Monday, June 27, 2005

Too Big To Ignore
After several weeks of reruns and sporadic postings due to travel, EnergyOutlook is back to its normal schedule. On my return, two stories caught my interest. The first involves the potential geopolitical ripples surrounding the belated bid by CNOOC for Unocal, exemplified by yesterday's lead editorial in the New York Times. The second is captured in a headline in the Financial Times, suggesting that high energy prices are finally starting to bite. I don't have much new to say about Unocal, having commented on this recently. The impact of high oil prices is another matter.

There's been lots of debate over whether we are in an energy crisis. While I still come down on the side of the nays--it looks to me more like a dress rehearsal for a crisis--it seems unlikely that energy prices could double and then plateau without forcing a significant realignment of the global economy. This was less obvious when the futures markets were steeply backwardated, that is, when prices for delivery a few years out were much lower, suggesting an imminent return to historical averages. But the price curve has long since flattened--with future prices close to current levels all the way out to 2011--and increasing numbers of analysts and industry executives are suggesting that current prices are here to stay, at least for the next several years.

The US economy is less leveraged to energy now than in the 1970s, particularly in terms of the energy input required for each dollar of GDP, but that doesn't mean that economics have been repealed. A sustained, long-term increase in energy prices puts energy- and transportation-intensive sectors at a disadvantage to those that use less energy. This should be even truer in rapidly growing countries where GDP additions require more energy, as, for example, in China.

This brings us to a conundrum that appears relevant to the pending Unocal transaction. If you look at the equity values of the major oil companies, including Chevron, they do not reflect $50 oil prices going out into the future. If Chevron's share price is built on a lower implied future price, how much over that price can they offer for Unocal's assets without incurring the wrath of the market? Should we be surprised that a Chinese company, reflecting policy concerns about the security of its home country's energy supply, might value Unocal's oil and gas reserves at a higher level than the US equity market--or Chevron's bid? Cutting through all the potential political maneuvering, this contest will likely boil down to a difference in views over the future value of the underlying commodity. It will be interesting to watch this game play out in the weeks ahead.

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