Energy industry may be headed for a bigger crisis

Nov 21, 2008 01:00 AM

by Syed Rashid Husain

Oil markets are facing a major slump -- for a number of reasons -- and continue to stream further down. As I write these lines, prices are already in the vicinity of $ 50 a barrel. Rather than seeking a ceiling, crude markets now appear looking for a floor -- somewhere -- at respectable levels.
What a transition indeed. And indeed this transformation is not without ramifications, of considerable magnitude, one can easily deduce.

Crude markets have entered a phase where, due to low prices, the incentive to invest in the industry is getting less and less. And if the trend continues, as some are arguing today, another round of price spiral may not be far off. The emerging scenario may not only be disastrous for the industry, but indeed for the overall global energy balance too -- a real cause of concern indeed. We need to wake up to the consequences now -- and not later.
Global crude prices have fallen by two thirds over the past four months and it appears set to fall further -- unless drastic steps are in place. Interestingly it took 40 months for oil prices to rise from $ 50 a barrel to almost $ 150 a barrel and just four months for them to crash to the current lows.

The London-based Centre for Global Energy Studies (CGES) now believes that the global oil demand would contract in 2008 for the first time in a quarter of a century. The dwindling fortunes of oil may indeed have brought smiles in some major global capitals. Many must be heaving a sigh of relief at the turn of events.
Yet, these are not the best of times for the industry. Energy is indeed a costly affair. In order to keep wheeling this crude-driven civilization of ours, investments in the industry is a must. And with falling prices, this investment is now in question. Would there be enough investments to keep meeting the growing global requirements, is a billion dollar question.

Early warning shots are already there -- investments in the industry are getting shy. With the global energy requirements continuing to grow -- albeit at a slower pace than before -- the issue of meeting the future global needs is a real one. From where the incremental supplies would come, in case investments in the sector continue to be bogged down -- due to the lack of incentives?
Platts, the energy information provider, had also projected last year that companies that produce, refine and transport oil and natural gas will need as much as $ 21.4 tn in capital expenditures through 2030 to meet the world's growing energy demands.

In its recently released World Energy Outlook, the OECD energy watchdog IEA underlines that more than a trillion dollars in annual investments is needed to find new fossil fuels over the next two decades to avoid the impending energy crisis that could easily choke the global economy.
At a time when major oil companies are pulling back investments in view of one of the most severe economic downturns in a generation, and lack of incentive to invest in the sector, the IEA stressed that it's vital for continued investment in new projects. The total potential tab through 2030 as per the IEA is to the order of $ 26.3 tn -- colossal by any means.

"There remains a real risk that underinvestment will cause an oil supply crunch'' by 2015 as the decline in output from mature oilfields speeds up, the Paris-based adviser to 28 oil-consuming nations said in its annual report. "The current financial crisis is not expected to affect long-term investment, but could lead to delays in bringing current projects to completion."
OPEC has also warned that crucial downstream investment -- in refining and distribution -- will be curtailed if the oil price is not maintained at a reasonable level.

The crisis is beginning to unfold. The prevailing uncertainty is already prompting companies to withhold billions of dollars of investment in new oilfield and refining projects. Royal Dutch Shell, Europe's largest oil company, said in October it was pushing back a decision on expanding an oil sands projectin Canada.
North American refining giant Valero Energy has also announced curtailing capital spending for the rest of 2008 and 2009. Also, Marathon Oil said it has delayed expansion of a gasoline refinery in Detroit "due to current market conditions."

Saudi Aramco has also fired the early warning shots. It's Chief Executive Officer Abdullah Jum'ah in a handout distributed earlier this month at an industry summit in Beijing said that a further drop in crude prices may curtail investments needed to offset declining output in aging fields. Investment is also needed to expand production capacity to meet long-term demand growth, Jum'ah emphasized in his message. And prices have dropped further since the early November salvo by Jum'ah.
Saudi Aramco was reportedly already "reviewing" parts of its $ 129 bn upstream push to boost oil production in light of the "current economic circumstances," recent reports said.

Khaled Al-Buraik, an executive director at Saudi Aramco was recently quoted as saying that though Aramco's short-term projects were on track and the Kingdom would reach its target of increasing production capacity to 12.5 mm bpd by the end of next year, but the development of the Manifa field, which was to add 900,000 bpd of capacity by 2011, was under review.
Things are definitely under evaluation. The comments indicate that sustained lower oil prices would not only impact the high cost non-OPEC or the Sand tar projects but could also affect future production even in an area of the world where oil production is comparatively cheap and easy.

"It is clear that collapsing oil prices are not only detrimental to the economies of oil-producing states, but also to future upstream investments to sustain future oil demand consumption,'' Vienna-based consultant JBC Energy said in a recent market report.
Demand for oil and crude prices may be falling with the economic slowdown, but that could well lead to a supply-side crunch in the next year or so, and that will push oil prices higher again.

And that is the big challenge. The industry needs to be prepared for tomorrow, even in these uncertain times. If we do not act now, another round of price spiral may not be far off.
Is anyone taking cognizance?

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