By Mike Killalea, editor & publisher
Signs are increasingly positive for the overall economy, but the energy outlook is a case of the Good, the Bad and the Ugly.
First, the good. At the time of this writing in mid-August, oil prices have risen above $70, But why, when oil demand has fallen off a cliff, are we seeing solid oil-price numbers?
THE GOOD, THE BAD…
First, the Chinese economy stubbornly chugs along, with GDP growth at some 8% per annum. While that’s dizzying relative to Western economies, it represents a major retrenchment from China’s recent double-digit growth.
Now for a bit of the bad: Beijing’s stimulus program (yep, they have one, too) will phase out in the spring, if the Chinese economy hasn’t built up a head of steam by then, oil demand and prices could drop precipitously.
Currency exchange rates also factor into the Good-Bad scenario. Ironically, the US dollar surged last winter when the recession hit home. Despite US woes, the dollar remains a great port in an economic storm.
But today the dollar is in the tank. And since oil trades in dollars, it rises when the dollar falls. That’s where we are now.
…AND THE UGLY
Unfortunately, he who earns dollars may not pay bills in them. If you are a Middle Eastern producer paying out in rials, euros, etc. That can be quite a squeeze on the old margin. If the trend continues, will producers finally make the long-discussed switch from dollar-based oil to, say euro-based? That has some critical implications for oil markets, and our financial structure alike.
And how ugly is $20 oil? Industry analyst Philip Verleger, founder of PKVerleger LLC, predicts oil prices will plummet to $20-$30/bbl by December, driven by low demand and a dearth of storage space. Dr Verleger made his remarks in the Bloomberg on the Economy podcast with Tom Keene. Other voices are less bleak, including Adam Siemenski, chief energy economist for Deutsche Bank. Mr Siemenski, speaking on a separate Bloomberg podcast, believes that storage pressure is lessening, such that Dr Verleger’s dire prediction is unlikely.
UGLY GAS & GREEN
The ugliest of all is probably North American natural gas. Gas drillers suffer not only from choked demand, but a looming oversupply, a result of very efficient drilling. Depletion is apparently less a factor in some of the new, unconventional plays than in the past.
The going quip is that the industry has drilled itself out of a job. Another apt expression is no good deed goes unpunished.
Deutsche Bank’s Mr Siemenski doesn’t see much relief for gas drilling until late summer 2010. But even with gas prices returning to, say, $6-$7, the next big threat is LNG. A world of global gas markets will be upon us soon.
We are entering a brave new world of environmental complexity, too. New government initiatives to promote fuel conservation and sundry green technologies are unlikely to spur oil demand. Further, the Obama Administration is revealing itself less than friendly to the oil and gas industry, to put it mildly. This can only serve to further shift E&P activity toward the international arena. This trend is already pronounced, but politics will exacerbate it.
Still, signs of buoying confidence are emerging. Some rig construction has restarted, and new contracts are being struck. Shale plays are profitable. Just as we knew that a downturn would eventually overtake us, another upturn is coming.
My advice: Hang onto your hats. It will be a wild ride.
You can reach Mike Killalea at email@example.com
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