It’s the oil price and cost, baby
I began what turned out to be a highly ranked leadership program for public officials at the University of Colorado in the early ’80s, as dean of the Graduate School of Public Affairs. I did the same for private-sector folks when I moved to Irvine, Calif., to run a leadership program involving Israeli startup CEOs for the Merage Foundations. Despite the different profiles of participants, one of the compelling themes that seemed pervasive to both — for- profits in Israel and governments everywhere — was and remains building the capacity of leaders to give brief, focused oral presentations or elevator pitches (or, as one presenter once said, “how to seduce someone between the first and fifth floor”). A seduction lesson in oil economics in a thousand words or three minutes’ reading time!
Now that I got your attention! Sex always does it! During the last few days, I read some straightforward, short, informative articles on oil company and environmentalist group perceptions concerning the relationship between the price of oil per barrel and the cost of drilling. Their respective pieces could be converted into simple written or oral elevator pitches that provided strategic background information to the public and political leaders — information often not found in the news media — press, television, cable and social media — concerning oil company or environmentalist decision-making.
This is good news. Most of the academic and, until recently, media coverage of the decline of oil and gasoline prices generally focuses on the dollar or percentage drop in the price of oil and gasoline from a precise date … 3 months, 6 months, a year, many years ago, etc. And, at least by implication in many of its stories, writers assume decision-making is premised on uniform costs of drilling.
But recently, several brief articles in The Wall Street Journal, MarketWatch, OilPrice.com, etc., made it clear that the cost of drilling is not uniform. For example, there is a large variation internal to some countries depending on location and geography and an often larger variation between and among oil-producing nations. Oil hovers around $80 a barrel now, but the cost of drilling varies considerably. In Saudi Arabia, it is $30 per barrel or less on average; in the Arctic, $78; in Canada’s oil sands $74; and in the U.S, $62.
If you’re responsible for an oil company or oil nation budget, a positive cash flow and a profit, you are likely to be concerned by increasingly unfavorable opportunity cost concerning costs of drilling and returns per barrel. In light of current and possibly even lower prices, both companies and nations might begin to think about the following options: cutting back on production and waiting out the decline, pushing to expand oil exports by lowering costs in the hopes of getting a better than domestic price and/or higher market share, lessening your investment in oil and moving toward a more balanced portfolio by producing alternative fuels. If you believe the present price decline is temporary, and that technology will improve drilling cost/price per barrel ratios, you might consider continuing to explore developing wells.
Up to now, the Saudis have acted somewhat counterintuitively. They have created dual prices. Overall, they have sustained relatively high levels of production. For America, they have lowered prices to hold onto or build market share and undercut prices related to U.S. oil shale. For Asia, they have increased prices, hoping that demand, primarily from China and India, and solid production levels in the Kingdom, will not result in a visible drop in market share.
However, the Saudis know that oil revenue has to meet budget needs, including social welfare requirements resulting in part from the Arab Spring. How long they can hold onto lower prices is, in part, an internal political and budget issue, since oil provides a disproportionate share of the country’s public revenue. But, unlike the U.S. and many other nations, where drilling for tight oil is expensive, the Saudis have favorable ratio between production costs and the price of oil. Again, remember the cost of production in the U.S., on average, is about 100 percent above what it is in Saudi Arabia and some other OPEC nations. Deserts may not provide a “wow” place for all Middle East residents or some tourists looking for a place to relax and admire diverse landscapes, but, at the present time, they provide a source of relatively cheap oil. Further, they permit OPEC and the Saudis to play a more important global role in setting prices of oil and its derivative gasoline than their population numbers and their nonoil resources would predict. Lowering prices and keeping production relatively high in the Middle East is probably good for the world’s consumers. But as environmentalists have noted , both could slow oil shale development in the U.S. and with it the slowdown of fracking. Both could also interest oil companies in development of alternative fuels.
Oil-rich nations in the Middle East and OPEC, which control production, will soon think about whether to lower production to sustain revenues. In the next few months, I suspect they will decide to risk losing market share and increase per barrel oil prices. U.S policy and programs should be recalibrated to end the nation’s and West’s often metabolic response to what the Saudis do or what OPEC does. Support for alternative replacement fuels is warranted and will reduce consumer costs over the long haul and help the environment. It will also decrease America’s dependence on Middle East oil and reduce the need to “think” war as a necessary option when developing America’s foreign policy concerning the Middle East.
