Hurricanes threaten Gulf of Mexico oil production - supply likely never to reach pre-Katrina levels: CIBC World Markets 2005-like storms could push gasoline to $5 per gallon



    NEW YORK, Aug. 29 /PRNewswire-FirstCall/ - CIBC (CM: TSX; NYSE) - With
 Tropical Storm Gustav bearing down on the Gulf of Mexico and most weather
 agencies calling for an active hurricane season, American motorists should
 brace for gasoline to spike to $5 per gallon as storms threaten to shut
 down oil production in the region, predicts a new report from CIBC World
 Markets.
 
     The report notes that oil production in the rig-dotted Gulf, which has
 been seen as America's best hope for greater energy self-sufficiency, will
 be increasingly threatened by severe storms that continue to grow in
 frequency and strength in the region.
 
     "Only three years after hurricanes Katrina and Rita devastated Gulf of
 Mexico oil and gas production, an emerging hurricane storm is tracking
 another potentially lethal swath through America's energy heartland," says
 Jeff Rubin, Chief Economist at CIBC World Markets. "And with both oil and
 gasoline inventories much lower than when Katrina and Rita hit, the price
 consequences could be even worse this time. Any replays of the 2005 storm
 season could see gasoline prices soar to $5 per gallon."
 
     While Mr. Rubin acknowledges that the supply disruptions, and attendant
 price hikes, will be temporary, he sees lasting impacts from hurricane
 damage on future supply growth. "Protracted multi-year delays to marquee
 projects like BP's Thunder Horse have meant that new production has grown
 at a fraction of earlier projections for the region and has lagged well
 behind rapid double-digit depletion rates that are characteristic of
 offshore fields.
 
     "The net result has been a multi-year, and now likely irreversible,
 decline in oil production from the region. Already down some 300,000
 barrels per day from its pre-Katrina peak, Gulf of Mexico production is
 likely to lose another 200,000 barrels over the next five years. Instead of
 ramping up production to over 2 million barrels per day as once dreamed by
 the Departments of the Interior and Energy, Gulf of Mexico production is
 likely to fall to a low of a million barrels per day by 2013 - almost a
 third lower than the region's production prior to the 2005 storm season."
 
     The report notes that while previous hurricanes have caused equipment
 damage and production losses, the toll has increased in recent years. The
 top five hurricanes, in terms of lost production, have all occurred in the
 last half-decade and their impacts are becoming more lasting. Three months
 after Katrina and Rita hit, nearly 40 per cent of Gulf oil production was
 still shut in. Together, Katrina and Rita damaged 167 offshore platforms
 and 183 pipelines.
 
     "The unprecedented 100 million barrels of shut-in from those storms
 does not even begin to count longer term losses due to delays of as much as
 three to four years in bringing new fields, like Thunder Horse, online,"
 notes Mr. Rubin. "They also took offline as much as 25 per cent of the
 nation's refinery capacity, 40 per cent of which is located in the Gulf
 States."
 
     While the impact of Katrina saw oil prices jump by 10 per cent to a
 record $70 a barrel, gasoline prices zoomed from just over $2 to well over
 $3 a gallon. Crack spreads - the difference between the cost of a barrel of
 oil, and the value of the products it can be refined into such as gasoline
 - leaped to the $40-50 per barrel range, as storm outages strained refinery
 capacity.
 
     Mr. Rubin says that alone added 75 cents or more to the cost of a
 gallon of gasoline. Wider retail margins on crude shortage fears added 20
 cents and the increase in oil prices themselves added another 20 cents.
 Given tighter supplies and lower inventories, he doesn't think it will take
 as large a supply shock today to cause a comparable pump price jolt as we
 saw in 2005.
 
     The report finds that the decline in Gulf production will be difficult
 to replace. It notes that even if approval is granted to open development
 in the Arctic National Wildlife Refuge (ANWR), the Department of Energy
 estimates that first flow will not occur until 2018, and initial first
 estimates from the Arctic are notorious for lengthy pushbacks. Moreover, it
 would take a minimum of a decade after that to reach its ultimate projected
 peak of 780,000 barrels daily.
 
     "Whether we will see any oil flow from that, or for that matter, from
 the other Arctic deposits in Canada, Greenland or Russia by 2018 remains to
 be seen," states Mr. Rubin. "But it is certainly clear that no matter what
 policies are taken toward the ANWR, the region will provide no offset to a
 further decline in both Gulf of Mexico production and lower 48 state oil
 production over the next five years."
 
     During that time, total U.S. production is likely to decline by almost
 600,000 barrels to 4.5 million barrels per day, with roughly half of that
 drop coming from further reductions in conventional production from the
 lower 48 states.
 
     The report also cites major challenges in increasing imports from many
 key suppliers.
 
 
- Imports from Mexico, currently running at almost one-and-a-quarter million barrels per day are likely to evaporate altogether over the next five years. The giant Cantarell field, the source of nearly 40 per cent of Mexican production, faces the potential loss of another 800,000 barrels per day over that time frame. Year-on-year rates of decline over 30 per cent or more in the field's output suggest Mexico will soon cease to be a net oil exporter altogether within the next half-decade. - Production in Venezuela, the next largest U.S. crude supplier, had already started to decline prior to Hugo Chavez becoming president and the drop has accelerated under his administration. While Venezuela has oil sands, its deposits are deeper and more costly to develop than Canada's. And unlike Canadian oil sands that are the recipient of billions of foreign direct investments, Chavez' expropriation of foreign oil companies will keep foreign capital largely at bay. - A simmering civil war in the Niger Delta makes Nigeria's 2.5 million barrel-per-day production capacity an even less certain source of supply. - Canada, America's largest and closest supplier, can increase its production only from oil sands. While industry plans call for a doubling in production from just over a million barrels per day during the next decade, lengthy delays and mounting cost overruns have become the norm for the now mammoth sized Canadian oil sands projects. And most of what is exported to the U.S. market requires extensive refining to convert the fuel into synthetic crude. "There is no debate that at today's oil prices U.S. demand will continue to fall," adds Mr. Rubin. "The question is whether demand destruction can keep pace with the destruction in supply." The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/saug08.pdf. CIBC World Markets is the wholesale and corporate banking arm of CIBC, providing a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.

SOURCE CIBC World Markets

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