Energy: Prices Hold Their Own In The Oil Patch

>>Rising global output will dent revenues and profits this year, but only slightly
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With the prospect of war in Iraq on the horizon, the energy industry faced a host of uncertainties going into 2003. Yet by yearend, the sector had racked up blockbuster returns, as the war and a variety of supply shortages kept oil and natural gas prices at near-record levels. Now, with many of those uncertainties gone, prices are expected to decline, though not enough to send the industry into a tailspin. Expect "a good year for energy, just not as good as last year," says Roger Diwan of Washington-based industry consultant PFC Energy.

The anticipated small dip in prices this year will rein in industry revenues and profits. L. Bruce Lanni of A.G. Edwards & Sons Inc. (AGE ) estimates benchmark West Texas intermediate (WTI) oil prices will average $27 a barrel in 2004, vs. $30.90 last year. On the natural gas front, the U.S. Energy Information Administration (EIA) is forecasting an average price of $4.39 per thousand cubic feet (Mcf) in 2004, vs. $4.92 last year. The upshot: The 23 energy firms in the Standard & Poor's (MHP ) 500-stock index will post a 10% decline in revenues and a 17% drop in earnings in 2004, according to Thomson First Call. That compares to an earnings jump of 54% on a 9% sales gain in 2003.

During 2003, Congress tried -- and failed -- to pass a sweeping energy bill, which would have offered massive subsidies or incentives to corn growers and ethanol producers, the nuclear industry, gasoline additive makers, oil drillers, and others. Some version of the bill is expected to make its way into law next year.

But the legislation's overall effects on the energy industry would be relatively small compared to the impact of market forces, which will be responsible for the lower prices in 2004. As in the past, high oil prices have enticed several nonmembers of OPEC, such as Russia and Mexico, to crank up their output. That has steadily eaten into OPEC's market share -- which analyst Lanni estimates will drop to 37% in 2004, from 40% in 2000 -- and makes it a bit more difficult for the cartel to keep prices high.

OPEC Threats

In addition, OPEC members like Iraq and Nigeria will increase output. Total global demand for oil is expected to rise only 1.3 million barrels per day, about the same amount as in 2003, according to EIA. Despite increasing demand from China, which will account for most of the growth in oil use next year, many of the world's industrialized nations, such as Japan, will grow only modestly. As a result, prices will be held in check.

At the same time, there's simply not enough excess supply, or oil in the pipeline, for prices to fall much. In the near term, continued geopolitical tensions and low worldwide inventories will keep prices firm. Longer term, the sluggish resumption of Iraqi production and the prospect of continued supply disruptions in Venezuela and Nigeria will work to keep prices from falling. And despite OPEC's eroding market share, the cartel has managed to prop up oil prices by adjusting supply to keep inventories low. That has allowed it to maintain prices within a range of $22 to $28 a barrel. At its February meeting, for example, OPEC is threatening to cut second-quarter production quotas to keep inventories from getting too high when demand is at its seasonal low. "They will be very aggressive about keeping production tight to keep prices at about $28," says Thorsten Fischer, senior economist at Inc. OPEC officials are even talking about trying to lift the price as high as $30. Their justification is that the decline of the dollar has cut into their purchasing power.

Sustained, relatively high prices are good news for the oil-drilling business. Lehman Brothers Inc. (LEH ) analyst James D. Crandall figures spending on global exploration and production will rise 4% in 2004, to about $144 billion. The money won't flow into U.S. operations, though. Most companies will continue to pursue big bets in far-flung locales such as Russia and West Africa instead of in the U.S., where mature wells are producing less. Crandall estimates total U.S. spending will decline 0.1%, to $32.6 billion, while spending outside the U.S. will grow by a solid 6.1%, to $98.1 billion. Exxon Mobil Corp. (XOM ), for instance, says it plans to begin production at several major oil projects in West Africa, natural gas projects in Norway and Britain, and a liquefied natural gas (LNG) project in Qatar.

Natural gas will also hold its own. The domestic industry hasn't been able to produce enough natural gas to meet growing demand because of shrinking production from old wells and low output from new fields. The EIA estimates natural gas demand will rise about 1% in 2004, while production will fall 1.5%. Why is demand slacking? Analysts say that the high cost of natural gas has induced some big buyers, such as chemical plants, to switch to other fuels, close plants, or move operations overseas.

Natural Gas Crunch

Still, with the flow of gas from Canada shrinking, other meaningful imports of LNG still years away, and several potential gas fields off-limits in the U.S., the natural gas crunch will be with us for a while. "Until we will get more LNG, we'll continue to see a pretty tightly constrained [natural gas] environment," says Mark G. Papa, CEO of Houston-based EOG Resources Inc.

That's not all bad. Economists point out that the prospect of sustained high prices forces energy-consuming companies to find ways to reduce energy use. In the long run, that makes the whole economy more efficient. Of course, experts add, the economy would benefit far more if the higher prices were the result of domestic taxes whose revenue could be returned as a stimulus to job creation, instead of being caused by oligopoly power wielded by foreign producers. But at the very least, the tightness and high prices in both oil and natural gas markets will make for another upbeat year for the energy industry.

By Stephanie Anderson Forest in Dallas

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