A turbulent year

Sam Fletcher
Senior Writer

The waning year of 2008 is sure to be remembered as one of the most turbulent in the history of the oil and gas industry, said energy analysts.

Some earlier assumed it would take years for crude to climb to the record high of $147.27/bbl that it achieved in July on the New York Mercantile Exchange. At one time, it also seemed inconceivable that a front-month crude contract could plunge from nearly $150/bbl to less than $45/bbl in just 6 months. The January contract for benchmark US sweet, light crudes dropped to $43.67/bbl Dec. 4—the lowest closing on NYMEX since January 2005. "It is now becoming apparent that we live in a world that is much faster moving and more interconnected than we appreciated," said analysts at KBC Market Services, a division of KBC Process Technology Ltd. in Surrey, UK.

Energy markets suffered a psychological blow Dec. 1 when the National Bureau of Economic Research (NBER) confirmed the US economy has been in recession since December 2007. NBER said US employment and incomes peaked last December; industrial production peaked in January; and sales peaked in June. "Almost the entire developed world is, to all intents and purposes, deep in recession with economic growth almost certain to be negative in 2009," said KBC analysts. It's the first time since World War II there have been simultaneous recessionsin the US, the UK, Europe, and Japan.

Recession cuts demand
In the Houston office of Raymond James & Associates Inc., analysts said, "The global financial meltdown is now likely causing meaningful oil demand destruction around the world. As a result, we are taking down our 2009 oil price forecast from $90/bbl to $60/bbl. We readily admit that our visibility and confidence in these new estimates are very low. There are simply too many moving parts to get any confidence in near-term oil prices." Still, they said, "Intuition would suggest that the market's recent rush to liquidity has caused oil prices to overshoot on the downside. Unfortunately, we don't know whether or not the market liquidation of virtually all commodities is over."

While short-term issues and energy prices remain anyone's guess, "eventual improvements on the demand side and additional OPEC cuts will turn crude prices around by the second half of 2009," said Raymond James analysts. The general consensus is that the Organization of Petroleum Exporting Countries will cut production by 1 million b/d Dec. 17 in Oran, Algeria.

Oil markets are so focused on demand rather than supply that a production reduction of 2 million b/d may not have any more effect on oil prices than a cut of 1 million b/d, said Paul Horsnell, Barclays Capital Inc., London.

Meanwhile, many observers suspect OPEC members have not been consistent in complying with the 1.5 million b/d production reduction that began Nov. 1. Although the group's output declined in November for the third consecutive month, other sources indicate only 66% of that most recent cut has been made, not yet enough to offset the decline in oil demand. Total OPEC output was down to 31.2 million b/d in November from 32.17 million b/d in October. The 11 OPEC members supposed to comply with the group's quotas produced 28.07 million b/d in November compared with 29.06 million b/d in October.

Most reductions have been among some OPEC members bordering the Gulf of Iran, with Saudi Arabia down almost 500,000 b/d. But no major reductions were yet evident among economically troubled members such as Iran and Venezuela.

Horsnell said, "Ultimately we expect that the market will get overtightened, but it will be an incidental effect of further severe disappointments in non-OPEC supply, rather than the result of any direct OPEC policy to overdo the supply-side contraction.

In New Orleans, Pritchard Capital Partners LLC analysts said, "There is simply no faith that global supply will tighten in the next 60 days, and the 'great unwinding' of leverage is still an ongoing process. Oil prices are not likely to rebound until either OPEC makes a substantial production cut or the economy begins to recover and refined product demand firms up."

KBC analysts surmised, "Higher prices will inevitably return." They expect world oil demand to grow by 21 million b/d between 2007 and 2030 at an average annual rate of nearly 1 million b/d, with China in the lead. "Total non-OPEC crude oil production will peak at the end of the next decade, and the world will need more oil from OPEC—biofuels will barely make a significant contribution," they predicted.

(Online Dec. 8, 2008; author's e-mail: samf@ogjonline.com)

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