Ferguson: Energy Matters: BP Pouring Oil on Troubled Tundra

By Published On: August 11, 2006

BP shut down the Prudhoe Bay oil pipeline this week, sending oil prices up and politicians scurrying. Four hundred thousand barrels of crude oil per day were shut in – about 0.5 percent of global supplies. Prices jumped $2.22/bbl when the news broke, about 3 percent. Cynics wondered whether BP revenues would rise as a result. Corrosion problems with this pipeline have been known for years, and a serious leak earlier this year dumped 200,000 gallons of crude oil on the tundra. The Environmental Protection Agency responded with a million-dollar slap on the wrist. A grand jury demanded that a 16-foot section of pipe be sent to Anchorage for study. BP, knowing that the leak was a symptom of extensive corrosion, had no choice but to fess up, cease pipeline operations, and repair the pipe. The legal wrangling will continue for years. The state of Alaska, with no sales or income taxes, is dependent on oil income from Prudhoe Bay. Alaska is now losing $6.4 million per day in revenue and will be broke in a matter of months if the pipeline is not rebuilt quickly. In addition to the legal fallout that is certain to occur, BP’s carefully nurtured green image was unmasked as a cynical marketing scam. BP has been a major advocate for opening the Arctic National Wildlife Refuge (ANWR) to oil production, citing the lack of problems at Prudhoe Bay as evidence of how benign operations are. Oops. Oil prices have returned to last week’s preclosure levels as markets realized that the oil world as we know it was not going to end with a temporary loss of only half a percent of supplies. Even California, which is heavily dependent on Alaskan crude, will survive. While the media are engaged in the BP news, a more interesting story is the continuing surprises in natural gas markets. Yesterday, the Energy Information Administration reported another decrease in U.S. gas storage, even larger than the one two weeks ago. Storage levels have never before decreased during the summer. The recent spate of hot weather has been blamed, but we forecasters attempt to factor that into our predictions. My forecast for yesterday’s report – for the week ending August 4 – was for little change in storage, as exceptional air conditioning demand ate up the usual surplus that occurs in the summer. Other forecasts I’ve seen were similar, but EIA reported that 12 billion cubic feet were taken out of storage. It is entirely possible that our computer models are not very accurate when faced with extreme temperatures. Several nuclear plants were also out of service, increasing gas demand. However, I continue to suspect that something more unusual than hot weather is occurring. Consumption of natural gas unrelated to weather dropped dramatically in the wake of the hurricanes last fall but has been rebounding ever since. Data for May, the most recent month available, showed that this consumption was back to pre-hurricane levels. It is unlikely, however, to have increased enough in the last few months to account for the draw on storage. The other possibility is that North American gas supplies have declined further. A few months ago, as readers will recall, there were concerns that storage capacity would be inadequate and prices would fall dramatically. Have some producers curtailed drilling in response to these expectations? If so, the strategy worked. Gas prices for delivery over the next 12 months are well above $9/MMBtu, with the price of delivery next January and February near $11.50/MMBtu. The market response to the BP news and the unusual gas results illustrate how closely we are operating to the energy edge. There is very little margin for error. It is not unreasonable to suspect that some producers may be manipulating the situation by limiting supplies to drive up prices. All this raises an intriguing question: Imagine that you are a director of a major energy company. Staff present a proposal that reduces the amount of energy your company would produce next year, together with a detailed analysis of how this plan would increase corporate revenues and profits by raising prices. You can find no downside to the plan. Do you have a legal duty to your shareholders to approve it?

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