Instability & Depletion Add Uncertainty to Energy Sector

by Joseph Dancy, LSGI Advisors, Inc. | April 3, 2009

Energy use correlates closely with economic growth. Last month the World Bank forecast the global economy will likely shrink for the first time since World War II. International trade will decline by the most in 80 years according to the report, a stark trend in an economy that has been ‘globalized’ over the last several decades.

Crude oil exporters on the list of those at high risk of political instability account for nearly 26 million barrels per day of production—a very high percentage of global petroleum output. Keep in mind globally we use roughly 85 million barrels of liquids per day, which is near the global capacity to produce.

With current crude oil prices around $45 substantial volumes of production will be shut-in or not developed according to analysts. Stanford Bernstein forecasts U.S. crude oil production will decline by 400,000 barrels per day next year if current crude oil prices remain in place.

Depletion, which runs anywhere from 4% a year upward (note Cantarell’s nearly 40% decline rate referenced above), reductions in capital expenditures, depressed energy prices, limitations imposed by the global credit crunch, nationalized oil fields, all will adversely impact future production levels.

Crude oil futures remain in ‘contango’ – a situation where the value in the future is much higher then at the present. Some analysts claim this is bullish for the commodity, an indication that the supply and demand for oil remains bullish. Companies can use this curve to hedge production from current reserves in the ground (chart courtesy Financial Times).