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Energy Insights – Energy Market

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The current state of the Energy market

Is Oil Running Out?

Not really – on current projections, there will be enough oil for at least another 50 years though the cost of extraction will likely rise as more of the low cost oil has been extracted. This is predicted even though oil demand is projected to double in the next 20 years. Oil prices over $15/bbl make oil sands economically attractive – there are huge quantities of such reserves in Canada and elsewhere. Global reserves have replaced product for the last few years.

The key issue though is likely to be expanding the global production capacity to meet the rising oil demand. Some $1 trillion of investment is required to expand capacity from the current 70 million barrels a day, to 150 million barrel per day by 2020. Much of this investment is in countries with high political risk – with state run enterprises.

Many of the countries such as Saudi Arabia have expanding populations, high local expectations with regard to social welfare - increasingly governments will be strapped for cash as they pay for the social costs of the expanding population whilst having to pay for production capacity and infra-structure upgrades. Because most of the Middle East reserves are likely to stay in the full control of state run oil companies and governments, with fairly minimal International Oil Company (IOC) involvement – it will make such capital investment difficult and hence there is likely to be future supply shortages as OPEC (Organization of Petroleum Exporting Countries) falls behind demand increases.

This is particularly so since capital intensive oil development in risky, and such countries are considered less attractive to the global investment markets.The financial markets also do not like the long lead times, uncertainty in oil price and risk of assets being seized, political instability or contractual terms changed.

Even though oil production is very profitable, the size of investment and risks have driven many investors into higher return, less capital intensive and lower risk service businesses in developed countries or the fast developing economies of China, India and the rest of Asia Pacific.

Is Gas Running Out?

No. There are huge gas reserves which are likely to last some 100-200 years. Russia, Iran and Qatar in particular have huge reserves. Low cost gas close to high population centres – e.g. in the USA and North Sea, are in significant decline. We will increasingly become more reliant on imported gas from greater distances – e.g. Russian gas into Western Europe and Canadian gas and LNG (Liquified Natural Gas) into the USA.

Indeed, the LNG business will likely see a huge expansion – with more LNG coming from Qatar, Australia, Nigeria and Indonesia – with demand rapidly rising in particular in China and the Far East, India and the Middle East. The huge up-front capital investments required for LNG plants will create demands for both the IOCs and National Oil Companies (NOCs) / governments. The gas business is likely to remain a profitable business, albeit with risks related to the long term investment

Is the Oil and Gas Business a Good Investment?

It depends. If you invest in the stock market, share prices can go up or down. The same applies for buying oil and gas shares. The smaller companies are particularly volatile – announcement of a new discovery can triple the share price of a small oil exploration company. Announcement of a dry appraisal well can halve the price.

The larger integrated oil companies have higher dividends, more stable cashflow and longer term projects. This degree of stability makes these shares more popular with investment fund managers, along with the fact many of these companies are part of either the New York Dow Jones or the London FT100 indexes.

In the longer run, the large companies will find it increasingly difficult to replace existing oil reserves. Meanwhile, the National Oil Companies in the Middle East, Russia and elsewhere are getting a larger proportion of oil reserves and production – their skills, expertise and use of technology and contractor services are all improving, making them less reliant on International Oil Companies (IOCs) expertise.

That said, the deals being done by the IOCs are generally attractive and the longer term cash-flows seem secure as long as oil prices stay above say $25/bbl – which seems highly likely. Purchase of IOC stock also provides a hedge against high energy prices – which can lead to higher inflation, interest rates and lower global growth for other businesses.

The alternatives to oil such as renewables and hydrogen are not being developed with any real vigour – hence oil is likely to remain a very important part of global economies for the foreseeable future. In any case, most IOCs are exposed to alternatives energy sources and therefore could shift rapidly into these markets if a change in energy usage occurred quickly.

Some of these companies have patents on Hydrogen and Fuel Cell technologies – which would become very valuable if automobiles converted quickly to such technologies.

Is Coal a Good Investment?

The price of coal has doubled from end 2003 to end 2004 – and is likely to rise further in the future. The massive increase in demand for electricity in developing countries such as China and India is driving up the demand for coal.

Both India and China have large quantities of low cost coal – which will increasingly be used for electricity generation. Interestingly, the USA has the highest coal reserves in the world – with vast reserves of high grade anthracite in Wyoming. Some open cast seams are up to 100m thick. In energy equivalent terms, the USA has the largest energy reserves in the world – it is just that much of this is coal.

The “dash-for-gas” has subsided in the USA because gas prices have been driven up by high demand, Canadian imports, no big gas reserves additions in the USA and lack of spare capacity. A similar situation has occurred in NW Europe. Increasingly LNG imports are seen as necessary to supplement pipeline gas imports.

Coal is attractive in that it is not volatile, open cast extraction is low risk and there are plentiful supplies. However, the downside is the high levels of CO2 emissions, particulate pollution in non clean burning power plants and high overland transport costs. Coal is likely to become an increasingly attractive energy option for those countries that are not signed up to the Kyoto protocol.

The impact of global warming and its links to CO2 emissions – produced by fossil fuels and coal might curtail this growth – but this depends on environmental pressures, commitment to the Kyoto accord and confirming the link between global warming and CO2 emissions. The pressures to provide an economically sustainable future for the huge populations of India and China are likely to lead these countries to expand coal production to provide energy for industrial expansion and economic growth.

The use of coal in the USA will be driven by declining oil and gas reserves, lack of economic alternatives, fears over nuclear power safety and reliance on expensive oil imports from insecure sources. Oil will be used to fuel automobiles whilst coal will increasingly be relied on to produce electricity.

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