Sun, Aug 01, 2004 page10

• Tight rein kept on energy supplies

  CHASING PROFITS While supply tensions have driven oil futures to record highs, the energy industry has concluded it's more profitable to go slow on new drilling

  • AP
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  The energy industry is taking a relatively conservative approach to boosting output even though profits are booming amid tight supplies of oil and natural gas. If demand remains strong, this production discipline could help sustain high and volatile energy prices at the pump and in the home.

  On Friday, oil futures rose to a record high because of the supply tension, while gasoline prices nationwide averaged US$1.90 per gallon. Oil for delivery next month surged US$1.05 to close at US$43.80 a barrel, surpassing the high of US$42.90 set earlier in the week on the New York Mercantile Exchange.

  Analysts cite a number of reasons for the industry's cautious approach, including the possibility of a price collapse that would make more aggressive drilling now look foolish later on.

  But another plausible explanation is that oil executives -- such as the leaders of the OPEC -- have concluded that it is more profitable to err on the side of underproducing as opposed to overproducing.

  "We have not seen the level of capital spending [on exploration and production] reflect the high oil prices or obscene profits," said Fadel Gheit, an equity analyst at Oppenheimer & Co in New York.

  "Cynics are saying that maybe, collectively, they have figured out that holding back production is financially beneficial," Gheit added.

  It is either that, "or they're really running out of good investment opportunities that would generate good returns in the event that oil prices come down," he said.

  But Jim Burkhard, director of global oil at Cambridge Energy Research Associates, said that explanation oversimplifies the situation, particularly by ignoring other market-shaping forces such as geopolitics and consumer demand.

  For example, the political strife that exists in oil-producing nations such as Iraq, Venezuela and Nigeria makes it difficult for those nations to maximize their output, constricting worldwide supply growth, Burk-hard said.

  Burkhard believes that over the next three to four years there will be substantial supplies added as rising investments in non-OPEC nations such as Russia, Canada and Brazil begin to pay off. But unfortunately for consumers, he added, "there's no tap that companies can turn on to boost production immediately."

  Even if they could, oil and natural gas companies would probably hesitate to do so out of fear that an economic slowdown would sap demand or that today's burning geopolitical problems would cool down, taking prices lower just as fast as they went up.

  "The price collapses of 1998 and 1999 threw this industry into a deep depression and so in terms of planning for the future you've got to be very cautious," said John Felmy, an economist at the American Petroleum Institute, a Washington-based industry group.

  These days, though, profits are soaring. On Friday, oil giant ChevronTexaco Corp reported that profits more than doubled in the second quarter to US$4.13 billion, while independent producer Anadarko Petroleum Corp's second-quarter net income jumped 35 percent to US$405 million.

  Capital spending at Houston-based Anadarko fell to US$684 million in the second quarter, down from US$826, while expenditures on exploration and production at ChevronTexaco increased slightly to US$1.6 billion, up from US$1.5 billion.

  "Our projects are moving forward at a pace guided by long-term corporate strategy and business plans and not by short-term market conditions," ChevronTexaco spokesman Stan Luckoski said.

  Exxon Mobil Corp, the world's largest publicly traded oil company, recently reported that its capital spending fell to US$2.8 billion in the second quarter, down from US$2.9 billion a year ago. Its quarterly profits surged to US$5.8 billion, up from US$4.2 billion last year.

  However, Exxon Mobil's annual production has declined for three consecutive years, A.G. Edwards analyst L. Bruce Lanni noted, and it faces the "increasing difficulty of growing production and reserves given the company's massive size and reserve base."

  Gheit said he found the industrywide disparity between profits and capital spending "puzzling."

  Still, according to an annual survey by Oil & Gas Journal, worldwide exploration and production spending is expected to rise 4.8 percent this year to US$53 billion.

  But that doesn't mean oil and natural gas markets will necessarily be awash in new supplies anytime soon. For one thing, oil demand is expected to grow by 3.2 percent this year to 81.4 million barrels a day, according to the International Energy Agency, leaving very little spare production capacity. Analysts estimate there is about 1 million of excess capacity globally, the bulk of it in Saudi Arabia.

  The other thing to consider, said Burkhard is that "very large projects take a lot of time to get ready to start up."
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