Who needs a roller coaster for thrills
when you can get just as light-headed by watching the ups and downs
of oil and gas prices — and without the risk of bodily harm?
Only a year ago, crude oil prices that hovered near
$30 a barrel and natural gas trades in the $10/Mcf range were conducive
to beefing up cap-ex budgets, and the drill bits were spinning all
over the place. Today, the world seemingly is awash in oil once
again, and the WTI tab per barrel plummeted to less than $17 at
one point in November.
Global crude oil inventories basically looked good
until the Sept. 11 attacks, when they began rising with the ensuing
hit on demand. The NYMEX traders stay fixated on inventory levels
to determine prices, relying heavily on forecasts by the IEA even
though many industry veterans contend the agency historically underestimates
consumption and overestimates non-OPEC production.
Last winter's high prices came on the heels of OPEC
actions to dry up some of the previous crude oil glut that triggered
the 1998 price collapse. Now, however, the cartel's once-comfy position
as kingpin of production quota setting is being tested severely
by some non-member countries.
Indeed, the game of "chicken" between OPEC and Russia
— its chief competitor as the world's second largest oil exporter
— has thrust yet more volatility into pricing, as the markets try
to get a read on Russia's willingness to implement the bulk of the
500,000 Bopd cut OPEC is demanding of non-OPEC producers. The cartel
then would implement its own 1.5 million Bopd reduction.
Expectations of Russian compliance of a quasi-acceptable
cut of 150,000 Bopd combined with renewed violence in the Middle
East early in December quickly bumped crude futures prices back
above the $20 a barrel mark.
If all this makes you feel a lack of control, don't
There's good reason for optimism, according to Steven
Pfeifer, first vice president and senior international and domestic
integrated oil analyst at Merrill Lynch.
"We're positive on the general outlook for the energy
industry," Pfeifer said. "We think the real issue now is the economy,
and as this improves, as we anticipate it will," he said, "the supply/constraint
issues in the system that were evident in 2000 in terms of capital
investment and production declines will re-emerge.
"We think this will be evident in the second half
Pfeifer looks at three scenarios to determine projections
- With the demand hit following the Sept. 11 attacks and the
weak economy, there could be excessive inventories coming out
of winter if OPEC does not institute cuts and keeps pumping at
current output. Inventories could become sufficiently high to
push prices below the $14 per barrel level.
- If OPEC implements anticipated quota cuts, inventories can be
kept where they need to be despite the weakest economy in 20 years.
- Should Iraq go offline, the supply/demand balance will change
dramatically. Inventories will de-stock, prices will escalate
and the power to increase volume to avoid price spikes clearly
will be in OPEC's hands.
Current energy market weakness reflects not just
the worst global economy in 20 years but also a 20-year period of
industry contraction and under-investment that has restrained capacity
The upside to all the years of belt tightening: The
U.S. industry finds itself not as vulnerable to a price downturn
this time around. Balance sheets are strong, and breakeven points
Even though the next six months could be a challenge,
Pfeifer emphasized the U.S. energy industry is much better prepared
than 1986 or 1998 to weather the current storm.
"Right now what is earnings power for the integrateds,
if you assume $14 a barrel all over again like in '98," he said,
"would be 30 percent higher now if under the same conditions."
What's unnerving is that $14 a barrel could end up
looking good, according to OPEC president and Algerian oil minister
A report issued by Salomon Smith Barney in late November
quoted Khelil predicting prices could drop dramatically. He indicated
it's not so much a matter of implementing cuts on the part of all
parties concerned, but the possibility that non-OPEC producers might
choose to flood the market with the 3.5 million Bopd that OPEC members
held back in 2001.
This would lead to a repeat of the 1986 and 1998
pricing scenarios, where oil went for the fire sale price of $8-$9
Kyle Cooper, vice president and energy analyst at
Salomon Smith Barney, doesn't see this happening.
"If there's no cut, then the fundamentals are bearish,"
he said, "but I don't think with the current levels of production
and demand we'll see a return to $8 or $9. But I see in the realm
of $14-$15 if a production agreement is not obtained.
"OPEC now has commitments of about 425,000 barrels
a day from others," he said, "and it's unclear what they will proceed
with if they don't get another 75,000 barrels a day before the end
There's a lot riding on this in Saudi Arabia, which
is ill-prepared to weather an oil price collapse.
"To avoid budget deficits, Saudi Arabia needs prices
to average $25 WTI-spot," Pfeifer said. "If they average $14.50
to $15, we estimate Saudi Arabia will run a deficit of $16 billion,
which will be even greater than their '98 and '99 deficits.
"They've been increasing budgets for medical facilities
and education, and they have the option to reduce expenditures,"
he said, "but that puts pressure on their domestic interests.
"So while $15 is a challenge to the industry, the
real challenge is there," Pfeifer said. "The Saudis have their own
Indeed, a spokesperson with the Saudi American Bank
reported the Saudi economy might slip into a recession next year
because of a drop in oil prices and output. It's postulated the
economy could contract by as much as one percent in 2002. Even with
high oil prices in 2000, growth was below the 6 percent needed to
absorb the multitudes that enter the labor force each year.
Oil accounts for 40 percent of the country's economy,
where unemployment now stands at 15 percent. The economic fallout
from a renewed period of sharply lower crude oil prices has the
potential to foster escalating discontent, particularly among some
of the more restless younger citizens who often have a different
agenda from the ruling class.
Back to the Future?
Although low oil prices provide a sizeable boost
to the U.S. economy, cheap oil clearly doesn't mix well with the
increasing debt and unemployment of some of our nation's shakier
It is noteworthy in view of the skepticism voiced
by many who follow the vagaries of the industry that OPEC has maintained
compliance to production quotas comfortably above 70 percent, according
to Pfeifer. He noted how inventories have remained near normal despite
a weak economy, suggesting the cartel has been successful in maintaining
When demand does begin to turn around, there will
be some scurrying to meet the supply challenge.
"A lot of companies believe decline rates are getting
steeper," Pfeifer said. "If we didn't invest another nickel, non-OPEC
supply would decline by three million barrels per day. With so many
mature fields, it's tough to keep the rate up."
And while the Russian economy relies heavily on oil
and natural gas revenue, Pfeifer emphasized the country must maintain
a lot of activity to offset underlying depletion.
As for OPEC, he noted spare capacity is concentrated
in a few hands, and excess capacity in 2000 saw most OPEC nations
tapped out. Only about 28 percent of the cartel's spare capacity
is held outside Saudi Arabia and the UAE.
"OPEC is now throttling back and trying to create
a bridge to respond to the worst economy in 20 years," Pfeifer said,
"but they're strained now, and the bridge is getting some cracks
in it as they must seek non-OPEC cooperation.
If his expectations for the near future hold true,
brighter days are just around the corner for the oil and gas industry.
"In the next six months, the talk will be about the
recession, the economy, demand and so on," Pfeifer said, "but out
further in the second half of 2002, it will be much like 2000 all
"Also, we think the administration's energy policy
will become much more evident," he said. "I think it's right on
the mark and hope to see a large part of it enacted."
He emphasized that at some point the challenge will
be for the industry to move forward from a 20-year decline and reactivate