Can the energy industry top a year when almost everything went in its favor? In 2004, oil and natural gas prices neared or hit record highs, and refiners, running almost flat out to meet demand, posted lush profits. But market forecasters anticipate softer oil prices and flat gas prices this year, thanks to slowing economic growth, increased capacity, and more conservation efforts by manufacturers and consumers.
As in so many other sectors last year, China emerged as a powerful force in global energy markets. Surprisingly strong Chinese demand helped boost worldwide oil demand by 2.5 million barrels per day (bpd) -- or 3.1% -- to 82.6 million bpd, says James Burkhard, director of global oil market research at Cambridge Energy Research Associates Inc. That was the biggest volume gain since 1978 and more than twice the average annual growth over the past six years. Any fall in world energy prices in 2005 will therefore depend in part on Beijing's effort to cool down the economy. The International Energy Agency predicts that global demand this year will grow by a slower 1.7%, or by 1.4 million bpd.
Fears of supply disruptions should ease later this year. With both OPEC and non-OPEC producers adding capacity, Burkhard predicts that the cushion of spare capacity could grow to a comfortable 3 million bpd by the end of 2005, closer to its level over the past decade. In late 2004 there was just 1 million to 1.2 million bpd of excess capacity, leaving little margin for error, and contributing to the geopolitical jitters that kept oil futures jumpy all year.
In fact, with prices already $10 a barrel from their peak and supplies plentiful, OPEC is now moving toward cutting production. It wants to avoid a glut that might cause the price of oil to crash, as it did in 1998, when it briefly touched $10 a barrel. Benchmark West Texas Intermediate (WTI) crude will average $37.67 a barrel in 2005, vs. $40.89 last year, according to Thomson First Call (TOC ) consensus estimates. Of course, that assumes there's no sudden collapse in demand caused, for example, by a recession. "OPEC can manage supply. It can't manage demand," says Burkhard. A shortage of critical infrastructure, from refineries to pipelines, should also help to keep crude prices from collapsing.
The risk that prices will rise -- and be volatile -- is greater for natural gas. North American production can't match demand growth. The U.S. Energy Information Administration predicts natural gas demand will grow by 3.7% in 2005, especially due to rising demand for gas-fired electricity generation. Yet domestic gas output will grow by only 1.9%. That gap makes for rising prices. Craig Pennington, global energy group director at Schroders, expects U.S. natural gas prices to climb to an average of $6.45 per thousand cubic feet in 2005, from $6 last year.
WIN SOME, LOSE SOME
It would help if the U.S. could import more liquefied natural gas from overseas. Yet boosting the flow of imported LNG, which now accounts for 4% of U.S. supply, is hard because there are too few of the specialized port terminals needed to offload LNG. Dozens have been proposed, but many face community opposition. Given the long lead times to permit and build the plants, LNG imports won't have a major impact until at least 2008.
The demand for electric power is also outpacing the growth of supply. Energy researcher Platts, which like BusinessWeek is a unit of The McGraw-Hill Cos. (MHP ), predicts that U.S. power demand will grow at a 2.3% pace through 2008. But total U.S. generating capacity will expand by just 1.6%, or 15 gigawatts, in the new year. Total earnings for the 27 largest electric utilities will rise by 15% in 2005, to $20.9 billion, predicts Reuters Estimates (RTRSY ). Meanwhile, the grid has seen only limited physical upgrades since the August 2003 Northeast blackout. The officials that manage power flow over the grid have altered their rules to prevent a repeat of the events that triggered the failure.
In the oil patch, last year's earnings gusher is clearly over. Thirteen major oil companies in 2004 posted a "spectacular" 46% surge in profits, to $96 billion, figures analyst Frederick P. Leuffer of Bear, Stearns & Co. (BSC ) Based on his below-consensus average forecast of $25 per barrel for WTI and some easing of refining margins, he projects a 40% earnings drop for the year. Looking at a broader group, Thomson First Call predicts that profits for the 27 energy companies in the Standard & Poor's 500-stock index will fall 5% this year, after a 47% climb in 2004.
Cautious oil and gas companies are planning modest increases in exploration and production (E&P) expenditures. Some of that increase will simply cover higher costs, as steel, oil field services, and other expenses continue to rise. According to a recent Lehman Brothers Inc. (LEH ) survey of 327 oil and gas companies, worldwide E&P expenditures will rise 5.7%, to $176.8 billion, in 2005. That compares with a 12.4% boost in 2004.
For now, at least, the main expansions planned in the U.S. are by smaller independents. Tiny Fort Worth-based Cano Petroleum Inc. (CAOP.OB ), which is squeezing more oil out of mature U.S. fields, is planning to boost its acquisition and development budget by at least 300% to over $20 million, says CEO Jeff Johnson. But supermajors like Exxon Mobil Corp. (XOM ) will go on returning cash to shareholders through stock buybacks and dividends. That's partly because they lack access to the best new drilling sites worldwide, such as Russia and the Mideast, says Matthew R. Simmons, CEO of energy-focused investment bank Simmons & Co. International.
Some U.S. producers are hoping Congress will pass the proposed energy bill that has been stalled on Capitol Hill for three years. Their wish list includes opening up more drilling prospects at home, including in federal lands in Alaska and the Rockies. Environmentalists are sure to resist, and even supporters acknowledge the plan would do little to improve the domestic supply picture. The greens may find solace if the White House balances a renewed push for more oil and gas subsidies with fresh incentives for renewable energy. No matter what, the chances for a single omnibus energy bill are slim. But even without Washington's help, the energy industry is counting on another bright year.
By Wendy Zellner in Dallas, with Christopher Palmeri in Los Angeles and John Carey in Washington