Energy: A Barrel of "Ifs"

-- Rising political risks, including war, are likely to mean volatile prices

-- Big energy companies will put more investment chips on projects outside the U.S., in Russia and maybe even Iraq

Energy company chiefs have an even trickier task than usual when planning for the coming year. The possibility of a war with Iraq puts a huge question mark over both supply and prices. And striking oil workers in Venezuela have further clouded the outlook.

Many forecasters were betting that the Organization of Petroleum Exporting Countries' three-year winning streak of high prices would come to an end in 2003. But the Venezuelan strikers may delay OPEC's comeuppance, just as tensions over Iraq did in 2002. At yearend, the problems of South America's biggest oil producer were taking 2.5 million barrels per day off the market. That's equivalent to the spare capacity of Saudi Arabia, the only OPEC member with ample slack. The result: Oil prices bumped back above $30 per bbl.--and they're threatening to stay there.

Still, Adam Sieminski, an analyst at Deutsche Bank in London, thinks prices for 2003 will average about $21.50 per bbl. The reasons for the drop: weak global growth in demand of only about 1 million bbl. per day, plus increased production outside of OPEC, notably from Russia. These forces are pruning OPEC's market share. And consuming countries such as the U.S., which have been paying an average of $25 or more for oil for the past two years, could get a break.

But with so much uncertainty in the OPEC lands, it may be foolish to bet on prices at all. And the Venezuela strike may roil markets for weeks or months. The situation in Iraq could create more serious turmoil. If the U.S. goes to war, the crucial question is whether the war will end soon or if it will be a slow, messy fight. If Saddam Hussein is toppled quickly, there will be little spillover into nearby oil giants like Saudi Arabia and only a mild price spike, predicts Washington energy consultancy PFC. Less likely scenarios include disruptions of supplies from Iraq's neighbors, Kuwait and Iran. Even assuming Venezuela's strike is resolved, that could send prices into the $40 range. A Middle East regional war embroiling Saudi Arabia and its oil fields might send prices into the stratosphere.

Whatever prices do, companies are under pressure to boost returns. They've squeezed about all the gains they can from big acquisitions such as BP PLC's (BP ) takeovers of Amoco and ARCO in 1998 and 1999 and Exxon's (XOM ) 1988 gulp of Mobil.

So companies are hunting for new sources of profits, and Iraq is an intriguing prospect. Saddam has kept Iraq's reserves of 112 billion bbl., second only to the Saudis', from being developed. If he is ousted, companies will have a shot at gobs of oil--once it is determined who has the rights to these fields. Saddam has promised huge chunks of reserves to France's Total Fina Elf (TOT ) and Russia's Lukoil (LUKOY ) in a bid to woo their governments. But Iraqi exiles say U.S. and British companies such as ExxonMobil Corp. and BP can expect to be rewarded if the U.S. and Britain liberate Iraq. Total capacity could be as high as 6 million bbl. a day.

Reaching that level will take five years at least. Assuming that a relatively stable government takes over, service companies such as Schlumberger Ltd. (SLB ) and Halliburton Co. (HAL ) will likely be called in to oversee Iraqi production--now around 2 million bbl. per day. The first task will be to head off a production decline caused by broken and missing equipment and poor reservoir management. Rehabilitating Iraq's oil infrastructure could add 1 million to 2 million bbl. per day in capacity over two to three years, estimates Deutsche Bank's Sieminski.

With Iraq's fate still up in the air, companies are warily eyeing Russia as another rich frontier. In the late 1990s, Western majors could have purchased Russian assets cheaply, says Simon Kukes, president of Russia's Tyumen Oil Co. (TYAVY ) Since then, the Russians have learned how to raise capital and hire service companies such as Schlumberger. Kukes says the majors may now be largely confined to technologically difficult projects such as Sakhalin Island, where Royal/Dutch Shell Group (RD ), ExxonMobil, and others are expected to sink as much as $18 billion by 2010 into huge oil and gas projects.

Investing outside the U.S. may be risky, but companies increasingly are making exploration and production bets abroad. Total U.S. spending in 2003 is expected to decline by 0.7%, to $30.3 billion, while spending outside the U.S. will increase about 6%, to $102.1 billion, according to a survey by Lehman Brothers Inc. in New York. "The U.S. just doesn't hold that much potential for finding major new reserves," explains James D. Crandell, a Lehman oil analyst.

Shell and others are putting billions of dollars into huge natural gas projects, figuring that demand will rise for this cleaner-burning fuel. Most companies, however, are proceeding slowly with alternative-energy plans. BP has a $12 billion annual investment budget. Yet it is investing just $500 million over three years in "renewables" such as solar and wind power. At best, predicts the U.S. Energy Dept., renewables will account for 9% of U.S. electricity generation by 2025. Oil and gas are what count for 2003--and for many years beyond.

By Stanley Reed in London, with Wendy Zellner in Dallas

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