One of the primary drivers of higher global oil prices over the last five years has been a sustained period of robust global economic growth, which led to stronger than expected energy demand growth.
A second reason for high global crude oil prices is constraints on expanding conventional supplies. The biggest constraint is rising resource nationalism that limits access to resources for development. In the 1960s, 85% of global oil and natural gas reserves were available for direct development by international oil companies, versus only 7% today. In addition, rising competition for access to the relatively limited resources that are open for development has enabled host governments to dictate fiscal terms that are so onerous that publically trade oil companies cannot economically pursue them. Increased taxes are a part of the change in the fiscal terms. Morgan Stanley estimates that the exploration and production tax rates of major oil companies have increased from about 30% to 45% since 2000. In some cases, governments change fiscal terms after investments have been made or increase taxes on existing production, even in mature producing areas in otherwise stable countries (Alaska in the United States and the United Kingdom). Such actions can make it uneconomic to invest the capital required to slow decline rates in existing fields. Increases in tax rates and other forms of government take are particularly problematic due to the maturity of oil provinces in areas such as the United States, the North Sea and Western Siberia and the increasing amount of capital required to offset the rising decline rates.
Resource access is also very limited in the United States, where an estimated 40 billion barrels of technically recoverable oil are either completely off limits or subject to significant lease restrictions. Similar restrictions apply to more than 250 trillion cubic feet of recoverable natural gas reserves.
Also pushing crude oil prices upward is the high geopolitical supply risk attributable to the world’s low level of excess oil production capacity and the fact that in several key oil-producing countries, political factors are constraining production. (E.g., Nigeria, Iraq, Venezuela and Iran.) The combination of strong demand growth and the need to offset lost production from these countries left the Organization of Oil Exporting Countries (OPEC) at year-end 2007 with only 2.5 million barrels a day of excess capacity, equal to just 3% of global oil demand. This contrasts sharply with the greater than 10 million barrels per day of excess capacity that existed in the mid q980s. This lack of spare capacity leaves world markets more vulnerable to oil supply disruptions caused by political events, storm damage to producing facilities, or unforeseen operational problems.
Within limits, OPEC could historically influence prices by adjusting its production to tighten or loosen the supply and demand balance. However, today the large amount of oil traded in futures exchanges (1.3 billion barrels per day) is 36 times greater than OPEC’s oil production of 36 million barrels per day. In addition, given OPEC’s small excess production capacity, its member nations have significantly less influence on the price of crude oil than they had in the past.
A final possible reason for recent increases in crude oil prices is the rising attractiveness of commodities to financial investors. Commodity index funds have been developed to provide investors with a financial vehicle to gain commodity price exposure. Investors have moved large amounts of capital into these funds in order to seek higher returns than are currently available through the stock and bond markets, to hedge the risk in their portfolios given the negative correlation between commodity prices and prices of stocks and bonds, or to hedge against inflation. Declines in U.S. interest rates or the value of the dollar stoke concerns about inflation, prompting an inflow of cash into these funds. According to Daniel Yergin, chairman of Cambridge Energy Resources Associates, “oil has become the ‘new gold’ — a financial asset in which investors seek refuge as inflation rises and the dollar weakens.”
Excerpted from yesterday’s testimony by John E. Lowe, executive vice-president, exploration and prroduction, ConocoPhillips, at U.S. Senate hearings on “Exploring the Skyrocketing Cost of Oil.”
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