Energy prices could collapse. However, even mainstream organizations like the IEA, EIA and the oil industry’s own council have recently released reports warning of tightening supplies so it is hard to realistically project a price collapse due to supply glut. The other possible scenario causing price collapse is a global economic meltdown. In this case, all asset classes will be affected. Energy assets will probably be the first to recover, however, as economic growth (or recovery) is not possible without energy.
Major risk lies with the Lower Tertiary play and its exposure to hurricane risk. The 2005 hurricane season devastated industry capacity. While Devon’s production was impacted by only 3%, new projects in the Gulf of Mexico coming online (Merganzer) or those in planning such as Jack or Kaskida could be affected more severely. In addition, hurricane insurance has dried up and Devon’s coverage has been reduced.
As resources and prospects become scarce, we may find ourselves in a receding horizon scenario where costs rise just as fast, if not faster, than realized prices. For instance, the cost of exploiting the Canadian oil sands has ballooned as environmental damage, labor shortage and ironically, natural gas and water supply issues all converge as production increases. Deepwater exploitation could follow a similar course.