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Long-term forecasts revised for the energy markets

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    Fw: [fuelcell-energy] ... LONG-TERM FORECASTS REVISED FOR THE ENERGY MARKETS Bullish Trends Continue by Joseph Dancy, LSGI Advisors, Inc. Adjunct Professor,
    Message 1 of 1 , Jan 4, 2006
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      Fw: [fuelcell-energy]
      ---------- Forwarded Message ----------
      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.

      Economic Growth
      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
      EIA studies.

      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
      heating demands.

      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
      Editorial Archive

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

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