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|  | JUNE 4, 2004
By Amey Stone Gas Prices: High -- and Staying There Because the real problems are refining capacity and worldwide demand, OPEC's increased output won't help much, says analyst Kurt Hallead Welcome to a new era of higher energy prices. Even though OPEC announced June 3 that it's raising its production limits by 2.5 million barrels a day in July and August, significantly higher crude and gasoline prices are probably here to stay, says Kurt Hallead, oil services analyst for RBC Capital Markets. Global demand for oil is only going to increase, while refining capacity in the U.S. will remain severely constrained, he says (see BW Online, 6/4/04, "Why the Saudis Fear Pricey Oil"). Gasoline prices are bound to slip from record levels once the peak summer driving season is over, but it won't be by much, he believes. That's the bad news. The good news is that Hallead doesn't think higher energy prices will hurt the U.S. or the global economy. Plus, increasing global demand for energy means improving earnings for stocks in the energy sector, including those in the oil-services group he covers, such as Halliburton (HAL ) and Schlumberger (SLB ). Hallead outlined why energy prices will stay high and the ways for investors to profit in an interview with BusinessWeek Online Senior Writer Amey Stone on June 3. Here are edited excerpts from their discussion: Q: Let's start with the news of the day: What do you make of OPEC's decision to raise its production ceiling? A: Basically the increase just puts the official quota in line with what OPEC countries have already been producing. What may be more important is that several countries, including Saudi Arabia and the United Arab Emirates, said they would add some incremental production. Q: Do you think the price of gas will come down this summer if the increase in production materializes? A: It takes about 45 days for increases in production in the Middle East to reach U.S. shores. I expect gas prices to stay high through the summer and come down as we get into August, partly due to a reduction in demand. Our forecast is for oil -- now around $40 a barrel -- to average $36 a barrel in 2004 and $34 in 2005. We're not going back to $26 a barrel like we saw in 2001 and 2002. Our broad thesis is that we're in a new era of higher energy prices. Q: Shouldn't lower oil prices mean lower gasoline prices? A: Higher gasoline prices in the U.S. aren't due to problems producing enough oil. The main problem is a bottleneck in refining capacity. There hasn't been a new refinery built in the U.S. in about 30 years, and refiners are running at full capacity now. The additional crude oil we'll be getting from the Middle East is of a heavier grade, and it costs more to refine. Higher oil prices also reflect supply-interruption concerns, due to fears of political instability and the potential for more terrorism in the Middle East. There is what's known as a security premium in the price of oil, now equal to $10 to $12 a barrel. If you could remove that, it would knock 35 cents off the price of a gallon of gas, but it's not going away. As long as there's a rise in Islamic fundamentalist extremism in the world, there will be some level of security premium. A year ago it was at $3 to $5 a barrel. Q: It doesn't seem like higher gasoline prices are having much of an impact on demand so far. A: Most economists believe prices have to get to $2.50 or $2.80 a gallon to really have an impact on consumer behavior. Energy spending, as a percentage of disposable income, also hasn't climbed significantly on average yet. Right now, the incremental cost for the average consumer of higher gas prices in 2004 is just 58 cents a day. That's not substantial enough to really alter buying patterns. Demand in the U.S. may cool if prices rise further.
BW MALL
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