Time to buy oil stocks?

…Costs are also supportive of oil prices. The marginal cost of production, at roughly US$60 to US$70 per barrel according to the IEA, means that many projects are unprofitable at current prices. So capital spending is on the way down and as producers scale back on capital spending plans, oil prices will eventually rise.

A major factor being overlooked, however, is that costs will come down. From 2000 to 2005 oil production spending increased by US$340-billion, but 95% of that increase was cost inflation. Oil companies were spinning their wheels because there was major competition for resources like oil rigs, engineers and other inputs to supply.


No doubt, this process will reverse and there will be cost deflation in the oil sector over the next year or two. Falling costs favour oil producers over oil service companies because what affects the bottom line for the former affects the top line for the latter.

Long-term support for oil prices may come from the aforementioned rising demand but also from production declines. Roughly 3.5 million barrels per day of production must be replaced each year just to maintain current supplies, according to the IEA.

That said, rising production decline is a long-term issue to watch for but has been a red herring in recent years. Despite dire warnings from many retired oil engineers also known as peak oil theorists, the IEA has found no visible increase in non-OPEC production decline in recent years.

Financial Post