Why High Oil Prices are Good

The price for a barrel of oil has been steadily rising and forecasts are calling for triple digit prices in 2011. I am sure many amongst you are back to complaining about paying more for gas at the pump. I don’t blame you especially that higher gas prices are looming on the horizon. As much as I don’t want to see oil above $100 any time soon, I also don’t want to see oil fall below $70. Oil prices need to remain strong because slipping below $70 has long term implications. Do you wish you can fill up your car again at $40 oil? I hope you will reconsider once you get exposed to the long term implications

Here is what our production currently looks like.

Every Oil well in production has a natural annual decline rate.  Generally speaking, oil production will tend to enter natural decline once around 50% of oil on the reservoir has been produced. This happens as fluids are produced from a sub-surface reservoir, pressure of the remaining fluids decreases.

The largest and oldest oil fields with low production costs are declining or soon will be. Producers have to seek new sources for crude in order to satisfy rising demand and replace natural declines. The problem with that is the rising cost of exploration and production whether from new conventional fields or from difficult unconventional ones such as oil sands or deep water.

The Cost of Oil

“It is pretty clear that there is not much chance of finding any significant quantity of new cheap oil. Any new or unconventional oil is going to be expensive.” Ron Oxburgh, ex-Chairman of Shell, 2008.

For mature projects in Saudi Arabia, Russia, Norway and the UK the cost for producing oil can be less than $20 a barrel. However, the cost of new oil is in a different range of pricing. Within the world’s remaining growth regions, analysts from Deutsche Bank reported in 2009 that the average oil price necessary to achieve a 15% rate of return is now $68/bbl in Angola, $62/bbl in the US Gulf of Mexico, $60/bbl in deepwater Nigeria, and around $60/bbl in Brazil.

Even those with low production costs can be dependent on a certain price level for oil to meet budgetary needs. Other established oilfields like those in the North Sea have breakeven costs of around $50 per barrel. The numbers are confirmed by the figure below presented at Canada’s oil sands conference in Washington in June 2010: the cost of new oil ranges between $50 and as high as $80 per barrel in some cases.

Dangers of low pricing

The search for oil has always been costly and involved risk taking, but the challenges facing explorers have intensified as wells have moved further offshore, into deeper reservoirs and to places with much higher political and physical risks.

Why would a company invest billions of dollars to develop a new oilfield if prices slip below 70$? If the price of crude does not justify the investment, the project will be canceled or postponed into the future. This could result in a supply crunch as current economic woes dissipate and demand growth accelerates.

One thing is for sure in the near future, we won’t be running out of oil but the resulting supply crunch will increase oil prices dramatically and it will be those with spare capacity such as Saudi Arabia who will fill the gap reaping some very profitable rewards. I just hate to know that more of my money would be ending up in the coffers of countries with questionable regimes/ideologies. I would use ethical dirty oil (oil sands) anytime over conventional cheap oil from these countries.

Final thoughts

High oil prices do not have to be in triple digit territory because that will create demand destruction as the world is pushed into another recession. High oil prices are what we’re seeing right now, a range that will keep us well supplied into the future as companies find it worthy to invest in exploring and developing new fields. In the end, it’s a win-win situation because alternative energies become more attractive and hopefully get pushed on the fast track of development and into mass deployment.

What is your view on high oil prices?