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NUS Consulting Group: Oil Is at a Tipping Point

The bullish drivers behind oil—the Mid-East crisis, weaker dollar and low interest rates—are not slowing down and that means the probability of a black gold rush should continue. But while events drive this commodity every higher over the short term, will the spike continue over the long term?

I decided to catch up with Richard Soultanian President of the utility cost management consulting firm, NUS, which recently published its forecast of market pricing through the end of 2011.

LL: What is your forecast on market pricing through the end of 2011?

RS: We at NUS Consulting Group believe that the energy markets will continue to be event driven in the near-term. Back in January our forecast called for oil prices to increase in Q1 and Q2 and then begin to gradually decline in the second half of the year. We continue to believe this to be the most likely scenario.

Over the past six months the price of energy has skyrocketed. This ascent has been propelled, in large part by two events: 1) last September’s announcement by the Federal Reserve of a second round of quantitative easing (QE2); and 2) the populist uprisings which started late January of this year sweeping the Middle East and North Africa (MENA). The former pushed prices from the low $80's in September to the mid $90s in January; while the latter propelled prices from the mid $90's in late January to their current level of approximately $106 and $117 per barrel for WTI and Brent respectively.

It is our view that the market is fast approaching a potential tipping point—either a new event (or the exacerbation of an existing event) will be necessary to provide further impetus to current pricing or the lack thereof will cause prices to decline gradually to more fundamental levels. Our current forecast calls for WTI and Brent to average approximately $95 and $107 per barrel over the calendar year 2011.

In light of today’s pricing this may seem a bit underwhelming; however, a bit of historic perspective is useful—WTI and Brent both averaged approximately $79.50 per barrel in 2010— so our forecast is calling for a year-on-year increase of 20 and 35 percent in WTI and Brent respectively. At the peak in 2008, WTI averaged $99.67 and Brent $96.94 per barrel. Accordingly, our forecast puts WTI just below and Brent above their historic highs.

LL: Is this the catalyst we need for Washington to pass a comprehensive energy reform bill?

RS: This is a bit of a sore subject for us at NUS Consulting Group—since our primary service is to provide energy procurement and risk management services to energy intensive business around the globe. In the past decade, many countries around the world have developed and implemented comprehensive energy policies—some good examples can be seen in the United Kingdom, Germany, France and China.

It is very frustrating that the United States, the largest energy consumer in the world, has been unable to make any quantifiable progress in this area. As a result, the United States has been highly vulnerable to increasing price volatility resulting from speculation, monetary policy, geopolitics, weather, etc.

We were of the belief that the most recent run-up in 2008 was going to finally push Washington to take action, but we were once again disappointed. Will the current run-up in pricing be the catalyst? We hope so.

However, we are realists and as such we recognize that there are many competing interests both in the private sector and Washington that are driving (or, more accurately, stalling) the debate. Unless all interested parties finally come to the realization that we are wasting very valuable time—developing viable and cost effective alternatives will take years and significant resources.

For the best interests of the country, we need to begin taking real steps to reduce our dependence on foreign energy or we may find ourselves in a situation one-day where energy prices do not pull-back appreciably from a peak and we are competitively disadvantaged as we belatedly try to find a way forward in this new, energy challenged, world.

LL: Do you think Congress will actually do it?

RS: It will most likely depend upon the trajectory of energy prices in 2011/12. If our forecast proves accurate and prices pull-back into the $80s/$90s in the second half of the year then the pressure to act will once again be alleviated and Washington will most likely follow its historical pattern—lots of discussion on the subject, but little real concrete action.

If, on the other hand, prices continue to escalate without any real relief or we suffer a “worst-case event” in MENA then the hue and cry from both businesses and consumers alike may actually force Washington to confront the issue in a practical and realistic way. We may not agree with all aspects of recent plans put forward, like Boone Picken’s energy plan, there can be no doubt however that our abundant reserves of natural gas must be an important feature of any realistic energy plan for our country.

LL: You said earlier that we at a tipping point.

RS: Yes, we believe this to be the case. In our view, the gap between market pricing and underlying market fundamentals is expanding rapidly and will soon reach an unsustainable level. This is not to say that prices cannot or will not continue to rise in the short term. However, in order for prices to continue their ascent, a new event (i.e., the announcement of QE3) or exacerbation of existing events (i.e., the worsening or occurrence of a worst case scenario in MENA) will be necessary.

Should this come to pass, we believe prices will spike. This price spike will most likely be temporary due to its negative impact on the global economy—i.e., spiking prices will result in significant demand destruction. Where the market does not secure an additional propellant, we believe prices will hover at or near current levels with WTI and Brent moving up or down by a few dollars depending upon the recent news cycle and slowly decline in the second half of the year.

LL: We have a lot of uncertainty out there from the Mid East crisis to talk of more quantitative easing. How did you factor all of this into your forecast?

RS: Yes, we have considered both monetary policy and the rising tide of unrest in the Mideast in our current forecast. As stated above, the recent ascent in energy prices has been propelled by QE2 and unrest in the Middle East. In our view the fuel behind the recent, sharp move in energy prices has been largely depleted.

First, the Federal Reserve’s QE2 program, which was the initial catalyst for the recent increase, is scheduled to expire in June. We believe that it is highly unlikely that the Federal Reserve will follow QE2 with a new initiative (i.e., QE3).

Our view is based upon the following facts: (i) anecdotal evidence indicates that the US economy continues to recover from the financial crises and that unemployment (at least according to the unemployment statistics published by the Bureau of Labor and Statistics) is on the decline; (ii) comments recently made by the President of the St. Louis Federal Reserve Bank, James Bullard, indicating that the Federal Reserve does not need to extend QE2 or initiate a new program in its place based on the current economic environment; and (iii) the Federal Reserve faced a significant amount of criticism from governments and reserve banks around the world as a result of QE2 and it will not risk reopening old wounds.

Second, although the situation in the Mideast remains extremely volatile, with each passing day the market is becoming more comfortable with the risk and uncertainty arising from events in the region.

In short, the initial fear of “worst case scenarios” is giving way to realistic risk quantification.

Specifically, both Tunisia and Egypt have moved from the initial phase of political unrest and protest against long-standing autocratic rulers to the phase of developing/establishing more democratic institutions. We recognize that this process will most likely be a long one and incur a number of setbacks, nonetheless, existing regimes have been removed and positive progress is slowly being made.

As for Bahrain, it appears that anti-government protests have been successfully repressed for the moment with the support of Saudi Arabian troops. The remaining “hot spots” are Yemen, Libya and Syria.

With regard to Libya, the passage of a UN resolution and the support of an international coalition to protect civilians, establish a no-fly zone and destroy Gaddafi’s military resources mean that, although the conflict may be long and drawn out, in the end Gaddafi will ultimately be removed from power or placed in a tight box.

Yemen has been unstable and subject to internal conflict for many years—it is only a minor producer of oil and gas and thus any production disruption would have little impact on energy pricing.

It is relevant to US security interests due to the presence of Al-Qaeda in the Arabian Peninsula (AQAP) within its borders and to Europe based on its location within the Bab el-Mandeb Strait which is a passageway for tankers headed for the Suez Canal or the SUMED pipeline.

Finally, the unrest within Syria has grown significantly in the past days. Like Yemen, Syria is not an important producer of oil or gas but its importance lies within its close ties to Iran and the risk of a disorderly transition of power triggering a major regional event.

To date, all of the “worst case scenarios” dealing with MENA have not come to pass, and as such, with each passing day the markets appear to become more comfortable (some might say complacent) with the risk associated with the region.

LL: What is the biggest threat to the energy markets?

RS: The biggest threat to the energy markets is that one of the “worst case scenarios” in MENA actually does come to pass and as a result the market suffers a material and long-lasting supply disruption. Should this happen, energy prices would most likely spike and remain at elevated levels for a significant period of time.

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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."

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