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FINANCIAL TIMES: Market Insight: Soaring infrastructure costs will keep crude price aloft: “The drive to find new assets lies at the heart of Shell's troubles over the past 12 months” ( 20 Jan 05


By Liam Denning

Published: January 20 2005


Crude oil has fuelled countless headlines over the past few years, but some industry analysts say higher prices will be with us for the next decade.


Long-term crude futures have traded above $30 per barrel since early 2004, the first time this level has been breached. This is not just a function of higher spot prices. When crude last nudged $40 back in 2000, futures for delivery in 2010 remained steady at the $20 mark.


Why this structural shift upwards? US Geological Service data show there is no physical shortage of oil. The problem is that the industry has not invested adequately over the past 20 years. Kevin Norrish, energy analyst at Barclays Capital, believes the low prices of the 1990s provided little incentive for major investment. "The oil industry is suffering from a lack of investment that has created bottlenecks at all points of the energy supply infrastructure.


"It will take many years before investment shortfalls in oil are made good. This means much higher long-term average oil prices."


Jeffrey Currie, managing director of global investment research at Goldman Sachs, says consumers enjoyed two decades of relatively cheap oil following the investment boom of the 1970s . Mr Currie says, back then, oil companies diversified away from Opec [Organisation of Petroleum Exporting Countries] nations into new areas like the North Sea while anxious governments provided subsidies for investment in in frastructure.


The cycle is now turning again. With traditional areas like the North Sea entering decline, oil majors are drilling ever deeper in riskier regions to find new long-life assets. "Near term, the required increase in spending is significant," Mr Currie says. "We estimate the total amount of capital spending required over the next 10 years in the oil industry to meet trend demand growth at some $2,400bn, nearly triple the level of spending during the 1990s."


The drive to find new assets lies at the heart of Shell's troubles over the past 12 months, and poses a significant challenge to all listed oil companies. A survey by J.S. Herold and Harrison Lovegrove, two energy consultancy and advisory companies, showed average finding and development costs for the industry more than doubled between 1999 and 2003.


The broader environment has also been transformed, with Western governments unwilling to underwrite large energy projects. "A significant shift in government policies has taken place, from subsidising to taxing energy production," said Mr Currie. He estimates extra taxation alone will add $5 a barrel to average oil prices over the next decade.


Even Opec, which for a long time struggled to control the oil price, has become more proactive in managing supply. Lord Browne, chief executive of BP, said in a speech last month that Opec has exercised tighter discipline since setting price bands for crude in April 2000. He said rising populations in oil-dependent Opec countries would drive them to try and maintain prices at around $30 a barrel. Fears of terrorist attacks add a security premium to this.


Several oil majors have priced these new expectations into their planning. Shell raised its oil price assumption by 25 per cent last September and said it would "rank projects more on price upside".


Despite his forecast of structurally higher prices over the next decade, Mr Currie cautions that the 10 years after that may be different.


"Once next-generation projects are completed and new production comes on line, prices will likely decline as the new production displaces the older, more expensive fields. Prices could fall to even lower levels than during the 1990s, as technological advances have significantly reduced the cost of producing the oil once the infrastructure is in place."


Drivers may yet enjoy some relief at the petrol pump, albeit not for some time.

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