In a comment on Murdoc's site, ACE pointed out this Forbes article which laments the fact that oil companies are not investing in new fields at the pace that many people would hope for, based on the current oil price of $70 per barrel.
The oil companies point to $106 billion spent this year so far on capital investments, but the article points out that this is far from enough to maintain current extraction levels, let alone grow the supply.
The article points out that this clearly implies that the oil companies do not believe $70 per barrel, or higher, will continue for a long period into the future. They quote an analyst guestimating that the oil companies are assuming $40 per barrel plus inflation over the long term.
They propose two explanations for why the oil companies assume this lower number, while I would add a third.
The first reason they propose is that
The oil companies haven't forgotten the 1986 bust that wiped out nearly half the industry. Today, they worry that a slowdown in the global economy or a flood of new supply could bring prices crashing down. The former happened in 1998, when the Asian financial crisis produced the lowest-price oil in inflation adjusted terms.
The second reason they propose is that
Over the longer term, oil companies are counting on getting cleverer at extracting more oil from any given field as well as from unconventional sources, such as oil shale or tar sands. If history is any guide, they will succeed.In the past, only 10% of oil discovered worldwide ever made it to market, says Jerry Taylor, the director of natural resource studies at the Cato Institute in Washington. But thanks to the march of technology, that portion has climbed to 35%; a move to 40% would create a big increase in new supply.
The third reason, which Forbes does not address but that I believe in, is that the current $70 per barrel price is not driven by current supply/demand dynamics alone, but by fear of near-term disruption in the balance. Supply could be impacted by further conflict in the Middle East, OPEC getting clever, another hurricane in the Gulf of Mexico, or any number of geopolitical issues. Demand in China and/or India could increase enough to temporarily outstrip supply. Oil companies would be worried that, over longer periods, supply might catch up, meaning any demand-induced spike in price would be short-lived.
But the oil companies seem to be the only ones who are bearish on the oil market:
On that score, the oil companies appear to be virtually alone. Wall Street continues churning out predictions of $100 oil. Hedge fund managers are pouring millions into oil futures. And peak oil theorists, who argue that humans have produced nearly half the oil that there is to produce, and that therefore prices will shoot up enough to bring economic growth to a halt, are enjoying their heyday.
However, the oil companies have much more money at stake in this game than any of those other analysts. In sheer dollars, oil companies' investments make any particular oil speculator's investment look like pocket change. Also, these other analysts' incentives are very different. Wall Street analysts tend to make bold prediction which they can trumpet if they come true, and never mention again if proved false. Hedge funds often (although not always) are making bets on the relative movements of various investments, so that they may not care about the absolute price of oil, but may have some offsetting investment in their portfolio so that what matters is how the price of oil changes relative to this other investment. In such a structure, they can profit even if oil prices decline, as long as this other investment moves in tandem as hoped.
One other factor pointed out in the article that I would like to repeat here is the following:
Up to 75% of the world's reserves are off-limits to private oil companies, calculates Philip Verleger, an industry expert at the Institute for International Economics in Washington. And the projects that are available aren't always that lucrative since national governments demand most of the profits for themselves.
So after reading the article, and adding some other tidbits that I've heard or read about the situation, I find it hard to fault the oil companies for assuming that, over the long term, oil prices will tend to average much lower than today's prices. Actually, that's not a fair characterization of their position. The oil companies do not necessarily believe that prices will be lower than today. What they believe is that there is a high enough probability that the prices will be lower, that they do not believe certain investments are justified.
Frankly, I find the whole anger at the oil companies to be misplaced. Oil and energy is such an important resource in our economy, and is so intertwined with our international relations, that anger should be focused squarely on Washington, D.C. which has managed to avoid having a rational energy policy since ... well ... ever (regardless of which idiots were in power).
Comments