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Uncertainty Clouds Outlook for Oil Sector



Published: May 18, 2009

NEW YORK — As its most prosperous decade screeches to a halt, the oil industry is confronting a far tougher and more hazardous future. The huge profits of the past years have mostly vanished, leaving companies to confront a difficult readjustment to a world of lower prices and uncertain demand.

Between 1998 and 2008, oil prices swung from lows of $10 a barrel to highs reaching nearly $150. But as the global recession last year pushed down oil consumption for the first time in 25 years, prices collapsed. Since the beginning of the year, oil futures have traded in a range around $50 a barrel.

As a result of the market’s slide in the second half of 2008, many small and midsize producers — though not the giants like Exxon, Total or Shell — have posted big losses, oil exporting nations are suffering crippling revenue declines, and even the major oil companies are seeing substantially lower profits this year. In response, many companies are sharply curtailing investments, reducing costs and firing workers in a frantic bid to drive down expenses.

To the uncertainties surrounding the outlook for shrunken economies and stuttering global growth has recently been added the specter of a global flu pandemic, prompting fears of a repeat of the epidemic of severe acute respiratory syndrome, or SARS, which curtailed international travel in 2003.

A recent note by analysts at Raymond James began with the following warning: “Short term, oil prices could go either direction.”

A similar feeling was echoed by Peter Voser, the chief financial officer at Royal Dutch Shell, who is to become chief executive in July. “This is a very difficult environment for the oil industry, and we need to be clear about that,” he said on a conference call with analysts last month.

Beyond the short-term fog, many executives expect that the world will face a new spike in prices once the global economy rebounds. The International Energy Agency, a forecasting agency, has repeatedly warned of a “supply crunch” as companies cut back on investments, which in turn could lead to fresh price surges.

“We know that as the global economy rebounds, demand for petroleum will also grow — and in the absence of such investments, the world is likely to face another vicious cycle of price spikes,” Khalid A. Al-Falih, the chief executive of Saudi Aramco, said at a recent conference in Washington.

Yet these warnings belie a startling new trend. Oil producing countries, which had been reticent to allow foreign investors access to their oil fields when prices were rising, have started to loosen up the rules again. The sudden drop in oil prices has hurt countries where petroleum exports account for the bulk of government revenues.

Venezuela is holding its first exploration licensing round since 2000, and President Hugo Chávez, who nationalized chunks of the country’s oil sector in recent years, is suddenly eager to strike deals with foreign investors to pump more oil. The country’s cash-strapped government, for example, is seeking a complex three-way deal involving China National Petroleum Corp. and Total, of France, to produce and refine heavy oil reserves.

Admittedly the signals from Venezuela are cryptic: the government also threatened to take over the operations of foreign oil-field service companies after the Venezuelan national oil company, Petróleos de Venezuela, fell behind on its payments.

Another cash-starved country, Iraq, which has been negotiating for more than a year with foreign investors, recently told them that it would seek multibillion-dollar loans from oil companies as a condition for granting them access to its formidable reserves.

Outside the 12-member Organization of Petroleum Exporting Countries, other oil producers like Russia, Mexico and Norway are also struggling to reverse declining output trends. The I.E.A. and other forecasters expect non-OPEC supplies to fall this year because of insufficient investments and slowing flows from mature oil fields.

Still, some analysts say that a period of lower oil prices does not necessarily lead to declining overall production.

“With low prices and low production, producing countries have a real appetite for higher volumes,” said Antoine Halff, an energy analyst at Newedge, a brokerage firm. “That’s a real departure from the trend we’ve seen in the last decade when companies and countries had few incentives to produce more because they could get more revenue per barrel.”

Some producers have accepted the current reality of lower demand and prices. Saudi Arabia, the world’s biggest oil producer, has signaled it will curb its drilling this year and release 15 rigs after completing a major expansion of oil production in the past five years.

At an energy conference in Tokyo last month, Ali al-Naimi, the Saudi oil minister who is responsible for a more realistic approach within the OPEC cartel, called $50 oil Riyadh’s “contribution to the world economy.” Qatar’s oil minister, Abdullah al-Attiyah, at the same meeting, said producers had to adapt to changed economic circumstances. “I think this is very pragmatic,” Mr. Attiyah said. “$40-$50, this is a pragmatic price for 2009.”

Still, not all producers are so philosophical. Abdalla Salem El-Badri, the secretary general of OPEC, has indicated that the oil cartel, is “not satisfied” with current prices, which, he said have had a “big impact” on investments by its members. Thirty-five out of a total of 165 projects were being put on hold until 2013 within OPEC countries, he said.

“A price at $50 is insufficient for oil investment,” Mr. El Badri told a recent conference in Japan. “I think more than $70 would boost investment.”

Oil prices have regained some of their lost ground in recent weeks, helped by hints of an economic recovery. These signals have pushed oil prices toward $60 a barrel but few analysts expect a recovery to last long, or prices to rise much further.

After basking in high prices and reaping record profits, the majors, including Exxon Mobil, Shell and BP, have all seen their earnings fall sharply in the first quarter. Still, they are trying to resist a spiraling contraction and to take advantage of the drop in costs throughout the industry.

The industry’s behemoth, Exxon, for example, said it would not curb a planned $29 billion investment program this year, despite a 58 percent fall in its net income to $4.55 billion in the first quarter.

Yet caution remains the rule of the game, said Paulo Scaroni, the chief executive of Eni, the Italian oil company.

“In all likelihood, prices may go down rather than up,” Mr. Scaroni said during a recent interview. “But the most important commodity in the world is left to totally erratic behavior.”

The spread of swine flu has recently added a new dimension to an already murky picture, prompting some experts to question what effect a global epidemic could have on transportation, trade and, ultimately, oil demand.

During the last global epidemic, the SARS outbreak in 2003, air travel was severely curtailed, pushing down oil demand. But while that epidemic occurred at a time of strong economic growth, particularly in Asia, the current global health scare is happening in a far different economic environment.

“The recession already has dramatically curtailed oil demand across the globe, including in Mexico itself,” according to Mr. Halff, at Newedge. “The outbreak takes place at a time of dramatically lower consumption and economic activity. Assuming that the pandemic does fizzle out, its net impact on demand is likely to be dwarfed by that of the recession and unlikely to cause more than a superficial ripple.”

The biggest uncertainty is how long the global recession will last and what effect it will have on oil demand.

In a report released last week, the I.E.A surprised oil watchers by sharply reducing its estimates for global oil demand this year. The agency estimated that daily average oil consumption would drop by 2.6 million barrels to 83.2 million barrels, down 3 percent from last year and about one million barrels a day less than most analysts expect.

“The pace of contraction,” the report said, “is close to early 1980s levels, with a growing consensus that economic and oil demand recovery will be deferred to 2010.”

The energy agency noted that the biggest declines in demand had come in the United States, Europe and Japan, industrialized economies that had seen the level of activity collapse in the first quarter. Even developing countries like China have seen a slowdown in their industrial output, and therefore in their oil consumption.

Yet some analysts consider the I.E.A.’s new forecast to be far too pessimistic. With the global economy showing some signs of stabilization, and with prices still low compared to the highs of past year, there could be a small rebound in consumption in the United States, the world’s biggest oil market.

Lawrence Goldstein, a veteran energy economist, said that gasoline demand in the United States, which has fallen sharply, might spike this summer as drivers took advantage of sharply lower gas prices. After rising above $4 a gallon last summer, gasoline now sells around $2.30 a gallon.

“You give the American consumers a reduction in price and consuming confidence is getting slightly better, I think people go back and take their vacations,” Mr. Goldstein said. “They don’t go on a spending binge but they ease up a little bit.”

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