October 30, 2004 in Business

Oil supply expected to stay tight

Brad Foss Associated Press
 
Associated Press/ConocoPhillips photo

The sun peeks over the horizon at ConocoPhillips’ Alpine Field operation on Alaska’s North Slope. The world’s oil supply is expected to be stretched thin for another two to three years, even as demand tapers off and the industry gears up for an exploration and production spending spree in 2005.
(Full-size photo)

The world’s oil supply is expected to be stretched thin for another two to three years, even as demand tapers off and the industry gears up for an exploration and production spending spree in 2005.

That could keep prices for gasoline, heating oil and other petroleum-based products high by recent historical standards, perhaps through 2007, even though analysts say the price of oil itself is likely to fall below $50 a barrel and possibly below $40 a barrel as early as next year.

“We have a surprisingly tight market that refuses to crack,” said Art Smith, chief executive of the energy research and consulting firm John S. Herold and a firm believer that the world has entered “the end of the cheap oil age.”

Smith and others believe higher-than-usual prices are needed to moderate consumer and industrial demand and to spur enough new drilling to give oil markets a bigger supply cushion.

There are signs this is beginning to happen on the supply side, fueled in part by the combined $18.8 billion third-quarter profits of the world’s four largest publicly traded oil companies – Exxon Mobil Corp., ChevronTexaco Corp., BP Plc and Royal Dutch/Shell Group – that are 80 percent higher than a year ago.

At the same time, the industry’s extraordinary gains are putting a dent in the finances of families and businesses. American consumers are expected to pay $40 billion more this year just to heat their homes and fuel their cars and trucks.

As for corporate America, perhaps no other sector has been hit as hard as the airline industry. The seven largest U.S. carriers reported more than $1.3 billion in combined net losses for the third quarter as soaring jet fuel bills undermined carriers’ best efforts to reduce expenses.

The Organization of Petroleum Exporting Countries, and Saudi Arabia in particular, has the ability to fortify world oil supplies much more substantially than privately owned companies, but analysts said this creates a dilemma for the cartel.

“I don’t see any interest on their part to rebuild any cushion,” said Roger Diwan, managing director of markets at the Washington-based consultancy PFC Energy. “Why would they invest in more (oil production) capacity that they’re not going to be using when that will destroy the value of the capacity they are using?”

Total industry spending on finding and drilling oil wells is expected to rise by 10 percent to 20 percent next year, an extra investment of $25 billion to $50 billion by private and state-owned petroleum companies, according to estimates from several analysts.

Analysts expect the bulk of that investment to be in non-OPEC countries in Latin America, the former Soviet Union and Africa, both onshore and offshore, while any rise in excess capacity will primarily come from Saudi Arabia.

Yet output — the actual number of barrels produced — is likely to grow only slightly faster than demand, at least in the near-term, leaving global supplies uncomfortably low.

In 2004, the challenge of satisfying the world’s oil thirst has been made difficult by the surprisingly rapid rise in demand, particularly in China. It has been heightened by the war in Iraq, hurricanes in the Gulf of Mexico and petro-politics in Russia.

Together these factors have produced both genuine and hyped-up fears on energy markets, driving crude futures prices to a record close of $55.17 per barrel last week on the New York Mercantile Exchange. The price of oil, which settled Friday at $51.76 per barrel, would need to surpass $90 per barrel to approximate the all-time high, in inflation-adjusted terms, set in 1980.

Many analysts believe the world’s largest oil companies are partly to blame for today’s ultra-thin supply cushion due to their cautious approach to exploration and production. Chief among the reasons for their tentativeness was the fear of a price collapse that would make more aggressive drilling look foolish in the future. After hovering around $20 a barrel throughout much of the mid-1990s, the price of oil dropped below $11 per barrel in December 1998.

The longer prices stay high, though, the more likely that attitude will change. Major oil companies are now looking into projects that would be profitable at $22-$25 a barrel, up from previous “hurdle rates” closer to $20 a barrel, said Kurt Hallead, an oil services analyst at RBC Capital Markets.

Still, the industry has used significant portions of its increased profits in 2004 to pay down debt, buy back stock and raise dividend payments to shareholders. And companies have been more inclined to pursue low-risk exploration and production strategies, such as working over wells in existing oilfields and acquiring proven reserves from others.

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