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The hurricane season of 2005 has been the most prolific ever.
Wilma's formation last month, followed by Alpha and Beta, gave us
23 named storms. The previous record - 21 storms - was set in
1933. According to hurricane expert Dr. Jeff Masters “We’re
living history this year. . . . This is a once in a lifetime
hurricane season.”
Dr.
Masters describes the ferocity of the recent storms: “There has
never been a hurricane like Wilma before. With an unbelievable
round of intensification . . . Wilma smashed the all-time record
for lowest pressure in an Atlantic hurricane. . . This is an
incredibly compact, amazingly intense hurricane, the likes of
which has never been seen. The Hurricane Season of 2005 keeps topping itself with new firsts, and
now boasts three of the five most intense hurricanes of all
time--Katrina, Rita, and Wilma.” (emphasis supplied)
Since
around 20% of our natural gas supplies and 25% of U.S. crude oil
production originate from fields in the Gulf of Mexico, the
increased storm activity has had a major impact on the U.S. energy
sector. The Minerals Management Service reports that 67% of crude
oil production and 54% of the natural gas production in the Gulf
of Mexico remains shut-in – over sixty days after
the first hurricane made landfall! In addition, over 5% of
U.S. refinery capacity remains off-line. Numerous natural gas
processing plants and pipelines remain shut down or are operating
at a reduced rate, as well as onshore oil and natural gas
wells.
The
Outlook for the Energy Sector
While
we expect the energy markets to be volatile, we remain bullish on
the energy sector for the following reasons:
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The
first week of November traditionally marks the start of
the heating season for the natural gas markets. At the
end of the summer injection season natural gas volumes
in storage will exceed 3.14 trillion cubic feet (tcf)
– around 100 billion cubic feet below last year’s
storage levels. Note that it took natural gas prices of
$13 per thousand cubic feet (Mcf) this summer for the
companies to acquire the necessary gas to fill the
storage facilities versus around $7.75 per Mcf in the
year ago period.
In ‘normal’ years 3.14 tcf in storage would be
considered satisfactory to meet expected winter heating
demands. Around 80% of winter demand is met by
production facilities and around 20% of demand is met
from natural gas retrieved from storage facilities. With
such a high proportion of the nation’s natural gas
production remaining off line there is a high
probability that larger than normal draws from storage
will be required to meet winter demand. If we have a
cold winter draws on storage will be much higher than we
have seen in recent years. If this thesis proves correct
expect natural gas prices to remain elevated, and
possibly spike, this winter.
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This
week natural gas futures traded for $13 per Mcf. Last
year at this time natural gas sold for $7.75 per Mcf.
The U.S. Department of Energy predicted the average
heating bill this winter in the U.S. will increase 47%
over last year’s level. The market clearing prices
needed to allocate natural gas production remain
elevated. Higher prices will result in higher cash flow
and earnings for any companies in the natural gas
extraction and marketing sectors.
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Long
term forecasters at Accuweather predict a colder than
normal winter in the Northeastern U.S. – which should
provide healthy demand for both heating oil and natural
gas. AccuWeather found a high historical correlation
between active hurricane seasons and cold ensuing
winters in the Northeast. Weather patterns existing in
the "hyper-hurricane" seasons of 1933, 1969
and 1995 resulted in abnormally cold winters in the
Northeast.
Accuweather’s forecast calls for Northeastern U.S.
temperatures to be as much as 3.5 degrees colder than
normal – significantly below normal in a high
population area.
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China’s
economy grew by 9.4% in the third quarter – an
incredible pace compared to most other economies. The
Chinese economy is not as energy efficient as more
developed countries, and the continued economic growth
of this area of the world will require additional
amounts of imported of crude oil. This incremental
increase in demand, in addition to the supply issues
faced by the U.S. and some of the other major energy
producers, should keep upward pressure on global energy
prices.
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Higher
energy prices have increased drilling and production related
activity. Demand for rigs, material, and equipment remain
elevated. The total drilling rig count in the U.S. has
increased to 1,474 versus 1,250 in the year ago period.
Canadian rig counts have increased to 567 from 356 in the year
ago period. (Source: Baker Hughes)
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The
International Energy Agency’s latest report forecast that
global oil demand was projected to increase by 1.75 million
barrels per day in 2006 due to increased demand from China and
continued global economic growth. This represents an increase
in demand of approximately 2%. Supply is expected to increase
by a smaller amount.
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Political
issues continue to smolder in Iran, Iraq, and Venezuela –
all major crude oil exporting countries. The Venezuelan
government continues to press their claim that foreign oil
companies owe that country millions in underpaid or unpaid
taxes.
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The
Louisiana Department of Natural Resources reports that 65% of
onshore crude oil production (or 135,000 barrels per day) and
60% of onshore natural gas production (or 1.3 billion cubic
feet per day) remain shut in from the hurricanes. No timetable
has been advanced as to when this production will be restored.
This shut in production is in addition to the offshore shut in
Gulf of Mexico production reported by the Mineral Management
Service (MMS data is presented in the chart above).
While
we generally attempt to assemble a well diversified portfolio to
reduce sector and company specific risks, we find the above
factors are compelling in shifting the risk/reward relationship in
our favor. We think the long term bullish trends in the supply and
demand equation remain in place. As such, we will continue to
over-weight the energy sector in our portfolio.
© 2005 Joseph Dancy
Editorial
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Contact
Information
Joseph Dancy, Adjunct Professor
Oil & Gas Law,
SMU School of Law
Advisor,
LSGI Market Letter
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