The Oil & Gas Market:  A Slower Pace, But Plenty of Demand

For the first time in about five years, the year-to-year changes in prices for oil and gas will be less than 10% and rig activity will grow only about 8% for the year, John Spears, president of Spears and Associates, told workshop attendees.

Crude oil prices stand at about $68.50/barrel, which is only about a 3% gain for the year, while average gas prices appear stable at about $6.50/ million btus, he said, which compares to about $4 three to four years ago.

What these figures show is that prices have slowed down a lot in the last 12 months. As a result, he said, U.S. drilling activity has slowed sharply.

Meanwhile, the global numbers look robust, Spears said, with world oil demand growing about 1 to 2% a year, up to about 86 million barrels per day (bpd). China accounts for about a third of that demand while the U.S. accounts for 15%.

Spare production capacity over the past few years has improved somewhat, starting at about 1 million bpd three years ago to today’s figure of about 2.5 to 3 million bpd. Still, the world is operating at about 97% utilization of its productive capacity, which is historically very low. In the past, it has operated at roughly twice what it’s operating at today.

“This is one reason the market is considered tight,” Spears said. Still, operators continue to moderate their expectations for future oil prices. In 2003, oil companies were looking at $25 to $26 per barrel, whereas two years later, it had more than doubled to $50 to $60.

“That kind of change will cause companies to look at candidate wells as extremely profitable. This explains why operators have massively increased their reinvestment ratios,” Spears explained. While they used to spend 20% of revenue on new drilling in the 90s, today they spend almost 50%.

The gas market has swung back and forth for most of this decade, but shown very little change overall in demand, Spears said. “All that says is weather plays a vital role.” Low points are late spring and early autumn when it bottoms out at 50 billion cubic feet. Then winter depends on weather.

Still, summer gas consumption has begun to creep up, which reflects back to the power generation market: gas-fired generators have been put in place, so there is now a major summer load for cooling purposes.

“How much gas is going into storage plays a huge role in support of the swings. Last year, August was very hot. By the middle of the summer, there was very little put in storage. That hasn’t been the case this year, which will leave a lot of gas around for the rest of this year,” Spears said.

He predicted that prices, because of that development, would weaken in the short term carrying into next year.

Meanwhile, rig activity, which has been robust the last few years, should flatten in 2008.

“Last year we built about 20 years worth of rigs for the U.S. market,” Spears said. Because lead times are about 12 months, those numbers reflected orders from 2005. By 2008, “we might be lucky to see 100 new rigs.” At the same time, however, drilling costs should drop by about 10 to 15%.

Another development with rig activity has to do with the types of wells being drilled. While all wells used to be vertical, about 45% of today’s rigs are directional—wells drilled horizontally from existing sites. Because of the success of such wells in several major U.S. sites, operators are now looking at similar formations on sites that have been ignored for years but may prove to be fruitful going forward.

FORECAST: Prices for oil will go up about 10% to $75 per barrel next year. U.S. gas demand is projected to surge this year by about 4% to $22.8 per trillion cubic feet. Spot natural gas prices will average $6.50/mtmbtu in 2008, which is unchanged from last year.