Where Is the Good Scenario?

Living in a different city, I don't read the New York Times as regularly as I used to. I try to keep up with the musings of the "gray lady", though, even if a few days after the fact. That's how I ran across these scenarios for North Korea from last Sunday's Week in Review (Times Select required, unfortunately.) The author's conclusion fits the title, "Four Scenarios, and Not One Ends Happily." That started me thinking about scenarios for the energy market, and how they've been affected by the remarkable accumulation of negative risk over the last several years. It's pretty easy to think of ways things might get worse, but much harder to see what could ease conditions any time soon--and that could be the main reason why the price of oil remains over $70.

If you've read my profile, you know that my paying work is in the field of energy strategy and scenario planning, so anything with the word "scenario" in the title gets my attention, even if most of the time it's used in an almost trivial sense. I don't know how rigorously Mr. Sanger developed his four views of how things could turn out in the latest round of "The Dear Leader" and his followers vs. everyone else. (I haven't chimed in on this, myself, because unlike the confrontation with Iran, there hasn't been an obvious energy angle here, unless it's about nuclear power in developing countries.) I'm not sure he's captured the full range of possibilities, but I'm not prepared to dismiss his choices, either.

Stepping back from Korea to look at the broader array of issues affecting energy, it seems like we've gravitated towards the downside of virtually every situation that's cropped up since 2002. Consider:

• The war in Iraq has kept that country's production stuck at roughly pre-war levels, and they've only managed that with some remarkable ingenuity on the part of the production and pipeline engineers involved. Billions of barrels of untapped reserves await stability.
• Venezuela hadn't even recovered from the aftermath of the 2002-3 oil industry strike, when Sr. Chavez decided that the terms given to the international companies--the same ones whose facilities had kept Venezuelan production from imploding altogether--were too generous, and unilaterally "renegotiated" them.
• Iran seems to believe it can develop nuclear weapons and attract foreign investment to expand its oil and gas sector. This hasn't been entirely irrational on their part, given the way they've played their hand, but the market clearly understands that things could get very ugly, very quickly.
• Nigeria has been one of the real oil success stories of the last decade, but every time you turn around, some group of indigenous people has occupied an oil platform, kidnapped oil workers, accidentally blown up a pipeline, or in some other manner impeded getting the resource out of the ground and to market.
• The growth in Russian oil production played a central key role in holding down prices earlier in the decade, but for reasons that remain open to interpretation, the Kremlin chose to dismantle and effectively re-nationalize the company with the best track record at expansion.
• What are the odds against three major hurricanes in two years plowing through the heart of the US Gulf Coast oil and gas production and processing?
• I could go on, but almost the only thing we haven't had is a major disruption from Saudi Arabia, which a lot of us expected to see in the wake of 9/11.

When you create scenarios, you need to think about the opposing extremes of a given uncertainty, the upside and downside, and the combination of these factors usually creates at least one fairly positive scenario. But any "good scenario" that I could construct from the upside outcomes of the above issues would probably seem unrealistically upbeat, after what we've been through and continue to experience. And yet, experience tells us that we can't keep rolling sevens indefinitely; things could start to turn around, and they are past due to do so. A market so driven by risk, but for which the underlying fundamentals have at least begun to ease, as I'll discuss tomorrow, could drop suddenly and catch a lot of speculators by surprise. What are the odds for that, versus yet another nasty surprise emerging from a long list of possibilities?