Providing coverage of Alaska and northern Canada's oil and gas industry
November 2008

Vol. 13, No. 48 Week of November 30, 2008

Dark inches ahead, bright mile beyond

Economist says oil price fundamentals haven’t changed: demand expected to grow, dollar expected to fall, prices expected to rise; long-term growth should be good for Alaska

Eric Lidji

Petroleum News

The future for oil and gas is bright, but only for those looking far enough down the road.

While sinking oil prices cloud the short-term view of the industry, a generally declining dollar and consistent long-term growth in global demand should be good for Alaska, according to Jonathan King with Northern Economics, an Anchorage-based analysis firm.

But in the short term, many factors will determine whether companies invest in the state, King said at the annual conference of the Resource Development Council on Nov. 20.

King noted that the world is in the middle of the first “concurrent” global recession since the end of World War II, meaning recessions in the United States, Europe and Japan.

“It’s deep and it’s cold outside,” King said.

With consumer confidence at a 25-year low and banks hesitant to lend, companies with cash are in the best position to weather the credit crisis, King said. But companies with those deep pockets are rare and, “We do expect reduced exploration expenditures,” King said.

High-cost basins like the Alberta oil sands are already seeing cuts. Although cheaper than the oil sands, Alaska is an expensive province as well, and with oil at $55 a barrel, “we’re right on that cusp. … We really don’t want to see prices go down below 40,” King said.

Those volatile prices will test the new state fiscal structure created in November 2007.

Proponents of the bill, called Alaska’s Clear and Equitable Share, or ACES, believe it strikes a balance between an increased tax rate and expanded exploration credits, while using progressive surcharges to make the tax code work at high or low prices. But opponents argue it threatens investment by raising the marginal cost of doing business.

“It’s going to be really interesting to see how ACES performs,” King said.

Silver linings in dark clouds

In the long term, King sees two reasons for optimism: the dollar and the Chinese.

“Exchange rates really matter for us as the owner state,” King said. “Commodity prices are directly related with what goes on with our dollar: When the dollar falls, commodity prices rise.”

This inverse relationship is why oil prices climbed between 2001 and this summer while the dollar slowly fell. And when price suddenly tanked this fall, the dollar jumped.

“The demand or lack of demand for our dollar drives oil prices nearly as much as supply and demand for oil does,” King said. “And we are in a long-term decline in the value of our dollar.”

Although the dollar has rebounded in recent months, King expects it to decline over the long term unless fiscal policy addresses federal budget deficits and trade imbalances.

“You cannot run a capital current account deficit for many consecutive years without destroying your currency,” King said. “We’re in the process of doing that right now.”

The declining dollar means increasing commodity prices, which is good for Alaska, but King warned that if the dollar falls too far commodities could eventually be priced in other currencies, like the Euro, which would change the dynamic for Alaska.

Demand will rise

While King expects the dollar to fall in the long run, he also expects demand to rise.

“Bubbles pop. … The long-term story is intact,” he said. “World commodity demand will return.”

King said recovery might begin in China, which he said needs 7 percent growth just to cover migration from rural to urban areas. The country recently initiated one of the largest stimulus packages in history, and maintains large reserves of foreign currency.

“They have deep pockets,” King said about the Chinese government. “They may be the engine that pulls us out of this global recession. So right now I say: Root for Alaska, root for America, and, frankly, root for China.”

King believes Alaska remains attractive for investment, largely because companies here don’t face the same threats of terrorism or government takeover they face in other prolific basins. But he added that the future depends on how companies respond in the near term.

“Shut-ins and project delays are going to fuel the next increase in commodity prices. The decisions being made now … will propel the next leg up in commodity prices,” King said, adding that while the timeline is unknown, “That will help us when it happens.”

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