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 $1.75 per litre

    TORONTO, Aug. 29 /CNW/ - 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, motorists should brace for gasoline to spike
to $1.75 per litre 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 $1.75 per litre."
    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 U.S.
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 U.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 in the U.S. 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
for the U.S. to replace. It notes that even if approval is granted to open
development in the Arctic National Wildlife Refuge (ANWR), the U.S. 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 for the U.S. 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's
        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.




For further information:

For further information: Jeff Rubin, Chief Strategist and Chief
Economist, CIBC World Markets at (416) 594-7357, jeff.rubin@cibc.ca or Kevin
Dove, Communications and Public Affairs at (416) 980-8835, kevin.dove@cibc.ca


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