The 2004 Forecast Challenge
by Richard Mason
|Tuesday, August 26, 2003
Abstract: Forecasting season begins in earnest next month. All signs point to a mixed bag for 2004. Of course, that can change.
Analysis: You've got to feel for the planning and forecasting folks next month as they begin constructing budget plans for 2004.
While the current energy market is a godsend for those who relish ambiguity, it happens to be a tough obstacle to overcome when planning for next year's business contingencies.
Those doing the prognostication have relatively mixed evidence available to them regarding which way things are headed in oil and gas. And when signs are mixed, they can be interpreted in many different ways.
Take rig count. Rig activity seems to be losing some steam as the third quarter matures. But commodity prices remain high, operator cash flow strong, and the end of the tax year is literally just around the corner. That event should prompt additional spending in the fourth quarter as a way to soften the tax bite from this year. So rig count could dip, then recover mid-fourth quarter before dipping again in the first quarter 2004.
But here is where the ambiguity comes to play. Some of the deflation in the current rig count stems from a single operator, Anadarko Petroleum, which has literally cut its rig employment in half within 30 days. The company has eliminated 25 rigs from the U.S. land drilling market so far, or more than twice the number that the company's CEO acknowledged last month during a conference call with nervous investors.
Events like this are a major reason the issue of sustainability in field activity seems to be fraying around the edges.
Market share among a group of the most active E&P firms in land drilling has fallen from a high of 34 percent during the first quarter this year to less than 28 percent currently. The 15 most active operators have seen collective rig employment drop from a June peak of 364 units to less than 315.
While Anadarko and a few peers are stepping back from the U.S. land drilling market, smaller E&P firms, most of which are not publicly held, still seem to be adding rigs at about the same pace. Which means rig count bounces up a little, down a little, week to week. At this point in the cycle, the smallest E&P firms are the swing players who will determine how the cycle plays out, and rig count, at least in the U.S. land market, will closely track their cash flow.
The next area of ambiguity is wintertime natural gas storage. This number, reported weekly by the U.S. Department of Energy, has evolved into a proxy for the health of the natural gas industry over the last few years. Spot gas prices, futures prices, and even the blood pressure of financial industry analysts seem to fluctuate up or down based on a variation of as little as a dozen billion cubic feet in storage inflow during any given week.
One can argue that the market is still in a horserace to return storage levels to historic norms by November 1. On the other hand, the energy industry started the refill season with a deficit versus historic averages of 46 percent at the end of April. The deficit is now down to eight percent with 60 days to go, assuming injection season ends November 1.
Ultimately, 2004 activity depends primarily on sustainability in commodity pricing. And right now, the consensus seems to be that pricing will remain strong. This time last year, some of the industry's most respected analysts were making the case that oil prices were destined to collapse. War in Iraq seemed a foregone conclusion. The theory was that a flood of Iraqi oil afterwards would alter the global crude markets in such a way that OPEC itself might be endangered.
But that hasn't happened. Despite the fact that the war took place, Iraq has been a no-show in the export markets except for a few hundred thousand barrels per day. While the Saudis ramped production up to 9.6 million barrels per day before the war to maintain market stability, they have since cut back to 8.6 million barrels per day, which may have been a misreading of the coalition's ability to get Iraqi oil flowing into export markets quickly.
Toss in some additional noise, namely the ongoing efforts in Organization for Economic Cooperation and Development (OECD) countries--including the United States--to refill petroleum reserves coupled with rising oil consumption in Asia, especially China and Japan, and the global oil market remains tight. Current crude inventories are near 28-year lows, which is why oil prices have returned to pre-war levels.
Ultimately, commodity prices should remain high enough to make oil and gas drilling worthwhile in 2004.
While commodity prices are near historic highs, field service costs are relatively modest. Rates are up some, but not to levels contractors expected, particularly when considering that U.S. land rig counts are at 90 percent of the 2001 peak, and about 95 percent of the 1997 peak.
This cycle seems to be exhibiting greater patience, which could translate into sustainability in 2004. Operators are less frenetic now as opposed to previous cycles. In the two prior events (the 1997 and 2001 peaks), rig rates were headed aggressively higher at similar points as operators bid up the price for scarce rigs in a tightening environment.
In both instances, rig availability was a major issue because of a tight labor market. This time labor is neither a bottleneck nor an issue. Furthermore, the contract drilling industry has added capacity, so operators have yet to perceive the rig market as tight, or getting tighter.
Perhaps the best evidence of greater balance this cycle is the fact that operators have yet to declare any project nonviable because of high field costs. When that happens, it is usually a sign that the cycle's inflection point is nearby.
So on the sustainability issue, it looks as though 2004 will be a good--but probably not a great--year for field activity. Operators will have the cash flow to sustain high levels of fieldwork.
Inevitably when cash flow piles up, it stimulates the urge to merge. This trend is abetted as the acquiring company issues debt-to-finance acquisitions. That, too, is an indication that the expansion phase of the cycle is coming to an end. And that has yet to occur.
Of course, all that can change dramatically depending on weather, geopolitics, or, for that matter, domestic politics.
Still confused on where things are headed in 2004? Go to the forecaster's main source of comfort. The 2004 Farmers Almanac is now on sale. It is predicting a colder than normal winter in major energy consuming regions of the United States.