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Capital expenditure (capex) in the oil and gas sector has reportedly been declining since the precipitous fall of crude oil prices from the peak of about US$147 per barrel in July 2008. Speculation has inevitably been rife about a price shock occasioned by the inability of supply facilities to meet demand requirements (due to withdrawal of the enabling investment) when the global economy begins to rebound. The International Energy Agency has projected a price crunch by the year 2012, just 3 years away.

Such concerns may be unrealistic and for three reasons:

First, there have been massive additions to the global production capacity far in excess of the projected losses. There are also equally massive capacities rapidly coming on-stream. For example, Saudi Arabia recently announced the introduction of a record 1.2 million barrels per day of light crude from the large Khurais field to the global tally. This value is expected to be exceeded by production from Brazil's recently discovered and even more massive pre-salt Santos Basin, likened to the North Sea in size and importance. The country's industry regulating agency puts reserve estimates for the basin at 80 billion barrels of oil equivalent (boe). Even more recent discoveries have been made in the contiguous Esprito Santo basin. Production from the Tupi, one of the fields in the Santos basin is expected to reach 1 million barrels per day in about 3 years.

Secondly, claims about a large capex decline may have been exaggerated, according to a recent report. The report indicates that while expenditure by National Oil Companies (NOCs) has remained largely unchanged from 2008, that of the International Oil Companies (IOCs) has only declined by US$22 billion, far less than the much-bandied US$100 billion. The report also held that the global economic downturn has favorably affected project economics; to wit, even where these IOCs have reduced their expenditure, such reduction is expected to be offset by substantial reduction in cost of resources (mainly labor and materials) arising from the decline in economic activity. The implication then is that even with capex reductions, effective investment for the current year may equal or exceed that of the previous year. Canada's Tar Sands projects are reportedly set to benefit from such cost reduction. Projects previously mothballed due to low price regimes, having been based on oil prices of US$85-US$90 per barrel, have become viable even at the much lower price of US$60 per barrel.

Finally, the current thrust of global energy and environmental policies inevitably conduces to lower oil demand. The recent framework for automobile efficiency recently introduced in the United States by President Barack Obama for example, is expected to reduce oil demand by 1.8 billion barrels by the year 2016, a mere 7 years away. This is approximately equal to the total U.S. domestic production for the 2008. By all accounts this is massive; even half of it is still a substantial reduction. Then there is the increasing ethanol penetration in liquid fuels transportation. Biodiesel, which is cheaper and a lot more efficient than petrodiesel is gradually becoming more attractive. According to the United Nations Environment Program, renewable energy has become the fastest-growing form of energy. The United States Department of Energy holds that about 40 % of all light vehicles in the U.S. by the year 2030 will be hybrid. These all indicate a reduced demand for oil. While oil will most probably be dominant for some time to come, biofuels and renewables will take increasing proportions of the global energy mix.

The oil price shock of 2008 had no fundamental support. On the contrary, prices were spiraling higher while the market was well-supplied. The recently recorded surges also showed no such support. The surges were in spite of massive supply overhang, weak demand and signs of deepening (or at best, lingering) economic recession. There may well be an oil price shock when the global economy rebounds from the current recession, but save for extenuating circumstances (war or the equivalent, etc), it is unlikely to hold any market fundamental support.

Source: Oil Price Shocks and Market Fundamentals