Stable business markets drive technological innovation in oil

Paul Boughton

According to the International Energy Agency (IEA)the world will need 50percent more energy by 2030 – energy to fuel vehicleselectrify homesprepare foodpower 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 Surveythe 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 perspectivesince the dawn of human historywe have consumed just one trillion barrels of oil.

What remains in question is the political leadership to develop this energy – effectivelyefficiently and economically.

Public policy decisions made by government leaders about how to accesstax 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.

Unfortunatelythe current information environment in which many policymakers operate is often not conducive to effective government action. That is a failingin partof 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 faceand 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 environmentwe must develop a better understanding of the nature and enormous scale of energy markets. To usthis understanding is intuitive. To many policymakers it is not.

Oil as a commodity

By its natureoil – 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 commoditieshoweveris its scale. As the primary source of transportation fuel andin some regionsa leading feedstock for heating and power generationoil is ubiquitous in the world economy. The scale of our industry is enormous.

Currentlythe world’s consumers use over 80million barrels of oil a dayor 40000gallons per second. The bill for the world’s petroleum consumption is more than E2 trillion a year at current market prices – about the size of the US federal government’s entire annual budget.

The realitythereforeis that the economics of oil is similar to that of other commodities in many respectsbut different in terms of the enormous scale in which these economics play out. Public perceptions of oil’s economics often diverge from these realitieshowever. And the resulting reality-perception gap can lead to counterproductive policymaking.

Takefor exampleprices. Many perceive petroleum prices as being disproportionately high. Prices for gasoline and heating oil are indeed higher this winter than lastputting a real strain on many household budgets – andconsequentlyputting pressure on policymakers to respond.

Overlookedhoweveris the fact that fuel prices are lower than prices for many other liquid commodities. Bottled waterfor examplecan cost over E8 a gallonas compared to an average of about E1.84 for a gallon of regular unleaded gasoline in the US. Not only would filling your tank with bottled water not get you farit would cost you more.

And from an historic perspectivethe real price of West Texas Intermediate crude has increased 11percent since 1985. This is far less than for other commodities. Over the past 20 yearsthe price of nickel has increased 66percentcopper 43percent and sugar 33percent. Howeverunlike other commoditiesconsumers see and feel fluctuations in the price of oil quickly and directly.

A second misperception is the belief that oil and gas industry earnings are disproportionately high. Undeniablymany energy companies posted high earnings last year. Profit marginshoweverremain in step with the national average for major US industries. For every dollar of sales during the third quarter of 2005the oil and gas industry on average earned about 8.2cents. That compares to a national average of about 6.8cents per dollar of sales for all major industries. Many industries had higher margins.

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 2005ExxonMobil spent E180billion 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 E157 billion 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 USfor exampledemand for energy exceeds domestic production by approximately 10million barrels of oil equivalent per dayaccording to the US Department of Energy. No combination of conservation measuresalternative energy sourcesand technological advances could realistically and economically provide a way to completely replace those imports in the short- or medium-term.

Moreoveruneconomic 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 oilall nations – exporting and importing – are inextricably bound to one another in the energy marketplace.

In this contextthe more effective means of securing supply without doing economic harm is promoting energy interdependencenot independence.

These realities about the energy industry – its commodity natureits enormous scaleits interconnectivity – are not widely understoodhowever. This can have profoundly negative policy implications. For examplewhen the US government imposed a so-called windfall profits tax on energy companies in 1980it drained E62billion in industry revenues that could have been used to invest in new oil and gas productionaccording to the Congressional Research Service (CRS). As a resultas many as 1.6billion fewer barrels of oil were produced domestically due to the taxaccording to the CRS.

More recentlyin 2002when the United Kingdom imposed an unexpected 10percent supplemental corporation tax on our industryit led to a slump in investor confidence in the North Sea. Exploration and appraisal wells dropped by 25percentfrom 60 to 45in the first 12 months after the tax hikeand investment fell by four per cent. The E9.5billion in wealth transfer from industry to the Exchequer over the next three years will result in 1.5billion fewer barrels of production from the UK North Seaaccording to Wood Mackenzie.

Contrast this with the response by localstate and federal government agencies in the aftermath of Hurricanes Katrina and Rita. By collaborating with the energy industry and removing obstacles hindering our emergency responsepolicymakers and regulators helped mitigate the effects of these natural disasters on domestic energy supplies.

Stable regulatory frameworks

By building stable regulatory frameworksestablishing a level competitive playing fieldgranting access to resourcesremoving obstacles to development and opening markets to tradegovernments enable international oil companiesNOCsand 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 offer to the world’s energy community. By building a stable business environmentgovernments can help stimulate the competition for ideas that leads to innovation and ultimately the best results for society as a whole.

Howeverachieving the required progress in a challenging new era of energy will requireas its priorityfreely functioning markets. When energy prices and corporate earnings seem highthe 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.


Recent Issues