NEWS ITEMS & LONG-TERM ENERGY SECTOR TRENDS
by Joseph Dancy, LSGI Advisors, Inc.
Adjunct Professor, SMU School of Law
April 7, 2006
NEWS ITEMS OF INTEREST LAST MONTH
The following news items drew our attention last month. We think the long-term trends they portend for the economy and energy sector are positive:
- The production decline rate at several major global oil fields has been steeper than expected. For example the U.K. is now a net oil importer with its production falling fast�it is now below 2 million barrels per day from the nation's peak of 2.9 million in 2000. Norwegian production peaked in 2001 at 3.2 million barrels per day, and fell to roughly 2.5 million last year. Production from Mexico�s Cantarell field � the second largest in the world - is also expected to fall sharply over the next several years.
- Government experts are reporting that gasoline prices will be unusually high and shortages might occur this summer because the U.S. ethanol industry can't keep up with the demand for fuel-grade alcohol to mix with gasoline. Imports of ethanol could meet demand but are subject to a 54-cents-per-gallon tariff. Ethanol � grain alcohol made mainly from corn � is being used to replace MTBE, a natural gas derived additive used for the last decade to meet clean air standards. MTBE can pollute groundwater supplies.
- The 2006 hurricane season will be more active than normal according to experts from AccuWeather. They claim this year's hurricane season won't top last year's record 27 storms and 14 hurricanes but will be �several storms above� normal. The hurricane season runs from June 1st to December 1st.
- Meteorologists at Colorado State University also call for an active hurricane season. The forecasters said 17 named storms are predicted in the season, well above the 50-year average of 9.6 storms, but below the record-shattering 27 last year.
- The International Energy Agency cut its estimate for this year's world crude demand growth. The forecast for growth in demand was lowered to 84.74 million barrels a day. World consumption is now expected to increase by 1.49 million barrels a day, or 1.8 percent. China's oil demand is expected to grow 6 percent.
- Demand for crude oil is rising so fast � by around 1.5 to 2 million barrels per day each year � that even Saudi Arabia's vast resources will be unable to cope without drastic help, oil executives and analysts claim. Even the Saudis, who control over a quarter of the world's known oil, are calling for relief from relentless demand increases.
- Multinational oil companies have shut in 630,000 barrels per day of light sweet crude due to violence in Nigeria's oil producing province. No quick resolution to this conflict is expected. Some 23 percent of Nigerian production remains shut in following attacks by militants.
- In the coming weeks crude oil inventories will probably remain high because spot market prices are lower than futures prices. When this condition occurs prices are in �contango�, and companies purchase crude on the spot market rather than draw on their inventories.
- With one week left in the traditional withdrawal season the level of working natural gas in storage (1,705 Bcf) is on pace to exceed the second highest ending inventory level since futures began trading. But prices remain relatively firm due to supply issues and concerns over the summer hurricane season.
- During the past 10 months, Arkansas Electric Cooperative Corp. has been forced to cut electricity production at its coal plants and ran its costliest natural gas units overtime. Arkansas Electric has a problem that is a growing concern for many U.S. utilities: It can't get enough coal to run its power plants because the trains that serve as its supply line aren't running on time. The ability of railroads to get coal to power plants when it's needed is suddenly no sure thing. Three other coal fired plants have cut electrical generation output in the last few weeks due to the low levels of coal stockpiles.
- Iraq's oil exports rose to 1.4 million barrels per day in February from 1.1 million barrels per day in January. Under former president Saddam Hussein Iraq shipped around 1.7 million barrels per day. Since October Iraq's oil sector has suffered heavy attacks from insurgents who blew up pipelines in the north and also attacked oil convoys.
- The battle between Sunni and Shia Muslims for control of Baghdad and Iraq has already started say some Iraqi political leaders, who predict fierce street fighting will break out as each community takes over districts in which it is strongest. Many Iraqi leaders now believe that civil war is inevitable but it will be confined, at least at first, to the capital and surrounding provinces where the population is mixed.
- The invasion of Iraq has weakened the United States' energy security and contributed to the recent surge in oil prices according to some energy experts. The expectation just after the invasion was that Iraq would produce close to 5 million barrels per day. Plans to develop the country's deteriorating oil infra- structure have been scrapped because of persistent insurgent attacks.
- Three years after warning that invading Iraq would unleash internal conflicts in the Middle East, Baghdad's neighbors fear they could be dragged into a brewing civil war. As Sunni-Shi'ite violence intensifies, governments in Turkey, Iran and nearby Arab countries are drawing up plans to prevent any sectarian or ethnic conflict spilling across borders and upsetting their internal political balance, analysts say.
- Some hedge funds are reportedly increasing their direct exposure to hard assets. This would have a disproportionate effect on commodity prices due to the relative sizes of the markets. U.S. equity and fixed income markets are worth trillions of dollars, while underlying physical commodities are valued in the hundreds of billions. A small move from the equity and fixed income markets to other asset classes would have a material impact on commodity prices.
- Gold hit a 25 year high last month, while silver surged to a 22 year peak. Copper and zinc also hit all-time highs last month, while crude oil futures topped $67 a barrel, up over 10% year-to-date.
- Last year, automobile sales in China were 5.92 million, exceeding Japan's 5.8 million in local sales to rank as the second largest car market behind the United States. When Deng Xiaoping took charge of the Chinese economy in 1979 there were sixty privately-owned passenger cars.
- China grew 9.9 percent last year, extending a 28 year growth record of 7 percent plus every year. China's economy has passed the fifth largest France, and is now the world's fourth largest after the US, Japan, and Germany.
In addition to the news items mentioned above, veteran energy analyst Henry Groppe granted an interview last month with the Financial Post. Mr. Groppe has 55 years experience in the business and a very accurate forecasting record in the energy sector, and heads an energy consulting firm Groppe, Long and Litell out of Houston. We found his comments on the energy sector supported our long term bullish position on the energy sector:
Q: How much control does OPEC have over oil prices now?
A: Let me put this into perspective. We view the history of the oil business in three major eras. The first one lasted 100 years, from 1870 to 1970, during which the United States controlled world oil prices. It's interesting to note that over that entire period, on an inflation-adjusted basis in 2004 dollars, the price of oil averaged US$13 a barrel. That period ended in 1970 because that's when the United States reached peak capacity.
For the next 40 years it was an era of transition, with OPEC in control for most of that time. They replaced Texas because they had the only incremental production that could be used to affect market prices. That era, in our view, came to an end a couple of years ago when total world oil production essentially reached capacity, so it's out of OPEC's hands now.
Q: What does this new era look like?
A: We're now moving rapidly into the new era, which I call an era of scarcity and price rationing. Just as U.S. production reached an all-time peak in 1970, it has now declined 50% since 1970 -- and nothing has been able to reverse this decline. One by one, the major producing countries have been reaching the same turning point. From this point on, total world crude oil production is going to slowly and irreversibly decline.
However, there's growing production of liquids related to the international gas business, in the form of condensate, liquefied petroleum gas (or LPG) and, toward the end of the next 10 years, increasing production of the synthetics. That wedge of growing natural gas liquids will roughly offset the decline in oil, so we'll have a stable total world petroleum supply.
© 2006 Joseph Dancy