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The Wall Street Journal: Oil Industry Barely Boosted Investment in Production, IEA Says

November 7, 2006 2:58 p.m.

The world oil industry has barely increased its investment in oil and natural-gas production during the past five years after accounting for inflation, a new study finds, suggesting global energy prices are likely to face upward pressure in the years ahead.

Data compiled by the International Energy Agency show investment in the oil and gas industry rose 70% to $340 billion in 2005 from $200 billion in 2000. But cost inflation for goods and services used by the industry accounted for almost all of that increase, according to the Paris-based IEA, the energy watchdog made up of 26 of the world’s major industrial nations. Adjusted for inflation, the oil industry’s investment increased by 5% between 2000 and 2005, the IEA said.

“That’s almost nothing; it’s inadequate,” Fatih Birol, the IEA’s chief economist and the principal author of the agency’s latest annual World Economic Outlook published Tuesday, said of the inflation adjusted rise in investment.

The IEA’s survey was comprehensive, including investment and plans of international oil companies, independent producers and national oil companies. Their plans involve spending of $470 billion in 2010, up 38% from the 2005 level. Two-thirds of the spending by the industry is expected to be directed into oil and gas production.

Because oil and gas projects take many years to complete, the results of any scrimping on investment during the first half of the decade will only become evident toward the end of the second half.

If world demand for oil rises faster than projected, or if production capacity increases are less than expected, the result would be upward pressure on prices. But even if demand and supply trends conform to projection, which is unlikely, the oil industry’s investments won’t significantly add to the world’s spare oil production capacity, a reserve that is needed to offset supply disruptions that periodically occur because of political, natural or industrial disasters.

Oil prices nearly doubled between 2000 and 2005, leading to a gusher of revenues and profits for oil-producing countries and companies. Among the reasons for the rise in prices was the industry’s inability to boost production capacity to match the surge in demand, a result of self-imposed investment restraints during the industry’s leans years in previous decades, which witnessed two severe price crashes because of excess supply.

For the first half of the current decade, world oil consumption rose 9.3% to 83.6 million barrels a day, testing the world oil industry’s ability to produce and refine so much petroleum. By the winter of 2004, the pumping and refining of oil was almost at capacity, raising fears the world would have to resort to strategic stockpiles of oil, if not face actual shortages, if something went wrong in the complex system of producing and transporting huge volumes of oil.

Mr. Birol said in an interview that he expects the oil industry’s capacity to produce will rise slightly more than demand through the end of this decade — or by 1.3 million barrels a day — “if all the projects see the light of day.”

Even then, when added to current spare oil-production capacity of roughly two million barrels a day, the total reserve of 3.3 million barrels a day still would be well short of the five million barrels a day needed to put the world into the comfort zone, Mr. Birol said.

Meanwhile, inflation faced by the industry has been fierce, with the cost of everything from cement and steel to drilling rigs and services soaring because of global demand. Among oil projects taking a huge cost hit was Royal Dutch Shell PLC’s massive undertaking in Sakhalin, in Russia’s far east. Investment needed for this project rose to $85,000 per barrel of oil-production capacity from the originally planned outlay of $50,000 per barrel, Mr. Birol said.

The latest per-barrel development cost in Sakhalin is more than 10 times what it costs to develop the capacity to produce a barrel in the oil-rich Middle East. But the Middle East’s huge oil reserves are largely closed to international oil companies, forcing them to go elsewhere to develop much more expensive oil resources, such as deep offshore West Africa and the Gulf of Mexico, and oil sands and heavy oil deposits in Canada and Venezuela.

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