Oil Firms Need Long Lead Times To Boost Supply

Petroleum Executives Say Projects Take Several Years, At the Fastest, to Complete 

BHUSHAN BAHREE / Wall Street Journal 4oct04

VENICE — With oil prices having settled above $50 a barrel for the first time ever, petroleum executives meeting here during the weekend say the industry won't be able to bring on enough extra supply in time to significantly tame high prices, due to the long lead times needed to gin up new fields.

Some industry observers say a substantial fall in prices isn't likely until the cost of oil rises high enough to spur consumers to use less.

In Washington, finance ministers and central bankers of the so-called Group of Seven countries, the world's largest industrial economies and great users of oil, fretted about oil prices damaging global economic growth prospects. They urged the Organization of Petroleum Exporting Countries, the world oil cartel, to produce more oil and consumers to moderate petroleum use.

The G-7 warning came after the U.S. benchmark light, sweet crude for November delivery settled up 48 cents at $50.12 a barrel, the highest close in the 21 years that oil futures have traded on the New York Mercantile Exchange.

Concerns are mounting about the price spike because costlier oil can hurt the economy by acting as a "tax" on consumers, who must shell out more for products such as gasoline and heating oil, and by denting the profit margins of companies that consume fuel. During the weekend, U.S. Treasury Secretary John Snow said soaring oil has "created some head winds for the economies of the world" and is cutting into consumer spending.

Still, the price increase shows no signs yet of triggering a recession-inducing shock. Indeed, a prime force behind the run-up in oil prices — soaring demand — is a product of the strongest global economic growth in a generation. The International Monetary Fund last week forecast global gross domestic product will grow 5% in 2004, the fastest rate in three decades. The IMF warned that oil prices will contribute to a slowing of the recovery in 2005, to 4.3% — slower growth than expected, but still brisk.

While at a record high in nominal terms, the price of oil is still short of the record $73 a barrel it hit in the early 1980s, when adjusted for inflation.

At a gathering of many top industry executives in Venice during the weekend, Western oil companies stressed they can do little to pump up output in the short term, as they typically produce at maximum capacity at all times. Some members of OPEC are raising their capacity to pump, but even in Saudi Arabia, which has the easiest reserves to develop, it takes as much as two years to bring new fields to production.

Even for the medium term, oil companies need access now to previously discovered reserves if they are to help meet the increasing need for oil to power world economic growth. Oil projects take several years to complete, at the fastest, and some can take a decade or more. In recent decades, big oil finds have petered out. International oil companies have had to go deep under the ocean, such as off west Africa, or to the Caspian Sea, which is landlocked and far from transportation facilities, to develop fields, while easy to tap giant fields in the Middle East remain off-limits to Western oil companies.

A major project by BP PLC in Azerbaijan will only start exporting oil in significant quantities next year, 15 years after it started. Part of the problem: building a pipeline through a clutch of countries to take the oil to a Turkish port. In Kazakhstan, a group of companies led by Italy's ENI SpA expects the first trickle of oil from the giant Kashagan oil field in 2008, about eight years after discovery.

"We can't go through the whole industry cycle of exploration, development and production" quickly enough to dent prices in the short term, said Thierry Desmarest, chief executive of France's Total SA, the world's fourth-largest oil company. Mr. Desmarest was one of the executives attending the Venice meeting.

Total, like many others, has been pressing countries in the Middle East, home to the world's largest discovered reserves of oil, for production contracts. But much of the Middle East is closed to Western investment in the oil sector.

"The problem is access to oil" reserves, said J. Robinson West, chairman of Washington-based PFC Energy, a consulting company that hosted the Venice conference. "The opportunity set in oil is shrinking," he said. Indeed, oil companies find that higher oil prices have made major oil countries less receptive to Western involvement in developing their resources, Mr. West said in summarizing some of the weekend's discussions.

Western oil companies typically offer capital and technology to develop oil fields. But oil revenues are rising, and the countries have little incentive to share some of this bounty with foreigners. Increasingly, they can invest on their own and contract service companies to provide off-the-shelf technology.

Some members of OPEC, such as Saudi Arabia and Kuwait, have said they are increasing their production capacity some. But it is unclear whether they are ready yet to invest in the large amounts of extra capacity that is needed.

Analysts reckon the world needs to add some six million barrels a day of new capacity every year. Some four million barrels a day of this is to replace production at depleting fields, using a conservative estimate of a 5% annual decline in the world's oil pumping capacity of more than 80 million barrels a day. Another 1.5 million barrels to two million barrels a day or more is needed to fuel world economic growth. More still is needed to restore spare production capacity that has been eroded in recent years. The spare capacity, a cushion against supply or demand shocks, is needed to tame volatility and high prices in world oil markets.