Long-term forecasts revised for the energy markets
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LONG-TERM FORECASTS REVISED FOR THE ENERGY MARKETS
Bullish Trends Continue
by Joseph Dancy, LSGI Advisors, Inc.
Adjunct Professor, SMU School of Law
January 3, 2006
Last month the Energy Information Administration (EIA), a branch of
the U.S. Department of Energy, released their official long term
forecast for the U.S. energy markets. The twenty-five year forecast
of energy production and consumption is radically different than the
one issued last year � with major changes in their assumptions:
"world oil prices have risen sharply as supply has tightened, first
as a result of strong demand in developing economies such as China
and later as a result of supply constraints resulting from
disruptions and inadequate investment to meet demand growth. As a
result . . . [the current study] includes much higher world oil
prices than were projected in [the year earlier study]"
How much higher is the new price estimate? The EIA increased their
long term crude oil pricing estimates by 66%. And this is not a short
term issue either � the EIA sees the price pressure lasting decades,
with demand "keeping pressure on prices through 2030." This change in
their long term forecast may not seem significant � and few in the
press even picked up on the change - but it has huge implications for
The EIA Study: Three Major Changes
In addition to forecasting substantially higher crude oil prices, the
EIA's base or `reference' case has two other major changes from last
year. Liquefied natural gas (LNG) imports to the U.S., required to
meet the shortfall of domestic natural gas production, will not be as
large as projected � in fact will be one-third lower in 2025 than
projected last year:
"More rapid growth in worldwide demand for natural gas in the
[current study] reduces the availability of LNG supplies to the
United States and raises worldwide natural gas prices, making LNG
less economical in U.S. markets."
Robust global natural gas prices will promote conservation efforts
in the U.S. the EIA reasons, and will also make many marginal or
difficult natural gas formations more attractive for development by
domestic exploration and production companies. LNG will still play a
major role in meeting natural gas demand in the U.S., just not quite
as large as projected last year.
The other major change is the EIA's projection that crude oil
production in the United States will increase until around 2014 "as a
result of increased production offshore, predominantly from the deep
waters of the Gulf of Mexico."
The trend in petroleum production, which includes natural gas liquids
and refinery gains in addition to crude oil, has clearly been
downward the last several decades. (See EIA chart at right). Note the
new study has the petroleum downward trend changing directions and
heading upward through 2014, then resuming a decline.
The EIA estimated that the U.S. gross domestic product, a measure of
economic growth, will grow at 3.0% per year- the same as last year's
study. Historically, economic growth and energy use are closely
correlated, although over time smaller amounts of energy are needed
per unit of economic growth.
Part of this trend is due to energy efficiency, part of this is due
to the fact that many energy intensive industries are now locating
Regardless, the EIA estimates that total energy consumption in the
U.S. is projected to increase at 1.1% per year, with electrical
consumption increasing 1.6% per year.
The bottom line is that as the economy expands, and as the population
grows, more energy will be needed. Note the upward trends in each
sector in the EIA chart above.
Implications of EIA Report for Investors
What we find interesting about the EIA report is the implications it
could have for investors. First, many Wall Street analysts have
repeatedly used a long term oil price of around $30-$35 per barrel in
their models � a price that in the past they noted was supported by
Now that the long term EIA price assumptions have been dramatically
changed, if analysts use a discounted cash flow model using the
higher EIA forecast prices the proper valuation of many production
related properties will be multiples higher than they were under the
old assumptions. If the EIA forecast is correct at some point
investors should realize energy firms are undervalued based on their
projected income � and firms with large reserves will be worth
substantially more in today's market.
If Wall Street analysts don't use the higher projected prices in
their determination of fair value, expect those who believe the EIA
forecast to institute a flurry of property acquisitions since market
prices for the most part will not reflect robust long term energy
price assumptions. Increased acquisition activity has already begun
in the sector, and will push the stock price of energy firms upward
toward more reasonable valuations.
Investors should find an attractive environment in which they can
select firms from a profitable, growing sector, with positive long
term trends. In our opinion the energy sector remains very appealing
for investors in 2006, and beyond.
Other Developments in the Energy Sector
ong-Long-term forecasts by both Accuweather and Atmospheric and
Environmental Research Inc. (AAER) both continue to predict colder
than normal temperatures in the Northeastern U.S.
For January, February, and March AAER's model (at right) shows cold
temperatures in the Northeast and the Great Lakes. The Northern
Plains and the Rockies will be warmer than normal.
The AAER model uses El Nino, recent temperature trends and Siberian
snow cover, as well as sea-level pressure anomalies, in its winter
Accuweather's forecast for January forecasts a cold Eastern coast due
to the orientation of the jet stream. Like the AAER model Accuweather
calls for a cold winter season in the East, a bullish scenario for
natural gas and heating oil markets (see "January Temperatures" map
Accuweather also notes that the coldest part of winter is just ahead �
something which should be very interesting in that massive amounts
of natural gas were withdrawn from storage to meet early December
The number of rigs drilling for oil and natural gas in North America
increased to 1,471 last week, an increase from 1,243 in the year ago
period. Crude oil futures prices were $61.04 per barrel, compared to
$43.45 in the year ago period. Natural gas futures prices were $11.22
per thousand cubic feet versus $6.15 in the year earlier period.
Alaskan crude oil production is falling much quicker than expected.
The fall 2003 State estimate had North Slope production averaging
937,000 barrel a day from 2006 to 2015. By the spring of 2005 that
estimate was down to 876,000 barrels per day. Last month that
estimate was reduced further � to 827,000 barrels per day. The
ability to maintain production in the face of natural field declines
has become a major issue.
Before the hurricanes this summer the Gulf of Mexico produced around
10 billion cubic feet of natural gas per day (bcf/d) out of a
nationwide total of 50 bcf/d. As of Christmas day around 2 billion
cubic feet of natural gas remain shut-in due to the storms.
China's economy is 17% larger and growing faster than previous
estimates, according to a year-long census released in Beijing that
revealed the existence of millions of previously unaccounted for
businesses. The findings vaulted China ahead of Italy as the world's
sixth largest economy. When the study is complete next month it may
vault China into the number four position � with the Chinese economy
larger than the U.K.'s.
The updated census added the equivalent of Austria's annual output to
the world's fastest-growing major economy. Economic growth and energy
use are highly correlated � and this is another indication of the
impact China is having on the energy and basic material sectors.
The growth rate of the Chinese economy next year is expected to be
close to 9% according to another report released by China's State
Information Center. In 2003 and 2004 the country's annual economic
growth rate was 9.5%, and in the first three quarters this year the
figure was 9.4%.
Morgan Stanley's Stephen Roach offers a more modest growth estimate
of 6.7% for China next year. In either case, should China's economy
grow at anywhere near these rates the incremental demand for energy
and basic materials will exert upward pressure on global commodity
China's oil imports have risen at an annual average of 24% in the
last decade, after being a net oil exporter until 1993. Of the 6.7
million barrels of oil a day that China consumed in 2004, almost half
came from imports. The United States imported about 10 million
barrels a day in 2004. China's incremental demand for energy will
continue to place upward pressure on commodity prices.
US energy giant ExxonMobil said it was evaluating its position in
Venezuela after receiving an ultimatum from the country's left-wing
government to join a state-backed venture. ExxonMobil is now the only
foreign major active in the world's fifth-largest oil exporter that
has refused to scrap its current contract and accept a minority
partnership with Venezuela's state oil firm.
President Ch�vez's government is demanding private companies
operating 32 oil fields under contract to form state-controlled joint
ventures by the year's end, and has billed the companies $3 billion
in `unpaid' taxes. Other firms have agreed to the demands � but
energy related investment in the country is expected to decline.
Venezuela's oil ministry will ask for increases in the income tax
rate for foreign companies operating in the country's heavy-oil
Orinoco belt from 34% to 50%. In late 2004, the royalty rate for the
four Orinoco projects was raised to 16.6% from 1%. The Orinoco
projects collectively pump around 600,000 barrels a day of tar oil --
converted into synthetic crude at special upgrading facilities --
accounting for around a fifth of Venezuela's total oil production.
Bolivia elected a new president whose leftist leanings will be "a
nightmare" for the U.S. (his quote). Bolivia has the second largest
natural gas reserves in South America. The new leader has aligned
himself with President Chavez in Venezuela, a major energy exporter,
and has threatened to nationalize the energy sector. This development
reduces the probability that major global firms will participate in
major energy developmental projects in that country.
The Energy Information Administration reported that U.S. demand for
petroleum reached 22 million barrels per day � a record, even with
the higher price levels. Higher energy prices do not appear to be
moderating demand in the U.S., or globally.
Worldwide demand for crude oil this winter could exceed worldwide
supply by 1 to 4 million barrels per day. The global energy system
has not experienced such a shortfall recently, and it could pressure
inventories and impact prices. Demand for crude oil will be highly
correlated with winter temperature over the next few months.
� 2006 Joseph Dancy
Joseph Dancy, Adjunct Professor
Oil & Gas Law, SMU School of Law
Advisor, LSGI Market Letter
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