On the same day this past December, Santa delivered the goods. OPEC pledged to cut output by 1 million barrels per day (starting this month), and two major Wall Street houses said E&P spending in North America will go up. And, oil and natural gas prices have retreated from untenable highs on the New York Mercantile Exchange. This marks the long-awaited return to sanity, with prices based on market fundamentals, not on hedge-fund speculation and war fears. Citigroup Smith Barney estimates North American E&P spending will rise 8.6% in 2005, according to its new poll. But rig activity may be even more robust than that. "We expect the pattern of expenditures exceeding initial budgets to be continued for a sixth straight year, even if oil and gas prices moderate further," says analyst Geoff Kieburtz. Citigroup's respondents assumed average prices of $36.69 per barrel of oil and $5.66 per million Btu of gas at the Henry Hub. These are record highs for the 23rd annual survey, but still rank below the futures strip on the New York Mercantile Exchange. Meanwhile, Lehman Brothers' survey of 249 companies active in the U.S. said domestic E&P expenditures will go up 7.8%, led by an impressive 24% increase on the part of small independents that spend less than $100 million annually. These rosy outlooks are based on producers finally accepting that even if prices do fall, they will remain permanently higher than in the past. After all, oil averaged $19.60 per barrel from 1985 to 2000-but since 2000, it has averaged $30, according to the International Energy Agency. Crude oil declined to about $41 a barrel at press time, but that's a sign of stabilization that may give producers the courage to pursue more acquisitions and corporate mergers-better sell the juicy assets now before the price goes down further. OPEC was right to cut overproduction back to its official limit of 27 million barrels a day-which was what it was supposed to be if members had not been cheating. The significance was not lost on the market, for this was the first time OPEC had promised to cut output since April 2004. Even so, the cartel is still pumping oil at its highest rate in 25 years and is promising to pump more if global demand keeps rising. Last fall, Saudi Aramco said it would start contracting more rigs. There are about 30 rigs operating in the kingdom now, but National Oilwell CEO Pete Miller said on a conference call with analysts that the kingdom wants to expand its fleet to as much as 60 rigs ultimately. Nabors Industries confirmed that Saudi Aramco entered 10 new rig contracts with Nabors; four were added in late 2004 and the balance will come this year. The cartel still tries to outsmart world markets, even though oil has traded above its stated price limit, $28, for more than a year. The dollars OPEC earns are worth about 30% less than they were two years ago, no small problem. The Chinese economy shows signs of slowing its hot growth pace. Other economies are starting to show strain from high oil prices as well. Less than a week before OPEC acted, the Organisation for Economic Co-operation and Development (OECD) lowered its 2005 economic forecasts for the U.S, Japan and Europe, citing oil prices. The same day OPEC announced its production cut, the International Energy Agency in Paris trimmed its 2005 global oil demand-growth number slightly, citing oil prices, to 1.4 million barrels per day. It forecast daily non-OPEC supply will go up 1.2 million. That would leave only 200,000 barrels a day of increase for OPEC to supply. Improved security for the Iraqi oil pipelines could easily make up that number. Drilling more wells is a top priority for oil and gas companies, which recognize that this is critical to the country. In a poll taken at Oil and Gas Investor's Senior Financial Officer Executive Forum last month, co-sponsor Ernst & Young asked attendees to list possible ways to reduce U.S. hunger for foreign oil. Some 57% said increased access to onshore and offshore areas was the solution. A wide majority, 86%, said companies would likely use their recent profits to invest in E&P, but 72% said gaining access to new areas for exploration and development will be the top challenge in the next five years. U.S. and Canadian producers are not the only ones to increase their budgets for 2005. The interim Iraqi government last October approved a $3-billion budget for the oil ministry-the highest budget ever allocated and substantially more than the $800 million appropriated in 2004, says a report from Cambridge Energy Research Associates. The money will be spent on upstream developments, pipelines and refinery expansions. The world has to hope that the outcome of the Iraqi presidential election does not stymie this plan.

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