Living with volatility

Tom Petrie has hardly hung up his spurs since selling his namesake investment bank, Petrie Parkman & Co., to Merrill Lynch & Co. in 2006 for an undisclosed sum. He's being called on by oil companies for his take on the state of the industry as well as to advise them on deals (he assisted Delta Petroleum Corp. on its sale of a 35% stake to Kirk Kerkorian's Tracinda Corp. in February for $684 million). He's also a sought-after conference speaker and TV commentator on oil and gas markets.

An analyst by background, Petrie has covered oil companies and markets through several booms and busts. He is also less of a rabble-rouser than Matt Simmons, the founder of investment bank Simmons & Co. International, who says the world is running out of oil, but more of a realist than industry booster Daniel Yergin, who thinks there's plenty of oil to be found with new technology. Petrie has made some good calls. Back in November, when oil prices reached $100 per barrel, he told fellow oilmen at a conference that it would take $120 to $150 oil to trigger the demand shifts that would stop oil prices' upward trajectory. Sure enough, oil prices began to slide after hitting $147 on July 11, when oil consumers began to cut back. Petrie recently spoke with The Deal's Claire Poole about what's behind oil prices' dramatic rise and fall and how it's affecting M&A.

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The Deal: Why did oil prices rise so high?

Tom Petrie: It's a combination of factors. Fundamentally, it was an attempt by the market to take into account peak oil. There's been a revelation that the ability on a global basis for us to increase output to meet the likely outlook for global demand has become problematic. It's between 86 million and 87 million barrels per day and another 2 million that don't necessarily have refining markets, so there's a question how much of that could come on the market at any time. When you recognize the limitations from Venezuela and Russia, 95 million to 100 million barrels a day may be a practical limit. A former senior person from Saudi Aramco recently said it would be a struggle to get past 90 million barrels a day.

So you don't think the run-up was because of speculators?

To try to blame speculators is a reach. The market has recognized the peak oil issue, and more capital has been allocated to not just oil but commodities in general. The supply-demand picture for oil, food, metals and so on has shifted. Blaming the speculators is an easy out for those who don't want to acknowledge that there's a failure of policy.

Then why did oil prices suddenly fall?

When we got to $100, it became self-reinforcing. At $140, it was ahead of itself to a certain extent. The market began to get data that patterns of driving are changing, jet fuel and distillates are changing and industrial products are being affected. It became pretty sobering pretty quickly. People are making changes in their consumption habits. The difference between what you can do short term and long term is huge. In 1979 and 1980, we saw no effect. In the second half of '81, we saw demand was beginning to slide, and by 1985, the call on OPEC had slipped by 10 million barrels per day. This time around, there are some differences. In the emerging markets of China and India, the rest of Asia and parts of Africa, there's a steep growth curve. And in Russia, there's a re-emerging growth curve. Growth will continue, which will dampen diminished consumption.

With all the political pressure over speculation and high prices, did the U.S. government jawbone people to take some money off the table and lay low for a while so energy prices would fall? Or was the recent drop just pure market forces at work?

There was a little bit of both, with President Bush coming out with a call for the lifting of the executive ban on offshore drilling. The congressional ban won't go away as easily or as quickly. Within OPEC, the Saudis have been trying to take actions, in terms of both stating publicly where they are in terms of production and that they'd like to see oil prices go up some, with $200 oil being right around the corner.

Increased nationalism and geopolitical events have been pushing prices up, but now they don't have the same effect as they had previously. A lot of the players in the financial sector had gains in the oil market and losses in other instruments, stocks and bonds and so on, so there is a motivation for market decision makers to take gains.

Do you believe U.S. government statistics on inventories, which also helped drive prices down?

The most recent numbers did provide a little bit of data that would suggest they're building a little better on gas. There were mixed numbers on oil.

Do you believe other countries' statistics on reserves, such as Saudi Arabia?

There's a lot of controversy about that. Matt Simmons has questioned it. Anyone who thinks that any data set is highly reliable could be disappointed and thus runs the risk of market reactions.

So are you more in the Simmons camp or the Yergin camp on peak oil?

I call it practical peak oil. I don't know if we've already peaked. We'll know well after the fact. But our global ability to produce more than 95 million barrels is doubtful.

What is volatility doing to the industry and to M&A?

Over the last three years, volatility has been rising, leading to higher prices and contributing to an expanding range of transaction activity. Acquirers are being rewarded, and private owners are motivated because they're seeing prices they never thought they'd see for their properties. Property deals are more attractive than corporate deals, and gas assets are more attractive than oil properties, probably because gas is being transformed by new resource plays.

Buyers have also become much more adroit at hedging techniques in their acquisition strategies. People are much more inclined to try and hedge over two-, three- and four-year periods, a good part of the production, so volatility has both motivated or incentivized buyers to be active once they become an owner.

Was the bankruptcy of SemGroup, which made some bad trades, an isolated event?

I'm inclined to believe that it was more of a one-off.

What do you see in your crystal ball in terms of oil prices?

For the next few months, my operating hypothesis would be that we're starting into a retracement of the advance in oil prices. It won't be back where we were a year ago, but somewhere between moderate and meaningful, between $100 and $120 per barrel.

How will it affect M&A?

I am not at all convinced it will affect M&A activity levels, because for those who go to the sidelines, there will be others who have been on the sidelines who will come back in and say, "This is what I've been waiting for." There are well-heeled entities that haven't been active. Volatility has an effect on individual decision makers, but for every decision maker, there's at least one or two that may move off the sidelines. We've got looming resource security issues, and we have exciting new ways to exploit resources. I just listened to a well-run company describe what they've done with their acquisitions over time, from horizontal drilling to refracs. Those doing acquisitions today are adhering to the notion that the buyer rarely buys what the seller thinks he's selling. Taxes are going up this year, and there are private people in the business who don't like the regulatory outlook and may decide to sell. On the buy side, those committed to be in the business in perpetuity can try these new techniques.

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