Oil prices at this level take us into a new world – “Break Point” – where the question is not only “how high can the price go?”, but also “what will be the response?” Is this the point at which oil begins to lose its almost total domination in transport?
Yes, the current high oil price may be a demand shock triggered by what had been several years of excellent global economic growth, and thus more benign than supply shocks caused by 1970s-style disruptions. It is amplified by a dollar shock caused by the fall in the dollar and by the embrace by financial investors of oil (and other commodities) as an asset class.
What is now unfolding is an oil shock. The fact that the world could take $80 in its stride in the context of strong economic growth does not mean that a price that is 60 per cent higher at a time of a credit crunch will be so easily assimilated. The economic toll is mounting. Airlines are certainly in shock as they start charging for checked luggage to find a way to pass on their biggest cost. Carmakers are reeling. Retailers are tracking the shrinking wallets of their customers. The rising prices for food reflect, in part, the impact of higher energy costs.
Oil supply, one might think, should be responding. Yet there are three obstacles. The first is time. These high prices have not been around all that long and development of new supplies takes many years. The second is access to new resources. And the third factor is what is happening to costs. The public focuses on the price at the pump, but the oil industry is preoccupied, and indeed somewhat stymied, by how rapidly their own costs are rising – far exceeding the rate of general inflation. The latest IHS/Cambridge Energy Research Associates (Cera) Upstream Capital Cost Index – the consumer price index for the oil field – shows that costs for developing a new oil or natural gas field have more than doubled in four years. Some costs have risen even more: a deep-water drill ship might have cost $125,000 per day to rent four years ago. Today it goes for more than $600,000 per day – if you can find one.
Everything is in short supply – people, equipment, engineering skills. Because of the contractions that came with the price collapses of 1986 and 1998, there is a missing generation in the oil industry. More than half the petro- professionals are less than 10 years away from retirement. A petroleum engineer graduating this year is likely to receive a higher starting salary than an Ivy League graduate going to Wall Street. This competition for people and equipment has driven up costs dramatically. These costs and shortages are now causing delays to new projects.
Demand is already responding to the new prices except in those parts of the world where retail fuel prices are controlled or subsidised. What can be done to improve the supply picture? The International Energy Agency's work on future supply is getting attention. But the IEA's message is not that the resources are not there. Rather it is the likely risk that the required investment will be “deferred” – will not take place in a timely way – because of these rising costs and because governments restrict access or postpone decisions.
This underscores the basic need during an oil shock – to encourage the timely investment that will relieve the pressures. That means encouraging efficient decision-making by resource-holding countries and facilitating complex projects that bring on new supplies. An example of the difference engagement can make is the support the US administration gave to the Baku-Tblisi-Ceyhan pipeline. Without that new 700,000 barrels a day capacity pipeline we would not have that additional oil flowing to the Mediterranean.
The impact of rising oilfield costs and the importance of encouraging investment need to be taken into account when considering a “windfall profits” tax or other new taxes. However attractive politically, the effect would be to constrain investment and to lead to lower production levels than would otherwise be the case.
Two years ago, Cera created its Break Point scenario, to explore how supply disruptions and delayed development would lead to $120-$150 oil. What was not fully anticipated was the impact of rapidly rising costs. Not anticipated at all was a falling dollar and how it has stimulated a rush by investors into oil. The real question in the scenario was what would be the response to such high prices. Could oil lose its traction?
That answer is already unfolding – in terms of public policy, technology, consumer response and corporate strategies. At the end of 2007, as oil was heading towards $100 for the first time, the US Congress passed the first bill requiring an increase in automobile fuel efficiency in 32 years. Consumers now want to buy fuel efficiency not sport utility vehicles. Hybrids are going from fringe to mainstream and a concerted assault has been launched on the problems of battery technology.
While the backlash against biofuels has gained in intensity with rising food prices, biology is now engaged with the energy business as never before; and biofuels will be a growing part of the motor fuel pool. If “Ethanol” was a country, it would have been ranked number five last year among countries in terms of production growth.
The break point is already here. Oil is in the process of losing its almost total domination in ground transport. It is not going to fade away soon – such is the scale of its use and convenience, it will retain a dominant position for many years. But it will share the transport market with other sources as never before, reinforced by a new drive for fuel efficiency.
Yes, the current high oil price may be a demand shock triggered by what had been several years of excellent global economic growth, and thus more benign than supply shocks caused by 1970s-style disruptions. It is amplified by a dollar shock caused by the fall in the dollar and by the embrace by financial investors of oil (and other commodities) as an asset class.
What is now unfolding is an oil shock. The fact that the world could take $80 in its stride in the context of strong economic growth does not mean that a price that is 60 per cent higher at a time of a credit crunch will be so easily assimilated. The economic toll is mounting. Airlines are certainly in shock as they start charging for checked luggage to find a way to pass on their biggest cost. Carmakers are reeling. Retailers are tracking the shrinking wallets of their customers. The rising prices for food reflect, in part, the impact of higher energy costs.
Oil supply, one might think, should be responding. Yet there are three obstacles. The first is time. These high prices have not been around all that long and development of new supplies takes many years. The second is access to new resources. And the third factor is what is happening to costs. The public focuses on the price at the pump, but the oil industry is preoccupied, and indeed somewhat stymied, by how rapidly their own costs are rising – far exceeding the rate of general inflation. The latest IHS/Cambridge Energy Research Associates (Cera) Upstream Capital Cost Index – the consumer price index for the oil field – shows that costs for developing a new oil or natural gas field have more than doubled in four years. Some costs have risen even more: a deep-water drill ship might have cost $125,000 per day to rent four years ago. Today it goes for more than $600,000 per day – if you can find one.
Everything is in short supply – people, equipment, engineering skills. Because of the contractions that came with the price collapses of 1986 and 1998, there is a missing generation in the oil industry. More than half the petro- professionals are less than 10 years away from retirement. A petroleum engineer graduating this year is likely to receive a higher starting salary than an Ivy League graduate going to Wall Street. This competition for people and equipment has driven up costs dramatically. These costs and shortages are now causing delays to new projects.
Demand is already responding to the new prices except in those parts of the world where retail fuel prices are controlled or subsidised. What can be done to improve the supply picture? The International Energy Agency's work on future supply is getting attention. But the IEA's message is not that the resources are not there. Rather it is the likely risk that the required investment will be “deferred” – will not take place in a timely way – because of these rising costs and because governments restrict access or postpone decisions.
This underscores the basic need during an oil shock – to encourage the timely investment that will relieve the pressures. That means encouraging efficient decision-making by resource-holding countries and facilitating complex projects that bring on new supplies. An example of the difference engagement can make is the support the US administration gave to the Baku-Tblisi-Ceyhan pipeline. Without that new 700,000 barrels a day capacity pipeline we would not have that additional oil flowing to the Mediterranean.
The impact of rising oilfield costs and the importance of encouraging investment need to be taken into account when considering a “windfall profits” tax or other new taxes. However attractive politically, the effect would be to constrain investment and to lead to lower production levels than would otherwise be the case.
Two years ago, Cera created its Break Point scenario, to explore how supply disruptions and delayed development would lead to $120-$150 oil. What was not fully anticipated was the impact of rapidly rising costs. Not anticipated at all was a falling dollar and how it has stimulated a rush by investors into oil. The real question in the scenario was what would be the response to such high prices. Could oil lose its traction?
That answer is already unfolding – in terms of public policy, technology, consumer response and corporate strategies. At the end of 2007, as oil was heading towards $100 for the first time, the US Congress passed the first bill requiring an increase in automobile fuel efficiency in 32 years. Consumers now want to buy fuel efficiency not sport utility vehicles. Hybrids are going from fringe to mainstream and a concerted assault has been launched on the problems of battery technology.
While the backlash against biofuels has gained in intensity with rising food prices, biology is now engaged with the energy business as never before; and biofuels will be a growing part of the motor fuel pool. If “Ethanol” was a country, it would have been ranked number five last year among countries in terms of production growth.
The break point is already here. Oil is in the process of losing its almost total domination in ground transport. It is not going to fade away soon – such is the scale of its use and convenience, it will retain a dominant position for many years. But it will share the transport market with other sources as never before, reinforced by a new drive for fuel efficiency.
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