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Marginal cost of oil production Written by Tony Rogers Thursday, 28 May 2009

Marginal cost of oil production
Written by Tony Rogers   
Thursday, 28 May 2009 00:00

What is the marginal cost of oil production?

The marginal cost of oil production is the point below which it becomes uneconomic to bring new oil projects to market. Above the marginal cost of production, product (in this instance oil) can be extracted and sold at a price that will return to investors an acceptable after tax capital return adjusted for risk.

Using 2007 data, the leading US Investment Bank Goldman Sachs in a late September 2008 report pegs the marginal cost of production for the oil industry at US$80-85 per barrel (/bbl). They also point out that forecasting for the 2009 year, the number is likely to be $85-90/bbl given cost inflation data observed thus far in 2008.

It is interesting to note that oil is different to other industries in that the traditional cyclical supply response does not arrive when the oil price rises above the marginal cost of production (as it would for example in copper markets). This is because sufficient non-OPEC oil exploration opportunities simply don’t exist (See ‘Who Controls the Remaining Oil?’).

Indeed, Goldman Sachs goes on to note that it can not see a particular oil price that would stimulate a major supply response (absent major global geopolitical changes). In areas where supply can be increased, such as Canada’s oil sands, prices well over $100/bbl are likely needed to generate a reasonable after tax cost of capital return of greater than 10% (could be as high as $110/bbl).

Last Updated on Tuesday, 09 June 2009 08:04