Market surprise, technical advance expected in 2005

Jan. 3, 2005
A year of market surprise and technical advance lies ahead for the oil and gas industry.

A year of market surprise and technical advance lies ahead for the oil and gas industry.

Nearly everything that happens in the markets for oil and natural gas will contradict forecasts. There are too many variables. Will Iraqi oil production rise or fall? Will Russian production maintain its strong growth? Will political unrest halt oil output in Nigeria, Venezuela, or another important exporter? Will Chinese demand keep climbing? Will the dollar regain lost value? Will weather in the remaining Northern Hemisphere winter be warmer or colder than normal?

Questions like those can't have answers at this point. And hovering over all of them is this: Has the ground shifted beneath oil supply and demand so that price strength of the past couple of years reflects permanent change? Or are oil prices above $30/bbl and gas prices above $5/Mcf—sometimes considerably above—quirks destined to give way to the market's penchant for stern correction?

As always, oil and gas operations and technology this year will be adventures. Exploration will go where ingenuity leads and authorities allow. Drilling and production will occur in once-unimaginable water depths with wells providing unprecedented subsurface control. Refineries will produce

fuels able to meet ever-stricter environmental specifications—hopefully in quantities consumers need when the specifications take effect. The LNG business will make progress toward the high hopes a world craving energy has for it. And pipelines will lace further into the biosphere to connect oil and gas production with processing centers and markets.

As in past years at this time, the Oil & Gas Journal editor asked staff editors for their expectations about the year ahead. Their responses contain the insights of journalists and engineers close to the subjects they cover and continuously in contact with industry professionals. In some cases they offer answers to the tough questions looming at the start of 2005. In some cases the best anyone can do is refine the questions.

The markets

The two OGJ editors who watch markets most closely expect growth in worldwide demand for oil to slow this year but keep pressure on the Organization of Petroleum Exporting Countries nevertheless.

Senior Editor-Economics Marilyn Radler notes the alarm that lasted through most of 2004 over the shrunken availability of spare production capacity—all of it in OPEC members. Because OPEC members with the necessary resource potential, Saudi Arabia key among them, have said they'll increase their capacity to produce oil, Radler expects the number of rigs active in Saudi Arabia and other member countries to climb. She also expects changes in the $22-28/bbl price range OPEC has used to guide production decisions since March 2000.

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"It's my opinion that the organization will formally adjust its price band upward to reflect the shift in oil prices, which many analysts now see as a permanent, fundamental change," Radler says.

Senior Writer Sam Fletcher, who writes the daily Market Watch article on OGJ Online and most of the market stories in the printed OGJ, agrees that an increase in the price band is likely. He cites a factor in this year's market that he thinks receives too little attention: weakening of the US dollar against the yen and, especially, the euro.

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"OPEC members sell their oil for dollars but do most of their buying in euros," he points out. "That difference will guide production decisions by OPEC members for the coming year."

The price of OPEC benchmark crudes has exceeded $28/bbl since Dec. 2, 2003. Purnomo Yusgiantoro, OPEC's conference president, has said the group is actually defending a price range of $28-32/bbl, which equates to West Texas Intermediate prices of $31-36/bbl.

Although the growth rate will diminish this year in response to elevated prices, a market still needing more oil will have to strain for supply, Fletcher says, citing rapid depletion in the Gulf of Mexico and North Sea and "stretched" infrastructure.

"US refineries have been operating at peak capacity for years," he says. "There's a shortage of VLCCs [very large crude carriers]. The industry is pushing production from deeper waters in the Gulf of Mexico. A major failure of any of that equipment would be devastating to the industry both in the disruption of supplies and resulting governmental investigations, likely resulting in more environmental or operational regulation."

Like Radler, Fletcher wonders when Iraqi production will be sustainable at prewar levels. He also offers a reminder that hurricane season comes annually to the Gulf of Mexico.

"I can see lots of opportunities for supply disruptions in the coming year, virtually no opportunity for near-term, massive increase in supplies, and only moderate decreases in the growth of demand for oil and gas," Fletcher says. "That shapes up as a year very much like 2004, which might be enough to prompt more spending on oil and gas exploration and production if the companies can get access to good prospects."

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Turbulence in oil and gas markets leads Senior Staff Writer Paula Dittrick to predict, "Energy trading volumes probably will escalate on futures exchanges worldwide." Her reasons: Physical trade patterns, especially for natural gas, will evolve as economies grow in China, India, and parts of the former Soviet Union. And industrial energy purchasers will increase their trading of futures or other forward contracts to hedge against unfavorable price moves.

Dittrick also notes that trading of greenhouse-gas emission and renewable-energy credits is getting under way, most actively in Europe.

News issues

Trading in emissions credits won't be the only influential story growing out of concern over growing concentrations of greenhouse gases in the atmosphere, Dittrick says.

"Climate change concerns could trigger unpredictable economic consequences and prompt more government environmental regulations worldwide," she says. "Warming in arctic regions and rising ocean levels are apt to draw increasing public attention and criticism of the industry."

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Steven Poruban, senior editor, says more-immediate questions in the US, with President George W. Bush having been reelected and Republicans having strengthened their positions in the House and Senate, are when a comprehensive energy bill might be passed and what it might contain.

Another story that intrigues Poruban is reserves disclosure.

"I'll be anxious to see which oil and gas companies—and there will be more of them—revise their past oil and natural gas reserves estimates and how that will play out for 2005," he says.

Economic developments with ramifications for 2005, according to Poruban, are weakening of the dollar against the euro and the high hopes US policymakers have placed on oil supply from Russia—hopes that, because of infrastructure limits and diplomacy questions, might prove too optimistic.

Judy R. Clark, senior associate editor, sees hope for one longstanding political goal of oil and gas producers.

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"With Republican influence in ascendancy in Washington, drilling in ANWR [the Arctic National Wildlife Refuge] may finally be approved in 2005, albeit not without continuing stiff opposition from congressional environmentalists," she says. But leasing bans off California and Florida are, in her view, "rock solid for the near term."

Clark thinks controversy may arise this year in another area.

"Sunlight on tainted Enron [Corp.] dealings may lead to that light's being directed toward evidence of corruption in other companies, the roots of which have yet to be exposed," she says. She thinks tax evasion charges by the Russian government against OAO Yukos, which filed for bankruptcy in December, "may not have been entirely political, and the investigation of that company could lead to others." What's more, she adds, investigations will put pressure on companies with units based in low-tax countries—and the companies advising them to take advantage of tax havens.

"More residual scandals may yet be uncovered in 2005 when those paper trails are followed more fully," Clark says.

Statistics Editor Laura Bell expects further industry consolidation this year.

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"One trend that will continue in 2005 will be more mergers between medium-sized independents hoping to maintain a larger presence and market share within the US," says Bell, who documents mergers by compiling the annual OGJ 200/100 for the magazine and the quarterly OGJ 200 for a new affiliate publication, Oil & Gas Financial Journal.

"We saw in the last quarter of 2004 several larger mergers take place. This is something that the oil industry will have to contend with for the next several years."

LNG developments

LNG trade will continue to grow in 2005—but not without impediments.

"Angst about the location and regulation of LNG terminals is long from over in the US," says Dittrick, citing recent legal battles over regulatory authority.

To Warren R. True, chief technology edito-LNG/gas processing, "Nothing tells the story of the direction of world LNG trade like the current state of vessel construction."

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In late 2004, he says, the active LNG tanker fleet comprised nearly 160 vessels, with the largest rated at 145,000 cu m. According to LNG Shipping Solutions of the UK, more than 90 vessels were under construction. The consultancy expected that by the end of 2004, seven tankers would have entered the fleet, adding nearly 2 million cu m to capacity. By 2009, more than 13 million cu m of capacity is expected to enter service with the average tanker having capacity exceeding 142,000 cu m.

This year, 18 tankers are to enter service, representing more than 2.7 million cu m of transportation capacity. The largest vessels under construction are four ordered by BP Shipping with capacities of 155,000 cu m each.

"In addition to the sheer magnitude of the fleet increases on the horizon and the increase in average vessel size, the other major development for LNG shipping has been the growth of vessels not committed to a specific project," says True, who edits LNG Observer, a quarterly publication of OGJ and Gas Technology Institute.

True cites UK consultant Andy Flower's estimate that for the first time in more than 2 decades several tankers are being built without commitments to specific LNG projects. Flower says surplus shipping encouraged expansion of short-term trading in LNG from 4 million tonnes/year (t/y) in 1999 to 13 million t/y in 2003.

At the start of 2005, worldwide liquefaction capacity exceeds 140 million t/y, 10 million t/y more than projected demand, says True, again citing estimates from Fowler, who expects 16.5 million t/y of capacity to come on stream this year, 800,000 t/y less than started up in 2004.

"The growing presence of Qatar is rippling through the entire chain," says True. "At nearly equidistant between both sides of the US and sitting on the world's largest nonassociated proved gas reserves, the country is adding LNG liquefaction capacity almost constantly and has embarked on the world's first large-scale commercial gas-to-liquids project. This latter project has large implications for the industrialized world's struggle to rid its distillate and gasoline supplies of sulfur."

LNG markets

The LNG supply expansions target growing markets in Asia (especially South Korea), Europe, and the US. In the US, more than 40 project proposals have surfaced during the last 2 years, not all of which can be built.

True thinks the Gulf Coast is the area most likely to accommodate LNG imports. The region's first offshore LNG terminal probably will start up this year. Liquefaction projects in Indonesia and Russia's Sakhalin Island will encourage development of service to the US West Coast—most likely, True says, involving import facilities in Mexico and a pipeline to southern California.

Several LNG import projects are proposed for the Canadian East Coast, primarily to feed gas into pipelines serving the US Northeast.

"Similarly, at least one import terminal will be built in the Bahamas, with natural gas moving via subsea pipeline into the Florida market," True says.

An imbalance is developing. True says Fowler has calculated that LNG supplies committed to the US are less than needed to meet needs of existing LNG plants after they're expanded—even before additions to import capacity from new plants. The combined capacities of the four existing US terminals will rise from 18 million t/y at present to 38 million t/y by 2008. Total LNG supply now committed to the US or likely to be delivered to the US on a long-term basis is about 32 million t/y.

Expanding exploration

Petroleum exploration this year will expand in some areas and contract in others, says G. Alan Petzet, chief editor-exploration.

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"New areas of the world formerly closed due to political reasons or off limits due to political or economic barriers will continue to open to exploration companies," he says. In the high-potential US West, however, "Environmental barriers to exploration will be erected to almost all drilling outside established producing areas."

Worldwide, Petzet says, companies will make growing use of partnerships in exploration and development projects to spread portfolios and reduce risks. And in the US and Canada, drilling will continue to shift away from new-field wildcats and increasingly concentrate on unconventional gas plays.

"Companies will pay more attention to the standards they use when calculating and reporting reserves," Petzet says, noting a committee formed to study certification of reserves estimators by the American Association of Petroleum Geologists, Society of Petroleum Engineers, and Society of Petroleum Evaluation Engineers.

A potential surprise this year is the extent to which the drilling response to strong oil and gas prices may strain the market for equipment services and continue to drive up costs.

"Wait times for rigs could lengthen this year if operators drill everything they have indicated," Petzet says.

Also in 2005, signs of a delay may appear in the peaking of global oil production. Periods of elevated price inevitably stimulate exploration and development, Petzet points out.

"This effect, combined with the lag from discovery to production, is probably happening now because of the large number of large fields worldwide that are somewhere between discovery and first oil."

More production

Although oil and gas prices subsided at the end of 2004, Production Editor Guntis Moritis believes 2005 will be another strong year for production activity.

"Forecasts of continued demand increases indicate that the industry in 2005 should have the incentive to continue accelerating production from known accumulations as well as initiating projects that will provide unconventional sources of oil and gas in the longer term," he says.

In many cases, Moritis adds, technology will determine the timing and amounts of production from high-potential environments such as deep water; thin coal beds; tight formations; high-pressure, high-temperature reservoirs; and deposits of heavy oil and bitumen.

He notes the range of technologies available to operators for producing hydrocarbons in these environments but notes, "Applying a technology to any given situation is seldom clear-cut. A lag time, often measured in years, still exists before many new technologies can impact greatly finding and producing practices."

A challenge looming for 2005 is elevation of the price of steel, which already has forced the deferment or redesign of some projects.

"These higher steel prices, if they don't stabilize or decline as expected in a cyclic industry, may open a door for industry to use more alternative materials," Moritis says.

Companies this year will hear more and more about carbon dioxide sequestration, "which may spur new enhanced oil and gas recovery projects."

And unconventional resources "that may make headway during the year" include gas hydrates, shale oil, and gasified coal. Moritis cites a GTI estimate that the latest coal gasification technologies are economic with gas prices of $4.50-5/Mcf. Although gas hydrates and shale oil remain in the research stage and at least several years from adding much to energy supply, "successful pilot tests could accelerate the time these resources may become economic to extract."

Drilling quickens

Drilling Editor Nina M. Rach expects the global rig fleet to grow and gain efficiency in 2005. Rigs will come out of retirement and be upgraded and refurbished, she says. Shipyards are opening in the Far East and elsewhere to provide fleet upgrade services.

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She expects a "steady stream of contracts for new offshore rigs" and comparable activity with land units.

"As the market for land rigs tightens worldwide, we will see a continued purchasing of regional land rig fleets, as well as continued newbuilding, particularly in Canada," Rach says. "Many land rigs seem to be moving to the Middle East."

She expects five new jack ups to be completed this year. Five jack ups entered service last year, four in 2003, three in 2002, one in 2001, and four in 2000.

Rach notes that many new land rigs have AC and hydraulic-based systems, rather than the DC systems common on older rigs. Casing drilling rigs already use all-hydraulic systems.

Rach expects more drilling with casing worldwide and some casing drilling offshore.

"So far, wells drilled completely with casing—surface to TD—have been only on land," she says. "But there has been some shallow conductor drilling offshore, and this will probably be tried to greater depths."

Advances in tubulars will include widespread use of dopeless pipe for casing—now required by the Norwegian government offshore—more use of expandables, and progress with "smart pipe" containing wires and relays for data transmission.

Expandables, Rach says, will allow operators to reach deeper objectives. Slimhole drilling will enhance the economics of some prospects.

"Perhaps we'll see new suites of slimhole tools, certainly more reliable tools for high-temperature/high-pressure conditions," she adds.

Refining issues

Refiners in the US this year are preparing for requirements for ultralow-sulfur diesel (ULSD) taking effect in the middle of 2006. David N. Nakamura, refining/petrochemical editor, says companies are making the necessary investments, but that's not the whole story.

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"Most capital is tied up in these [desulfurization] projects," he says. "US refiners have been unable to invest in significant crude capacity expansions."

Worldwide, Nakamura says, refining capacity hasn't kept up with growth in demand for petroleum products, especially in Asia and the US.

"I think the industry may have seen a fundamental shift to higher refined product prices," he says. "A few plant upsets, especially in the summer, could have far-reaching implications."

According to OGJ's construction surveys, all grassroots additions to distillation capacity this year will be in Asia. A few expansions of existing facilities are planned in the US, Europe, and Latin America.

"Investors in those regions can still buy existing plants for less than it would cost for a new grassroots facility," Nakamura says. "Until prices for existing plants increase, there will be no new facilities."

Also discouraging refinery construction is worldwide concern about contraction of refining margins.

Nakamura notes a "global shift" in the petrochemical industry, as capacity shrinks in North America and grows in regions with lower feedstock costs, especially the Middle East.

A potential problem this year for US refiners is supply of hydrogen, which is difficult to transport and dependent on natural gas as a feedstock.

"With all the hydrotreating capacity starting up in late 2005 and 2006 [to remove sulfur], refiners need a lot more hydrogen," Nakamura says. "This exposes more refiners to volatile natural gas prices, which may eat into their profits appreciably."

Citing regulations under development to require ULSD in off-road vehicles, Nakamura says, "I think refiners need to start planning in 2005 for the additional units to comply with this regulation."

Refiners generally expect lower profits this year than in economically robust 2004. But that's if 2005 goes without mishap.

"I do think that if there is only one major shutdown this summer, profits could meet or exceed those of 2004," Nakamura says. "The supply-demand balance is so precarious in the US that one upset has potentially huge ramifications."

Although refiners expect a smooth transition to ULSD, he adds, "Any project delays may result in refiners having to purchase sulfur credits, which might be expensive."

Pipeline outlook

Pipeline activity in 2005 will follow markets, says Robert G. Lawson, senior editor-pipelines.

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"With energy demand increasing almost everywhere around the world, it follows that there must be increased and more flexible ways to move that energy to market," he says. He expects to see "a lot of creativity" this year "as new plans for moving energy are devised and old ones pulled out of the files and moved forward."

Lawson points to progress on the proposal for a Canadian pipeline to move gas from the Mackenzie Delta to northern Alberta. Canada's National Energy Board received the application for the project last October. Hearings are to occur this year, with a decision expected in 2006.

Lawson thinks gas from Alaska's North Slope will eventually move south through the proposed Alaskan Highway pipeline—but not before 2012.

Although development of LNG import facilities in the US would trigger pipeline construction, Lawson notes that local opposition has dulled the outlook for many projects.

"Don't expect anything to change this year unless there are serious supply disruptions and cooler-than-usual weather in the Northeast US—and probably not even then," he advises.

The US Federal Energy Regulatory Commission has approved two LNG-related pipelines: AES Corp.'s 24-in., 54-mile Ocean Express line to Florida from the Bahamas and Cheniere Sabine Pass Pipeline Co.'s 26-mile connection to an existing line of a terminal proposed in Cameron Parish, La.

Outside the US, a major project due completion this year is the 1,100-mile, 1 million b/d Baku-Tblisi-Ceyhan crude oil pipeline from Azerbaijan to the Mediterranean.

Elsewhere, Lawson says, the World Bank has approved a $125 million loan guarantee for ChevronTexaco Corp.'s 375-mile, offshore West African Gas Pipeline to carry gas from Nigeria to Benin, Togo, and Ghana. First deliveries are expected in 2006.

Construction has begun on the second part of the 625-mile Sino-Kazakhstan crude oil pipeline, a venture of China National Petroleum Corp. and KazMunaiGas, the Kazakh national oil company. Work on the first phase, designed to move 10 million t/y of oil to China, is to be finished this year. The second phase, scheduled for completion in 2011, will double throughput capacity.