ANALYSIS-Oil price strength to bring only limited investment

OPEC’s big producers not only sit on the world’s largest reserves, but also have some of the lowest recovery costs, making it much easier for them to open up output than non-cartel rivals.

But many nations either do not allow foreign investment in oil, or have unattractive investment and legal terms.

This has slowed down production capacity growth in most OPEC nations, meaning that most are producing flat out to meet current demand.

ANALYSIS-Oil price strength to bring only limited investment
Reuters, 05.12.04, 6:54 AM E

By Toby Reynolds

LONDON, May 12 (Reuters) – Sustained strength in oil prices will bring a modest rise in exploration and production budgets, but consumers should not expect a wave of new finds to rescue them from rising energy costs, analysts said.

Benchmark West Texas Intermediate crude has averaged nearly $36 a barrel so far this year, on course for the highest level in two decades and more than $10 above consensus company expectations at the end of last year.

Even so, energy firms are making only cautious increases in their outlay on the business of finding and producing oil, analysts say. The lack of new investment will continue to tether world oil production growth, feeding oil’s price strength.

“Our expectation now is that we will see a global gain of about seven percent,” James Crandell, author of Lehman Brothers’ ‘Original E&P Spending Survey,’ told Reuters.

Lehman had originally predicted a four percent increase in upstream oil and gas investment in 2004, on the basis of a survey in which energy firms expected WTI to average $25.29 a barrel.

Oil market signals suggesting that high prices are here to stay seem to invite a wave of new investment. Not only are near-term prices flying high, but forward energy prices have also jumped: the New York long term swaps market is now pricing WTI for 2009 delivery at about $28.50.

But despite a five-year market boom that has seen oil average nearly $29 a barrel since the start of 2000, only former Soviet Union states have made any meaningful contribution to non-OPEC supply in that time.

Oil companies have been cautious on spending since the ‘97-’98 price crash slashed their share prices and forced them into a spate of mergers. What’s more, big oil reservoirs are becoming harder to find and more expensive to develop.

“Capital spending budgets are not rising fast enough to keep pace with higher finding and development costs. The result is a disappointing outlook for non-OPEC supply growth,” Merrill Lynch (nyse: MER – news – people) wrote in a research note.

STRENGTH ABOVE EXPECTATIONS

Cautious OPEC ministers and the market’s long-term bears have predicted for several years that high oil prices will bring out a flood of non-OPEC supply, eating into the cartel’s market share and precipitating a price crash.

In 1999, as oil’s five-year price boom was in its infancy, the then OPEC Secretary General Rilwanu Lukman, and former Saudi Oil Minister Zaki Yamani, warned together that oil prices over $20 a barrel were not in the cartel’s interest.

But higher finding and production costs have gradually undermined the argument that high-price policies will only bring about a price crash.

“Upstream capital spending has increased compared to trough levels in 1999-2000, but the increase has not resulted in a surge in new supply because the increase was met with much higher costs of developing new reserves,” the Merrill Lynch report said.

“We believe it is likely that non-OPEC supply growth will also be less than expected. Therefore, OPEC is likely to remain firmly in control of the oil supply/demand balance, while increasing its market share.”

Another survey by Citigroup Smith Barney found that 29 percent of the energy firms it questioned would change their E&P spending if oil averaged $3 a barrel more than they had anticipated for 2004 — a near certainty, given the firms had predicted $25.68 as the average price for the year.

Smaller, independent oil firms, developing lower-cost short-term projects are definitely taking advantage of the current price outlook.

UK upstream firm Dana Petroleum, focused mainly on the North Sea and in Mauritania, attributed the approval of gas re-injection plans at the North Sea Banff field, in which it holds a stake, to current oil price buoyancy.

“This (Banff) is the kind of project that can be unlocked by the higher oil price prices,” Dana Chief Executive Tom Cross told Reuters, adding that his firm also intended to drill 10 exploration wells in the next two years, more than it would have planned had prices been lower.

BIG ECONOMICS

By contrast the margin-driven oil majors have focused on large-scale projects. Many of these ventures are in remote areas, which demand expensive equipment and are more susceptible to delays.

“High oil prices could encourage smaller field developments. They are the ones where you can get a rapid reaction. But big fields usually have big economics attached: we wouldn’t expect to see a surge in big fields,” said John Westwood of upstream consultants Douglas-Westwood.

It would take a huge number of developments like Banff, which will recover about 30 million barrels of oil equivalent and extend field life by about eight years, to cause a price crash on the 80 million barrel per day world oil market, or to threaten OPEC’s more than 30 million bpd production capacity.

OPEC’s big producers not only sit on the world’s largest reserves, but also have some of the lowest recovery costs, making it much easier for them to open up output than non-cartel rivals.

But many nations either do not allow foreign investment in oil, or have unattractive investment and legal terms.

This has slowed down production capacity growth in most OPEC nations, meaning that most are producing flat out to meet current demand.

The International Energy Agency expects 1.2 million barrels per day of non-OPEC supply growth in 2004, coming mostly from Russia, it said in its monthly oil market report released on Wednesday.

By contrast, the OECD energy adviser is forecasting demand growth of 1.95 million bpd in 2004.

Not all analysts are so gloomy about production growth. Upstream consultancy IHS Energy forecast nearly two million bpd of non-OPEC output growth for 2004, and said it saw output capacity at least matching consumption over the next four years.

The consultancy’s report, billed as a challenge to market concerns over oil supply, was restrained in its bearish sentiment, saying that production capacity growth “may even allow a softening of prices.”

Copyright 2004, Reuters News Service