Option Investor
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Feast or Famine

HAVING TROUBLE PRINTING?
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Energy investors would not know how to act if they saw two days of positive gains back to back that were not followed by an even stronger decline. The chart for crude looks like the path of a falling star. The chant is no longer "Drill baby drill" but dive, dive , dive!

Last night when I wrote my commentary oil was trading at $70.50 and tonight it is under $65. It is feast or famine and for investors the time in a position is being measured in hours not days. Evidently the media did not read last night's article because they were back at it again on Thursday claiming that the weak economy was driving down demand and that pressured the price of crude. Come on guys you can't have it both ways. On Wednesday you said demand was improving and pushing prices up and today demand was decreasing and pushing prices down. Maybe you should find another career.

On the global front Robert Dudley, the outgoing chief of TNK-BP, said Russia's oil production was poised for a protracted decline due to a lack of investment. He said Russia appears to have peaked in August but it would not be a sharp drop but probably a gentle decline from the older mature fields. As is the case elsewhere the old giants are in decline and the new exploration in hard to drill places is only turning up smaller fields with lower flows. Lukoil said Russia could cut production to help OPEC prop up prices. Leonid Fedun a Lukoil VP said, "We are seeing that Russia and OPEC are beginning to cooperate. I believe the future of the Russian industry and price stability hinges on close cooperation with OPEC." He added that Russia could afford to cut production and exports by 300,000 to 400,000 bpd to help OPEC and executives from Russian oil companies could attend the next OPEC meeting in December.

Matthew Simmons said the lower price of oil was already having an impact on future exploration and the profits of the drillers. With oil at $60 many companies are reconsidering those expensive day rates on deepwater drilling rigs that can run $600,000 per day. Add in $130,000 per day for support vessels and $300,000 per day for anchor handlers and rig towing ships and suddenly the cost benefit analysis is just not working out. We have known for many months that the marginal cost of deepwater oil is about $85 per barrel at the current depths being drilled. If you sell it for $60 you would be out of business very quickly.

Petrobras said the lower price of oil was making them reconsider the deepwater development of their new mega-field off the coast of Brazil. The estimated cost for developing the field was $500-$600 billion and that worked at $125 oil but at $60 the project may have to be scaled down substantially.

The IEA warned that a decline in exploration because of prices could have serious repercussions when demand returns. The time frame to restart exploration, develop and complete, then begin production is measured in 5-7 years on an average project. If energy companies put off the exploration until process are back over $100 that eventual production could be years into the future when we will need it immediately.

Several companies are rethinking their billions in oil sands investments. Shell is on the verge of canceling some announced plans to increase production on fears it will not be economically feasible. Suncor said they could still make money at $60 but their $21 billion Voyageur expansion due for 2012 would require crude prices of $85 to be profitable. Suncor said last week they were going to scale back spending in 2009 by $6 billion because of the price drop.

I hope readers see where this is going longer-term. Lower prices are shrinking development, which will lead to much higher prices later as global demand continues to grow. It is a vicious cycle and most analysts don't see the impending crisis 2-3 years from now.

Jim Brown

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