<THE DRIP PORTFOLIO>
The Economic Scene
...and its effects on energy demand
by Brian Graney ([email protected])
ALEXANDRIA, VA (Nov. 18, 1998) -- After yesterday's brief introduction to international politics and its effects on the oil and gas industry we are studying, it's time to turn our attention to the equally important nuances of global politics' sibling, international economics.
Again, we are sailing into some normally forbidden waters with this topic, as we did yesterday with our discussion of things political. Economics can be a fascinating subject in its own right, of course. However, some folks will always find the subject a little on the dry side, preferring instead the intellectual stimulation provided by a good game of tiddlywinks or reruns of The Three Stooges. For the most part, Jeff and I belong to this second camp and prefer to work around the topic of economics as much as possible in order to avoid saying anything dumb.
After looking at how international policy issues can impact oil and gas supply, though, it may be equally instructive to examine global demand issues by exploring the role of international economics. The two subjects are inter-related, and addressing one without sharing our thoughts on the other might be construed as... well, dumb.
Oil and gas supply and demand issues are especially relevant right now, considering that the financial results of several companies in our study have taken a hit from falling energy prices over the last year. In the case of oil, slowing demand is a major issue in the recent price slide.
After rosy demand forecasts prompted production increases around the globe this time last year, the oil industry is now confronting a glut. According to a recent International Energy Agency report, the worldwide demand for oil is projected to grow at an anemic 0.75% annual rate this year, which will be the lowest growth rate in five years. Moreover, oil demand next year is expected to grow at a less than breath-taking annual pace of 1.7%. Most of the blame for the growth slowdown is being laid on the rickety doorsteps of Asia and Russia, where demand for oil has plummeted on the heels of a persistent (and contagious) financial slowdown.
In economics, lower demand must be offset theoretically by lower supply to maintain a balance, even in the energy world. It may be helpful to think of the situation in terms of a global game of tug-of-war where neither side is allowed to win. When one side gets even the slightest advantage over the other, the market will step in to even things out. In this case, the demand team is losing its grip on the rope. To correct the situation, the market has stepped in with lower oil prices in order to get the supply team to stop pulling before everyone ends up in the mud.
This is simplifying things a great deal, of course. Yet, the folks on the supply end of our imaginary tugging match are indeed responding to the lower demand conditions by reining in production. So far this year, the eleven large oil producing nations belonging to OPEC have attempted to cut the world's supply of oil by a total of 4% through various pledges, promises, and oaths. Even non-OPEC members, such as Mexico, have offered to cut back production.
But because many countries around the world depend on energy production for their own economic well-being, cutting back supply is always a difficult choice, regardless of the imbalances that may exist in the world. Political considerations come into play, throwing a monkey wrench in the functioning of such well-regarded economic concepts as supply-demand theory.
Under this theory, the market should be able to correct any imbalance on its own. Unfortunately, economic theory gives little in the way of guidance on just how long it may take to restore a balance in the marketplace and which suppliers should bear the brunt of the needed production cutbacks.
It is at this point that the heretofore separate issues of economics and politics start to blend together like the colors on an artist's palette. Curtailing global energy supplies when demand is low may seem like the rational thing for energy-rich countries to do under economic theory. But at the same time, cutting back domestic production of a needed export may appear to be completely irrational from a political standpoint. It would likely be an unpopular initiative domestically as it runs the risk of lowering the country's economic growth.
Stuck in the middle of this policy tightrope act are the U.S. oil and gas producers on our list, which, as we know, are relying more and more on their international operations for their own business growth. On an individual basis, they can do very little to change the economic or political environments existing at any one point in time around the world. Their only hope is to react to the conditions facing them by cutting internal costs, lowering future overseas exploration and production budgets, and taking other steps until the imbalances can work themselves out in the marketplace. This is precisely what we are seeing the big U.S. producers doing right now.
We'll look at the current cost-cutting efforts of individual companies a little bit later. But first, we'll take a closer look at the global oil and gas marketplace and how commodity prices can affect the financial performance of the companies in our study. Until then, drop by the message boards and contribute your own two cents to our ongoing discussion.
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