Industry officials expect oil and gas markets to rebound in last half of 2002

Sam Fletcher
OGJ Online

HOUSTON, Feb. 14 -- Industry executives and analysts apparently are convinced that both international oil and US natural gas markets will rebound in the second half of this year.

"Long term, we believe the fundamentals for natural gas have not changed, so the question is not if there will be a rebound in (US drilling) activity but when," said Michael E. Wiley, chairman, president, and CEO of Baker Hughes Inc., Houston, in a telephone conference with financial brokers Thursday.

He said, "The (US) economy is showing signs of recovery, which should translate to higher industrial demand, and supply will be affected by the (current) decrease in drilling activity." As a result, Baker Hughes expects "a bottoming of rig activity in the first half of this year, with an increase in the second half at a rate roughly the same as the growth rate in 2000."

"If we are wrong," he said, "the recovery will be pushed out through another winter to 2003. Any scenarios for recovery sooner than the second half of 2002 are unrealistic."

The latest US drilling cycle that began its upswing in the second half of 1999 and then turned down during the third quarter of 2001"was natural gas driven. And the recovery will be natural gas driven," said Wiley.

Paul Horsnell, head of energy research for London-based JP Morgan Chase & Co., recently listed six market conditions that must be met to spur higher oil prices this year. Five of those are already in place to varying degrees, he said, including:

-- Economic recovery, "the sooner the better for prices."

-- Global oil balances "conducive to upwards price pressures."

-- OPEC cohesion to production quotas.

-- Sufficient non-OPEC production cuts.

-- Continued political uncertainty, "particularly over Iraq."

The sixth requirement not yet in place is for weekly US inventory figures to start reflecting a concerted draw down of oil products, Horsnell said.

"This may appear to be the most trivial, but in terms of the short run dynamics of the market, and in particular in terms of setting perceptions, it is the most vital," he said. "A large swathe of the market looks no further than the weekly US figures."

Much of the erosion of oil futures prices this year "can be explained almost entirely by those statistics," he said.

A pessimistic view of the general world economy is unjustified, said Horsnell. "The economy is shifting upwards through the gears. The dramatic improvement in emerging Asia that is already coming through in the figures is of particular significance to the health of the oil market," he said.

"Once the fog caused by over-reliance on US weekly data lifts, the trajectory for oil prices will be upwards," said Horsnell. "In short, we are forecasting a massive first quarter global stock draw. Further, we are not alone."

He said, "There is likely to be so little left in the cupboard outside the USA by the start of the second quarter that the pressure of the physical markets should be making itself felt."

Like Wiley on natural gas prices, Horsnell said, "Our (oil) price view remains not one of 'if' but rather 'when' the rise in prices starts."

The National Climate Data Center reported last week that the 2001-02 winter so far has been the warmest on record. As a result, it will likely end with more natural gas in storage than the historical averages.

Meanwhile, assessments by 25 of the 40 largest publicly traded US producers, who account for nearly 90% of total US gas production, indicate a drop of 0.5% in fourth quarter gas production compared with the third quarter, said Robert Morris of Salomon Smith Barney Inc.

"We believe that for the same reasons that domestic natural gas production increased only 1% last year with a 75% increase in the domestic natural gas rig count from the beginning of 2000 to the middle of 2001, production will drop only around 2% year-over-year in 2002," Morris said. "In other words, production should not 'drop off a cliff' as the domestic natural gas rig count continues to abate, because rigs that are being laid down are those that were adding very little incremental production when put to work.

"These rigs are being laid down because the volume of production added by each is too little to be economic with composite spot natural gas prices below $2.25-2.50/MMbtu," he said.

No weather-related factors are likely to push up US natural gas prices this summer. "Even if temperatures this summer are 10% warmer than last summer (11.5% warmer than the 10-year average), we estimate that this would result in only about 1 bcfd of incremental demand compared with last summer," Morris earlier reported.

Moreover, he said, an incremental increase in demand for power for summer weather won't necessarily translate into an increased demand for gas that "is likely to be largely, or more than, offset by ... increased hydropower supplies. In fact, we believe that increased hydropower supply could result in roughly 1-1.5 bcfd of reduced natural gas demand in 2002 compared with last year."

Morris predicted that final figures will show North American finding and development costs jumped more than 30% last year over 2000 levels. That, he said, "is likely to put greater emphasis on mergers and acquisitions, given that acquisitions of reserves have often come with a lower price than with the drillbit."

"We should not mistake the calm in today's natural gas prices as anything more than the low side of our normal business cycle," said R. Skip Horvath, president of the Natural Gas Supply Association, Wednesday at the Cambridge Energy Research Associates annual conference in Houston.

"Producers need to know both the depths and heights of the competitive marketplace in order to make proper investment decisions," Horvath said. "Volatility is normal and we should expect it of a healthy, competitive market going forward."

Since the early 1990s, the highest and lowest gas price levels in every cycle have both been just a little higher than in the previous cycle. Moreover, Horvath said, "the high-low price spread has increased. Neither of these two trends will necessarily continue, but both underscore the underlying volatility."

He said, "The reason for the volatility is simple: We are a commodity market and volatility is inherent in competitive commodities. But the long-term reason for the swings is more fundamental: supply."

"The fields where we drill are old, yielding less and less natural gas," Horvath said. "Today, we have to produce 6 tcf/year of new natural gas supply just to stay even, much less the amount required to meet growing demand. We can produce the natural gas required to meet market demands, but we must have changes in government policy to plan for the future."

Contact Sam Fletcher at samf@ogjonline.com

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