The Real Oil Crisis

Oil prices are over $30 per barrel (London Brent crude closed at $32.

Oil prices are over $30 per barrel (London Brent crude closed at $32.28 yesterday).  An invasion of Iraq is pending.  Venezuela's production has not recovered from the impacts of the strike (production is at 1.9 million barrels per day (bpd); it was 3.1 million bpd last November).  Oil inventories are at record low levels.  OPEC has admitted its surplus capacity is down to about 2 to 4 percent of world demand levels and it cannot make up for supply shortages caused by a disruption of Iraqi production in addition to the Venezuelan shutdown.  Non-OPEC producers are already producing at capacity.  Even if we squeeze through these near-term shortages, the surplus capacity will disappear in less than 3 years with normal demand growth in recovering economies causing long-term upward pressure on oil prices which will stifle that same growth.  

 So why is the oil industry not expanding its operations?  Why are capital budgets this year predicted to be flat or lower than last year's?   Why is the worldwide rig count and number of active seismic crews lower than they were a year ago?   Why is Houston not eagerly anticipating boom times?

 The answer to these questions is simple: Because investment in oil development is a bad investment.   

Capital commitment for large projects runs in the hundreds of millions, or billions, of dollars.  From capital commitment to significant production, and income, averages about 5 years for large projects.  Prices are volatile and unpredictable and if the projects successfully bring on new production, the price of oil will drop and reduce the rate of return.  Investment has a high degree of political, economic, security, geological, event, fiscal, and technical risk.  The industry has a reputation for capital destruction.  All these factors combine to make an oil development project a hard sell to prospective investors.  

 Besides these direct impediments to investment are more subtle influences. Lulled by economic expansion and unconcerned about oil supply for twenty years, the American public developed several widespread opinions and attitudes that are manifested in political activity.  These political activities make the oil industry the scapegoat for the country's problems, constrain any attempt to formulate an energy policy, and have perverted legitimate public concerns over pollution and the environment for political gain.  Although many of these opinions are inconsistent, outright conflicting, based on unrealistic expectations, or counter to scientific evidence, they have been used to mislead the public and politicians and achieve political objectives that are irrelevant to energy issues.  These attitudes have hardened into an unreasoning vicious fanatical opposition to all activity by the industry and, by adding an additional element of risk, discourage investment.  In addition, people in the industry are leaving in large numbers, fed up with being, as one told me recently, "over-legislated against, over-regulated against, over-litigated against, and vilified in the press - I'm going to cash out and get out".  The exodus of experienced personnel is beginning to stall large projects. 

So we have an imminent threat to the general world economy and well-being.  As yet, little or no action has been taken to prevent or alleviate it.  We have an oil shortage facing us and the investment is not being made to develop additional supplies.  As usual, the United States must take the responsibility of finding a solution; no one else will, or can.   

 Additional investment for oil development to meet world demand by 2015 is estimated at between $800 billion and $1.5 trillion.  Under current conditions, the Middle East is a concentrated source not only of oil but of trouble and instability, so investment should be directed to developing diverse sources in other locations. 

No one expects the United States government suddenly to become a developer of foreign oil fields; it does not have the expertise and such an activity is not consistent with American concepts of the role of government.  The government can, however, through various actions and policies, create a more favorable environment for investment by the industry.   

These activities fall into two categories.  First, a program of diplomatic attention and aid to improve the investment climate in areas and countries where we would like industry to develop additional oil supplies such as Russia and Latin America.  That diplomatic attention and aid will have widespread benefit by improving general economic conditions in those areas with resultant benefits for political stability and improvement of living conditions for the populations.  Second, regulatory steps must be taken to change the mechanism of oil pricing to be more consistent with industry conditions and investment requirements.  Government should not set prices or interfere with the market, but it can change the rules of the oil market to offer more stable, long-term price and market expectations.     

 From a technical standpoint we know where additional large foreign oil supplies can be developed: Russia, Mexico, Colombia, Venezuela, offshore west Africa, and Central Asia.  This is not an optimal set of choices.  Mexico allows no foreign investment in its oil industry.  Investment in the others is hampered by varying combinations of unattractive fiscal terms and working conditions, unstable political systems, and unsafe and insecure working conditions.