WHAT THE INDUSTRY EXPECTS IN 2008

Optimism from supply growth and more LNG dampened by politics, the low dollar

David A. Pursell, Managing Director, Tudor, Pickering & Co. Securities, Inc.

Crude oil should have another solid year in 2008 as long as prices don’t go too high, too fast and crater global demand. International exploration and development activity should remain robust as oil prices will remain high in 2008, likely not the current $90/bbl, but well above $60/bbl. Natural gas is in for another choppy year. Our long-term fundamental optimism is tempered by 2008 onshore supply growth, lack of GOM decline and more LNG.

Geopolitical events in 2008 may be overshadowed by election-year issues in the US. The specter of high oil and gasoline prices during next year’s political debates is enough to put a smile on Bill O’Reilly’s face.

Political issues. Two words-carbon tax! Get ready for whoever wins the White House. Carbon legislation will tax oil and coal to fund clean energy technology. Natural gas likely “wins” in the near term as it has the lowest carbon intensity of the mainstream fossil fuels. Also, pull up a chair during the political conventions next summer and listen to the gnashing of teeth as gasoline prices near $4/gallon during the summer driving season.

Peak oil has become mainstream. With oil prices heading towards $100/bbl as I write this article, it seems that the peak oil debate is everywhere as an explanation for high oil prices and a future of ever-increasing oil prices. The peak oil debate will remain with us in 2008, but the trouble with the debate is that we won’t really know if oil production has peaked until we are well past the point of no return. Whether oil peaks in the remaining month and a half of 2007, 2010, 2020 or beyond remains to be seen. During a college football game in early November, Boone Pickens discussed peak oil with Brent Musberger ... no, I am not making this up!

Demand implications? If peak oil is upon us, which I do not believe, then beware because prices will have to rise high enough to curb demand growth. What price does it take to curb demand? We may already be there as recent US demand figures show anemic growth through the summer and fall of 2007. If not, higher prices are likely in store and the potential for economic dislocation is very real.

Taxation without representation. Host countries are increasingly taking a larger portion, or their so-called “fair share,” of oil and natural gas revenues through higher royalties and taxes, or just plain renegotiating contracts. Note: the term negotiation implies a two-way discussion. Renegotiating oil production contracts is similar to the way a parent may “negotiate” with a child over punishment-it is often a one-way discussion. This leaves cash-rich oil companies with fewer places to invest their money without increasing fiscal and geopolitical risk.

Can’t we all just get along? Talk about supply-side risk! Iranian nuclear ambitions, or alleged nuclear ambitions, took center stage in 2007, and with presidential elections almost exactly one year away, I don’t think this issue will simply fade away. Iran’s 4 MMbpd of oil production capacity, if taken off-line, would cause a large and rapid oil-price spike. Russia will likely continue to wield more geopolitical influence due to its position as the world’s largest oil and natural gas producer, and the petrodollars that accompany its enviable export position. Finally, Al-Qaeda and the potential for a terror attack against global oil infrastructure still looms over us. Don’t assume one failed attempt in Saudi Arabia will dissuade them from another attempt.

Economic issues. There are a number of economic issues that are impacting the price of oil and the market’s assessment of the oil price.

• Demand-high oil prices are impacting demand in the OECD, with recent demand trends showing negative demand growth vs. one year ago. Can the developing countries, such as India and China, keep global oil demand growth positive as oil prices continue to rise?
• Dollar weakness-Dollar weakness pushes oil prices higher. Globally, oil is priced in US dollars and with a devalued dollar, OPEC requires a higher oil price to “stay even.” Consuming countries can afford to pay more for oil as local currencies strengthen vs. the US dollar.

Natural gas. It looks like another challenging year for US natural gas producers as gas prices will struggle to move higher than recent levels. Gas has averaged at about $7/MMcf for the past two years. The real story is the supply side:

• Gulf of Mexico-GOM gas production decline has been stopped, at least in 2008. The 1 Bcfd Independence Hub and Atlantis deepwater projects and several shelf projects could actually cause GOM production to increase for the first time since 2001.
• Onshore gas production is growing. We estimated 2008 onshore supply will grow 1.5 Bcfd, roughly 4%, with growth occurring mainly from the Barnett and Fayetteville Shales and the Pinedale Anticline.
• LNG-Two years ago many folks had a hard time spelling LNG, and now it is a reality. LNG imports in 2007 increased 0.7 Bcfd (+50%) and we expect similar increases in 2008. The summer of 2007 was an “ah-ha” moment for LNG skeptics as the US imported 3 Bcfd, even though US gas prices were relatively weak.
• Canada-The one supply-side bright spot for natural gas markets is how much will Canadian imports decline in 2008. The question is not “if imports decline” but by “how much.” Weak Canadian rig count coupled with a royalty tax change in Alberta should cause Canadian imports to decline next year. We model imports down 0.8 Bcfd, or about 10%.

THE AUTHOR
	David A. Pursell is Managing Director at Houston-based Tudor, Pickering & Co. Securities, Inc., responsible for macro energy analysis. Previously, he was the director of upstream research at Simmons & Company International. Earlier in his career, Mr. Pursell was manager of petrophysics at S. A. Holditch & Associates (now a division of Schlumberger) after beginning in operations and field engineering at ARCO Alaska, Inc. He earned BS and MS degrees in petroleum engineering at Texas A&M University.