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The Oil Investment Dilemma

Author: Toni Johnson
November 11, 2008

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A drop of over 50 percent in oil prices from their summer high of $147 per barrel seemed like good news to many beleaguered consumers. Instead, experts are signaling alarm. "Prices are falling, but they're falling for the wrong reasons: because of reduced demand and [as] a consequence of reduced economic activity, not because we have increased supply or increased energy efficiency," BP Chief Executive Tony Hayward said this month (AP). This precipitous drop, coupled with a shaky global financial system, has some oil experts worried about future investments in new oil production. In October, International Energy Agency Executive Director Nobuo Tanaka said delays in investment in oil projects might lead to a supply crunch (WSJ) by 2015.

With prices hovering in the $60-per-barrel range and credit increasingly unavailable, oil producers worldwide are already beginning to rethink investment plans or scale back on existing projects. Small African oil producers face mergers or takeovers (Reuters) given that relying on equity or debt to finance drilling and production may no longer be an option. Small production firms in the Middle East face a similar fate (The National), though the region's state-run oil giants can afford to continue investing from their huge cash reserves.

Oil has also become more costly to extract. An increasing amount of new output comes from more expensive "technically complex fields" (PDF), writes Christine Jojarth of the Global Oil Governance Performance research project at Stanford University. For example, Canada's oil sand development projects need at least a $65-per-barrel oil price just to break even (Canadian Press). Other experts say many new oil projects remain viable even at current prices (DowJones).

The investment picture poses special concerns for producers that are not part of the OPEC oil cartel, some of which are experiencing significant drops in output. A Barclays Capital oil analysis concludes there is no "significant signal in the current supply landscape suggesting we are about to turn the corner and stop the bleed down of non-OPEC supplies" (PDF). Earlier this summer, analysts predicted that Russia, the biggest non-OPEC producer, faced a multiyear production decline due to a lack of investment. An October 2008 report from the International Energy Agency concludes that credit shortages (PDF) "are rapidly becoming yet another in a long line of impediments to industry investment."

Even with record high oil prices, investment in oil development for 2007 remained flat, according to research firm IHS Herold Inc. The firm says that oil company profits have also remained relatively flat, in some cases due to increasing production costs and government uptake of more than 50 percent of industry revenues. The effect of government levies on companies can be crippling. The Russian government recently slashed its export duty of more than $50 dollars per barrel because oil prices are now so low that producers couldn't break even (Platts).

The volatility of oil prices in 2008, leading to gasoline prices over $4 per gallon in some places, aroused concern over U.S. energy security while spurring debate about the best policy path. One initial step was Congress lifting a ban on drilling off most U.S. coasts. The U.S. Government Accountability Office said in an October 2008 report that the agency that handles U.S. oil and gas leases could do more to encourage development (PDF) of existing approved areas for development. At the same time, a September 2008 report from the Center for American Progress, a left-of-center think tank, argues that investing in alternative energy is more likely to spur job growth and alleviate high gas prices than investment in more oil production (PDF). President-elect Barack Obama is contemplating a number of policy options, including asking oil majors to invest profits in alternative energy (LAT) or possibly face a windfall tax. But even with increased support, alternative energy still faces the same credit crunch as the oil industry.

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