Oil and gas prices plunge, budget deficit looms

Published: Tuesday October 14, 2008

Less than one month after presentation of the 2008-2009 Budget, the Finance Minister and her Government must be secretly bending under the folly of their ways, while putting on a brave face in public. With the Budget debate still ongoing in the senate, crude oil prices have plummeted to below US$80.00 per bbl. At the time of writing, West Texas Intermediate (WTI) was trading at US$77/bbl, its lowest level in 13 months. Oil prices have now lost nearly 50 per cent of its value since peaking in July 2008 at US$148/bbl.

John and Jane Public may well believe that the fiscal package is still in the black given a stated Budget price of US$70.00/bbl. Citizens of the Republic must understand, however, that the average price of T&T crude is about US$18-20 /bbl below the price of WTI. An oil price of US$75/bbl translates into a domestic price of US$55-58/bbl or 20 per cent below the budget oil price of US$70/bbl. It follows, therefore that projected Government revenue for the fiscal year is in jeopardy at this juncture. If oil holds at US$75.00/bbl, the revenue short fall could be as much as $2.4 billion. But there is more.

The bulk of Government revenue, we understand, comes from gas and not oil. While the situation in the gas market is not as extreme, current prices are also below the budgeted figure and heading further south. At the time of writing, natural gas at Henry Hub (the US Benchmark trading hub) was trading as US$6.50/ mmbtu.

So what does this mean for us?

Government has indicated a budget gas price of US$4.00/mmbtu. In a media interview, Energy Minister Conrad Enill indicated that the gas price was an average well head price, but did not indicate the relationship between the prices seen internationally and the well head price.

Information sent to this columnist by a kind reader suggests that the well head price of gas sold as LNG to the US was about 48 per cent of the prevailing Henry Hub price at the point of delivery. This rough rule of thumb means effectively that a Henry Hub price of about US$8.15/mmbtu is required to yield a well head price of US$4.00/mmbtu. At US$6.50/mmbtu, the realized well head price of gas will approximate US$3.15/mmbtu some 22 per cent below the budget price.

However the derived price of gas sold to the domestic market may help to mitigate the impact of the falling LNG well head price. LNG accounts for about 55 per cent of total gas consumption while the other large user, the petrochemical business, accounts for some 32 per cent of utilisation. Gas prices to the petrochemical users are tied to the market price of ammonia and methanol both of which have been at record levels during 2008. Although still at high levels - methanol US$500/tone and ammonia US$700/tonne, the market for both commodities have started to trend downwards suggesting softer commodity markets, and by extension domestic gas prices for fiscal 2009.

Is this simply the unpredictability of international commodity markets or was the Government being overoptimistic in its price forecasts for oil and gas? The evidence weighs heavily in favour of the latter. There are at least three reasons why Government's choice was deliberately overoptimistic.

Firstly, in the previous fiscal year the Government was unable to spend the money budgeted at US$50/bbl. This was mainly because the economy is currently operating at full capacity and certainly in the short-term cannot meaningfully absorb more expenditure. Secondly, the financial crisis had already hit the USA and recession loomed, with a consequent fall in oil demand.

In such a scenario it was foolhardy to expect oil prices to hold firm.

Thirdly, OPEC also suggested that demand growth was slowing down. At its September meeting, OPEC agreed to cut production by some 500,000 bls a day in order to shore -up prices above US$100/bbl. These were sure indicators that the oil and consequently the gas markets could not be expected to be as strong in 2009 as they were in 2008.

So why would a Government that prides itself on sound economic and financial management seek to increase the size of its budget under such conditions of uncertainty? The reason is quite transparent to me. The next fiscal year will see a huge outlay of both recurrent and capital expenditure associated with the hosting of the two international Conferences: The Summit of the Americas and the Commonwealth Prime Minister's Conference. Tenders for the purchase of 200 luxury vehicles are only the tip of the iceberg.

Government's response to the current crisis is predictable. This is normal fluctuation in the markets and prices would soon rebound. Unfortunately, the outlook for the commodities markets does not support such optimism. Unless there is a major sudden recovery in the global avalanche and an immediate uptick in demand, it is likely that both oil and gas prices will continue to head south. The reality is the short-term equilibrium will be around US$60/bbl, a far cry from the budgeted US$70.00/bbl, given the pricing differentials. It is still days, but the situation is very reminiscent of 1982, the first year of deficit in the last boom.


Source: Trinidad Express Newspapers
http://www.trinidadexpress.com/index.pl/article_business_mag?id=161387274