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The TSC Energy Roundtable, Part 2

Christopher Edmonds

Christopher Edmonds: Let's end the focus on oil by putting each of you on the spot. Dan, where do you think oil prices will finish the year in 2001?

Dan Pickering: Our official, end-of-the-year 2001 price is $25 a barrel. And I'd say the average price for the year will be about $27 a barrel.

John Segner: I'm going to say $26 into the next year.

Marshall Adkins: $32. My guess is that the bias will be even higher than that. Probably higher early, lower later.

Doug Hohertz: I'd say in the $26 to $27 range for the year.

Bryan Dutt: Through Ironman's "extensive commodity pricing modeling forecast," at the end of 2001, I believe it's going to be shockingly low, around $18.25.

Christopher Edmonds: Let's turn our attention to natural gas. While energy prices, in general, have increased, gas has clearly outpaced crude oil in price gains this year. Is it possible that natural gas and crude oil prices are beginning to decouple? If so, can it last?

Doug Hohertz: Well, I think there's a chance of decoupling this time for reasons we've never had in the past, and that's the enormous amount of growth in gas-fired new power generation. And the amount of power generation that's slated to be developed over the next five years is significant. I think there's over 250,000 megawatts of projects that have been announced. Now, not all that's going to get built. But even if you build 100,000 megawatts of that, you're going to have to bring on 8 or 9 billion cubic feet [Bcf] a day of additional gas supply to deal with it.

And the prices that power generators can pay and pass through are in a much higher range than where gas has traded in the past. So even though you may have crude pull back some, you're going to see gas maintain at a higher range, because of this new increased demand.

The question is, at what level do consumers get prices out of the gas market? We've had ammonia producers who are shut down and some industrial users continue to shut down. And businesses like steelmakers are reducing gas consumption when they can.

So the question is, how much demand do we price out of the market in this transitionary period?

Jeff Dietert: I think high gas prices are forcing the products to come together. We've seen examples where natural gas prices are higher than natural gas liquids prices, so many of the processors are avoiding taking out liquids. While at the same time we've seen examples of refiners who are selling their natural gas back into the spot market for natural gas and burning propane or butane as alternative fuels. That can't happen for very long -- you've got to continue to take the liquids out so that they will be available as an alternative fuel. I think the markets have to work together.

Christopher Edmonds: John, in your fund, do you focus on gas more than oil here?

John Segner: Yes, I do. We have more of a natural gas bias not only because of the economic growth and the power demands on natural gas, it's also environmental. It's more acceptable and it's going to be a priority, with regulators and everybody else pushing natural gas as much as possible. "I think California is the first symptom of what we're going to see across the U.S. before the end of the winter; significant rationing of natural gas."

Christopher Edmonds: Marshall, your firm is very bullish on natural gas prices. You think we've only seen the beginning of price inflation in natural gas. How high can it go?

Marshall Adkins: I think everybody in this room who really studies gas has been very bullish on gas. I mean, pretty much everyone here has been bullish. I'll tell you, probably the only difference is, as I was looking at it, I basically made the assumption that, if we're running the risk of running out of natural gas, as I think we are regionally here in the U.S. this winter, how high are prices going to go? I hold that they're going to highly inelastic. When you run out, people pay whatever the hell it takes.

I think California is the first symptom of what we're going to see across the U.S. before the end of the winter; significant rationing of natural gas. And the way you ration natural gas in a free market is you take the prices up sufficiently to slow down demand.

And, to a degree, that's what's happening in all of these energy markets. You're in a supply-constrained market. If you're in a supply-constrained market the only way that you can allocate those limited resources is through a higher pricing mechanism. I think the gas equation is much tighter than the oil equation. It's a much safer bet than oil, there are fewer wild cards at this stage of the game and, accordingly, that's why we're so bullish on natural gas.

Is there going to be this decoupling that lasts? My analogy is you used to have gas and oil connected with a chain. Whenever one moved, it jerked the other one up or down with it. Now it's more like a bungee cord where, over time, they'll tend to exert pressure on one another to come back in line. So you're probably not going to see a huge, lasting deviation over the long term, but in the next year or two, I think you'll see major outperformance by natural gas.

Christopher Edmonds: Can we really run out of natural gas?

Bryan Dutt: We'll never run out of natural gas, that's the nature of the commodity. As Marshall said, the market pricing mechanism is how you ration, so we won't run out of gas. We won't freeze in the dark. That's just not going to happen.

Christopher Edmonds: Not even in California?

Bryan Dutt: The politicians might be able to screw that up sufficiently.

I'd like to add to Dan's major caveat that I'm very concerned about potential government intervention. Maybe they do another windfall profits tax or something similar. There aren't a lot of electoral votes to be lost in Texas or Oklahoma. I think it'd be very politically advantageous to whack big, mean, nasty oil and do something legislatively that could really cripple our industry again. "I think it'd be very politically advantageous to whack big, mean, nasty oil and do something legislatively that could really cripple our industry again."

Christopher Edmonds: You think that's a possibility, even with the Bush administration?

Bryan Dutt: I think it's certainly diminished with a Bush administration, but I think the political pressure might be onerous on him to do something, especially if we have gas prices where they are right now.

Once consumers start to get their electric and gas bills, I think the utilities group is going to really feel the wrath and then it may filter through the rest of the industry. I think it's a serious consideration.

Christopher Edmonds: So you're suggesting there's political risk in many of these stocks?

Dan Pickering: Yes, but I think it's still too early. I think there's some California political risk that may place some heat on the power generators that supply that market and then the blanket spreads over everyone. You may have some political risk in some of the convergence stocks.

But, to me, people don't believe yet. To impose a windfall profits tax, you have to believe that there are going to be sustainable windfall profits. And we're not there yet. The companies aren't there. The government's not there yet, because we're still in somewhat of a denial mode. Even we are predicting crude prices that are generally lower than current levels for next year.

So I still think it's too early to worry about that, but it will become, I think, a much bigger weight on the stocks as the bullish views turn into consensus. That's when I'm going to really worry about it.

John Segner: Political risk may exist, but I think it has diminished. I mean, I think the new administration is going to show some leadership in this area and explain that the problem here is that we don't have enough capacity. What we need to do is have less regulations and encourage the industry to expand capacity and don't lower the rate of return by imposing taxes. You can't make someone expand capacity if they don't get a good rate of return. And having a windfall profits tax will not get us from undersupply to oversupply, which is where we as a country would like to get so we can resume robust economic growth.

So I think the new administration is more likely to articulate what the real problems are in the industry, instead of making the energy industry a whipping boy. It doesn't help much when you go around talking about "big oil," like one of the presidential candidates did all the time. That doesn't help solve the underlying problem.

Christopher Edmonds: Does that suggest we'll see a Bush administration relax environmental regulations and possibly open up new exploration territories in Alaska, the Rockies or even the coasts?

John Segner: This industry is actually very responsible environmentally. That's one of the misconceptions out there. If you look at the new developments, they are very environmentally sensitive.

The image is that we've got these old cranky rigs you always see on TV, the 1950s kind of technology. That's not what we use anymore. And there's not a company I'm aware of that doesn't put safety and environmental issues at the very top of their lists in the way they do business.

Natural gas is particularly clean in the development process. And not only producing the gas, but also the way we use it. It's an educational process and I think the new administration has some people with some unique knowledge who can help articulate the real facts.

But I don't think we necessarily need to relax environmental policy. But to just automatically say we're not going to develop a new area because of the environment isn't good policy. I think first we have to determine if there's anything in some of these areas and then we can talk about the "strictest of strict" environmental ways to develop it. "Having a windfall profits tax will not get us from undersupply to oversupply, which is where we as a country would like to get so we can resume robust economic growth."

Jeff Dietert: One thing that's changed, too, I think, if you look back at the 1970s, the major integrated oil companies were integrated from the wellhead through the refinery and into marketing. And one of the things we saw in the second quarter, when the Chicago prices blew out, is that it was really difficult to pinpoint who was making all the money. There are different players in the refining business than there are in the marketing business, and the marketers were on the street, their margins were poor, yet prices were high. You now can't just pass a windfall profits tax and simply address the issue that you're trying to address. So I think that would be much more difficult this time around.

John Segner: You know, it's kind of funny, we always have these little investigations, or witch hunts, to find out who made money, like we did in the Chicago situation this summer. You know, we never hear the results of them, isn't that funny? I mean, they never find anyone guilty of anything.

To read where the Roundtable members think natural gas prices will end the year, click here.