Comments: High oil prices are here to stay

Lots of interest this week, including a speech from the Shell chief exec.

But this business of the oil price is very complicated. Alarm bells ought to sound when we hear there is such a thing as Ďaí worldwide price. It says that normal competitive forces are not at play. Also, why should the price for all oil worldwide be decided by the price of marginal supply? If BP owns a platform in the N. Sea that pumps oil along a BP pipeline to a BP refinery and eventually to BP petrol stations in the UK, why should the price of UK petrol vary with the spot market price of oil in New York? And since itís Ďourí oil, why should the government allow this to happen?

Stepping back, thereís a lot of oil price info here: http://www.oilnergy.com/
- with graphs here: http://www.oilnergy.com/1onymex.htm

The last graph on the above page shows average annual oil prices. In 1998 the price was just over $10/barrel. Over the past twelve months itís been $50. Has our perception of future supply really changed that much in seven years to justify a five-fold increase?

Perhaps itís our perception of demand rather than supply. The low price in 1998 is generally associated with the Asia currency crisis and Asian recession. But the reduction in oil use in Asia in 1998 canít have been so great as to actually create a world glut at the time. Equally, the increase of oil use in China today hasnít actually led to a breakdown of supply. It looks as though the oil price grossly exaggerates any perceived problems in either direction of supply or demand.

So to say the high oil price is here to stay amounts to saying high economic growth worldwide is here to stay. That would be a better problem to have than a recession - but the 1998 experience shows it should only take a recession in one region, not the whole world, to reduce the oil price again.

But on the supply side, will we really run out of oil soon? Letís look at the background. A quick Google shows that BP Amoco made 8000 staff redundant in 1998, along with 8000 from Shell. Itís less well known that similar redundancies took place among the contractor companies. (As a geophysicist I was made redundant, on my 50th birthday, along with hundreds of others in just our one contractor company).

The common factor in most of these industry-wide redundancies was that the people were aged 50 or over Ė i.e. it was a pensions issue.

Now I donít remember popular street protests in 1998 at the scale of job losses caused by the $10 oil price. But my theory is that the low oil price in 1998 caused a big investment in new trucks by UK hauliers. The increased competition then contributed to the fuel protests in 2000 when the oil price went back to $25.

Meanwhile BP and Shell, having removed many of the staff that had discovered and developed all their fields from the 60s onwards, drastically cut back on exploration from 1999. They just concentrated on looking for Ďelephantsí (as daft an idea as it sounds). Only this week has Shell had a change of heart.

Whatís more, crazy management behaviour (Enronism) that affected the oil industry in the late 90s resulted in an obsession with mergers and acquisitions that reduced the number of companies in the industry and sidelined technology development.

So itís true that new finds have not been great over the last few years but thatís because the industry stopped looking hard. However the breakthroughs in 3D seismic and horizontal drilling from the early 90s havenít been applied to all existing fields yet and there are lots of new fields that would be viable today at an oil price above $25.

Now looking at Saudi Arabia Ė again, itís a story of missed opportunity. Up until 1983 the exploration analysis that found the major fields took place outside the country. Then a major exploration centre was set up in Saudi Arabia and eventually the Saudi Aramco company took over from the US oil companies in the late 80s. In practice, in spite of a large number of expat workers, by moving analysis work to Saudi Arabia the countryís oil exploration effort was deprived of the best minds in the industry. Matters have been made worse by the recent terrorist attack on expats in Khobar in 2004.

So I think thereís no real technical or physical reason to worry about a shortage of supply for a long while yet Ė but there are lots of are management/political issues (especially in the US).

If Gordon Brown had any sense he would give the energy industry the same close attention as the financial industry receives. The UK is in a very lucky position with oil. Thereís still time to give the tax incentives and regulatory oversight to encourage the growth of small oil and contractor companies that could exploit the many remaining opportunities that still exist in the UK continental shelf. BP and Shell can take care of themselves.

Posted by David Sandiford at June 24, 2005 07:55 AM

P.S. Now we know why Merv made his pre-emptive strike making the case for holding interest rates Ė to balance the release of the MPC minutes showing Charlie Beanís vote for a cut:
http://www.bankofengland.co.uk/publications/minutes/mpc/pdf/2005/mpc0506.pdf

But a read of the Agentsí summary of business conditions in May doesnít show any sign of panic Ė itís very much Ďsteady as she goesí:
http://www.bankofengland.co.uk/publications/agentssummary/agsum05june.pdf

Iím supporting Merv. Roll on the summer sales.

Posted by David Sandiford at June 24, 2005 08:08 AM

Quote of the week from Dr. Marc Faber in his article:

Housing bubbles and resource misallocation
http://www.ameinfo.com/62979.html

"But nor to worry, we know by now that the US economy is a service economy and does not need to produce anything to prosper except printing machines to keep increasing the supply of money (most printing machines are probably imported too).

Needless to say that the quality of US services is 'the envy of the world', as Mr. Bush, Rumsfeld, Cheney & Co. might articulate and - according to the Census Bureau's Economic Census - with the fastest growth being registered not in 'mundane' businesses such as biotechnology, nanotechnology and high tech industries but in high value added and intellectually highly demanding sectors such as lawn care, childcare providers, janitorial services and nail and hair salons!"

Posted by David Sandiford at June 25, 2005 10:19 AM