MINUTES JOINT MEETING HOUSE AND SENATE FINANCE COMMITTEES March 29, 1995 8:20 a.m. TAPES SFC-95, #25, Side 1 (000-end) SFC-95, #25, Side 2 (575-135) CALL TO ORDER Representative Mark Hanley, Co-chairman, House Finance Committee convened the Joint Meeting of House and Senate Finance Committees at approximately 8:20 a.m., in the Senate Finance Committee Room, State Capital Building, Juneau, Alaska. PRESENT In addition to Representative Hanley, Senators Phillips, Sharp, and Zharoff were present. Senator Rieger arrived soon after the meeting began. ALSO ATTENDING: Senator Torgerson; Senator Green; Mike Greany, Director, Legislative Finance Division; aides to committee members and other members of the legislature and representatives of the press. SUMMARY INFORMATION Cambridge Energy Research Associates Presentation on Oil Pricing and Production Forecasting by Ann-Louise Hittle Upon convening the meeting, Representative Hanley welcomed Ann-Louise Hittle, Director, World Oil, Cambridge Energy Research Associates, to committee. Ms. Hittle advised that, as agency director of world oil, she heads the consulting business on "the crude oil side," including crude oil price forecasting. Directing attention to her handout (copy on file in House and Senate Finance Committee minute books), Ms. Hittle advised that her presentation would cover: 1. The oil outlook through 1996 2. Demand/supply. (Non-OPEC supplies and OPEC production and politics) . 3. Oil price outlook 4. Crude quality differentials 5. Exploration and productive capacity outlook with specific reference to Alaska 6. Longer-term price forecasting The price outlook is "a little bit more supportive, a little bit more positive" than outlooks in recent years. For FY 95, it appears ANS will average "about $16.50." The price for FY 96 is expected to be $16.70. The positive news is that the price is not going down but remaining within a steady range. The market in recent weeks has indicated ability to retain levels gained in the last year. A snapshot of the market indicates more of the same. Demand is rising at about the same rate as last year (this year's rate is 1.3%). Non-OPEC production is up again, and OPEC has continued the same quota (24.52) and is producing at a level the market can tolerate. The market continues to await a signal on oil exports from Iraq. Saudi Arabia and OPEC are relying on the market to set the price. In effect, they are waiting for demand to absorb production increases that have occurred over the last few years. Speaking to demand, Ms. Hittle advised that the driving force is the world economy. She directed attention to page 3 of her handout and noted that the world economy is presently in a strong economic convergence. For 1995, that results in demand growth, on an annual calendar year basis, of 0.9 to 1.1. Cambridge is estimating a demand growth of 0.9 mbd's (900,000 barrels a day) for calendar 1995. Next year, the range is expected to be 1.3 to 1.4 mbd's. The driving force in demand is the Far East where growth, excluding China, is expected to be 6% in 1995. Demand will grow 3% in the Middle East, Latin America, and other areas. There will be a marginal increase in North America, but it will not be as much as that caused by cold weather last year. On a yearly basis, demand was down in the first quarter. Ms. Hittle directed attention to page 4 of her handout and explained that steep declines in the former Soviet Union (FSU) have hidden sharp increases in demand in other areas of the world. The rate of decline in the FSU has started to trail off and is now not so steep. Between 1994 and 1995, a decline of 330,000 barrels a day is expected. As decline is reduced, the impact of demand increases in other regions is felt in the market. Ms. Hittle next advised that non-OPEC supply has become a dominant market feature. Page 4 of the handout demonstrates the rebound in non-OPEC supply over the last few years, driven by increases in the North Sea, the Far East, Latin America, etc. While prices have fallen every year since 1990, output has increased since 1993. That reflects the impact of technology reducing the cost of finding and developing oil. As an example, Ms. Hittle remarked on development of the West of Shetlands field in the North Sea for less than $5.00 per barrel. Low oil prices have also caused countries that previously were closed to foreign exploration efforts to change their rules and "take . . . economics over politics." It is now possible to go into Algeria. As a result there has been a sharp increase in Algerian reserves, and there will be increases in Algerian production. This is also occurring in Latin America. Further, due to low oil prices, exploration and production companies are streamlining and using "partnering" and alliances to overcome operating costs in a low- price environment. Ms. Hittle cited BP as an example of a company that has worked effectively, over the last few years, to overcome problems in that environment. Increases in non- OPEC supply result from a surge in exploration and production. The precedent of economics over politics makes the world more competitive for producers who are trying to focus exploration and production work in their own areas. That has relevance for Alaska. Ms. Hittle noted liberalization of terms in Vietnam and other areas where it is now easier to explore. Directing attention to the graphics on page 6, Ms. Hittle noted that the biggest increases in non-OPEC supply, over the last few years, have come from the North Sea (Norway and the U.K.). The graphic on page 7 evidences that despite the sharp decline in production in the FSU in the last few years (as well as the sharp decline in demand), exports to the world oil market have remained "pretty much steady." Even in 1997, when it is expected that FSU production will bottom out at 6.4 million barrels a day (compared to the previous level of 12 million barrels a day), Cambridge expects exports to remain steady at the 2.2 mbd level. While one would think that decline in FSU production would support oil prices, it has not because of the fact that "They've kept exports up." Senator Phillips asked if the recent Soviet oil spill and transportation problems within the country impacted projections. Ms. Hittle acknowledged that it is difficult to move oil around the FSU. That has caused the flow of exports to be "very erratic" and has had a short-term effect on the market. Last fall, oil coming into the Mediterranean was erratic, and prices in that part of the world went up, with some spill-over effect. Despite those surges on an annual, average basis, the FSU is keeping exports level. Responding to concerns regarding transportation and the condition of FSU pipelines, Ms. Hittle advised that Cambridge "is not really bullish on the former Soviet Union." The graphic on page 8 relates to OPEC production and politics and attempts to present OPEC's hidden strategy. This is important to the market because, since September of 1993, OPEC has kept its quota flat at 24.52. That quota will have been in effect for more than two years at the end of this year. Demand has increased (last year 1 million barrels a day, this year 900,000) while OPEC held production steady within a range slightly above the quota. That has had two impacts on the market: 1. It has caused the role of swing supplier to fall off from OPEC. "It's now much more the industry and inventories." 2. The role of inventories is more important. In the event of a cold winter in the first quarter and a large draw on inventories, the surge in needed supply is not going to come from OPEC. It will come from inventories. That can be a supportive feature. It is one of the reasons the market is experiencing stable prices at the present time. Referencing page 9, Ms. Hittle explained that OPEC has created a "margin of tolerance." Although the quota has remained flat at 24.52 since the fourth quarter of 1993, because demand has increased, there is market tolerance for OPEC's overproduction. At the present time, OPEC is producing at 25.1. That overproduction is welcomed by the market. It is not a price depressant. Three years ago, OPEC would have set the quota at a level that was "probably a little bit above demand." If OPEC overproduced, that would have a price depressing impact. Because the present quota is set below demand, when the cartel overproduces, the market tolerates it. The graph on page 9 provides signposts on "where OPEC can produce." If production in the fourth quarter of 1995 starts to inch above 25.3, a lower price is expected. Similarly, in the second and third quarter, if production increases above 25.1, that will have a price depressing effect. It could be as much as $0.25 to $0.50 a barrel, on a quarterly average basis. Senator Rieger suggested that the present scenario (particularly in the case of Saudi Arabia) is different from the past where Saudi production went up and down to match swings in demand from season to season or to negate cheating by other OPEC members. It now appears that instead of varying OPEC production to meet changes in demand, holding constant is a source of stability. In the past, holding constant was the source of volatility in price. Ms. Hittle said that she did not mean to imply there would be no volatility in the price. The current OPEC approach, on an average basis, is price supportive. There can still be volatility because of reliance on inventories. A price spike could occur in the event of cold weather in the first quarter, because Saudi Arabia will not be there to surge and meet that demand. Overall, however, the impact has been price supportive. It has had a positive effect on market psychology and has generally tended to help keep prices firmer than they might have been. OPEC is no longer the swing supplier in the market. Senator Rieger inquired concerning Saudi Arabia's production in terms of overall OPEC production. Ms. Hittle said that Saudi production is at 8 million barrels a day. It has been steady at that amount since the quota went into effect in September of 1993. The Saudis intend to keep production level. They are, in effect, waiting for demand and prices to increase. Because of the surge in non-OPEC supply, even though OPEC has adhered to its quotas and has not cheated much, prices have not gone up much. Directing attention to the graph on page 10, Ms. Hittle explained that it demonstrates OPEC's change in strategy. In the pre-1995 market, it was the high priced team (Iran, Algeria, Nigeria) versus the volume capacity reality team (Saudi Arabia). The post-1995 scenario shows OPEC acting as a group in a standoff against non-OPEC production. Necessity has caused OPEC to take that stand. If the cartel increases its quota and fights for market share against non- OPEC countries, prices will fall. OPEC cannot afford that because member countries are under extreme revenue pressures. The graphic on page 11, presents a picture of the impact of production or lack of production from Iraq. If oil from Iraq enters the market, OPEC capacity utilization would fall to 83%. If Iraq is not in the market, the OPEC percentage is 87.3. The message is that even if Iraq does not come into the market this year or next, capacity utilization in OPEC will not be that tight. The big surge in prices one might expect will not occur if Iraq does not come into the market. Conversely, if Iraq enters the market, utilization will fall off but not as sharply as one might expect. Ms. Hittle voiced her belief that entry to the market by Iraq would have "about a $2 a barrel lowering effect, on a quarterly basis, on price." By the second quarter after start up, price recovery would be underway. Speaking to sanctions against Iraq, Ms. Hittle told members that the United States has succeeded in reinforcing a majority security council commitment to minimum core requirements: 1. Iraq must meet requirements on weapons of mass destruction. This is particular to biological weapons. It includes releasing some suppliers and ensuring that the monitoring process is working smoothly. 2. Iraq must account for missing Kuwaities. 3. Iraq must return seized equipment taken during the invasion of Kuwait. Sanctions cannot be lifted until minimum requirements are met. At an April 10 meeting of the security council, the head of the U.N. special commission will report on Iraq's adherence to weapons of mass destruction. Although there may be much talk in the press regarding the sanctions, Ms. Hittle reiterated that they cannot be lifted until the foregoing requirements are met. In addition to the foregoing, the United States has two broader requirements: 1. It would like Iraq to prove its peaceful intentions in the area. 2. It would like Iraq to observe human rights within Iraq. Acceptance of these broader requirements, by the security council, is not "very extensive." By July, Iraq will have had time to address minimal core requirements. Hypothetically, if all goes well, and Iraq cooperates on the above three items, extensive debate will occur on whether or not sanctions should be lifted. Given the right circumstances it is possible, but not assured, that by the end of 1995 there could be some sort of compromise measure that would take into account U.S. concerns. The foregoing assumes that Iraq has met minimum requirements. Oil from Iraq could reach the market by the end of 1995. That is, however, with many "ifs, ands, and buts." The signpost to watch is Iraqi progress in meeting minimum requirements. Senator Rieger asked if the threat of Iraq's reentry to the market had already depressed oil prices. Ms. Hittle responded affirmatively. Actual reentry would engender a short-term reaction to inflow of 1 million barrels a day to the market. The actual start up is factored into price. That happened in the summer of 1993. Actual inflow will cause a surge, but it will not be as extensive as in 1993 when prices lost $3 to $4 a barrel. Fear of Iraq production which arose in the summer and fall of 1993 has not yet been completely worked out of the market. It remains in the price. Impact from actual Iraq entry to the market will be "a lot more short term and less of a reaction than we would have had otherwise." Directing attention to the triangle graph on page 12 of the handout, Ms. Hittle said it represents the triangle of competition for market share that will occur when Iraq comes on line. She stressed that when Iraqi oil enters the market, two other components are going to be vying for market share in addition to ongoing non-OPEC production: 1. OPEC oil. 2. World inventory patterns. If, in July, it appears that sanctions might be lifted, market participants will start to draw on inventories. They will anticipate that once oil from Iraq starts to flow, the price will fall, there will be much oil on the market, and inventories purchased at a higher price will become a detriment. Companies will thus draw on inventories even before Iraqi oil starts to flow. That is something to watch for. If it occurs, it will diminish the impact when oil from Iraq actually begins to flow, since inventories will be lower. The price effect could thus occur before export from Iraq begins. The graphic on page 13, provides an additional picture of the previous dynamic. Assuming oil from Iraq starts to flow in 1996, there will be a 1.3 to 1.4 million barrel a day increase in demand in that year. The threat to price from non-OPEC will be 0.4. Inventories and OPEC production are also part of the equation. Ms. Hittle directed attention to the graphic on page 14 and advised that it demonstrates what non-OPEC production has done to the market. It has pulled the rug out from under what should be strong prices because of strong economics, good demand growth, and steady OPEC production. The fact that the price is not where it should be is evidence of increases in non-OPEC production. However, in 1996, non- OPEC supply will only increase 0.4. There will thus be "somewhat of a tailing off of that trend." The graphic demonstrates the quandary presently facing OPEC. The cartel has little choice. If it increases its quota to gain market share from non-OPEC producers, the result will be weaker prices, and market psychology will turn negative. Ms. Hittle stressed that market psychology is an extremely important factor. She reiterated that in the fall of 1993, market psychology was expecting Iraqi oil to start to flow. That is the reason prices fell so sharply. It was not fundamentals but market psychology. If OPEC raises its quota, market psychology will turn negative. Concern will be that if OPEC has increased its quota, how will it deal with Iraq when Iraq commences production. A higher quota when Iraqi oil begins to flow means a battle within OPEC when it attempts to cut the quota. Fear of OPEC in disarray will undermine psychology. If the OPEC quota remains flat, the cartel will be in a much better position to deal with start up in Iraq. The Cambridge assessment is that if OPEC remains at the current quota of 24.52 when Iraq begins production, the most the cartel will do is pull current overproduction back toward the actual quota. It is not anticipated that OPEC will move to cut its quota below 24.52 to accommodate Iraq. With increases in demand, return to the actual OPEC quota should be enough. Ms. Hittle explained that oil prices increased $3 to $4 dollars a barrel in the spring of 1994 (even though demand usually falls a million barrels a day between the first and second quarter because of reductions in winter heating demands) as a result of the new price seasonality. In the old world market, prices would have been weak and strong in the fourth quarter. In the new market, growing demand and lack of Iraqi production, have produced a feeling that there may not be a sufficient supply of oil in the fourth quarter. There is thus a tendency to "do a lot of anticipatory buying" in the first and second quarter. That is supporting prices in the latter. In the fourth quarter, when it becomes evident that supplies are adequate, prices tend to weaken. That is reflected in the ANS price outlook (p. 16). In response to a question from Senator Phillips regarding lack of a price increase during fourth-quarter winter months, Ms. Hittle said that in the fourth quarter of 1993, when the winter was extremely cold, prices hit a low in January. That was because non-OPEC supply increased by 700,000 barrels a day from the North Sea. The surge in supply caused prices to fall off, despite the weather. The North Sea remains a factor in the market today. Referencing the graph on page 16, Ms. Hittle highlighted the following ANS prices: Third quarter - An average of $16.81 Fourth quarter - Steady prices at $16.75 A Factor contributing to the foregoing prices is no repeat in the spring price increase (new seasonality). The greatest effect from the new seasonality, in the second quarter of this year, will be that prices are not going to go down. They will remain steady. While they could go up, the picture at this time anticipates that they will remain steady. There is no anticipated repeat of the steep price increase of a year ago because: 1. The market is not as "oversold" as last year. It was oversold in the futures market and had plunged to lows by March. The market is $3 dollars a barrel higher and thus not in an oversold status. 2. No OPEC meeting is planned for the second quarter. There will thus be no surprise from the cartel. A year ago, OPEC provided impetus for the change in market psychology when it extended its quota through the end of the year. 3. There will be a larger stock supply in the fourth quarter consisting of "a 1.6 mbd build." That compares to stocks of 1.4 last year. 4. There is no whiplash effect anticipated from the Iraq factor. A year ago, there was much expectation that Iraq would be in the market. In the spring that expectation started to fade. That is one of the reasons prices "ran up." Currently there is no such expectation. Iraq is "kind of a neutral factor in the market." Ms. Hittle set forth the following prices for 1996: First quarter - $16.25, reflecting the cumulative build in stocks: 1.6 in the fourth quarter and 1.3 in the first. Second quarter - $16.75, based on increase in demand in the fall and winter. A 2.1% demand increase is projected, and non-OPEC supply will be increasing at its lowest rate. In the second half of calendar year 1996, the assessment is that OPEC could again roll over its quota. That will provide a good psychological boost to price. It is further assumed that at that point Iraqi exports have not started. Ms. Hittle next spoke to factors and signposts that could cause variations: 1. If OPEC produces beyond market tolerance, prices will be lower than expected by $0.25 to $0.50 on a quarterly basis. 2. Conversely, if OPEC produces below market tolerance-- production is maintained at 25.0 to 25.1 through the end of the year--prices will be approximately $0.50 a barrel stronger than expected. It would not be unreasonable for OPEC to take this approach because of problems with capacity in Nigeria and Iran. 3. The demand pull from Asia which has caused much crude oil to move into that part of the world. A much warmer summer than usual would help keep prices stronger than they might otherwise be. 4. A downward pull could be exerted if discussions in the U.N. security council start to look favorable for commencement of Iraqi exports. 5. Higher exports in the former Soviet Union. That would have a downward impact on prices. Directing attention to page 19 of the handout, Ms. Hittle referenced the "triangle of price determination" and noted that the graph highlights factors to look for. She advised that three components form the price of oil: 1. Physical fundamentals--supply and demand. 2. Market psychology 3. The effect of technical indicators in the market. Ms. Hittle next spoke to technical indicators and their impact on price. At the present time, managed future funds which have played an active role in forming the price of oil futures are a neutral factor in the market. A year ago, investors were buying crude oil futures as a hedge against fears of inflation. These funds are now buying moderately and not having an impact on price. If fears of inflation recede, managed futures funds could start to pull out of the crude oil futures market. If they all did so at the same time, that could have a downward impact on price. Conversely, fund managers are aware that demand is supposed to be increasing, so they have tended to buy. They are also anticipating there will be the typical spring run up in price. Their effect is to strengthen the volatility in the market. If the market is moving in a particular direction, they strengthen movement up or down. These indicators should be monitored. Fears of inflation or a psychology in the market pro or con Iraq may cause technical players to take that and "run with it and increase the move either up or down." Referencing the signposts graphic on page 20, Ms. Hittle advised that in tracking oil on a month-to-month basis the signposts would provide a guide on how prices will move. In response to a question from Senator Rieger, Ms. Hittle explained that although the effect on demand or supply may force the price into the foul or out-of-bounds realm, it tends to come back into the playing field. While the graph cites the OPEC basket, "it's really almost virtually the same, at this point, for ANS." Ms. Hittle noted the importance of crude quality differentials on the price of ANS oil. ANS has been and will continue to increase in value relative to higher quality crudes. She directed attention to the ANS Minus WTI graph on page 25 of the handout. WTI is a much higher quality crude than ANS, but the differential has narrowed dramatically in the last year. The same trend is more sharply evident in the next graph entitled "ANS Minus OPEC Basket." In 1994, the differential averaged -$0.23 compared to -$1.76 in 1991. The graph entitled "ANS Minus Kern River" (a heavy California crude) shows that a crude of lower quality than ANS is gaining in value. The increase in value is long-term rather than short-term. While differentials may not grow narrower, the trend is in place "at least through the end of the decade." Reasons for the narrowing include: 1. Technological evolution. Technology allows refiners to create a greater quantity of more valuable products from lower quality crudes at a lower cost. End: SFC-95, #25, Side 1 Begin: SFC-95, #25, Side 2 2. Economies of scale. There is a tendency by refiners to build a larger unit than needed with the result that there is more upgrading capacity than needed. 3. The changing product demand barrel. The tilt is very much toward a growing share of light products in the total product demand barrel. That means refiners need more upgrading capacity. 4. Environmental regulations. These require that refiners invest in refinery upgrading capacity even if the differential in price between high-quality and low-quality crude does not justify it. The upshot of the above four factors means there is more demand for low-quality crudes to run in upgrading capacity, and there is less demand for high-quality crudes. The price of high-quality crudes has thus been relatively depressed. And, the price of lower-quality crudes, such as ANS, has been increasing. That is one of the reasons behind the strength in ANS, in the last year, compared to other crude oil. On a short-term basis, there is volatility in the differentials. Referencing page 23 of the handout, Ms. Hittle directed attention to equilibrium differentials. She explained that a surge in North Sea light crude would cause differentials to fall lower than they might normally be. Overall, the range is expected to remain narrow, despite volatility. Even the start of Iraq with its heavy, sour, low-quality crude will not set the trend aside. There will be a short-time widening in the differential between high and low-quality crude oil, but over the medium term it will revert back to narrow differentials. This is positive for ANS in terms of its pricing against other quality crudes and its use in refinery upgrading units. Ms. Hittle directed attention to page 24 of the handout and explained that even though the quality of the crude drives the differential between high and low-quality oil, the world crude oil quality is not going to change. It has not changed over the last few years, and it is not going to change, on average, through the end of the decade. Refinery-related issues are driving the narrowing of differentials. In reviewing the world average total, in 1997 the average API for crude is 32.37. In the year 2000, it is 32.32. That means that, on average, the crude oil supply in the world has improved. This is counter to industry conventional wisdom. That is why Cambridge does not believe that crude oil quality, on the longer-term basis, will be what drives the differential. The issue will be refining upgrading and factors that create more refinery upgrading such as environmental rules and regulations. Ms. Hittle next spoke to trends in exploration and production and productive capacity. She noted a general, strategic shift on the part of exploration and production companies toward exploration for gas as opposed to oil. Efforts are particularly focused on involvement in expansions and grass-root LNG projects in order to meet the expected surge in gas demand. Much of the focus is in Latin America and Southeast Asia. The next graph points to exploration and development hotspots worldwide. The strategy of exploration and production companies is to focus on core areas--areas they have been in for a long time and in which they have expended substantial dollars. Indicators are that Alaska is becoming a core area for BP. Core areas are differentiated from hotspots. Hotspots are areas where companies are building up their engagements. As an example, Ms. Hittle cited the "flexure trend" in the Gulf of Mexico, the West of Shetlands in the North Sea, the Timor Gap in Southeast Asia, Vietnam, Algeria, Colombia, and the East of Andes area in Latin America. Another strategic effort for companies is to move into "frontier, high-risk areas." These include the former Soviet Union, China, Iraq, and offshore West Africa. Speaking to productive capacity, Ms. Hittle advised that she would address: 1. World liquid capacity 2. U.S. crude and condensate 3. Alaska and North Slope production She explained that "producibility" is the capacity to produce rather than the actual production rate. Components of producibility are: 1. Existing production which has a built-in decline rate by definition. The only adjustment that can be made in that rate is the effect of new technology. 2. Recent significant discoveries. Cambridge follows new discoveries very closely and attempts to estimate lead time prior to producibility or production. 3. Future discoveries. This is the largest wild card. Assessment of future discoveries is based on an overall view of the pace of exploration and production activity. Assessment indicates that, despite low oil prices, there is much exploration and production activity. Cambridge is thus optimistic in its view of future discoveries and the impact on producibility. The feeling is that there will be "a lot of wildcats drilled . . . in Alaska." Ms. Hittle next spoke to world liquid productive capacity and noted that several things stand out. The first is that from 1994 to 2010 there will be an increase of 14.1 million barrels a day in world liquid productive capacity (from 71 mbd to 85). Most will come in the OPEC gulf--an increase of 13 million barrels a day. That demonstrates the role of OPEC, Middle-East gulf countries. The remainder of OPEC is not "going to do much." There will only be minor increases from Indonesia, Nigeria, Venezuela, etc. Non-OPEC production peaks in the year 2000 at 40.7 (an increase of 1.2 mbd from 1994). It then commences a minor decline into the year 2010. That means a much larger role for OPEC as time moves beyond the end of this decade. Non-OPEC capacity outside the United States and former Soviet Union, increases to the year 2000, but declines will begin after that time. Most of that will come in the North Sea, Brazil, Colombia, Australia, and Vietnam as follows: The North Sea 1 million barrels a day Brazil and Colombia 300,000 to 400,000 barrels a day Australia and Vietnam 200,000 barrels a day Speaking to production in the United States, Ms. Hittle noted a decline from 1995 to 2010. However, decline will moderate from 1997 to 2000 due to the "flexure trend in the Gulf of Mexico." Approximately 300,000 barrels a day will come on from discovered fields in the flexure trend in that time period. Decline is flat from 2000 to 2005 because of that production and, more importantly, a net increase of North Slope production of 400,000 barrels a day. An additional 100,000 barrels a day will come on line from off- shore Southern California. After the year 2005, the decline resumes. Throughout the period, production in Texas, the mid continent, and the Rockies will be declining. The only variance will come from the flexure trend, off-shore California, and the North Slope. Providing numbers in support of the foregoing trend, Ms. Hittle cited the following: 1994 to 2000 - Total U.S. production will fall from 6.8 mbd to 5.9. 2000 to 2005 - No decline, 5.9 to 5.8. 2005 to 2010 - Decline from 5.8 to 5.1. Looking at Alaska, including Cook Inlet (despite an increase from 43,000 to 65,000), capacity will be as follows: 1994 to 2002 - From 1.71 to 1.21 2002 to 2005 - Increase to 1.73 2005 and beyond - Slow decline Senator Sharp questioned the increase between 2002 and 2005. Ms. Hittle explained that the increase relates to the North Slope. She cautioned that the above numbers reflect "capacity numbers" rather than production rate. Output can vary extensively from capacity due to many things. As an example, she cited the impact of weather which, if too cold, may halt tanker loading at Valdez. If the weather is too warm, the efficiency of the pipeline is lowered. There could be hookups of new fields, repairs, etc. The foregoing can produce a variance of up to 100,000 barrels a day between production and capacity. The outlook for productive capacity assumes no production from ANWR. Cambridge includes 70,000 barrels of NGLs a day, spiked into the pipeline feed. Ms. Hittle next noted four components of North-Slope Alaska liquid productive capacity (p. 35 of the handout): 1. The Prudhoe Bay field which is in continuous decline. 2. Fields producing or under development (Kuparuk, Lisburne, Milne Point, etc.). 3. Fields not currently under development. This is the area where growth is likely to occur. Assessment of this number is based on BP's recent, aggressive exploration and production policy. As an example, Ms. Hittle cited moves to acquire from other parties on the North Slope. That will provide the foundation for BP to move forward to develop the "string of pearls" fields east of Prudhoe Bay. If development is not forthcoming, numbers shown for fields not under development would be pushed back. Attention should be paid to what BP does with Badami, and the North Star complex. Other players in the area are also becoming more aggressive. If BP develops Badami, that will enable linking of the string of pearls fields and cause fields not now under development to start to contribute to productive capacity. 4. Future discoveries. These discovers are not based on ANWR but on the overall level of exploration and development in the world today and, in Alaska, the number of wildcats being drilled, appraisal drilling, the Colville Delta, and Sourdough/Yukon Gold. It is viable to assume there will be future discoveries. Senator Rieger asked if one field dominates in the "not under development" category. Ms. Hittle responded affirmatively, advising that members should watch Badami. Senator Rieger then asked if Badami would be the key to development or the largest producer. Ms. Hittle advised that Badami is the key to "it all happening," but she said she did not know if it would be the biggest production field. Senator Rieger inquired concerning West Sak, asking if it is also linked to Badami. Ms. Hittle voiced her understanding that development of the string of pearls fields is contingent upon "bringing up Badami and then enabling the start up." If BP does not develop Badami, development could still occur "through other measures." Badami is the key to watch. MIKE GREANY, Director, Legislative Finance Division, interjected that state agencies tracking production are monitoring the tie-in between Kuparuk and West Sak with the idea that, at some point, it would be economical to use the Kuparuk facility to produce West Sak. Ms. Hittle advised that she did not have sufficient details regarding West Sak. She said she would inquire and return information to committee. Senator Rieger asked how much of the approximate production of 700,000 barrels a day relates to West Sak and other development fields. Ms. Hittle said she would provide a breakdown. Directing attention to the final page of the handout, Ms. Hittle spoke to the long-term outlook for ANS under three different price scenarios. Cambridge is currently reassessing the scenarios. The real price increase evidenced by the Global Dawn scenario might be lowered somewhat after the year 2000, but the basic trend remains in tact. Current signposts indicate that the Global Dawn scenario is now in effect. However, changes in signposts could indicate that the trend is slipping into one of the other scenarios. As an example, Ms. Hittle explained that a signpost indicating "much less world economic growth" could signal the Pax Faustian scenario. A signpost for the Gilded Cage scenario would be a decision by OPEC to take a more aggressive stance to immediately increase the price of oil. The eventual effect of that scenario would cause prices to move down because of the impact on demand. The Global Dawn scenario reflects what is happening today-- cooperation, almost, between producers and consumers, the rule of the market over politics, economics, a wait and see attitude within OPEC, and good economic growth. Beyond the year 2000, there is increasing reliance on OPEC productive capacity and less reliance on increases in non-OPEC production. An assessment of demand and supply indicates there will be enough oil, but prices will start to "tighten up" a bit. Ms. Hittle pointed to page 38, referenced the assessment of world oil demand through the year 2010, and specifically noted demand of 78 million barrels a day. Of relevance to the United States is the fact that 65.7% of future demand growth through the year 2005 will be concentrated in Asia (handout, page 39). Directing attention to the page 42 graphic entitled "PADD V Crude Productive Capacity and Demand," Ms. Hittle explained that PADD V incorporates Alaska and the West Coast. Between 1996 and 1997, productive capacity will be less than demand, and imports into PADD V will increase in order to meet refinery demand. If the ban on export of ANS is lifted, that action should have a positive impact on price. Senator Sharp voiced his understanding that a comparison of comments by Cambridge several years ago with those of today indicates that elements impacting price and supply have narrowed. Comments concerning production from Russia appear more pessimistic for the next ten to fifteen years. He then inquired concerning the impact of recent events in Libya and internal strife in Algeria. Ms. Hittle advised that Algeria is producing approximately 800,000 barrels a day, including condensates. She concurred that Algeria raises potential for price instability. ARCO has had four major finds in the area in the last year. Algeria has now stabilized its productive capacity. Increases should be evident next year. Senator Sharp next voiced his understanding that new discoveries in the North Sea are expected to taper off, and older fields will be reduced in capacity. He then suggested that world recovery and maintenance of OPEC quotas appear to indicate price stability. The Senator advised of his belief that Iraq would reenter the market in the next year or two and voiced his recollection of earlier comments indicating that market reentry would be tempered. Ms. Hittle explained that Cambridge anticipates FSU production, as well as demand, to decline to 4.3 million barrels a day by 1997. There will then be a slow recovery of productive capacity to the year 2000. Most of the increase will occur after that time. Between 2000 and 2010, FSU productive capacity will increase 3.5 million barrels a day. That reflects eventual progress in the Caspian Sea. One of the most significant changes in the productive capacity outlook is "pushing the FSU back." At the same time, there have been sharp increases from the North Sea. However, non-OPEC production will peak in the year 2000. Non-OPEC productive net gain will only be 0.4 million barrels a day next year. That is in contrast to 0.8 million this year. Speaking to price stability and reentry of Iraq, Ms. Hittle stressed that even though the outlook is stable on an annual average basis, within the year there is "lots of room for price instability, uncertainty, and volatility." Much of it will be driven by the Iraq factor, but it will not be to the extent previously seen. The effect in demand increases over time will be less. Referencing Libya and Algeria, Ms. Hittle said that the United States has raised the ante by requesting an oil embargo from its allies. It will not succeed. There will be no acceptance of that request since it would have too much impact in Europe. Reality says it will not succeed. While this could have had an impact on market psychology two years ago, there have been so many threats of a Libyan oil embargo that the psychology of the market is not reacting to it as much as it otherwise might. Ms. Hittle acknowledged that if the "rhetoric really ratchets up," there could be impact. It is something to watch. She reiterated her prior statement that, in reality, the embargo is not expected to be imposed. The situation in Algeria has worsened and is unstable. However, to date, there have been no problems for operators. Islamic guerrillas have avoided oil facilities which are located in out-of-the-way places. While there is potential for instability, production and exports have not been impacted. Ms. Hittle further advised of movement by a group in Washington to press for an embargo against Nigerian exports. That would be difficult to impose. This is also a situation to monitor due to problems within the political regime in Nigeria. Ms. Hittle referenced the strike last year, and the fact that, this year, joint venture partners are not spending moneys needed to maintain productive capacity. For that reason, Nigerian production is not "increasing much, this year. . . ." Senator Sharp asked if Iran is "totally back in the market now." Ms. Hittle responded negatively, indicating that Iran is having problems maintaining productive capacity. In one month there is a surge up to quota, and the next month it falls back. This difficulty in keeping production at quota comes at a time when Iran would prefer to cheat because of revenue problems. The country needs western investment for needed work on its fields. The regime is paralyzed over the issue of whether or not to undertake and how to structure deals with western firms. There was not full agreement within the regime on the CONOCO agreement. While the agreement was made, it was a contentious issue. There is no green light for these types of agreements. Senator Rieger pointed to the long-term outlook whereby OPEC continues to add production capacity to the year 2010 and asked if OPEC would be meaningfully into reserves or could continue to increase production. Ms. Hittle explained that projections are based on the assumption that investment occurs. There is no foregone conclusion that OPEC will be at projected rates by 2010. After that time, the increase OPEC might be able to achieve becomes much more nebulous. Cambridge knows OPEC could reach projections to 2010, "pretty much on the basis of what we have." It is much more unknown whether or not there could be increases after the year 2010. Assuming that demand will increase, the question is "Will there be enough oil?" Senator Rieger again inquired concerning the portion of reserves that would have been produced by that time. Ms. Hittle said that projections assume an increase in reserves. She further advised that she could not presently say where those reserves would be. Speaking to the extent to which reserves may have been drawn down, Ms. Hittle advised she would have to calculate "what the reserve level will be as opposed to the productive capacity." She said she would undertake that calculation. ADJOURNMENT The meeting was adjourned at approximately 9:45 a.m.