Energy officials assess industry challenges

Sam Fletcher
Senior Writer

HOUSTON, May 27 -- A panel of industry experts assessed a variety of challenges facing the oil and natural gas industry at a 2-day energy conference in Houston this week, hosted by KPMG LLP.

China, which recently surpassed Japan as the world's second largest consumer of crude, will be driving the global market over the next few decades "whether you like it or not, said Richard Court, former premier of Western Australia,

"China's economy is overheated and there will be a number of corrections, but overall it is very much a growth story," said Court, now an industry consultant, in the panel discussion Wednesday.

Chinese outlook
Chinese officials hope to quadruple that country's gross domestic product to $4 trillion by 2020. "Last year, China was responsible for more than one third of the world's total demand growth in oil. It's an amazing change because that country used to be largely self-sufficient in energy," Court said.

China's oil imports are projected to escalate to almost 10 million b/d by 2030, equal to more than 80% of its total demand, up from less than 2 million b/d at present. "Now China does not like importing anything, and they don't like importing other people's commodities," Court said.

As a result, he said, the Chinese government has authorized "a number" of Chinese oil and natural gas companies "to go out and put their foot on international reserves" by "taking equity in upstream oil and gas opportunities. They like to import things from companies that they actually have an equity position in."

Moreover, Court said, China is ready 'to invest in countries with much higher sovereign-risk profiles than is practiced by the majors and independents," including some countries where US investment is banned "or is simply seen as too risky." When North American interests exited Sudan, for example, he said, "China came in."

There are "a number of countries in the Middle East and Africa where [Chinese companies] are prepared to invest in projects that would otherwise be seen as quite risky," said Court.

Deregulated utilities in Japan also are following a similar strategy of obtaining foreign upstream holdings, Court said. "There is a lot transaction work out there as these countries are out there competing with the traditional US and European companies, looking for those new opportunities," he said.

With China's oil consumption on the rise, that nation soon will "have to be brought to the table" in negotiations between the Organization of Petroleum Exporting Countries, "representing the major oil producers and the US being the No. 1 consumer," in a 25-year long "loose cooperation and understanding that has helped keep some form of stability" in the world oil market, Court said.

Meanwhile, LNG is becoming one of China's "growth areas," with "all of its coastal provinces fast-tracking development" of such projects, he said.

Pipeline problems
Another member of that panel, Barry Pearl, president and CEO of TEPPCO Partners LP, Houston, said the US petroleum pipeline industry has responded well to market challenges of supply and distribution, but its operations are becoming more complex with the proliferation of fuel grades.

Pipeline companies provide "a great deal of flexibility in our crude supply system," but they also face "a number of challenges," said Pearl. "We're faced with declining domestic production with very little onshore crude oil drilling activity, resulting in increased dependence on offshore [Gulf of Mexico], Canadian, and other foreign crudes. This has resulted in the shutdown of some crude lines and conversion of some pipelines to other service."

Changing refinery crude slates and some refinery closures "have also altered traditional supply paths," he said. "There has been a lot of change in the Gulf Coast and Midcontinent infrastructure to better match crude supply grade to refinery demand. We spend a lot of time at our company working with refiners to understand what grades of crude they're going to run in the future. It's not as simple as just having a pipeline from point A to point B."

Meanwhile, "a pretty heavy period of consumption growth in recent years" is straining product pipelines' capacity in certain regions, with the Midwest, West Coast, and Gulf Coast markets most affected. "It's not unusual for a pipeline that handled 10 product grades a few years ago to now handle 40 grades of product," said Pearl. "Lack of refined product pipeline capacity has resulted in less market liquidity, again resulting in tight supply that has cause periodic shortages and higher prices."

In addition, he said, "Our asset base is aging. There are technical limitations as to how much it can handle, and significant investment is required to meet demands of this industry."

Pipeline companies also face "escalating expenditures" to comply with "a list of regulatory challenges that grow each day," including pipeline and tank integrity, operator qualifications, public awareness, and environmental remediation. "Our responsibility to maintain a safe and reliable pipeline system is not negotiable," Pearl said. In safety testing, he said, "we're actually outperforming the rules."

'Great day' for refiners
"It's a great day to be in refining," said a third panel member, Don Kuenzli, Port Arthur refinery general manager for Premcor Refining Group Inc., a unit of Premcor Inc., Old Greenwich, Conn. "There is a demand growth that we have to supply, and that is pretty much brand new for the refining industry." He foresees "a demand oversupply of maybe 1 million b/year" over the next several years, "which means a pretty good market, all things being equal."

He said, "Of course, the environmental and other regulatory challenges for our business are always there and always very challenging and always demand a huge amount of capital. But if you're there to stay the course, there are rewards even in those."

To expand a refinery's existing capacity—"not build a new grassroots refinery"—is "at least a 3-year venture," Kuenzli said. "There aren't very many, if any, grassroots facilities that take even longer, and it takes a whole bunch of capital to make that happen."

He noted that market demand for energy among "the Chinese and the Indians and others is growing rapidly. A lot of our stuff is going to be going that way, and the margins should remain robust."

Refinery shakeout
Since 1990, there have been "about 60 closures" of refineries around the world, said Kuenzli. "In the first 3 years, a lot of it came from environmental regulations changes. But some of it was just that markets weren't too good during that time, and some people got out of the business," he said

Kuenzli questioned if there might be a similar shakeout of refineries in 2004-06, because "low-sulfur gasoline and low-sulfur diesel regulations are demanding huge investments." It may mean that some small refineries "just can't stay the course." In addition, he said, the rising cost of materials and inflationary pressures are "pretty dramatic."

On the other hand, he said, "The import of products into this country now is a little more difficult because our standards in terms of low sulfur and other environmental specifications are pretty tight, and they're getting tighter."

Contact Sam Fletcher at samf@ogjonline.com

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