Louisiana Oil & Gas Association -

Economic concerns forcing investors to ‘flee from dollars’ to relative stability of oil

by Emilie Bahr

A chart tracking the price of oil over the past several months might be mistaken for one tracking the temperament of a moody teenager, with seemingly impossible peaks and valleys and tenuous stabilizations.

After surging last July to an unprecedented high above $145 per barrel, oil had stumbled by the end of the year with the collapse of the global economy to the $30 range.

As of July 7, the price had risen to $62.88, a slip from last month when oil hit the $70 mark for the first time since October.

The fluctuations have made it tough for state officials to anticipate future revenues and for oil producers to make decisions about drilling projects with the economics of such endeavors uncertain.

Louisiana began a new fiscal year July 1, basing its spending plans on oil at around $54 a barrel, said Greg Albrecht, chief economist for the Legislative Fiscal Office. He is loathe to make any predictions as to where the commodity is headed.

“I’m anticipating them going up and down,” Albrecht chuckled. “That’s what they’re doing now.”

The state typically resets its oil price forecast a minimum of three times each year by averaging estimates from the U.S. Energy Department, the research firm Moody’s and the state Department of Natural Resources, Albrecht said.

The $54 forecast “looks a little low” to Albrecht, who said basing the state budget on a conservative estimate last year proved advantageous when some were predicting oil’s inexorable rise. Due in large part to declining oil prices, Louisiana faces a $1.3 billion revenue decline in fiscal 2009 — a shortfall that would have been worse had the budget been based on a higher oil price.

Eric Smith, associate director of the Entergy/Tulane Energy Institute, says two primary factors are breathing new life in to the oil markets lately, upending what he calls the “classic supply-demand analysis.” Prices have climbed despite flush oil inventories and demand that’s still suppressed by the floundering economy.

“The first is that nobody goes out and looks for oil that will sell for $30,” Smith said, noting that in most of the world, producers count on oil at $70 a barrel — OPEC’s target price — to guarantee a “reasonable return” on their investment.

“For any of the typical large producers of international crude, they just can’t find oil and extract it for $30,” he said.

The second major reason for oil’s rebound, Smith said, is that prolonged concerns about the U.S. economy are forcing fearful investors around the world to look to a relatively safe place to invest their money.

“As Congress fiddles and comes up with their cap and trade programs and their stimulus programs and what have you … you’ve got a concern about the general quality and level of the economy in the United States,” he said. “The problem is people don’t trust investing in currencies. They want to hold something that’s real. … And as people flee from dollars because they don’t trust the politicians, what they invest in are commodities.

“The first thing they hit on is oil.”

Don Briggs, Louisiana Oil and Gas Association president, said producers are optimistic that oil’s June rise past the $70 threshold for the first time in eight months heralded the commodity’s correction.

“And we believe that that is certainly true,” said Briggs, adding that his view is not swayed by oil’s recent slip into the low $60 range. He pins the drop in part on a glut of oil that had been stored in tankers recently entering the market.

“I think that this is not a major crash,” he said. “This little downturn here is not turning anybody away from drilling prospects.”

Smith, for his part, believes the volatility in the oil markets has subsided, at least until the economy cranks back up.

When that happens, he predicts the world could be in for another historic surge in oil prices, with short spare oil-producing capacity — a major factor in last year’s oil price spike — again an issue.

“$140,” he said, “might look like a bargain.”•