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by Joseph Dancy, LSGI Advisors, Inc.

Adjunct Professor, SMU School of Law
June 6, 2006

Energy Markets Attractive: Hurricane Risks a Concern

As we enter the 2006 hurricane season the energy sector remains mired in short term uncertainty. The Gulf of Mexico still has roughly 10-15% of both crude oil and natural gas shut in from last year's storms. The impact on supply - if any - from this years storms remains to be seen. Historically most severe storms form in August, so we have several months before peak storm season.

Politically it appears the fuse is on a �slow burn� in a handful of countries critically important to the world's energy supply: Iran, Iraq, Nigeria, Russia, and Venezuela. Throw Bolivia in the mix, with the trend in Latin American elections, and the short term risks to supply multiply.

From a weather standpoint spring has been very warm in the U.S. compared to historical norms, which increases the odds that summer will be above average temperature wise. With the electrical grid relying increasingly on natural gas �peaker� plants to meet incremental electrical loads created by air conditioning demands the uncertainly extends to the demand side of the energy equation. Natural gas storage is above normal for this time of year, but supply interruptions or demand spikes can change that equation quickly.

The following developments and trends indicate the long term trends in the energy sector remain attractive:

April 2006 was the warmest April on record in the U.S. since record keeping began in 1895 according to Dr. Jeff Masters. The U.S. has now had two "warmest ever" months this year, January and April. Globally, April ranked as the 7th warmest April on record, and the period January through April ranks as the 6th warmest such period on record globally.

Masters notes that that the entire tropical Atlantic region where hurricane formation occurs was warmer than average during April, but he expects no early start to the hurricane season as strong upper level winds will reduce the chance of a tropical storm forming in the Gulf the first two weeks of June. He predicts the hurricane season will see �significant� activity.

Accuweather also predicts an active hurricane season, with one in six Americans who live on the Eastern Seaboard or along the western Gulf of Mexico being impacted. The graphical representation of their forecast is at right.

Dr. Jeff Masters also prepared a summary of long term forecasts versus the average hurricane season last month. NOAA indicates an 80% chance of an above normal season, 15% chance of a near normal season, and a 5% chance of below normal activity. Note August is the month went the most hurricanes form according to historical data (chart at right from NOAA).

Forecasting firms are all looking for an above active hurricane season according to Dr. Masters:

Average year:
10 named storms
6 hurricanes
2 intense hurricanes


Tropical Storm Risk, Inc.:

13-16 named storms
15 named storms
8-10 hurricanes 8 hurricanes
4-6 intense hurricanes 3.6 intense hurricanes

Colorado State University:

Cuba's National Weather Institute:

17 named storms
15 named storms
9 hurricanes 9 hurricanes
5 intense hurricanes

Investment banker Matthew Simmons included the chart of gasoline demand at right in one of his recent presentations to illustrate the demand for gasoline in the U.S. continues a long term climb. Occasionally a commentator will note that the U.S. is becoming more energy efficient, but the long term trend in total gasoline usage is clear.

� China's demand for crude oil rose at its fastest pace for two years in April with estimated consumption up10.8 per cent year-on-year. U.S. demand for crude oil, over the longer term, also continues to climb (chart by investment banker Matthew Simmons)

President Vladimir Putin announced the creation of a Russian oil and gas bourse along with his intention to convert the ruble into a convertible currency that would be used for the trade. Russian oil exports make up 15.2% of the world's export trade in oil. The bourse is scheduled to begin trading in June. The bourse is expected to impact both energy prices and the U.S. dollar.

� Opec will meet to discuss oil production quotas this week in Venezuela. Most experts expect the production quotas to remain unchanged. Venezuela will spend $5 million to host the meeting � 20 times higher than the cost of the normal Vienna meetings. It is expected Venezuela leaders will attempt to use the meeting as a political forum.

A top Iranian lawmaker said that Iran should reevaluate its continued membership in the Organization of Petroleum Exporting Countries in view of the organization's continuing demands for higher production that often overlook the long-term benefits of reduced production on oil reservoirs. He said the organization's call on its members to raise their production jeopardizes the overall yield of oil from reservoirs in the long term. OPEC should be focused on preserving the long term viability of the member�s reserves, not on reducing global oil prices by pumping excess supplies.

Iraq has the world's third-largest proven oil reserves. Before the invasion in March 2003, Iraq was producing 2.5 million barrels of oil a day. In 2005, production was down to about 1.8 million barrels a day. So far, the outlook for 2006 is little better.

© 2006 Joseph Dancy

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