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With oil prices dropping and the world facing recession, it’s interesting to study the relationship between these two dynamics.
The recent financial meltdown in the United States, ramifications of which are being felt throughout the world, has people understandably worried. Those of us working hard for retirement wonder what will be left once we get there. But from an oil and gas perspective, I think there are some interesting dynamics afoot here.
I’ve long maintained that US $100/bbl oil is NOT good for the industry because it’s not good for the economy. While the recent months of high commodity prices have allowed for the development of fields that would otherwise have been left alone, the burden has been felt throughout the rest of the value chain, from transportation fuel to food prices (which also suffer, of course, because of the deranged view that ethanol will solve all of our problems).
So now oil prices are dropping. On Oct. 17 the New York Times reported that the cost of a barrel of oil dipped below $70/bbl for the first time in 14 months. This has got to be making some people nervous, particularly those who were counting on high stock prices to exercise stock options or those who have just signed the agreement to develop a field that is uneconomic at lower prices. But in a time when a serious recession is rearing its ugly head, a drop in oil prices might help stave off the beast.
Recently Schlumberger announced its third quarter earnings, and Chairman and Chief Executive Officer Andrew Gould had some interesting insights into the current situation.
“As we enter the fourth quarter, the recent rapid deterioration in credit markets will undoubtedly have an effect on our activity, though we anticipate this will largely be limited to North America and in some emerging exploration markets overseas,” Gould said. “The strengthening production of North American natural gas has also led a number of customers to reduce spending early.
“At the present time, the rate at which the world economy will slow has become increasingly uncertain. We have always maintained that the one event that could slow the rate of increase in worldwide exploration and production spending would be a reduction in the demand for oil caused by a severe global recession. At the moment, it is still too soon to predict to what extent current events will affect overall activity in 2009, but we anticipate a slowing in the rate of increase in customer spending.
“However, the weakness of the current supply base, the age of the production profile, and the decrease in reserve replacement — all of which we have indicated on many occasions — are such that any significant drop in exploration and production investment would rapidly provoke an even stronger recovery.”
I daresay I agree. The last 14 months have been a welcome anomaly, but assuming that $100/bbl oil is sustainable for any length of time is probably folly. I would expect prices to continue to drop in the near term. But once they reach a certain point, exploration will dry up, companies will scale back to protect their bottom lines, and an economy no longer worried about recession will again begin demanding more oil than the industry can produce.
The main question becomes one of, again, survival. Many small start-ups have emerged over the past couple of years, taking advantage of the industry’s ceaseless need for better technology to find new reserves and reevaluate existing fields. Several new geophysical contractors have also been formed, many with large up-front expenditures for the latest acquisition equipment. Will they have enough fortitude to survive another downturn if one is imminent?
For their sakes, I hope so.