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Oil Prices

Financial Times: Lex Column: Commodities: oil

Published: May 9 2008 03:00 | Last updated: May 9 2008 03:00

As with mining, why has the energy bull market not prompted more supply? Tracking the industry’s spending is tricky, given the preponderance of opaque, state-owned companies. However, JS Herold, a consultancy, finds that, between 2002 and 2006, when average oil prices rose by 124 per cent (in constant dollars), upstream capital expenditure by a sample of 228 listed oil companies rose at roughly the same pace. Developing an oilfield takes years and today capacity is tight. When crude prices collapsed in the late 1980s, so did interest in oil as an investment and a career – even Dallas , TV’s celebration of big oil and big hair, bowed out in 1991. Today’s shortages of manpower and equipment raise costs. A study of 53 oil groups by the International Monetary Fund concluded high industry inflation ate up more than two-thirds of incremental capex between 1999 and 2006.

The bigger issue, however, is inefficient allocation of capital. Political constraints, particularly in the lower-cost Opec countries, push investment towards higher-cost projects such as Canadian oil sands, or block it altogether. Together the six largest western majors reinvested only 46 per cent of cashflow last year, not much more than they distributed to shareholders, according to consultancy PFC Energy. This year, ExxonMobil will not spend much more in its upstream business than Chevron, a company less than half its size. If the world really has entered a “new paradigm” with regards to oil prices, holding back on spending is short-sighted. However, this is a sector with a long history of value destruction. For executives ultimately beholden to Wall Street, the temptation to harvest assets rather than go for growth is great. Moreover, with $120 crude undermining the economy of the world’s largest oil consuming nation, and strains in resource nationalism appearing in countries from Russia to Mexico, few companies will quickly adjust capex budgets to today’s high prices.

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