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Oil pumps at work on an oilfield in Los Angeles on May 12, 2009.
Oil pumps at work on an oilfield in Los Angeles on May 12, 2009.

Fundamental Thinking

Oil's up now but where is it going? Add to ...

The price of crude oil has rallied strongly in recent months. Where will it go from here?

For an answer let's turn to Simon Wardell, director of oil analysis and forecasting at IHS Global Insight, a Lexington, Mass.-based consultancy that provides intelligence and forecasts to corporate clients in 14 countries.

We might also ask: what are the better places to invest in the industry? For an answer, let's turn to a specialist in oil-and-gas equities, Bob Gillon. He is senior vice-president and chief insights officer with IHS Herold Inc., a sister company to IHS Global Insight.

First up is Mr. Wardell:

Q. How is global demand for oil holding up?

A. In annual terms, global oil demand is likely to fall by about 2.2-million barrels per day (b/d) in 2009. That puts demand back where it was in 2004, so we've taken a five-year step backwards.

Q. How is global supply faring?

A. Supply has, in fact, fallen sharply since 2008 as the Organization of Petroleum Exporting Countries (OPEC) has cut back production to try and prevent massive over-supply. Nevertheless, even with these cuts, we have still seen a surplus in the market. Inventories have been growing by about 700,000 b/d in 2009. Organization for Economic Co-operation and Development (OECD) onshore inventories are likely to surpass the record highs of 2.77-billion barrels we saw in 1998.

Q. Will storage capacity run out soon and lead to a reversal in oil prices?

A . It's unclear how much global storage there is. We are likely to be very close to full capacity - though there remains a very large tanker fleet which can store surplus oil should onshore storage be filled. It would take a monumental surge in Chinese demand to draw stocks down to anything close to the "normal" range - and we really aren't seeing signs of that happening. Based on the physical market, there appears to be a big risk that prices could fall sharply in coming weeks.

Q. Where does OPEC fit in?

A. We expect OPEC to slowly increase production in the second half as rising prices reduces quota discipline. But with demand likely to rebound, we expect inventories to draw down over the second half - but not enough to significantly tighten the market.

Q. Longer term, what are your expectations for oil prices?

A. Anyway we look at it we see prices rising in the future. This is probably the best explanation for the recent rally in crude prices - almost everyone in the industry and the market would agree that over the longer time frame of 5 to 10 years, $60 (U.S.) per barrel will seem cheap. Demand growth will resume when the economy exits the recession, and excess supply capacity will very quickly be used up. Capital investment certainly has been set back over the past 6 to 12 months, but even if investment again picks up with higher prices we will still be facing tightness in the not-too-distant future - unless the current recession proves to be much deeper and much longer than is currently estimated.

Now over to Mr. Gillon:

A. What areas of the energy sector can be expected to do relatively well?

Q. I believe resource-type projects in areas such as shale gas, oil sands, coal-bed methane and LNG [liquefied natural gas]have an advantage. They have opportunities beyond the incentive of rising prices to expand production. That is, they have major uncommitted supplies to develop and are in areas where advances in technology and techniques can be expected to substantially lower costs and improve yields.

Q. Where might opportunities be for investors with three- to five-year horizons?

A. We recommend companies with asset bases in the areas I just mentioned and others such as deep-water drilling and stranded gas. They have greater potential for finding and developing new reserves. Within this group, we prefer experienced companies because they have typically found ways to do things better.

Q. Any particular companies?

A. There is Southwestern Energy Co. of Arkansas. It has found better ways to retrieve shale gas, resulting in lower costs and a doubling of reserves. Suncor Energy is our choice for in-situ recovery of heavy oil. In deep-water drilling, there is Brazil's Petrobras . Australian-based Santos Ltd. is a player in stranded gas and has two LNG projects that should be among the earliest to come on stream when the market tightens.

Q. What about integrated oil-and-gas companies?

A. The major integrated companies have strong balance sheets compared to producers. Exxon Mobil Corp., for example, has $40-billion (U.S.) cash on its balance sheet. Given there are over 300 producers globally, we have been puzzled by the low level of consolidation in the industry. That could change now that credit markets are getting back to normal. Exxon Mobil should be a beneficiary of industry consolidation.

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