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Energy Industry to Struggle for Two or Three Years, Analysts Predict

If demand for oil and natural gas continues to decline, damage to the energy industry could be significant and the downturn may last up to three years, according to several energy experts.

"We could be at $70 oil much faster than we predict, but I think we'll be at $30 if demand is down again in 2010," said Dan Pickering of Tudor Pickering, Holt & Co. Securities Inc. He spoke at the Offshore Technology Conference (OTC) in Houston.

Most of the U.S.-based independent exploration and production (E&P) companies should be able to make it through the recession without having to consolidate, but debt-ridden gas-heavy companies will struggle, he said.

"You will see some guys overstretched and not make it through this natural gas downturn, but most independents will remain healthy...although they're limping along now," Pickering told an audience. "It will be tough in the back part of the year, but service costs are coming down, which should help, particularly on the drilling side."

J. Marshall Adkins and William Eagan of Raymond James & Associates Inc. came away from the OTC with a view that the industry's focus has shifted from "adding capacity to implementing numerous cost-cutting measures (or survival mode) for what could be a multi-year downturn" in the energy sector.

"Last year, we came away from the single biggest oilfield conference thinking that we didn't expect investment in the oilpatch to slow down anytime soon thanks to robust commodity prices and solid E&P economics," said Adkins and Eagan. "A year later, the industry has undergone the most rapid and massive meltdown in modern history. What happened? The global economy collapsed, credit markets seized up, crude and natural gas prices were cut in half, and the U.S. rig count dropped 55% from its peak."

A common theme from "hundreds of companies" at OTC "was that business was bad, but everyone was hoping for a rebound," said the duo. "Unfortunately we don't expect that rebound to happen anytime soon as we may be in the early stages of a multi-year down cycle for the industry, eerily similar to the early 1980s.

"Many companies have yet to truly feel the pain because pricing for equipment hasn't dropped dramatically yet. The lack of any ordering activity is creating a mirage where prices appear to be holding up as equipment and services priced a year ago flow though the earnings statements. In reality, prices will fall and fall sharply, once ordering activity resumes."

Until service costs drop dramatically, the Raymond James analysts said they expect that "some companies, especially smaller players, will continue to be too optimistic (think ostrich burying its head in the sand). All in [all], the conference highlighted the fact that the industry is starting to brace itself for a downturn, though some companies (and investors) are likely to underestimate the magnitude of this decline."

A slowdown in the energy industry may have a big impact on Houston's economy, said University of Houston's Barton Smith. The economics professor offers an annual economic forecast for Houston, and he said the city should prepare for a no-growth period for two to three years.

Up to 60,000 jobs may be lost in Houston over the next two years, with many in the energy industry, Smith predicted.

The downturn in Houston, the fourth largest city in the United States, may not be as bad as it was in the 1980s, when 225,000 jobs were lost following the oil bust, said Smith. But a lot of people may be looking for work.

"We went through the tech bust, 9/11 and Enron, and we didn't see this type of job loss," Smith said of Houston. "This will be the greatest job loss Houston will experience since the 1980s."

In the "last mini energy bust of 1998 to 1999, Houston lost almost 25,000 energy jobs, but continued to grow because of the strength of the national economy and, hence, the energy-independent portion of Houston's economy," Smith said.

The nation's self-proclaimed energy capital has taken a circuitous path in the global recession, and so far has not suffered too many ill effects, he noted. However, the decline in gas and oil demand led to a dramatic fall in prices, which in turn led to reductions in exploration -- and ultimately, that means Houston job losses.

"Last year was a pretty darn good year for Houston," Smith said. Almost three-quarters of the city's economic growth was attributed to energy exploration, he said. "But now that is gone."

The upstream sector will take a big hit, jobs-wise, predicted Smith. Around 9% of the upstream jobs will be lost -- and that follows a big push to bring new people into the industry over the past few years.

However, Smith said the energy sector decline will only be a "temporary setback" in Houston. "We will see a massive need for Houston and its energy business in two or three years," he said.

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