ENERGY
MARKETS SET TO IGNITE
by Joseph Dancy,
LSGI Advisors, Inc.
Adjunct
Professor, SMU School of Law
October 2, 2005
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The chance of either storm making landfall in the U.S. is 21% according to their models. While they do not forecast a projected landfall location, existing ‘steering currents’ have tended to nudge this year’s storms into the Gulf of Mexico.
As damage reports slowly trickle in from both of the recent hurricanes we expect they will reveal severe, extensive, and long term damages to both onshore and offshore facilities that will take massive amounts of capital and manpower to repair. Time will tell if our thesis is correct.
Offshore oil and gas fields in the Gulf of Mexico in normal times supply approximately 20% of the nation’s natural gas production and around 25% of the crude oil production. Hurricane Katrina and Rita have shut down a substantial amount of this crude oil and natural gas production - for an entire month. Possibly a substantial amount of this production may be out for many months to come. On average, over the last month, roughly 58% of the nation’s offshore natural gas production and 79% of the nation’s offshore oil production has been shut in due to the storms. Numerous onshore production facilities have also been affected. In addition to the impact on natural gas and crude oil production Katrina shuttered four refineries constituting 4% of U.S. refining capacity. Hurricane Rita took additional refining capacity off line, of which 13% remains shut down. A sum total 17% of U.S. refining capacity is non-operating due to the hurricanes as of October 1st – an astoundingly large number. Damaged refining facilities will be offline for a period of weeks to months as equipment repairs are made, pipelines are patched, electricity restored, facilities tested, and the workforce repopulates the stricken areas. We expect gasoline and diesel prices to work their way upward over the next few months, possibly by a substantial amount. Crude oil production shortfalls, and to some extent refined product shortfalls, can be replaced by increased imports. Natural gas production shortfalls are another matter. Natural gas imports from Canada are limited by pipeline capacity constraints, as are imports of liquefied natural gas (LNG).
Around 52% of U.S. homes are heated by natural gas. Utilities traditionally inject large volumes of natural gas into underground storage facilities around this time of year to meet winter heating demands. Injection volumes over the next month are expected to be shockingly low due to the natural gas production outages. We expect high natural gas prices will be required to ration supply and demand, and to provide adequate levels of storage for the coming heating season. The plat below (from the RigLogix website) details the destructive path of both Katrina and Rita – and their track through the offshore mobile rigs (orange dots) and fixed platforms (gray dots).
As both onshore and offshore facilities are inspected we expect the damage to far exceed current expectations. The economic impact will be extensive and global in scope. In the end the market will allocate additional capital to the sector in light of higher energy prices – which will facilitate repairs – and should provide robust shareholder returns.
[1] Estimated annualized returns after costs and expenses, but does not include manager’s performance incentive fee. The LSGI Fund portfolio was established on July 1, 1999, and is over six years old. Contact
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This
is not positive news for an energy sector already beset by supply
disruptions. Hurricane Katrina and Rita will collectively be the
most expensive storms for the oil and gas sector in history –
with damages and lost production volumes exceeding those of
Hurricane Ivan by a factor of two or more.
