What's Ahead in 2006

Today is great, but what about next year and 2010?

Dale W. Steffes, Founder, Planning & Forecasting Consultants, Houston

This year, 2005, will go down as one of the best years ever for the petroleum producing industry. I wish I could say that I forecasted this great year, but I did not. In 2002, I did forecast that the oil price was going to rise to a higher price paradigm, and in the spring, I am on record that the oil price would hit $70/bbl this year, which it did.

You know the energy industry is having a good year when your main problem is defending your profits in the Senate. Remember, many of you promised that if the Lord gave you another good year, you promised not to screw it up again. Do you remember that promise? I am honored to be asked to contribute to this exclusive leadership forum. I hope I can convey some wisdom and certainty to merit this audience. It is my intention to contribute to this magazine’s industry guidance.

Some brief historical background. Let us begin with a short history from my perspective. I started my own energy forecasting and planning firm in July 1973, right before what is commonly known as the first Arab Oil Embargo. I had been a corporate planner for five years for a regulated gas transmission company. However, I did acquire and hone my forecasting and planning skills for these two management functions at this assignment. I claim no skills for the other five functions of management. I am sorry to say that many companies have lessened the importance of these two functions. They can make the difference between success and failure.

My forecasting history illustrates that I am not generally known as a consensus forecaster. A consensus forecast is not nearly as valuable as an accurate “off-beat forecast.” How can a small consulting firm compete with larger consulting firms and academic institutions? It is very easy – just be right more often. I have. To explain why I am right more often over a 33-year track record, I will share my processes and models.

When I started Planning & Forecasting Consultants (P&FC), I had to build my own world energy model. When I was with Panhandle, I went to Washington to search for a government energy model and data. To my surprise, there was very little available. The Department of Interior had one written, macro energy forecast. It was not even computerized. With that document and a couple of Rice University students, I designed the first electronic US energy model in 1970. It ran on an IBM 360, which was the state-of-the-art computer of the day. I wish I could say that this model was successful, but it was not.

I believe that this 1970 Interior Department study is the basis for today’s Energy Information Administration (EIA) NEMS model. Even though the EIA has an $80-million dollar budget, I contend their model is not as representative of the energy industry as ours.

P&FC’s energy model traces BTUs for US dollars. BTUs start at the top of the model and flow toward the consumer. Consumer dollars flow upward, toward the producer. So, the model traces the BTU money transactions.

But it’s mostly in the assumptions. It is not uncommon to be asked, what is my oil price forecast? My reply is that this is the wrong question. The question should be: What are my assumptions? If I know your assumptions, I essentially know your price forecast. The assumptions are critical.

For our assumptions, we have developed over the years what we call our Assumption Generator. We have categorized all assumptions into seven prime Influences: Social, Political, Economics, Ecological, Technology, Natural Resources and Geography. An Influence is a matter that cannot be controlled but that affects the entity that must live with it. By definition, you cannot control any of these Influences; you can only forecast them, and you have to live with them, right or wrong.

How the Assumption Generator operates. When a particular Influence changes, it affects the other six Influences; i.e., a change in oil economics makes more, or less, natural resources available. To forecast an individual Influence requires that the other six Influences (externalities) be defined. A technology forecast only pertains to technical ability and science, while a technology assessment defines how the other six Influences will react to this technology change.

Now let’s talk about assumptions for illustration purposes. Normally, the assumptions are the largest part of our study. You get the assumptions right, and your study will be generally right:

• Natural Resources. First, is the world tapped out of oil? If you are in Matt Simmons and Colin Campbell’s camp, you might easily expect $200 oil, or even $300 oil. On the other hand, World Oil and other trade journals are truly the definitive sources on world oil reserves. Their contribution has been to survey annually the world for these numbers. They have been doing this for decades.
• Technology. How do horizontal drilling, 3D seismic, water drilling depths, fuel cells, combined cycle generation and vehicle efficiency affect the industry?
• Environmental. How do access to drilling sites, disposal of waste and climate change affect the industry? Permitting?
• Economic. What is their GNP? How energy-efficient is their economic system? Where are they in the industrialization developmental scheme?
• Social. How many people consume energy, and what is their standard of living?
• Geographic. Where is energy found versus where it is needed? The Alaskan oil pipeline was a major energy Trend Discontinuity. It was a major change for the world oil flows. Alaska’s North Slope natural gas has been stranded since 1968
• Political. What is each country’s national energy policy? Are they favorable or unfavorable? Are they going to use energy trade for political purposes? This is probably the most critical of all the Influences.

Remember, all things that can Influence your company must be in one of these seven categories and must be forecast. Forecasting should be done prior to the study.

With these seven Influences defined, you can describe a society or culture in the past, present and future. This be-comes a scenario that describes the world you compete in. With this set of reliable Influences, your entity can now make strategic plans based on the “Issues.” An Issue is a matter that can be controlled and which should be considered and described sufficiently, so decisions can be reached about it. Strategic Planning deals with Issues.

One last thing about the assumptions; they must be recorded. As they change, and they will, you can then change your strategy. I don’t know how many times I have heard a company say after a bad experience, “why did we do that,” and they don’t know. With written assumptions, you will know why you did something, and if the assumptions change, you will have to change also.

Change in location of the energy leadership. A major discontinuity is now taking place in the decision-making for world oil supply and demand. The world energy capital is being transferred from Houston to Riyadh. Just this past November, the International Energy Forum (IEF) moved into its new permanent offices in Riyadh.

Let me share some history on how this came about. A group of producing (OPEC) and consuming (IEA) countries were meeting together, periodically, since 1991. At the seventh meeting, in 2000, Saudi Arabian Crown Prince Abdulla (now King) proposed that this group have a permanent secretariat in Riyadh. In 2002, they started a Joint Oil Data Initiative. All of the major countries, including the US, now actively belong to this organization. Is this good for the energy industry? Yes, but it would have been better if it were in Houston. At the World Energy Congress that was held in Houston in 1998, I had recommended a similar organization called World Energy Ministers Association.

The producing countries want security of markets, and the consuming countries want security of supply. One would think that it would be easy for the new IEF to meet both of these wants, but it will not be.

Some oil price insights. In 1985, with oil at $28, P&FC forecasted that oil would go to $15 and stay there for 15 years. To say that this now proven forecast was not well received in the oil patch is a gross understatement. My model indicated that Middle Eastern oil was going to go to zero exports by 1990, if the price remained at $28. I knew some-thing had to give, and the Saudis decided to buy back their market. They had production capacity of more than 10 million bopd and had reduced their output to about 2.5 million bopd, trying to keep the price up. It was a very easy forecast.

So what is this oil price cycle going to be like this time? For one thing, today’s producers do not have excess production capacity that is anything like 1985’s levels. Furthermore, I don’t think that consumers have voted yet on the new, higher energy prices. My consumption numbers for 2010 are much lower than EIA’s. In 2002, the world consumed 408 quads of energy. For 2010, EIA’s International Energy Outlook forecasts consumption at 503 quads. Our first-pass forecast is only 433 quads. How can a 70-quad differential exist between us and the EIA? We are working on understanding and confirming this discontinuity.

Several prominent forecasters, who I know and respect, have the price falling back from today’s high levels. I am in their camp, and that worries me. My belief is that their lower prices are due to higher production, while mine are due more to lower consumption. I am quite aware that many others are forecasting $100 oil and up.

Our forecast is that for the rest of the decade, there will be good oil prices, in the $30-to-$45 range, trending from the higher toward the lower. OPEC will be in the driver’s seat for this period. At one of their latest meetings, OPEC had seven additional producing countries observe, which will help enforce world production discipline. Our forecast is valid, only if you agree with our assumptions.

Between April 1999 and March 2000, OPEC, led by Mexico, demonstrated how to manage the oil market. They took it from $10 oil to $30 oil by reducing exports 3.3 million bpd. That was a major Trend Discontinuity. So, a message to producers – don’t screw up the good times this time!

THE AUTHOR
	Dale W. Steffes founded Houston-based consulting firm, Planning & Forecasting Consultants in July 1973, immediately prior to the first Arab oil embargo. Previously, he worked for Panhandle Eastern Pipe Line Co, starting as an engineer in 1959. From 1965 through 1967, Mr. Steffes worked with gas storage and the Marketing Department. In 1968, Panhandle transferred him to Houston, to be a charter member of the firm’s Corporate Planning Department. Mr. Steffes has degrees from Kansas State University in mechanical engineering and business administration. He also holds a degree in theology from the University of St. Thomas in Houston. He is a member of the Association of Energy Engineers, the International Association of Energy Economics, the Association of International Petroleum Negotiators and the Interstate Oil and Gas Compact Commission. He is a registered Professional Engineer and a Certified Energy Manager.