The current slide in crude oil prices could accelerate into a plunge to as low at $35 per barrel next year, ConocoPhillips' chief economist, Marianne Kau, told a group of economists in Anchorage Oct. 11.
That's a sobering prospect for the next governor of the state - who will take office in early December - because a dip in oil prices, combined with declining North Slope production, could throw the state budget into a deficit again after two years of surpluses.
"I'm very worried about the downside price risk in 2007. If the economy continues to slow and there is no unusual geopolitical event influencing the market, we could see a price collapse next year," Kau said in a luncheon talk to the Alaska Chapter of the International Association of Energy Economists.
Prices won't dive to $9 per barrel that Alaska saw in 1999, but they could go to $35 per barrel, Kau said. "Given the current slowdown in the economy and high inventories in the market, prices should logically be at $35 per barrel now," she said.
Kau said the huge global economic recovery of 2004 that has propelled prices upward is not sustainable. Markets are now experiencing the start of a cyclical downturn, she said.
What has helped drive prices up is a huge flow of money coming into oil markets from commodity investment funds. These funds are likely to exit the market as prices slide, quickening the downturn, Kau said.
"These new financial players are creating a lot of short-term price volatility. For example, when some of them learned Prudhoe Bay production would be restored to the market more quickly than predicted, while there were also reports that the U.S. economy may be slowing, some of them panicked and left the market. That helped pull down the (West Texas Intermediate crude oil price index)," Kau said.
The state of Alaska's chief petroleum economist, Michael Williams, said he agrees with Kau's assessment. "Commodity hedge funds and others have introduced a new volatility into the market that we haven't seen before. Political factors alone can't explain the rapid run-up of oil prices in the last two years as well as the decline we're now seeing. It's something we're very concerned with," Williams said.
Kau believes long-term market fundamentals haven't changed, however. These include rising demand in places like China and India, declining crude oil production from non-OPEC producing countries and uncertainty over how much OPEC capacity will be available, she said.For the nearer term, however, oil supply is expected to grow faster than demand.
The growth of world crude oil demand reached a 20-year record of 3 percent in 2004, propelled mainly by China. The International Energy Association is predicting 2.5 percent growth in world oil demand this year, but Kau said she thinks that is too high.
China's oil demand is down this year because much of the 2004 requirements were for diesel-fueled power generation. The Chinese have switched more to coal-fired generation this year, reducing their demand for oil. That, plus high crude prices pushing some industries to move from oil-based energy supplies, will soften world demand below IEA projections, she believes.
On the flip side, parts of China and India are quickly modernizing, increasing consumer demands for automobiles and other goods. "Vehicle sales in China are up 20 percent for the first half of 2006," which will translate soon to more demand for transportation fuels.
Meanwhile, industry is getting caught in a squeeze in the short term. Finding and development costs for new oil are still rising, and estimates of $60-per-barrel replacement costs are not out of line, she said. This is putting industry in a squeeze in terms of replacing production, Kau said.
Steel prices have doubled since 2002 and are still rising. There are severe also shortages of equipment and skilled labor, she said.
"Oil prices have flattened or come down, but costs are still rising. Those factors, as well as higher taxes in many places, such as Alaska, mean that margins are shrinking in the industry," Kau said.
"There are challenges even in maintaining production from the North Sea and North Slope. Our board room is not a happy place these days."
Rising costs are also causing some companies to delay big development projects. Exxon Mobil's decision to defer development of Gorgon, a large natural gas project in Southeast Asia, is one example, she said.
Tim Bradner can be reached at
tim.bradner@alaskajournal.com.
