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The Economist has published in its most recent edition a survey of oil, which I promised to review here. As it is behind a subscription wall, the links (below the jump)  are unlikely to be accessible to most of you, so I have tried to summarise its content before critiquing it.

The survey is an interesting contrast before good insights on the oil markets, the threats to and the behavior of the oil majors (with insightful comments on the above table), and the importance of government regulations, and a deliberately optimist take on "peak oil" and the likelihood for alternatives (especially fuel cells) to replace oil use in transport.

In a nutshell, this is the well-informed, but nevertheless deliberately rosy official view of corporate America.

In this first part, I will comment on the good insights of first half of the survey. In part II, which can now be found here, I will critique the rosy stuff, i.e. their views on peak oil and the future of alternative energies.

I'll also comment briefly on their article in the same edition about the recent Energy bill in a third diary.

Jump in!

The survey is actually quite short for the Economist; it comprises 6 articles which I will go through in succession:

Oil in troubled waters (Intro article)
Not so shocking (about oil prices)
Global or National (about the threats to the oil majors)
The incredible shrinking companies (about how oil reserves are booked)
The bottomless beer mug (about peak oil)
Consider the alternatives (the conclusion - there will be alternatives).

1. Oil in troubled waters

In this introductory article, the currently high prices are described, and explained, for the most part intelligently:

  • the initial cause is a conscious decision by the Saudis to track inventory levels in the West, and to lower production whenever such inventories rise too much from their perspective. (That decision followed the ill-timed 1997 OPEC decision to increase quotas just as the Asian crisis started, thus causing the painful - for them - fall in prices of oil to the low teens or worse);

  • demand growth has been stronger than expected, lead by both the US and China, and this, despite the significant rise in oil prices in recent years;

  • the geopolitical premium, linked to instability in Irak, the de facto re-nationalisation of Yukos and other nationalistic and/or anti-private sector policies in Russia, and Chavez's stridently anti-American tone;

  • some speculation on the financial markets, which the Economist dismisses  as it has actually been declining since March 2004 (as measured by net "long" positions, i.e. the amount of bets that prices will increase).

The result has been that spare capacity has reached record lows, as shown in this graph:

The Economists thinks that demand growth will slow down (China's demand growth being "unsustainable") and links to a disputed CERA (Cambridge Energy Research Associates, a respected consultancy in the sector) study that "rivers of oil" are about to come on stream from fields under development in the next few years, adding up to 13 mbd of new capacity (net of declines elsewhere).

They conclude this first article by saying that prices could just as easily go to 100$/b or to 10$/b. While this may be a chickening out, I personally think that the simple acknowledgement that 100$ oil is very much possible is a very strong message from them, even if it is an indirect one.

2. Not so shocking

Their second article goes on to say that oil prices are not so important anyway, as their impact on the economy is much less than it used to be.

It tempers that optimism by noting that we may be getting close to levels where further increases could hurt the economy, and that oil-importing developping countries are suffering already. Also, the dependence of our transport sector on oil has been underlined more starkly than ever.

Nothing new or objectionable in that part.

3. Global or national?

This part, which is about the oil majors, is probably the most interesting of the whole study. After noting the exceptional profits of the big oil companies, it notes that:

the chief factor behind today's profits is the surge in the oil price. And beyond that mountain of profits, the industry faces challenges that could ultimately wipe out some or most of these firms, once venerated as the Seven Sisters.

The biggest firms may be running out of good ways to invest their money. Oil bosses such as BP's Lord Browne and Exxon's Lee Raymond vigorously deny it, but it seems that the majors, though cash-rich, are opportunity-poor, just when their dwindling reserve base badly needs topping up.

"Oil is a depleting asset. Every day, if we don't spend money and find more oil, we lose assets. Most oil companies, by doing nothing, will shrink to one-fifth today's size."

Oil majors's existing assets (first of all in the North Sea, Alaska or the Gulf of Mexico) are "entering periods of rapid decline", and they are now facing the challenge of having to go seek more difficult and more expensive reserves in places like ultra-deep offshore in the Gulf of Guinea, the landlocked Caspian basin or unfriendly countries like Russia or Venezuela. Worse, most of the remaining reserves are in countries that are totally closed off to them.

This table, which I find the most significant of the whole study, shows who controls today's existing reserves (supposing that the numbers are correct):

It's pretty unusual to see a table where Exxon, BP or Chevron are near the bottom, right? Well, that's the reality of today's oil business, and a worrying one for all of us. Big Oil is running out of places where to invest, and the national oil companies have no real incentive to invest in new production capacity (it costs money "better" used by their governments, and it puts downwards pressure on oil prices, thus reducing the value of their current production).

So the oil majors are turning to "drilling on Wall Street" (i.e. buying rivals to boost their reserves), to unconventional fuels (like Canadian tar sands) and to natural gas, with uncertain prospects in temrs of the volumes required.

(As a side note, the Economist says that this is bad news for the environment, as national oil companies are much less responsive to pressure form NGOs than the oil majors are).

At this point in the survey, there is nothing really objectionable. It presents a reasonably balanced view of the oil markets and the factors influencing it (although it glosses over the Iraqi war), of the short term economic consequences of more expensive oil, and it has a good perspective on the challenges faced by the oil majors, many of which I agree with and have pointed out in previous diaries.

Don't worry, though, the hack job comes in the second half, which I will present in my next installment in a short while.

It will be about this:


Originally posted to Jerome a Paris on Sun May 01, 2005 at 12:03 PM PDT.

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