EconSouth - Fourth Quarter 2007

The Southeastern Economy in 2008

Energy Demand Sizzles in 2007

photo of gas pump handleOil prices are high and volatile, geopolitical tension continues to threaten the oil supply, consumers are facing higher costs at the pump and at home, and businesses are facing higher fuel expenses. Could there be good news in such a situation? One glimmer might be the increased deepwater exploration for oil off the coasts of Louisiana, Mississippi, and Alabama, which is reaching new heights (and depths). Also, the oil-producing states in the Gulf are seeing an increase in oil and gas revenues. The downside, of course, is the potential for higher consumer prices for a wide range of goods and services.

Reaching deep for profits
In a time when crude oil prices have risen by more than $30 a barrel within a year and the energy market shudders from news of a new supply shock, expansion in deepwater exploration brings good news to Gulf Coast states. Deepwater exploration, made practical by higher oil prices, continued to increase through 2007. The number of rigs drilling in ultradeep water (at least 5,000 feet) in the Gulf of Mexico hit an all-time high in August 2007, according to the Louisiana Department of Natural Resources.

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Exploration in the Gulf area received an added boost from a record number of technology approvals granted by the U.S. Minerals Management Service (MMS), the federal agency that manages U.S. natural gas, oil, and other mineral resources on the outer continental shelf. Being able to drill in deeper water and extract greater amounts of oil per rig have resulted in greater offshore crude oil production through October 2007 than the same period in 2006.

Gulf Coast oil extraction potential was further enhanced in October 2007, when the federal Central Gulf of Mexico Lease Sale generated the second-highest total bids in U.S. leasing history. The federal areas off the shores of Louisiana, Alabama, and Mississippi could bring up a potential 1.3 billion barrels of oil—more than four times the total U.S. production in 2006—to the market. Another 5.2 trillion cubic feet of natural gas, about 20 percent of 2006 gross production, could also come from the area. The sale attracted several foreign oil companies who are willing to forgo higher potential yields in the Middle East, where nationalism and geopolitical strife have made doing business difficult.

Related Links
On the Web:
Energy Information Administration
Oil and Gas Journal

State governments generate considerable revenue from their own onshore lease sales. Louisiana oil and gas revenues hit a record for the fiscal year ending June 30, 2007, and approximately 43 percent of the tax collections came from leasehold payments, according to the MMS. In addition, states collect revenue from oil and gas removed from within their borders. Through September 2007, Louisiana collected $672 million from oil and gas extraction, Alabama collected $129 million, Mississippi collected $52 million, and Tennessee collected $1.1 million, the states' revenue departments indicate.

Consumers confront higher prices
Although oil companies reaped the benefits of oil prices topping $99 a barrel at one point in November, these higher oil prices also mean higher prices at the gas pump. The fall of 2007 did not see the typical seasonal drop-off in oil and gas prices (see chart 1).

Compared with 2006, gasoline prices in Southeastern states in 2007 fell only slightly after peaking in the summer. In 2006, retail gasoline prices for regular grade dropped after the summer peak to less than $2.20 a gallon in the region by October. This year, the U.S. average retail gasoline price broke the nominal record of $3.07 a gallon in May, then only dropped to around $2.75 a gallon in September before climbing back up above the May peak.

Chart 1
West Texas Intermediate and Louisiana Sweet Crude Oil Spot Prices in 2007
Chart of West Crude Oil Spot Prices
Source: Wall Street Journal

Chart 2
U.S. Gasoline Inventories, 2005–07
Chart U.S. Gasoline Inventories
Source: U.S. Department of Energy

Chart 3
U.S. Crude Oil Inventories
Chart U.S. Crude Oil Inventories
Source: U.S. Department of Energy

Increased demand and a significant decline in domestic gasoline stocks drove the record gasoline prices in 2007 (see chart 2). Refinery outages in Mississippi, Louisiana, and Texas had a notable effect on gasoline stocks. One of the more serious shutdowns was at a Chevron refinery unit in Pascagoula, Miss., which shut down after a fire in August. The unit, capable of processing 330,000 barrels of oil per day, was operating at reduced capacity in November. Repairs should be completed by first quarter 2008, according to Bloomberg.

Many of the factors blamed for the continued rise in oil prices boiled down to supply concerns about sufficient crude oil inventories and ongoing tensions in the Middle East. For most of 2007, crude oil inventories in the Gulf of Mexico—and in the United States as a whole—remained either around or above the five-year average. Although still within the average, crude inventories began to decline in July and reached a two-year low in October. Crude oil inventories hovered around historically normal levels by the end of the third quarter of 2007, but concern exists that the growth of the oil supply is not matching the growth in demand (see chart 3).

Looking ahead to 2008
The outlook for oil prices is quite uncertain. This time last year, the Energy Information Administration (EIA) forecast that oil prices would rise moderately, to around $65 per barrel by the end of 2007—in hindsight, an optimistic projection. Currently, oil markets appear influenced by a variety of factors, and while oil prices might retreat from record highs, it is unlikely that the U.S. prices for a barrel of crude will return to the $50–$60 range any time soon. The EIA forecasts that U.S. crude in 2008 will average $85 a barrel.

Companies that participated in the Gulf of Mexico Lease Sale were willing to spend millions of dollars on lease rights that will take several years to develop and turn into profits, suggesting that the firms anticipate that oil prices will remain high for some time. Additionally, the Organization of Petroleum Exporting Countries increased oil production by 500,000 barrels a day in November, and some analysts believe the increase will not alter the current tight market enough to affect prices. In 2006, the United States alone consumed more than 20 million barrels of oil per day, according to the EIA.

Higher crude oil prices will likely mean higher natural gas and heating fuel prices for consumers this winter. Natural gas prices in the South this winter are expected to be 7.2 percent higher and heating oil prices 31 percent higher than last winter, the EIA says in its winter outlook.

But higher prices also have stimulated substantial new production in the region. The Independence Hub in Mississippi, now the world's largest offshore natural gas processing facility as well as the deepest production platform in the Gulf, began production last July. The hub, which expects to reach its full capacity by the end of 2007, could increase natural gas supplies from the Gulf by 10 percent, according to the Oil and Gas Journal and Bloomberg.

The world's largest floating platform, Thunder Horse, off the coast of Mississippi, is scheduled to begin production in early 2009. This platform has the capacity to produce 250,000 barrels of oil per day. British Petroleum's Atlantis platform in the Gulf of Mexico is also scheduled to start production by the end of 2007 and can produce 200,000 barrels of oil and 180 million cubic feet of natural gas per day, the company says.

Other new rigs capable of drilling in very deep water are being constructed in the Gulf. These rigs should be ready in late 2008 or early 2009, which could mean a noticeable increase in crude oil production, the MMS says. Marathon Oil is spending an estimated $3.2 billion to expand its refinery in Garyville, La., increasing the refinery's crude oil capacity from 245,000 barrels a day to 425,000 barrels a day. The expansion began in March 2007, with completion scheduled for late 2009. The construction will require around 2,000 workers, and the expansion project will create approximately 200 new full-time employees. In addition, Valero Energy Corp. will expand production—currently 250,000 barrels a day—at its refinery in Norco, La., over the next three years.

Therefore, while energy producers scramble to increase the supply of their product on the market, the worldwide appetite for energy will likely keep supplies tight and prices high.