Random Thoughts

Jim Brown
 
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OPEC wants to see $100 oil to offset the shrinking value of the dollar. Transocean hits the jackpot. Chesapeake says natural gas boom is over.

The October OPEC meeting is behind us but the comments coming from the attendees are still making waves. Several OPEC nations lobbied for some additional controls that would push oil prices to $100 in order to offset the 13% decline in the dollar since June.

OPEC left its quotas that were decided in December 2008 intact for production of 24.84 mbpd. That excludes Iraq, which is not operating under a quota. Members believed the market was well supplied and even though crude prices were testing $84 they wanted more money to offset the weak dollar.

Algeria, Libya and Venezuela pushed for prices in the $90 to $100 range. Since Algeria and Venezuela already can't produce enough to meet their current quotas they would like for other countries to take a cut in pay by reducing their output. I would not hold my breath on that expectation.

It is pretty much a unanimous understanding among analysts that $85 is the current ceiling price for oil and anything over that will begin dragging down the global economy and potentially trigger a new recessionary dip. Since the $85 level will be breached in 2011 we should prepare now for that eventuality.

The latest consensus estimates for the peak in global production is 2014 if claimed excess capacity actually exists and 2012 if that capacity is only a hopeful gleam in some oil minister's eye.

You may remember comments from Goldman Sachs last week when they predicted "substantially higher prices" for oil in the second half of 2011 and 2012. They believe the supply-demand balance will continue to tighten in the current quarter as global economic growth slowly improves. Goldman said "moving into the second half of 2011 and 2012, we expect the global inventory surplus to be exhausted and OPEC spare capacity to be drawn down to balance the market." This will lead to substantially higher prices.

If the Fed follows through with another QE program designed to lower interest rates and stimulate growth it will also further cheapen the dollar. This will also force oil prices higher and be seen as an energy tax on global consumers.

Transocean

Transocean (RIG) announced last week it had signed a five year contract with Exxon Mobil for $703,000 per day to lease the Deepwater Champion, a specialized ultra deepwater drillship to drill for oil and gas in the Black Sea, Gulf of Mexico and off the coast of Brazil. The rig will initially work in the Black Sea for the first year and then move either to the Gulf of Mexico if permits are being issued or to the deepwater off the coast of Brazil.

Gas Boom Over

Chesapeake CEO Aubrey McClendon told investors during the company's annual meeting that all the shale gas in North America had been discovered. By the end of 2011 all the major shale basins in North America will have been drilled. That does not mean there is no more gas, only that there are no more large deposits remaining to be found.

Most people don't realize that hydrocarbon geology is an open book and has been for more than 50 years. Geologists have maps of the underlying strata that are probably more detailed in many cases than an AAA road atlas. Once oil or gas is found in a specific type of formation, every formation like that was immediately targeted for exploration. With possibly more than one million wells drilled in the U.S. since the industry was born there is very little that is unknown about U.S. geology. There were nearly 35,000 wells drilled in 2009 alone.

McClendon told investors Chesapeake was done being primarily a natural gas company. He said the company would continue to joint venture with others to drill out existing gas acreage but Chesapeake was transitioning to primarily an oil company. McClendon said CHK is sitting on 10-15 billion barrels of oil and that would change the valuation of the company over time.

CHK just inked a deal to sell a third of its Eagle Ford interests to CNOOC for $2.16 billion in cash and funding for drilling. This is just one more in a long line of deals where CHK sold off interests to raise cash. Like other gas exploration companies they overspent for existing acreage and gas prices plummeted preventing them from cash flowing by drilling alone.

This is the direction most active gas drillers are taking. The price of oil has remained stable and rising making wet gas with a high level of natural gas liquids profitable along with the quantities of oil produced. After beating their collective heads on the ground in frustration with the falling gas prices they have elected to move elsewhere and take the methods they have learned in shale gas and concentrate on similar formations with tight oil concentrations.

I don't think CHK is a buy yet because I believe they still have cash flow problems. Once they actually begin producing oil and NGLs in volume we will probably just be entering the next price spike into peak oil and they will be a major U.S. player. If we see a continued decline back to $20 on CHK I would consider starting a position.

Jim Brown

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