Editorial Comment

After pegging $20 oil at mid-year, this forecaster sees $26 by year-end

October 1999 Vol. 220 No. 10
Editorial

Thomas R. Wright, Jr.,
Editorial Director

Oil prices could rise more still

When spot prices on the New York Mercantile Exchange closed above $24 per barrel last month, it seemed a good time to obtain a fresh view on prices. So, we visited with Henry Groppe of the Houston consulting firm, Groppe, Long and Littell — the first and only outfit we know of to predict the turnaround this year. In fact, it was last October when we heard them say oil would reach $20 per bbl by midyear 1999 and $26 by year-end. Keep in mind that at this same point in time, oil company economists, Wall Street analysts and most other forecasters were telling industry to get used to $12 oil since it would be around for another three or four years.

Mr. Groppe says the firm has since taken another look at the numbers following the OPEC meeting in March this year, but saw no reason to change the original forecast.

Asked about comments from naysayers who think that higher prices will cause OPEC members to cheat on their production quotas, thus weakening prices, Groppe disagrees. "We think there is a misperception widely held by the International Energy Agency (IEA), the analysts, the press and most of the industry that there is 8 million bpd of capacity shut in. This is based on an estimated 3 million bpd of unused capacity in early 1998, plus an assumed 5 million bpd of production cuts during the past year and a half.

We think most of these were "paper cuts" from exaggerated high levels of claimed production. With the actual capacity-demand balance tighter than most believe, a total of only 1.25 million bpd of actual cuts (by Saudi Arabia, Kuwait and Abu Dhabi) are required for our forecast of $26 by year end.

As to supply / demand numbers issued by the IEA, which have overstated supply in the past, Groppe says, "We are seeing them forecast much higher draws from inventories during the last quarter than we think are realistic. So, we think that this is how the extra barrels of oil in storage that IEA has been reporting will disappear. They created them on paper, so they are going to remove them on paper by forecasting a bigger gap between production and consumption than is actually the case."

Natural gas. Along with $26 oil by year-end, the consulting firm also expects natural gas to reach about $3.80 per Mcf. "Looking at our estimates for 1998 — a very warm year — gas inventories grew by an average of 1.5 Bcfd. But this year, we are estimating that inventories will be drawn by an average of 1.5 Bcfd by the time we get to year-end," says Groppe.

If the above situation occurs, it will amount to a 3-Bcfd shift in the supply / demand balance, and will have more and more effect as demand continues to outstrip supply. With oil prices in the $26-range, then low sulfur fuel oil (the alternative fuel under dual-fired boilers) will correspond to gas at about $3.80 per Mcf.

Declining gas deliverability in the U.S. will soon become a significant concern. Groppe sees only two areas with the potential for raising production — the deepwater Gulf of Mexico and tight gas reservoirs in the Rocky Mountains, particularly in Wyoming. However, he says, "We don’t think those are adequate to offset the declines in our biggest sources of production. In fact, the principal growing supply for the U.S. the last 13 years has been imports from Canada. And without those we would have had a severe gas shortage long ago."

Canada is producing gas at capacity, according to Groppe, and he doesn’t think the country will be able to continue its past growth rate, since it has already run its reserve-life index down from about 28 years to 10 years during the past 12 years. Furthermore, during the last 12 years, Canada only replaced production with reserve additions during one year. And to keep the pipelines full, including the new Alliance pipeline coming on next year, Groppe thinks Canada would have to double its average annual reserve additions of the last 12 years.

In view of the above, Groppe sees the U.S. entering its first real gas deliverability shortage in the history of the industry.

So, with oil prices double what they were at year-end 1998 and an optimistic outlook for gas too, why are operators so slow to react? Maybe it’s akin to the situation of the farmer using his horse Buddy to help a car stuck in the mud:

He hitched Buddy to the car and yelled, "Pull, Nellie, pull!" Buddy didn’t move. He hollered, "Pull, Buster, pull!" Nothing. Then he commanded, "Pull, Coco, pull!" Still nothing.

Finally, the farmer nonchalantly said, "Pull, Buddy, pull!" When the car was pulled out of the mud, its driver asked the farmer why he kept calling his horse by the wrong name.

The farmer said, "Oh, Buddy is blind and if he thought he was the only one pulling, he wouldn’t even try."

Maybe it’s time to blindfold a few oil company CEOs and tell them to get back to work.