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Daily Telegraph (UK): Why oil is such a sticky business: “Mr Van der Veer spoke of Athabasca as if it was a fantastic new opportunity, but this Canadian sand pit has been in on-off development since 1883. It's a filthy process to produce an inferior crude oil, and the gains are marginal.”: “…Shell is reportedly already $2billion over its $10billion budget for the second phase of its gas project at Sakhalin Island.” (


By Malcolm Moore (Filed: 30/10/2004)


From Texas to Turkmenistan, the bigwigs of the oil industry gathered in London this week for the annual Oil and Money boondoggle. These days it takes a lot of the latter to buy the former but there was little talk of record profits in the genteel environment of the Mayfair hotel where the conference took place. 


A couple of miles to the east, BP revealed it was making £1m an hour, while Shell clocked up $10.3billion in its third quarter, despite its domestic difficulties. The US Energy Department now estimates that the Opec oil cartel will rake in $300billion this year.


It is not just the oil companies that are in the money. High oil prices will boost Gordon Brown's revenues from the North Sea by over £3billion this year, and he also gains an extra £240m in VAT on petrol, bringing the total he can expect from taxing oil this year to £27billion.


High oil prices transfer wealth from the consumer to the producer, and to governments, and in the long run they will damage global growth, the economists say. So why don't the oil companies flood the market with the black stuff and drag prices down?


We are some way from running out. IHS Energy, a UK oil consultant, says we have only used up half the 2,300 billion barrels of oil discovered so far.


The US Energy Department guesses that there are 7,600billion barrels sloshing around in the Earth's crust.


However, it is one thing saying there is plenty of oil and quite another getting the right product to the right place at the right time. Two years ago, BP announced that it was going to spend billions hunting for elephants - the industry's nickname for giant oilfields. It has not been a conspicuous success.


The find in the deep waters off Angola, which it described as a "key profits centre", is producing only a fifth of the peak production from the Forties field in the North Sea. Other oil companies have backed away from the region. Ominously, the oil majors spent $8billion between them looking for oil last year, and found less than $4billion worth.


As a result, they are dusting down old projects which need high prices to be profitable. At Oil and Money, Jeroen van der Veer, Shell's new chief executive, spoke glowingly about its Athabasca project, where oil has to be extracted from sand, much like scraping pebbles on an oily beach. Mr Van der Veer spoke of Athabasca as if it was a fantastic new opportunity, but this Canadian sand pit has been in on-off development since 1883. It's a filthy process to produce an inferior crude oil, and the gains are marginal.


It is not just the projects that are ancient. The people squeezing the oil out of the sand may find themselves with creaky knees. The average age of a drilling crew in the US is now 52. In the 1980s and 90s, with the oil price depressed, the industry stopped hiring.


"They lost two generations," says Paul Horsnell, an analyst at Barclays Capital. "That's not healthy, that's a dying profession. There are some very experienced people, all of whom are going to retire in 10 years and there are no 30 or 40-year-olds to replace them."


Then there is the awkward fact that the largest prospects are in the worst parts of the world. BP has bought its way into Russia, as has ConocoPhillips, but other oil companies have been put off by the lack of proper law and a capricious government. Roughly 60pc of the world's oil is underneath Saudi Arabia, Kuwait, Iran, Iraq and the UAE. There are problems with nearly all of them.


There are very few new projects that will deliver profits even at BP's upgraded long-term planning price of $20 a barrel (it rose from just $15 a barrel earlier this year). Such projects are big bets, and Shell is reportedly already $2billion over its $10billion budget for the second phase of its gas project at Sakhalin Island.


This kind of spending has pushed up the average cost of extracting a barrel of oil from $5 to $11 in the last four years. The International Energy Agency's World Outlook believes the industry must spend $3,000billion between now and 2030 to meet demand for oil. Since local governments can demand up to 90pc of the profits for drilling their oil, even big prospects may be uneconomic. It is no wonder that the oil industry only managed to replace half as much new oil as it sucked out of the ground last year.


Meanwhile, the price of the cheap oil of the 1990s is now apparent in the shocking under-investment the industry has made. Refineries are bursting at the seams to meet demand, while Russian oil will only become cheap to extract once pipelines to China or the ice-free port in Murmansk are completed.


For the time being, the fundamentals of the industry dictate a high oil price. Barclays' Horsnell predicts an average price of $48 a barrel for 2005, $38 for the year after and then $43 in 2010. In the short term, demand for oil does not respond much to price; it makes no sense for companies to shut their doors because the fuel bill has gone up.


Wood Mackenzie, an energy consultancy, expects another round of electricity and gas price rises in February, but while we complain about higher household bills, we do not rush out and install double-glazing.


The CBI calculates that industry's energy bills could rise by more than £5billion next year. This will be far more effective than any government policy for roof insulation or energy saving.


As Mr Van der Veer put it: "I do not understand the logic of using an SUV to go shopping and then complaining about a high oil price." Higher oil prices will push car companies towards better fuel efficiency; the average mpg of a car has barely changed in the last 20 years, according to the Department of Transport.


The economy is also unlikely to be as badly damaged by a high oil price as it was in the 1970s. Back then, trade union activism, wrong-headed monetary policy and the collapse of the international monetary system were all major factors in triggering high inflation and a severe recession.


Britain is well placed to withstand the effects. Not only are we still a net exporter of oil, but we use oil more efficiently than any other G7 major economy. There's some perverse comfort for drivers, too. Because the Treasury takes almost three-quarters of the pump price, the crude price would have to double again to take the cost past £1 a litre.


We may all be slightly more out of pocket, except for the Chancellor, but a high oil price is nothing to be feared. The bigwigs have flown home from their conference, and perhaps they will think about one of the iron laws of economics, that today's shortage is tomorrow's glut. It's just a question of when. 

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