oil and natural gas industry in 2010? I certainly do not pretend to have a crystal ball, and I do not believe anyone else does. How often have we been blind-sided by major swings in the industry?

The first oil crisis occurred in 1974 with the Yom Kippur War and Arab Oil Embargo, which drove oil prices to $10 per barrel. The 1979 Iranian Revolution was the second oil crisis, driving oil prices even higher. With OPEC flooding the world market with its surplus crude, the crash of the mid-80s drove crude prices to the cellar. The U.S. active drilling rig count plummeted from 4,000 plus rigs to 800 rigs almost overnight. In 1990, the fourth crisis commenced when Iraq invaded Kuwait. Oil prices quickly rose followed by a drop in prices that put Louisiana’s drilling rig activity at its lowest point in decades. In the late ’90s and at the turn of the century, the Southeast Asia economic downturn caused oil prices to crash to $8 per barrel. From 2002 to 2008, oil prices tracked upward. The U.S. invasion of Iraq in 2004 and the economic growth of China and India both drove prices to a record high in 2008 of $147 per barrel. China’s and India’s crude oil demand literally devoured OPEC’s surplus crude capacity. In addition, speculators in the commodity markets were blamed for the unprecedented rise. However, the spike in prices was short-lived with prices crashing to $35 per barrel in 2009 due to the “subprime lending” crash. It will be interesting to see how history will treat the collapse of 2009. Today, crude oil prices have recovered to near $80 per barrel.

If you step back and observe all of the major swings in the oil industry, what comes to mind? I cannot help but think of the saying in the mid-80s, after the crash: “Please Lord, give me just one more boom; I promise I won’t mess it up.” The fact is we have no control in the ups and downs of the oil industry, nor, as you can see from the swings previously described, can we predict with pinpoint accuracy the geo-politics of the world.

The bottom line is the U.S. is addicted to oil. We consume 25 percent of the world’s crude oil demand, which equates to roughly 20 million barrels per day. The U.S. only produces 5 million barrels per day and has a mere 2.5 percent of the world’s proven reserves. Importing nearly 65 percent of our demand from countries around the world, which for the most part dislike the U.S., puts our country in a most tenuous position. A key fact in all of this is that 96 percent of the transportation fuel that runs the engines of the 250 million vehicles in the U.S. comes from a barrel of oil. Dating back to President Truman, every U.S. president has been warned by the Department of the Interior that our dependency on foreign oil is a threat to our national security.

On Jan. 12, the U.S. Energy Information Administration released its Short-Term Energy Outlook through December 2011. The following are some highlights from EIA’s Energy Outlook. However, keep in mind that the EIA also does not have a crystal ball. Forecasts in past years could not predict the major swings mentioned above.

Crude Oil: EIA expects that the price of West Texas Intermediate crude oil, which averaged $62 per barrel in 2009, will average about $80 and $84 per barrel in 2010 and 2011, respectively. EIA’s forecast assumes that U.S. real gross domestic product grows by 2 percent in 2010 and by 2.7 percent in 2011, while world oil-consumption-weighted real GDP grows by 2.5 percent and 3.7 percent in 2010 and 2011, respectively.

Comment: I believe that is a fair expectation, especially for 2010. Consideration of a floundering U.S. economy could fluctuate crude demand upward or downward from EIA’s forecast. China’s economy continues to show signs of upward growth and will have a significant impact on the forecast.

Also, at OPEC’s 155th Conference held on Dec. 22, 2009, ministers decided to maintain OPEC’s current quota of oil production at 24.84 million barrels per day. Before the meeting, OPEC’s Secretary General Abdalla Salem El-Badri described the current oil price, hovering between $70 and $80 per barrel, as “very comfortable” and signaled that output would remain unchanged.

For years we have heard and/or read about OPEC’s meeting to discuss the oil market, where its members decide one of three options:

1. Increase oil production, putting more oil into the market to lower prices;

2. Cut production, taking oil out of the market, thus driving prices higher; or

3. Leave production quotas of the OPEC countries at current rates, as the status quo.

In other words, OPEC can either open or close the valve, thus controlling the price of a barrel of oil. From 2003 to 2008, the surplus capacity was around 1 to 2 million barrels per day. In that period, China and India devoured the surplus. World demand for crude decreased in 2009 thus putting 2 million barrels per day back in surplus capacity. It is also very telling how tenuous and delicate the Middle East front is to our country’s energy infrastructure.

Natural Gas: EIA estimates that total marketed natural gas production increased by 3.7 percent in 2009, despite a 59 percent decline in the working natural gas rig count from September 2008 to July 2009. Working natural gas rigs have since turned around from the mid-July 2009 low of 665, increasing to 759 as of Dec. 31, 2009. While production growth in 2009 was supported by the enhanced productivity of new wells being drilled, steep declines from initial production at these newly drilled wells and the lagged effect of reduced drilling activity are expected to contribute to a 3 percent decline in 2010 production. EIA expects marketed production to increase by 1.3 percent in 2011 with growth in production from lower-48 non-Gulf of Mexico fields offsetting a decline in GOM production.

Comment: EIA is predicting natural gas prices to be somewhere in the range of a lower limit of $3.88 per thousand cubic feet and an upper limit of $8.47/mcf. If the winter continues to be as cold as it has been, I believe we will see prices average close to $7 and up for 2010.

The recession has had a big impact on the natural gas market with prices collapsing from $13 in 2008 to $3 in 2009. Additionally, the demand for natural gas declined in 2008 causing a severe gas oversupply, which actually started prior to the recession with 80 percent of the U.S.’ rigs drilling for natural gas. Today 65 to 70 percent of the active drilling rigs are drilling for natural gas. We can expect to see more rigs move to the oil side in the next year until gas prices firm up.

However, a colder winter than normal will change the oversupply problem in a hurry. On Friday, Jan. 15, Platts Gas Daily cited an EIA report from the previous day: “A 266-Bcf gas storage withdrawal during last week’s deep freeze didn’t quite break the all-time weekly record but managed to carve a big chunk from the year-ago and five-year-average surplus in the nation’s inventories.”

As if predicting oil and gas prices were not difficult enough, we are currently facing the most liberal, anti-industry administration the U.S. has ever seen. Serious pieces of legislation are working their way around the halls of Congress. In some cases where the legislation has stalled, such as cap and trade, governmental agencies have stepped in and are threatening to take control. This year is going to be a game changing year to say the least, but it is anyone’s guess how it will finish out.

Don Briggs lives in Lafayette and has been president of the Louisiana Independent Oil and Gas Association since 1992.