16-08-04 Sky-high oil prices are threatening to send the global economy into a spin, but to what extent are the big oil multinationals to blame for the crisis? Much has been made about disruption to supplies from Iraq, booming demand from China and the fact that world's appetite for oil is close to outstripping what the producing nations can produce.
The top 10 independent oil companies account for 20 % of global production, and they are raking in cash from the high oil price, and giving it back to shareholders through share buybacks and chunky dividends.

Jon Rigby, oil analyst at Commerzbank, says this is because capital expenditure "is not being flexed. That is why cash is coming back to shareholders." But he also suggests that such spending has not been "flexed" throughout the current oil price cycle, which saw prices averaging a rock bottom $ 12.72 in London and $ 14.39 in New York in 1998.
So are the companies partly to blame for the current surge, which could see prices nearly treble the 1998 average this year, because they failed to develop new supplies quickly enough?

Clearly, expecting them to balance world demand is unrealistic -- they do not operate as a cartel, restricting supply to manipulate price, in the way OPEC does: they sell all their output. Yet could they have invested earlier to ensure that greater capacity was available now?
"When the price was low, they were probably underinvesting," Rigby said.
Indeed, the raw figures for the for the top 10 companies compiled by oil industry consultant Wood Mackenzie show a drop from $ 45.9 bn in 1998 to $ 36 bn in 1999. The total did not return to 1998 levels until 2001, before accelerating last year to $ 57.6 bn.

However, Derek Butter of Wood Mackenzie says: "Companies are now spending at record levels. The reasons for the high price are not simply on the supply side; it is also a consequence of surging demand, coupled with supply disruptions, particularly in Iraq and Nigeria, due to civil unrest."
The firms themselves emphasise that capital spending is dictated by long-term considerations, not price volatility. But most have recently revised upwards their expectations of the long-term oil price, while analysts say the size of their investment is inevitably affected by cash generation and the market price.
"Capital expenditure is not going up in cyclical terms. There is a view in the market now that the level of capacity comfort above demand is due to the low spending by both nationalised oil companies [such as Saudi Aramco] and independent companies," Rigby said.

Adjusting the raw spending figures by linking them to production gives a clearer idea of the trend throughout the cycle, as firms pump oil more when the price is higher. So in 1998, the ratio of expenditure to production was 3.4 times. It fell to 2.6 the following year, and did not reach 1998 levels again until 2003.
"You find that the oil companies reacted very quickly on the downside, and have been much slower to come back up to mid-cycle levels," Rigby said.
Butter has a caveat: while there is a link between spending and production, it is a lagging one, and the production figures from the top 10 companies have been boosted by mergers and takeovers.

Nevertheless, the trend may be prudent. BP for example, spent freely in the Eighties on exploration and production, as did Shell in the Nineties, but with unhappy returns. And in the short term this may have contributed to today's cash bonanza and the highlighting of oil companies as top picks by equity market strategists.
However, in the longer term, companies maintain their value by finding more oil to pump (major finds have declined and replacement of reserves has been slipping), while energy consumers hope they will keep finding it to keep prices down. BP's performance is obscured by the huge mergers with Amoco and Arco of the US that transformed its scale. Shell had a major overhaul in 1998, partly spurred by the lower oil price, that saw it impose harsh capital discipline.