Future supply concerns grow as oil becomes cheaper

Oil_Sands_02.jpg

Large energy projects for oil, gas and renewables are facing a “double whammy” of falling oil prices and tightening financing conditions, raising concerns about future supplies once demand start to pick up again, experts have warned.

“Currently, oil prices are falling for fundamental reasons” linked to the economic recession and its effects on supply and demand, said Jan Stuart, a global oil economist at UBS Securities.

Crude oil prices fell in the United States last week as demand for fuel weakened and inventories rose after a series of bad economic reports. Consumer spending for durable goods was at its lowest in seven years, according the US Department of Commerce.

“In the near term, there is no fundamental support for oil prices,” Stuart said. “It means, I think, that oil prices will keep on sliding” and get “closer to a floor” in the second quarter of 2009. Due to the deepening economic recession, average prices next year will be “no more than $60,” Stuart predicted.

Stuart was speaking at an event organised by the French Institute for International Relations (IFRI) in Brussels last week (25 November).

‘Non-conventional’ oil projects hitting a brick wall

As a result of falling prices, Stuart warned that some of the more expensive oil development projects, such as “non-conventional oils” and deep-water drilling, would become too costly.

$60 a barrel, Stuart said, “is not enough to spur investments” by companies and ensure an adequate rate of return on new projects, citing Total’s “ultra-deep oil” project in Angola as an example. “If you think that Total is going to do that for a 12.5% internal rate of return, you are dreaming. Those projects need a much higher internal rate of return.” Projects such as Alberta’s oil sands, which are being developed by Shell, “need $85 or more,” Stuart explained.

In the longer term, he warned, oil companies will be hitting a “brick wall”. “You hit that wall not because you’re running out of oil but mostly because of ‘above-ground factors'” such as oil markets and politics, he said.

No credit crunch for energy firms?

“There are links” between the financial crisis and energy investments, said Jan Horst Keppler, professor of economics at Parish-Dauphine University in Paris and a senior associate at IFRI’s energy programme.

But unlike Stuart, Keppler said he was optimistic about energy firms’ capacity to attract funding, even in the currently tight market conditions. “I think the energy sector will not be constrained by more difficult conditions in the financial sector,” Keppler said, pointing out that “the energy sector traditionally has very good access to financing”.

This, he said, is due to a variety of reasons: “The companies are of very large size, they are usually well diversified, they are very professionally managed [and] have a stable cash flow”. Besides, energy remains “a basic necessity”, with relatively small demand variations due to price rises, Keppler pointed out. In addition, energy development projects usually are decided on “very long timeframes and bankers know that,” he said.

Keppler was equally upbeat about “the positive role” that sovereign wealth funds can play in financing large energy projects.

And he pointed out that, despite the downturn, the prices of gas, coal, electricity and CO2 had remained high. “We’re not yet in a low-price environment in the energy sector,” Keppler said, “at least not in Europe”.

“So the direct impact of the financial crisis on energy investments I think is limited.”

Long-term investment cycles and lack of governance

However, Keppler admitted that the economic slump presented risks for energy investment. Among these are the “long lag” between the short-term formation of expectations on the market and investment decisions, and their eventual impact on prices. “Everybody decides to invest which means that in five years’ time, prices will be low. If prices are low, nobody will invest and prices will be high.”

Oil prices were as low as $10 a barrel in 1998 and climbed back to a peak of $147 in July this year, Keppler pointed out. They have since fallen sharply, hovering around $50 a barrel end of November.

A second risk for energy investment, Keppler continued, comes from the “lack of governance” shown by both oil producing and consuming nations. 

In producing countries, Keppler said the “not-in-my-backyard phenomenon” was hindering the implementation of new large-scale energy projects.

In Europe, Keppler said it was the “lack of priorities” and countries’ “inability to get their energy policy defined” which acted as “a source of uncertainty” and “a big barrier to investment”, particularly in the electricity sector. “At the European level, very clearly, it is the electricity sector that will have the greatest constraints in the next five to ten years.”

Oil prices reached new highs in 2008, with crude reaching a record $147 per barrel in July. Some analysts even predicted that prices could easily surpass the $200 mark in 2009.

But this scenario has been shattered by the financial meltdown and the resulting economic recession, with prices now hovering around $50 a barrel.

A conference held last week (25 November) by the French Institute for International Relations (IFRI) explored what this meant for the financing of large energy projects.

Subscribe to our newsletters

Subscribe
Contribute