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Vol. 13, No. 42 Week of October 19, 2008
Providing coverage of Alaska and northern Canada's oil and gas industry

Cash is king

It’s too early to know final impact of economic crisis on oil, gas industry

Alan Bailey

Petroleum News

The financial crisis that is churning its way around the world economy seems likely to cause an international recession at best and could cause a global economic meltdown at worst. But how might this disruption in world finance markets impact the oil and gas industry?

It’s too early to say, John Felmy, chief economist for the American Petroleum Institute, told Petroleum News Oct. 14. People are waiting to see the impact of the measures that the U.S. government has taken in response to the current crisis, he said.

On the other hand the U.S. economy has become relatively weak and that could put the brakes on worldwide economic activity.

“That could affect things like purchases which of course could then cascade around the globe, because of impacts on China and India and so on,” Felmy said. That could then push oil prices lower because of changes in international energy demand.

A recent drop in the price of diesel fuel would seem to point to a continuing decline in oil prices, he said.

“In my mind that is a leading indicator,” he said.

Credit squeeze

Given the current credit squeeze, some of the smaller oil and gas companies have started to run into issues with financing new exploration and development projects, Ken Thompson, managing director of Alaska Venture Capital Group, told Petroleum News Oct. 15. AVCG subsidiary Brooks Range Petroleum is engaged in a multi-year exploration program on Alaska’s North Slope.

Thomson said that he knows of one company in the Lower 48 that recently sought financing for an expanded drilling program.

“They went out for financing for about $150 million,” Thompson said. “… This time only one offer came back and the interest rate was above 12 percent, so they’re actually deferring a lot of the development into future years.”

On the other hand, major oil companies should not run into immediate problems with funding projects because these companies are likely awash with money as a consequence of the recent high oil prices.

“In this kind of climate, cash is king,” Thompson said. If companies don’t have adequate cash they’ll scale back, seek additional partners and may even become acquisition targets. And it is possible that companies that do have adequate cash will choose to restructure their programs because of current uncertainties, he said.

Thompson said that AVCG and its partners already have funds for their exploration drilling and seismic program for the coming winter and don’t need to take on any debt. And the investment tax credit arrangements in the new Alaska’s Clear and Equitable Share tax mean that the State of Alaska is now sharing some of the exploration risk, thus improving project economics, he said.

“We’re still progressing with our exploration plans of three more penetrations in the Gwydyr Bay area, to see if we can confirm sufficient reserves for a commercial development,” Thompson said. “… The credit crisis … is not affecting us. All the companies (involved) already had the capital lined up.”

And, although oil prices soared to dizzy heights earlier in 2008, AVCG/Brooks Range Petroleum has taken quite a conservative view of future prices for its project economics, Thomson said.

Thompson actually sees the current economic situation as having potential for future benefits in Alaska. Interest rates are going down and that will lessen the future cost of capital, once the current crisis is past, he said. And, as the country moves past the coming recession, people will want to start investing capital again. All of that bodes well for projects such as the North Slope gas line.

“The best time for equity investment is usually six to eight months prior to the end of the recession,” Thompson said. “… At the end of the recession should be the prime time to move ahead on a gas line.”

State revenue

Petroleum News also checked with the Alaska Department of Revenue on the impact of lower oil prices on the state’s financial plans — oil prices have already dropped significantly in response to the world economic turmoil.

With nearly 90 percent of the State of Alaska’s funding originating from oil and gas revenues, oil prices are critical to the state’s financial health. At what point would the state’s finances start really hurting, if a recession in the United States were to feed through to reduced world oil demand and a continuing decline in oil prices?

According to Department of Revenue data, the state has assumed an average oil price of $83.04 per barrel for state revenue in the financial year from July 1, 2008, to June 31, 2009. As of Oct. 15 the price of Alaska North Slope West Coast crude had dropped to $71.48 per barrel.

But that drop below the state’s assumed price projection is not necessarily a problem. The average oil price for July, August and September ranged between $101 and $132. So the state could achieve its revenue targets for the complete financial year, even if for the remainder of the year the oil price remains significantly below that assumed $83.04 level, Cherie Nienhuis, acting chief economist for the Department of Revenue, told Petroleum News.

And Alaska oil production, the other critical variable in the state revenue equation, has so far met the state’s expectations of an average of 689,124 per day during the financial year.

“It seems to be on track for the year,” Nienhuis said.

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