David Pursell, Research Principal, Tudor, Pickering, Holt & Co.
Oil and natural gas price volatility in 2008 was nothing short of stunning. Given the huge range of prices experienced this year, when you hear someone predicting oil and gas prices for the coming 12 months, immediately grab your wallet and run for the door. Relax, your wallet is safe (at least until April 15) as I am not going to prognosticate on price; instead I will discuss the key factors driving oil and gas prices in 2009.
The coming year will start with more uncertainty than usual as global economic angst clouds the ability to forecast crude oil and gas demand. In addition, the US domestic E&P industry is a victim of its success as natural production growth is an issue for the first time in a decade. Given this uncertainty, here are the factors we think will dictate the direction of price movements in 2009:
2008: The year of volatility. Oil prices started the year at $90/bbl and rapidly increased to $145/bbl by mid-year, then fell even faster to the mid-$50s/bbl as I write this article. It is hard to imagine volatility staying at these elevated levels … but a degree of volatility is a fact of life in the commodity markets, so buckle up!
Financial crisis. We are all personally impacted, either directly or indirectly, by the ongoing financial crisis, and the resolution will ultimately determine the pace of global demand growth and commodity prices. Here is a little holiday wish for Paulson and Co.: that they have a steady hand at the wheel, since our personal and professional well-being is, like it or not, strongly dictated by their actions.
The limited ability to access capital markets, combined with lower than anticipated commodity prices, will force many companies to reduce—significantly in some cases - 2009 activity plans. Quite simply, the current capital markets are forcing companies to spend within cash flow, or to sell assets to pay for deficit spending. Unfortunately, our crystal ball is particularly cloudy on the duration of the capital market issues.
Demand. As we pointed out in last year’s outlook piece, “Crude oil should have another solid year in 2008 as long as prices don’t go too high, too fast and crater global demand.” (Italics added.) Oops! Record high prices in the first half of 2008 and the ever-expanding financial crisis were a vicious combination, resulting in US demand declines of about 1 million bpd (5%) in 2008. One has to dial the way-back machine to the early 1980s to see larger US demand declines.
China India Inc. The developing world will dictate whether 2009 global demand grows modestly (as in 1998 and 2001) or contracts (early 1980s).
If it is similar to 1998 and 2001, OPEC can manage slow or no demand growth, as non-OPEC supply growth is anemic. OPEC would only have to cut modestly to balance the market, which would not create sufficient excess capacity to push price lower from current levels.
A return to the large demand contraction seen in the early 1980s would likely put further downward pressure on oil prices, regardless of OPEC actions. If OPEC fails to cut enough, inventories will build and prices fall. If OPEC cuts enough to balance the market, this will create visible excess production capacity, and prices will fall.
Geopolitics. In last year’s outlook, we speculated that Iran, Russia and Venezuela posed the most geopolitical risk to crude oil supply. Today, these same countries have supply vulnerability as emerging market currency instability adds another layer to political risk in these countries. Factor in that terrorists may choose to “test” President-elect Barack Obama, and the potential for supply disruptions has likely increased.
Speaking of politics? Where did the speculators go? As oil and gas prices were soaring to record levels, the public debate revolved around the power of the mythical commodities “speculator” to drive oil prices higher. These “speculators” were the reason gasoline prices were inflated and they were the scourge of consumers, politicians and media pundits. Funny (or not so much) that no one mentions the evil “speculators” as the reason that commodity prices came tumbling down in the second half of 2008. The public energy debate is very one-sided; get used to it. Note: Calling someone a speculator is as descriptive as calling a “dog” a “non-cat”; it fans public sentiment but does not add substance to the public debate.
Carbon legislation. The last political item! A carbon tax is coming. We still are not sure of the magnitude or the phase-in timing, but we are confident that under President-elect Obama it will be a priority. Natural gas should be the “winner” in the fossil fuel sweepstakes (gas >> oil >> coal), but there is the potential for a hefty tax even on gas, which will certainly increase the price to the end user. It is hard to assess the absolute net benefit of a carbon tax, because gas demand should benefit via the power sector … but will higher price offset that benefit?
Growing gas supply. The market finally came around to the realization that gas supply is growing, as Gulf of Mexico declines are only partially offsetting the significant onshore growth.
Onshore growth is being driven by shale plays, which have been rendered commercial by higher gas prices and improved technology. In last year’s outlook, we did not forecast the hyper-leasing activity in East Texas and North Louisiana that became Haynesville-mania. Although the lease rates and overall craze have been tempered by lower gas prices and a tight credit market, the long-term outlook for the shale improves as more wells are drilled and more data becomes available. Onshore gas production can grow, which has sparked a new conversation around the potential for gas as a transportation fuel.
The combination of US gas supply growth and anticipated continued weak demand in the industrial and power sectors is creating an oversupplied situation. This will most likely cause E&P companies to reduce drilling. This has implications for domestic oilfield service activity and prices in 2009, as there will most certainly be downward pricing pressure.
Economic and market uncertainty will continue to translate into commodity market volatility as it relates to demand. Crude oil prices will remain uncertain until there is more confidence in the global demand outlook. In the meantime, lower oil prices and the uncertain economic climate will reduce investment in non-OPEC supply growth. The catalyst to “fix” the gas supply overhang is more obvious: investment and rig count will fall to moderate the impressive onshore supply growth. That means 2009 is an uncertain year for natural gas … but 2010 should see better times. 
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THE AUTHOR
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David Pursell is the Head of Macro Research at Tudor, Pickering, Holt & Co. Securities, and was one of the founding partners of Pickering Energy Partners, Inc. Mr. Pursell is responsible for macro-oil and gas strategy, which includes supply, demand and pricing outlooks. Mr. Pursell previously worked as Director of Upstream Research at Simmons & Company International, and in various production and reservoir engineering assignments at S.A. Holditch and Associates (now part of Schlumberger) in College Station, Texas, and Arco Alaska in Anchorage. He holds BS and MS degrees in petroleum engineering from Texas A&M University.
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