Beware the Ides of November

Abstract:Bad news has a way of hitting the oil and gas industry in November. We may have dodged the bullet this year.

Analysis:When sitting down at the Thanksgiving dinner table tomorrow, take an extra moment to be thankful that the oil and gas business is exiting another November without some ominous event garnering headlines. November is the cruelest month for oil and gas. If bad news is going to surface, it usually comes to light in November. This connection is surely coincidental, but the oil and gas "Tough News Hall of Fame" features some incredible exhibits over the last decade.

The most obvious occurred last November when Enron Corp dissolved in full public view. In the intervening year, the public has evolved from viewing Enron as an anomaly in energy trading to widespread suspicion that energy traders created volume oftentimes through market manipulation and accounting tricks rather than leaving it to fundamental market dynamics.

A laundry list of repercussions over the last 365 days includes the demise of Arthur Andersen, the spread of corporate governance scandals from Enron to telecom, potential bankruptcy for several utility-owned trading operations, and a dramatic loss in public confidence. But Enron is just one example of November surprises in the oil and gas industry. Here are some others:

November 1993—Metalgesellschaft. This German-based conglomerate sought to build an integrated refining and wholesale fuel distribution outlet in the U.S. The company gained market share in gasoline distribution through a series of long-term fixed price contracts to retailers. The conglomerate then relied on contract rollovers in the commodity markets to supply the volume necessary to service the agreements. When the energy commodity markets did a "contango/backwardization repolarization" in November 1993, Metalgesellschaft found itself with massive open contract exposure. Commodity traders feasted on the circumstance. By the time the frenzy played out that November, commodity traders had pushed oil prices into the low teens and the German government/banking/industrial complex narrowly avoided financial collapse.

The Metalgesellschaft incident had a chilling effect on capital and commodity prices just when the industry was starting to show signs of life after the 1986 oil price collapse. The oil and gas business spent another 24 months in a semi-depressed state. Many independent operators turned away from portfolios brimming with oil and began to focus exclusively on natural gas.

Sometimes these November episodes don't appear in the national headlines.

November 1997—The Equity Market Collapse in Land Drilling Stocks. After a great valuation run in equity prices during 1997, the land drillers were earning respect on Wall Street. The sector had been considered a dinosaur in oil and gas, destined for extinction as everyone headed offshore or international in pursuit of hydrocarbons. In late 1996 the nation discovered it needed additional natural gas. The easiest way to jump-start the process was onshore. As the drilling boom spread from offshore to land—and to Canada—land drillers became a crucial component in generating incremental gas production. U.S. land drillers simultaneously experienced a roll-up in assets as a number of smaller firms were combined through mergers and acquisitions into a handful of large publicly held drilling companies. When Wall Street discovered the energy story was real, and immediate, stock prices for publicly held drilling companies soared tenfold in some cases, with the group peaking in early November. Then the story repolarized. Land drillers lost a third or more of their value in three weeks as $2.4 billion in market capitalization disappeared. Ultimately, the sector lost two-thirds of its valuation as investor perceptions changed from a market in undersupply to one of excess capacity.

Now fast forward one year.

November 1998—The Missing Barrels Caper. This refers to statistics that indicated the world was awash in crude oil. As November 1998 arrived, the discrepancy between excess barrels counted by the international forecasting agencies as production, minus consumption, compared to Organization for Economic Cooperation and Development (OECD) crude stocks approached half a billion in number. There were many theories why the "missing barrels" were not showing up in OECD stocks. Some thought the Saudis were storing oil in Africa; others that crude was in transit on tankers but prevented from unloading because stocks were already full. There were probably theories on talk radio about crude oil sequestered in a closely guarded government hangar near Roswell, New Mexico.

Although the "missing barrels" never existed, hedge funds entered the commodities market in a big way, betting oil prices would fall. They did, and reached near historic lows as 1999 got underway.

If November is the cruelest month for oil and gas, 1999 became cruelest year for the oil and gas industry as rig counts followed commodity pricing down and operators were seriously impaired in the financial milieu that followed. E&P firms were branded on Wall Street as capital destroyers who not only failed to provide a return on investment, but also failed to return any investment. The repercussions were evident in 2000 when a rise in energy commodity prices signaled impending tightness in the energy business. Operators were hamstrung in their attempts to obtain outside capital—and thus late to begin the drilling program necessary to meet surging demand. Energy prices subsequently spiked in the winter of 2000-01 and public anxiety over a looming "energy crisis" prompted the push to draft a national energy policy in May 2001.

In fact, one phase of that perceived crisis surfaced the previous November.

November 2000—Energy Crisis Hits California. November is the month news of a growing California energy crisis moved into the national spotlight. Specific causes for the California energy shortage range from the unintended circumstances surrounding a flawed deregulation program to a set of unusual events that created a cascading crisis, including a series of wildfires imperiling transmission lines into the state, a midsummer natural gas pipeline explosion in New Mexico that restricted the movement of natural gas into the California market, and a surge in consumer demand for electricity as the dot com boom began to peak.

The least expected stimuli at the time were unscrupulous trading practices and market manipulation among over-eager energy marketers. Apparently, there was more of this going on than anyone believed. By the time the process ran its course, two large public utilities in California were forced into receivership, rolling blackouts garnered national headlines, and Californians responded by cutting energy consumption.

In retrospect, this November has been relatively benign for oil and gas. True, there is a bifurcated single hull tanker filled with oil at the bottom of the Atlantic off the coast of Spain. And rhetoric over war with Iraq could stir things up in the Middle East. But the future actually looks better for oil and gas rather than worse.

So use this Thanksgiving as an opportunity to sit back—and exhale. Had Shakespeare been in the oil and gas business during the 1990s, he would have warned readers to beware the Ides of November. Since those are behind us, enjoy the holiday.