Commentary, 1/2 2009

Published Feb 9, 2009
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Business as Unusual

Oil prices continue to sink and the pace of activity has begun to wane. News reports talk of the deepening market slump, which traders take to mean further reductions in demand. And shrinking demand sends prices even lower.

Much of the industry – oil companies as well as the service industry – has already responded to the downturn by announcing world-wide layoffs. Projects have been scaled back, stopped or left on the drawing board. While not so many months ago low refinery capacity was often cited a one reason for high oil prices, there’s now talk in the US of possible refinery shut-downs.

Repeated production cuts by the Organization of Petroleum Exporting Countries have yet to show a significant effect on the market. OPEC, whose membership includes a significant number of countries with national oil companies, has promised additional production cuts if prices continue to fall. And for many national oil companies – often having the highest operating costs – current oil prices are said to be almost half of that which they need to turn a profit.

One thing for certain is that it really can’t be “business as usual” for much longer.

All types of oil companies – nationals, majors, independents – are seeing higher and higher break-even points. Existing reserves are becoming more and more difficult – and therefore more expensive – to exploit. Add to that the fact that world-wide reserves are diminishing, with a replacement rate that has slowed considerably – even before the world economy went into freefall – and it’s not difficult to imagine supply problems once economies begin to turn around.

The market is either an oil company’s best-best friend or its worst-worst enemy. On one hand, an oil company must make decisions on projects that take years to bring a product to the market. If all goes well, prices are favourable as a project comes on-line and expenditures are recouped at a reasonable rate. On the other hand, an oil company lives or dies on its quarterly results. Quarterly reports of record profits six months ago have now been replaced by grim reports of losses dues to low oil prices, high operating costs and less-than-favourable currency exchange rates.

This duality wreaks havoc with the industry. All too often it seems that boom or bust is determined by the toss of a coin.

Looking back just 10 years, the low oil prices of the late 1990s and subsequent industry slow-down are a primary cause behind the remarkable rise in oil prices of the middle of this decade, which culminated in last summer’s peak. The International Energy Agency has warned us that as the world economy begins to pull out of its slump and real demand increases, we will most likely see the same trend, although on a much dramatically higher scale. IEA projections for demand, looking far beyond the market’s short-term view, warns of energy shortfalls beginning as early as the coming decade.

We can hope that the current economic crisis will lead to the financial world revising the methods it uses to determine the “winners” and the “losers”, especially when it comes to industries that measure achievement in years rather than in quarters. But in the meantime, the industry must work with itself – from suppliers to oil companies to the service industry – to ensure that everyone wins.

What ever the solution, it should be one that keeps the most employed, while maintaining a level of activity that allows for ramping-up as demand increases.

This time around, surviving may be the ultimate success.

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