I wrote last week how oil prices were stagnating even as OPEC cut the daily output by 2.2 million barrels, a move that definitely failed to jack up oil and gas prices. Right now, the “demand” side of supply and demand is calling the shots and, while the long term looks reasonably positive, for the short term, oil investors need to be careful.
 
Why? Because lack of demand across the globe is already impacting the economic health of foreign oil producers, and not in a good way. Inflation in Russia, for example, could climb as high as 15 per cent in 2009 depending on oil price levels. Another major oil and gas producer, Venezuela, is trying to replace flattening energy prices by taking over some of the country’s largest private and highly profitable gold mines.
 
Hey, even our armed forces are taking a hit. Pushed by federal legislative mandates and the need to save money on energy costs, the U.S. Navy has reduced its overall consumption level by 12 percent in 2008 and will do the same, if not more, in 2009.
 
Now, I’m an optimist, especially for the long-term, but as I said last week, things are getting tough out there. So for the short term, at least, oil producers won’t see much relief. Exhibit “A” is a report from Deutsche Bank that, in 2009, demand for oil will fall to its lowest levels in 25 years. (Of course, even Deutsche Bank concedes that the price of oil will bounce back close to $50 per barrel by the end of 2009).
 
But others are more upbeat, or as upbeat as the current energy investment picture will allow. Fitch Rating Systems is out with its 2009 oil and gas outlook for North America. According to the report, the outlook for the U.S. oil & gas industry in 2009 is “stable but weaker due to the sharp drop in commodity prices.  With the multi-year run-up in energy prices grinding sharply to a halt in the third quarter, credit metrics across the oil & gas sector are set to drop from their recent highs. As global economic conditions continue to deteriorate, risks for further downward movement in commodity prices remain possible as global demand for commodities is expected to continue to come under pressure.”
 
Yet Fitch is rather bullish on drillers, and bearish on refineries, in 2009. Says Fitch; “In general, the offshore drillers within the drilling and services sector are best suited to weather the current downturn due to their large backlog of contracts signed during the earlier boom. In contrast, refiners are among the most exposed to the downturn as fuel sales and refinery utilization rates continue to slump in response to sinking global demand.”
 
For drilling and services providers, growth will be bolstered by good credit quality and sizeable backlogs and continued drilling on long-term projects. One area for oil drillers to be aware of is the stability of commodity prices. It’s a two-sided coin, it will cost less for oil drillers to build and streamline infrastructures, as the price of steel and iron decline. But pricing power after the oil gets out of the ground could suffer, too.
 
The Fitch report makes for good reading. Check it out at http://uk.reuters.com/article/oilRpt/idUKWNA162520081211.
 
For domestic drilling investors, it’s a mixed bag going forward – some good prospects and some labored ones. But that’s only natural in a volatile energy investment environment. Above all, emotions, as always, are where the focus should lie. The temptation is to look in the rear view mirror in hopes that the worst is behind us as a new year beckons. But as the famous scene from Jurassic Park tells us, where the T-Rex chases the jeep through the jungle, objects in the rear view mirror are closer than they appear.
 
To that end, we still haven’t shed some of the problems the oil industry faced in 2008, at least completely. Demand remains down, and should stay that way through the first quarter of 2009. In the meantime, most oil and gas infrastructure projects will be delayed or at least stretched out so outlay costs are minimal, but progress will still be made when demand resumes in mid-2009, as most experts are indicating.
 
Still, expect oil to rebound to a range of between $50 and $65 as the year progresses, and long-term, expect the price of oil to exceed $100 by 2010 as we finally leave that T-Rex behind us for good.