Technological innovation and expertise are the essential elements that international oil companies offer. However, as Exxon Mobil Corporation Senior Vice President Stuart R McGill explains, this requires governments to develop stable business environments and freely functioning markets.
According to the International Energy Agency (IEA), the world will need 50 per cent more energy by 2030 – energy to fuel vehicles, electrify homes, prepare food, power factories and perform countless other functions that lift living standards in developed and developing countries alike.
The future challenge is as much geopolitical as it is scientific. There is little question that abundant energy resources exist – according to the US Geological Survey, the Earth was endowed with more than three trillion barrels of conventional recoverable oil resources. Conservative estimates of heavy oil and shale oil push the total resource to over four trillion barrels. To put those quantities in perspective, since the dawn of human history, we have consumed just one trillion barrels of oil.
What remains in question is the political leadership to develop this energy – effectively, efficiently and economically.
Public policy decisions made by government leaders about how to access, tax and regulate these resources will play a pivotal role in shaping the world’s energy and economic future. It is therefore crucial that these decisions benefit from the most reliable and most realistic information.
Unfortunately, the current information environment in which many policymakers operate is often not conducive to effective government action. That is a failing, in part, of those of us in industry.
We in industry have a duty to share information about the fundamental workings of our business and the realities we face, and to do so in a way that is coherent and not confusing. Those in government have a duty to act on this information responsibly.
To build a richer information environment, we must start by developing a better understanding of the essential nature and enormous scale of energy markets. To us, this understanding is intuitive. To many policymakers it is not.
Oil as a commodity
By its nature, oil – like corn or copper – is a commodity. It is a primary good that is fungible and freely traded in markets around the globe.
What differentiates oil from other commodities, however, is its scale. As the primary source of transportation fuel and, in some regions, a leading feedstock for heating and power generation, oil is ubiquitous in the world economy. As a result, the scale of our industry is enormous.
Currently, the world's consumers use over 80 million barrels of oil a day, or 40 000 gallons per second. The bill for the world's petroleum consumption is more than two trillion Euro a year at current market prices - about the size of the US federal government's entire annual budget.
The reality, therefore, is that the economics of oil is similar to that of other commodities in many respects, but different in terms of the enormous scale in which these economics play out. Public perceptions of oil's economics often diverge from these realities, however. And the resulting reality-perception gap can lead to counterproductive policymaking.
Take, for example, prices. Many perceive petroleum prices as being disproportionately high. Prices for gasoline and heating oil are indeed higher this winter than last, putting a real strain on many household budgets – and, consequently, putting pressure on policymakers to respond.
Overlooked, however, is the fact that fuel prices are lower than prices for many other liquid commodities. Bottled water, for example, can cost over eight Euro a gallon, as compared to an average of about 1.84 Euro for a gallon of regular unleaded gasoline in the US. Not only would filling your tank with bottled water not get you far, it would cost you more.
And from an historic perspective, the real price of West Texas Intermediate crude has increased 11 per cent since 1985. This is far less than the increase in price over this period for other commodities. Over the past 20 years, the price of nickel has increased 66 per cent, the price of copper 43 per cent, and the price of sugar 33 per cent.
However, unlike other commodities, consumers see and feel fluctuations in the price of oil quickly and directly. Prices change frequently, and are displayed on service station signboards at street corners everywhere, day and night. And, because the cost of the underlying commodity – crude oil – is the primary factor in the final product price, consumers are impacted directly.
A second misperception is the belief that oil and gas industry earnings are disproportionately high.
Undeniably, many energy companies posted high earnings last year. Our profit margins, however, remain in step with the national average for major US industries. For every dollar of sales during the third quarter of 2005, the oil and gas industry on average earned about 8.2 cents. That compares to a national average of about 6.8 cents per dollar of sales for all major industries. Many industries had higher margins – some as high as 18 per cent.
The disconnect arises from the difference in the volumes and costs involved in the petroleum business. Producing and delivering energy is an expensive enterprise. In the first nine months of 2005, ExxonMobil spent 180 billion Euro to cover production and delivery costs.
Also overlooked is the reality that energy companies use today's earnings to make the investments needed for future energy needs. The IEA estimates that industry needs to invest an average of over 157 billion Euro each year between now and 2030 to produce and deliver the oil and natural gas required to meet the world's needs.
A third misperception taking hold is the belief that any nation can achieve energy independence.
In the US, for example, demand for energy exceeds domestic production by approximately 10 million barrels of oil equivalent per day, according to the US Department of Energy. No combination of conservation measures, alternative energy sources, and technological advances could realistically and economically provide a way to completely replace those imports in the short- or medium-term.
Moreover, uneconomic attempts by governments of energy importing nations to achieve energy independence threaten domestic jobs and handicap businesses with a significant cost disadvantage vis-à-vis their foreign competitors.
The notion of energy independence arises from a misunderstanding of the global commodity market for oil. Because we are all contributing to and drawing from the same pool of oil, all nations – exporting and importing – are inextricably bound to one another in the energy marketplace.
In this context, the more effective means of securing supply without doing economic harm is promoting energy interdependence, not independence.
These realities about the energy industry – its commodity nature, its enormous scale, its interconnectivity – are not widely understood, however. This can have profoundly negative policy implications. Misunderstandings often lead to unintended consequences.
For example, when the US government imposed a so-called windfall profits tax on energy companies in 1980, it drained 62 billion Euro in industry revenues that could have been used to invest in new oil and gas production, according to the Congressional Research Service (CRS). As a result, as many as 1.6 billion fewer barrels of oil were produced domestically due to the tax, according to the CRS.
More recently, in 2002, when the United Kingdom imposed an unexpected 10 per cent supplemental corporation tax on our industry, it led to a slump in investor confidence in the North Sea. Exploration and appraisal wells dropped by 25 per cent, from 60 to 45, in the first 12 months after the tax hike, and investment fell by four per cent. The 9.5 billion Euro in wealth transfer from industry to the Exchequer over the next three years will result in 1.5 billion fewer barrels of production from the UK North Sea, according to Wood Mackenzie.
Contrast this with the response by local, state and federal government agencies in the aftermath of Hurricanes Katrina and Rita. By collaborating with the energy industry and removing obstacles hindering our emergency response, policymakers and regulators helped mitigate the effects of these natural disasters on domestic energy supplies. By allowing markets to work, governments helped defy dire predictions about severe energy shortages.
So the most effective policies are those that help create a business environment that invites investment and stimulates competition.
Stable regulatory frameworks
By building stable regulatory frameworks, establishing a level competitive playing field, granting access to resources, removing obstacles to development and opening markets to trade, governments enable international oil companies, NOCs, and other industry participants to fulfil their roles in making energy available and affordable.
The reason is simple. Providing private industry more opportunities and latitude to operate enables us to do what we do best – innovate. Technological innovation and expertise are the essential elements that international oil companies, like ExxonMobil, offer to the world’s energy community. And technology holds the promise of helping us meet the energy challenges on the horizon.
By building a stable business environment, governments can help stimulate the competition for ideas that leads to technological innovation and ultimately the best results for society as a whole.
However, achieving the required progress in a challenging new era of energy will require, as its priority, freely functioning markets. When energy prices and corporate earnings seem high, the temptation to tamper with markets is strong. Succumbing to this temptation could jeopardise our energy future. Resisting this temptation can enable us to master it.