The fact that the stocks of a number of oil and gas companies lost ground last month can be attributed to the Oct. 31 end of the tax year for many investment entities, but the big question is what will be happening next year, Houston market analyst John Olson said.
The October slump came as investment managers captured the gains on their energy stocks to offset the poor performance of the rest of their portfolio, said Olson, co-manager of the Houston Energy Partners equities hedge fund. "We've had a lot of big air pockets open up, and we've seen a lot of gains cut by a third to half."
Those gains over the last year marked "a once-in-a-lifetime move for crude oil and natural gas prices. This has raised everyone's expectations, especially on Wall Street. The best outcome we can see through 2006, especially the second half, is if we just have a soft landing."
The forward price curves for 2006-2010 are on a 2-3% downslope for oil and a 10-11% downtrend for natural gas, the veteran analyst said. In the meantime expect a very choppy, very volatile market. Olson believes there could be some downside in the December indexes, "which are not going to be $13.85 at the Hub -- probably more like $9 to $9.50 or wherever the market takes us. If the market takes us to $6.50 or $7 there's going to be a counter-revolution. It depends on the next two weeks of weather, subject to the Thanksgiving Holiday."
Olson, who gained widespread public attention when he was fired by Merrill Lynch for refusing to recommend Enron stock in 1998 when it was still a high roller, runs an equities hedge fund in energy stocks and bonds, which he classifies as "an entirely different game" and less risky and technical than commodity hedge funds. "If you ever see us do a commodity trade in natural gas, you can just fly down here and shoot us," he quipped.
In a wide-ranging interview with NGI, Olson said trading in commodities is "highly technically calibrated. The funds made an absolute killing once in a lifetime," but now the forward curves aren't looking as good. In the commodities business "you can get caught very quickly being on the wrong side of a trade, long or short. Given the volatility of this business, you're a hero this year, and a complete goat next year."
He noted that more and more hedge funds are being financed by European money in fund-to-fund transfers. But in many cases in the fund market the investor can pull large amounts of money out very quickly -- in which case "you're a goat without any money."
Questioned about the viability of a windfall profits tax, Olson observed "it already has had an unnaturally long life, courtesy of the Republicans who are very, very mindful of polls reflecting dissatisfaction with the Bush administration. They have no friends and they're trying to chase any number of opportunities like this" to gain popularity.
Part of the reason the oil industry made a great deal of money recently, Olson said, is that knocking out 3 million bbl/d of refinery capacity boosted the normal margin for gasoline crack from an average of $5.21/bbl for the last 10 years to over $38/bbl after the hurricanes in September. "Those prices were not manufactured; they reflected the supply loss." He also noted that most of the majors' gains came from overseas arenas.
Nevertheless, "the windfall profits tax does have some currency, especially to get through this coming winter." He noted the low income help in the LIHEAP bill, but there is a question whether Bush will sign it or not.
"Over the next five to 10 years we are facing an unprecedented amount of political risks, environmental litigation and risk, and drilling and business risk." In the United States, producers have gone from drilling 26,000 gas wells a year to 35-40,000 wells a year simply to prevent production from dropping by more than 1-2%. "It's a very different reality."
In the larger arena "the whole world has suddenly become very aware of a possible energy crisis and possible trade war in coming years. History is repeating itself in a real clash of civilizations. Arabs control 60% of the world's oil, and that is why I will bet you a dollar to a dime the U.S. is going to be in Iraq and Afghanistan for many years." This country also will be keeping tabs on Uzbekistan, Kyrgyzstan, Diego Garcia and a lot of other places.
"Iran is very capable of blowing up, with well over half its population well under 30 with no jobs, no nothing." Olson said there are B-2 bombers and support systems in five different countries around Iran waiting for trouble. Iran is "going down a path very much like North Korea, but the difference is they have tremendous oil and gas reserves." In one field in Iran, wells are producing 98,000 bbl/d compared to typical production elsewhere of 6,000-7,000 bbl/d.
"All the oil is in the wrong place. There is a huge supply hole over the next 15 years which is totally scary." World oil analysts generally predict the world will need an additional 26 million bbl/d, "which more realistically might be 15 million, but we don't have 15 million anywhere in sight."
Large consumer nations such as China and India are taking steps to bolster their energy investments. "The Chinese are taking their $84 billion-a-year trade surplus with the United States and using our money to buy into tar sands plants in Canada, finance a $2.5 million pipeline in British Columbia from the tar sands, do a $2.2 billion buyout of EnCana in Ecuador, and pay $4.3 billion for Petrokazakstan. They also are doing long-term LNG deals.
"Those are our dollars," Olson said, "and as a result of American foreign policies past and present, we're in a losing game on energy resources. We have fewer friends, and exporting democracy is not high on their list. We're going to have a very interesting five to 15 years."
Over this period the U.S. will suffer as more and more industries migrate to China because of the difference in wages, which average $36/hour in the U.S. and $2/hour in China. "You're now getting your sneakers and blouses from China, and you'll be getting your cars soon too."
The "two bright spots are Houston and Calgary," Olson said. Those two cities are "likely to be the most dynamic in the world for the next 10 years because of all the oil and gas money cycled through there." All the producers either are headquartered or have staff in Houston. With Schlumberger's move to Houston, all the oil service firms in the U.S. also are there. "The combination of intellectual capital, the know-how; the hands-on abilities of the American oil service industry will provide most of the dynamics for this town," he said.
Calgary also has extensive oil service firms. And for these companies, "the greatest game is Russia," which has tens of thousands of oil and gas wells, completed with very crude, obsolete technology. "When British Petroleum, which now has more than half its gas reserves in Russia, bought the Russian firm TNK some years back, they got 25,000 wells in central Siberia and about 10,000 of them didn't work." The company brought in Canadian oil service firms to go back into the wells, acidizing, fracturing and recompleting them.
Projections are for oil and gas industry revenues to continue increasing, in the U.S. and around the world. In the 1990s average yearly wellhead revenue in the U.S. for the entire industry was $83 billion. In the last five years it averaged $154 billion. Forward price curves recently were projecting $250 billion yearly for the next five years.
In the much longer term some demand could be lost or shifted. United Nations demographic projections show populations in Russia and China declining, Olson said. Russia, which had 149 million people in 2000 is expected to drop to between 75-100 million in 2050 "because of all the epidemics, and Russian women want zero to do with having children in Russia; they all want to marry Americans or Irish or whatever."
And because of its policy over the last 25 years of limiting families to one child, China has an aging population which will likely decline. One problem is that the combination of the single child policy in a country which has a long tradition of favoring male children, doesn't produce enough girls. "Most of the Chinese population is over 30, in contrast to the Arab world where 50-60% are under 30 and don't have jobs."
John Olson will be a featured speaker at NGI's GasMart 2006 in Denver May 3-5.
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