There’s Still a Story Left in Energy

by Inya Ivkovic, MA

It’s true; far too many people have far too many times, for far too many both right and wrong reasons, debated the price of energy. The bottom line, however, appears to be relentlessly the same — buy energy! And in the long run — consider buying some more!

Although the story behind this is a simple one, it does not mean there is not a story left. The world literally devours about 85 million barrels of oil on any given day. There are no ifs, ands or buts about it — the depletion of fossil fuel resources is unrelenting, while the demand for them over time has nowhere else to go but up. With the supply decreasing, albeit at a slower pace than predicted some two or three decades ago, prices are more than likely to move in the opposite direction — up! Until, of course, the world finally runs out of it, at which point we will either revert back to horse-drawn carriages or find other ways to feed our sedans and SUVs the juice of modern-day transportation.

In the meantime, investors should not fret too much about low crude oil prices. About a decade ago, oil hit a historic low of just about $11.00 per barrel. But then, for the next 10 years, it roared and conquered. The energy pricing process is simple. When oil prices are low, digging for new oil is usually not economically viable. So, no one does it and the world lives off of its already produced and stored oil. However, oil reserves can keep up with the demand for only so long. Eventually, as the demand vs. supply gap widens, prices start going back up, and oil exploration and development economics start making sense again.

Perhaps history does not repeat itself in every single detail, but a clear pattern can certainly be recognized. For example, according to the International Energy Agency (IEA), global production from existing oil fields has already declined seven percent on an annual basis. More importantly, this rate of decline is gathering momentum. However, with oil currently trading at about $51.00, $52.00 per barrel, new drilling simply isn’t happening. Not that it shouldn’t; it just doesn’t. Far too many development projects have been put on the back burner, especially the expensive ones involving oil sands.

Yet, the math of the matter is indisputable. As long as there is no new oil coming into the market and the world is getting by on reserves, oil prices will have to reflect that, by going up, come recession or recovery. In the longer term, the demand will increase even faster, regardless of some analysts’ claims that appetite for oil may have peaked, particularly in the Western economies. But when making such claims, how can anyone ignore the fact that there are also about three billion people in the developing world who are screaming for more oil, while currently consuming only a fraction of what’s guzzled up by the West?

At what price would producers go back to looking for new oil? Don’t forget there is a bit of a price tug-a-war between OPEC and non-OPEC producers. Interestingly, during the energy boom from 2004 to 2008, non-OPEC production has actually declined, despite its focus on the developing world and it having the money and technology to pursue new exploration and development projects. So, why the decline? Even at high oil prices, non-OPEC producers have difficulty thriving once they hit the point of diminishing returns. Obviously, there is something to be said about oligarchy market types. And this is where OPEC producers come into play, quoting a price of $75.00 per barrel as “fair” to them and to the world.

Of course, a price of $75.00 per barrel is a far cry from its historic peak in 2008. Yet, it is also still not realized today. Making matters even worse for oil producers, it appears that oil is cheaper on the market than it is in the field. No wonder exploration and development projects have screeched to an abrupt stop. However, despite all the negative news flowing from the oil patch instead of oil, the good news is that oil’s historic pattern becomes even more obvious. When oil is at its darkest (no pun intended), the investment opportunity is typically at its brightest.