Industry Needs Stable Funding

In reporting on the May Offshore Technology Conference in Houston, the Oil & Gas Journal said that "Oil and gas companies are becoming more adept at maintaining long-term business strategy in the face of short-term uncertainty stemming from oil price cycles." In a session on "Coping with price volatility: how will it affect major capital projects," executives discussed cost-cutting measures that include lowering capital budgets and renegotiating contracts.

The responses were hardly revolutionary or even evolutionary. Adjusting budgets is the time honored response to fluctuating oil prices. Unfortunately, the knee-jerk, cash-flow driven reaction is dead wrong. What it amounts to is buying high and selling low.
As profits rise, driven by high oil prices, companies increase spending and operating costs rise driven by restrictions on goods and services. When prices drop, budgets are slashed and oil field activities drop. The recent decline in drilling activity has occurred much faster than in previous down cycles. The herd mentality prevails and oil and gas companies line up to announce reductions.

Where are the contrarians? We believe that the best approach in dealing with the highly volatile oil market is to maintain constant real dollar budgets. This level spending will enable companies to focus on the long-term and take advantage of opportunities during business cycles.

From a strategic position, upstream companies should focus on development during up cycles and exploration in down times. When profits are high, build a cash reserve that can be used to fund projects when revenues drop. For downstream companies, low prices and low demand periods are opportunities to invest in capital projects to add capacity and improve efficiency.

Short-term Savings May Lead to Long-term Problems

Parade magazine had an interesting article titled "Who Profited From Oil Prices?" in the January 25, 2009 edition.

A more appropriate title might have been "Who Profited from Lower Oil Prices?" as the story indicated that the winners were consumers who benefited from a $2/gallon drop in gasoline prices for annual savings around $282 billion and hedge fund managers who shorted oil.

The losers were OPEC and other major producers who saw their revenues decline which could cause "political and economic turbulence" in Venezuela, Russia and Iran.

While oil companies lost revenue as prices declined they also saw their costs for oil field equipment and supplies drop as well. Oil producing states that earn revenue from production taxes saw their income slashed. Alaska projects a 7% drop in oil revenues and Louisiana forecasts a $2 billion budget shortfall by 2010.

Green technology suffered as well as lower oil prices made solar and wind power less attractive. T. Boone Pickens' green-tech fund lost more than $1 billion.

Another factor is the fluctuation in oil prices which drives planners nuts. National, state, and company budgets and programs suffer with price volatility resulting in delays and cancellation of programs.

A short-term mentality affects the marketplace and causes delays in development of alternative energy supplies. Consumers may benefit from short-term savings but project delays will produce long-lasting impacts and higher energy prices.