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Deepwater Horizon Rig Crisis

05/03/2010
The events surrounding the Deepwater Horizon Rig crisis, which began on April 20, has now reached the impact point for oil prices. Toward the end of last week, spot prices advanced beyond $86. In addition, near term supply constraint concerns are narrowing the steep contango that the market experienced 10 days ago as the European travel shutdown increased stock piles of jet fuel. That "narrowing" is a bullish sign for spot prices.

However, in the near term I am not overly concerned that the situation will evolve into a "spike" for spot oil prices. Even if the worst case scenario, closing of the LOOP (Louisiana Offshore Oil Port), was to occur, stockpiles of oil remain high. In addition, President Obama has a rather full reserve supply of oil resting in the SPR (Strategic Petroleum Reserve) that he could release, or lend out.

My concern is "beyond the moment."  The disaster will have several potentially damaging repercussions for future oil supply growth. First, I would anticipate serious delays in the implementation of the White House's March 31st five year offshore drilling plan. Inspections will now begin on 30 drilling rigs and over 40 other production plants.

There are five energy companies negatively impacted by this event and they will experience significant balance sheet draw downs as a result. To increase our long term supply of oil, we need balance sheet strengthening of those five companies. It is estimated British Petroleum (BP) will have a $6 billion dollar balance sheet hit from this disaster. Anadarko, Cameron, Halliburton, and certainly Transocean will also feel balance sheet pain. The market has punished those stocks all this week; each of those five companies, except Halliburton, is down over 10% since April 20th.

Overall, a very sad event for all Americans, the impact of which will be felt over the next several years as much needed investment dollars are not spent on increasing supply. The room for error is margin thin for the energy sector when gauging our ability to offset rising demand for oil from the emerging markets.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.