Summary
The simple fact is that the world is no where near running out of oil and/or natural gas. Former Aramco Chief Engineer and spokesperson Nansen Saleri has spoken with uncommon clarity on this issue; most recently in a Wall St. Journal Article on March 4th titled “The World Has Plenty of Oil.” The technical aspect of Peak Oil theory has now been effectively debunked by the industry. However, the underlying causes of the current price spike are deeper than a “few ‘ol boys on Wall St trying to make some money on a slow day…” as a major oil company CEO once commented in the 80’s. While the world has plenty of oil and gas, the extraction, processing, and transportation of those commodities will require greater capital, more human resources, higher technology, and (most importantly) assurances of sustained higher prices to justify the increased investment cost and risks.
Analysis
As it has been frequently stated with simple elegance, free marketers truly believe that, “The solution for higher oil prices is….higher oil prices.” What’s left unsaid in this statement is that not many oil men truly believe that free markets can and will prevail for oil and gas. Thus, based on past history, they are continually skeptical of governmental involvement in their industry – usually to their detriment. Just a look at recent examples gives a fair clue as to the basis for this thinking including: Venezuela’s effective nationalization of their industry, Kazakhstan and Russian strong-arm tactics to assume greater stakes in their resources, Libya’s recent noise about changing their fiscal terms, and even Cambodia, with no production to speak of, stating that they were looking at changing the contract terms before even a single significant commercial discovery had been declared. Thus, the “risk premium” applied to major, long-term energy projects has increased dramatically to the point where some companies are applying in excess of 500 basis points to their economics as well as a commodity price discount that can be in the range of 50% of today’s spot price. These “premiums” are further justified in the investor’s eyes by: 1)rapidly escalating project costs, 2)project delays due to lack of skilled, experienced personnel, 3)shortage of available capital for smaller companies to finance major and/or riskier projects and 4)fear of precipitous price drops due to the “potential production” overhang from major projects in W. Africa, the Caspian, and the Middle East (esp Iraq). Thus, while Mr. Saleri’s commentary remains technically sound, it cannot be immediately applied in practice to current commodity pricing because of the industry’s self-imposed and external factors that discount free market pricing in favor of speculation and the highly conservative, long-term economic models based on negative past experiences and fears of repeating previous mistakes. In my opinion, the only near-term break in this situation will have to come by intervention - and only governments or OPEC seem to have that power.
