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Developments in the Energy Sector Point to Higher Prices Ahead

Joseph Dancy, LSGI Venture Fund
Adjunct Professor
of Energy Law, SMU School of Law
August 6, 2007

We found a number of developments of interest in the energy sector last month - most of which were incredibly bullish - including the following:
  • Total energy use is soaring in a boom that has seen China's economy grow by 11.9 percent last quarter, its fastest quarterly rate since 1995. China's crude oil imports for the first six months totaled 3.3 million barrels a day, up 11.1% from a year earlier. Chinese industries use 20 to 100 percent more energy per unit of output than their U.S. and Japanese counterparts according to a study by the World Bank. China's government says the gap is even bigger, putting energy use at 3.4 times the world average.

  • Chinese consumers purchased over 7 million vehicles in 2006, and demand is increasing by around 20% per annum. U.S. automobile demand is stagnant at the 16-17 million per annum level, increasing only in line with population growth.

  • A report by Deutsche Bank issued last month predicted that Chinese oil demand would rise strongly next year. Chinese oil consumption, which last year was 7.16 million barrels a day, is expected to grow by an annual 6 percent over the next two years. By 2015, Deutsche Bank estimates China's oil demand at 10 million barrels a day.

  • Global economic growth accelerated for five straight years reaching 5.4% in 2006, the highest rate of growth in at least 27 years, according to the International Monetary Fund. That's despite oil prices doubling over that time. Energy use and economic growth are highly correlated.

  • The International Energy Agency revised their latest forecast and raised their global oil demand estimates, predicting oil use would rise by an average of 2.2 percent a year for the next five years. They also noted the share of world oil consumption represented by the developing world will rise to 46 percent of global demand by 2012 from 42 percent. Demand for crude will increase to 95.8 million barrels a day within five years, up from 86.1 million barrels today.

  • Goldman Sachs analysts warned in a recent report that without swift action from Saudi Arabia to increase crude oil production oil prices could rise above $90 a barrel this fall. They said that an increase in OPEC production could help push prices down by $5 to $10 a barrel.

  • Deliveries of gasoline reached a record 9.23 million barrels a day in the first half of this year, according to a report from the American Petroleum Institute. In June, gasoline deliveries topped 9.79 million barrels a day, the strongest demand ever for a single month. Higher gasoline prices have not discouraged consumption to date.

  • Oil refineries across the country have been plagued by a record number of fires, power failures, leaks, spills and breakdowns this year, causing dozens of them to shut down temporarily or trim production. A third of the country's 150 refineries have reported disruptions to their operations since the beginning of the year, a record according to analysts. As a whole, refining disruptions have been considerably higher than in previous years: they averaged 1.5 million barrels a day in the first quarter, compared with 700,000 to 900,000 barrels a day from 2001 to 2005.

  • A pullout from Iraq may be the event that pushes oil to $100 a barrel according to Boone Pickens. Pickens predicts oil at $80 within six months, and he says growing chaos in Iraq would be a bad sign for lower prices.

  • Cantarell, the world's second largest oil field by production rate, saw output fall 12 percent in 2006 and it is forecast to decline 15 percent this year. For the first five months of the year, the field has produced 17 percent less than the same period in 2006. The decline in production is adding to tightness in the global oil markets.

  • In 2006, crude oil production fell by 6.9% in Norway, 10% in the United Kingdom, 2.1% in Mexico and an estimated 5% in Venezuela. In all of those cases, the rate of decline is accelerating. The problem is geology, not politics (although political issues has shut down 25% of Nigeria's oil production and has impeded exports from Iraq). No quick 'fix' exists for many of these declines, and attempts to stabilize the geologic problem will be expensive and take years to implement.

  • The tropics remain quiet, with only two named tropical storms to date. In May, called for a total of 13 or 14 storms in the Atlantic Basin, with three or more likely to be major hurricanes (Category 3 or higher). Chief forecaster Joe Bastardi said last month that his forecast has not changed, but the real issue is where the storms will go and how strong they will be when they get there. Bastardi believes six or seven of the storms could strike the U.S.

Data over the last century indicated the frequency of hurricanes begins to pick up in earnest in mid-August, so the relative quiet to date is not unusual.

Joseph Dancy
LSGI Venture Fund
Adjunct Professor
of Energy Law, SMU School of Law
August 6, 2007

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