A 'Total' Shift in the Oil Industry

With the Dow down 250 points and oil pressing its all-time highs, commodity investors may have missed the most important news bit hitting the airwaves Friday. Speaking to the Financial Times, Christophe de Margerie, CEO of the French oil giant TOTAL, said that the price of oil is high and is likely to stay high for the foreseeable future.

That may not seem like such a revolutionary statement ... more like a statement of the obvious ... but it's actually critically important.

Here's what Margerie actually said:

Demand is still strong in Asia, [and there is] strong demand in the Middle East," Mr. de Margerie said. "So definitely the price will remain high, and we have to build our strategy on this.

The key lies in that last half of the sentence: "we have to build our strategy on this."

Oil companies, you see, are a pretty conservative lot. They make gobs of money, and the financial equations they operate by are fairly straightforward: It costs $X dollars to get oil out of the ground and you can sell it for $Y dollars. If Y is more than X, you're happy.

But because energy prices are so notoriously volatile, energy companies have learned that they need a cushion between X and Y to make sure they aren't caught up if the price of oil suddenly plummets. After all, if you started developing a resource that is profitable at $70/barrel, and the price of oil falls to $30/barrel, you're out of luck. In fact, you're out billions of dollars: it costs a huge amount of money and takes a huge amount of time for new energy projects to come online.

Because of this, the planning decks - the exploration and development guidelines at the oil majors - have been slow to adapt to the high price of crude. A few years ago, they were still planning for $20/barrel oil. In recent years, that's crept up to $35-$45/barrel. But if Margerie's comments are reflective of the industry, that number could creep significantly higher... and soon.

What would that mean? It would mean all of the marginal projects will soon get a lot more attention. It will mean that oil sands and even oil shale might finally see their day in the sun. It will mean that big energy companies will start looking into alternative fuels and strategies, and will look for new ways to do things like liquify natural gas (which is getting downright cheap these days) and gasify coal.

With oil now creeping steadily toward $80 barrel, and OPEC saying the market looks good, that seems to be where the thought process is in the industry right now. The planning decks are coming up; high prices may be here to stay; and all those marginal projects aren't going to stay marginal for long.

Comments

[Georealist]

Mr. Margerie's cooments are hardly earth shattering...and certainly don't stand as a pertinent invesment marker. What he left unsaid..and every oil company of any note has been saying with their investment dollars...is that, despite high prices new oil/gas investment is more difficult to find and the cost analysis (PROFIT!) trickier to accomplish.
Investors need to be very careful in assuming that because a commodity has strong pricing power that this will translate into profits. Look who holds most of the oil gas cards..it's not companies. I'd bet on the commodity...and let the Exxons of the world sort out their futures.

[whboyce]

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