DEVELOPMENTS IN THE ENERGY SECTOR
by Joseph Dancy, LSGI Advisors, Inc.
Adjunct Professor, SMU School of Law
March 16, 2007

We found several developments of interest in the energy sector last month, including the following:

• Energy investor T. Boone Pickens stated the relatively high crude oil prices are evidence that daily global production capacity is at — or very near — its peak. If demand for crude oil rises beyond the current global output of roughly 85 million barrels per day prices will rise according to Pickens, reflecting tight supplies. "If I'm right, we're already at the peak," Pickens said. Pickens manages a multi-billion dollar energy sector hedge/commodity fund.

• The International Energy Agency raised its 2007 oil demand forecast. The energy agency said global oil product demand should total 86 million barrels per day, an upward revision of 273,000 bpd from the last monthly report. The IEA raised its oil demand projections for China for 2007 by around 2%.
  
• China's oil demand in 2006 rose 9.3 percent, increasing the nation's reliance on crude imports. China consumed about 6.9 million barrels a day the Ministry of Commerce said last month (see EIA chart at right).

• Oil and gas production in the North Sea is expected to be about 10 per cent lower over the next few years than previously thought according to a recent survey. The faster than expected decline in production is bad news for Britain’s energy security, increasing the country’s dependence on imported oil and gas. The survey also shows a steep increase in costs and an expected decline in North Sea investment over the next couple of years.
  
• Production at Cantarell, Mexico's largest oil field, is slipping faster than projected. Mexican officials see few options for quickly replacing the main source of that nation's oil riches. Mexico is the world's No. 5 oil producer. Production at Cantarell, the world's second-largest oil complex, averaged 1.78 million barrels a day in 2006. That's a 13% drop from 2005 according to Pemex, a decline more than twice as great as the company's predictions. The slide is expected to continue into 2007 with average daily production forecast to fall to 1.5 million barrels a day forecast. Within five years the aging field is expect to decline to a rate of 700,000 barrels daily – less than half of current production.
  
• Tens of thousands of Mexicans protested against the spike in the price of tortillas last month. The price of tortillas rose by more than 50 percent over the last several months - with the spike being blamed on demand by U.S. ethanol plants which use corn as a feedstock to make gasoline additives. Some referred to the protests as the “tortilla riots”.

• Iraq is currently producing less than 2 million barrels a day, well below the 2.8 million barrels before the 2003 invasion. A new draft of Iraq’s oil and gas laws is being debated by the legislative body. Short term increases in crude oil production or exports from Iraq are not expected.
  
• Iran, the world’s fourth-largest oil exporter, sits on the second-largest oil and gas reserves. But it has struggled in recent years to keep its oil production, currently running at about four million barrels a day, from falling. Strong growth of internal consumption of crude oil could also impact exports in the near future according to experts (see chart at right).
  
• The CEO of the world’s largest oil company - Saudi Aramco - predicted an increasing dependence on fossil fuels despite the emergence of alternative energy sources in a talk at Harvard University last month. The CEO attributed the increased dependence on oil to growing demand for oil from rising global population levels, and as a result of improving living standards in the developing world.

• In a speech to industry former Federal Reserve Chairman Alan Greenspan warned that crude oil supplies are  precarious and susceptible to disruption. He explained that undeveloped reserves take a long period of time to bring into production, and the fact that even small disruptions create large movements in prices. “We're treading on the edge in which any minor catastrophe creates a spike in prices,” he said. He added that a sharp decrease  in supply would have “a very major impact on global economic activity.”
  
• The severely cold weather in the Midwest has drawn natural gas storage levels down to levels nearing the five year average. While we are entering the spring ‘swing’ season of slack demand, we expect demand from natural gas ‘peaker’ plants this summer to exert upward pressure on natural gas prices.
  
• Long term weather forecasters last month issued some preliminary hurricane forecasts and predicted we would see a more active than normal hurricane season in the Gulf of Mexico. Such storm activity would increase the odds of supply interruptions. 
  
• The U.S. consumes 21 million barrels of crude oil a day, more than No. 2 China (which consumes 6.9 million barrels a day) and No. 3 Japan (at 5.4 million), according to a senior advisor to the U.S. Secretary of the Treasury. The vast majority of this goes to transportation, with ninety-seven percent of the energy in the transportation sector coming from oil. The U.S. remains heavily dependent on imported oil to meet domestic demand.

© 2007 Joseph Dancy
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Joseph Dancy, Adjunct Professor
Oil & Gas Law, SMU School of Law
Advisor, LSGI Market Letter
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