Falling oil prices mean companies are scaling back on hard-to-exploit sites. What does that mean for oil supplies – and green energy companies? Tim Bennett reports.
What’s going on?
“Investment in alternative energy is becoming less attractive,” says Bob Parker, vice-chairman of CSFB Asset Management on Bloomberg. Many analysts expect oil majors such as BP and Shell to slash investment in “hard to exploit” locations, such as Canada’s oil-rich tar sands, says The Wall Street Journal’s Keith Johnson. This is despite Canada’s sands being home to “the biggest crude reserve outside Saudi Arabia”. Meanwhile, two of Canada’s biggest “tar-sands-to-crude” producers, Suncor and Petro-Canada, are already scaling back capital expenditure – most recently postponing spending on the “upgraders” that turn tar-like bitumen into high-quality crude oil.
What’s causing this sudden pullback?
Tumbling oil prices. As recently as July the price per barrel of Brent crude was setting new records – touching $147.27 – and seemed to be heading for the $200p/b (per barrel) price forecast earlier in the year by Goldman Sachs analysts. Yet the price has since crumbled to about $60 a barrel: that’s a jaw-dropping 60%. Speculators have pulled out of the market amid clear signs of rapidly disintegrating global demand, as the world economy has slowed sharply. At the current level, as Johnson puts it, “tricky new oil-production projects simply don’t make sense anymore”.
But isn’t the world running out of oil?
It is. Take Britain – according to the Statistical Review of World Energy produced by BP, we may have just six years until we run out of oil. Many other countries are in a similar pickle. Mexico has ten years until its proven reserves run out, the US about 12 and Russia around 22. But with oil prices now falling fast, for many firms the risk and costs involved in finding and extracting oil from new sources exceeds the potential revenue they can earn from doing so – particularly with costs having risen sharply in recent years as demand for the tools and labour needed for oil exploration jumped. In short, says Tim Iacono on Seekingalpha.com, the prospect of earning $60 a barrel – a 17-month low for “black gold” – is hardly enticing when “you’re working on a project that requires a price of $80 to $90 or more to break even”.
What about ‘green’ energy?
High oil prices were also good news for substitutes, such as solar power, ethanol and wind, which all “looked better and better” the higher oil climbed, says David Baker in the San Francisco Chronicle. But if oil prices fail to stage a recovery, these alternative energy technologies “will have a hard time competing” and may even be abandoned. It’s happened before. American interest in alternatives and renewable energy “swelled during the oil shocks of the 1970s”, but the oil price crash of the early 1980s “took the country’s interest in oil substitutes with it”.
So is renewable energy doomed?
Maybe not. As The Guardian’s Ashley Seager notes, the oil price may have changed direction, but politicians – wary of the power of the “green lobby” – have not. The British Government plans to introduce a “feed-in tariff”, which effectively guarantees above-market rates for companies that generate electricity from renewable technology, such as wind turbines and solar panels. And in America, the $700bn banking system lifeboat package included $16bn of tax breaks for renewable energy, cleaner fuels and energy efficiency. Last week the United Nations Environment Programme even called for a new “Green Deal”, modelled on President Franklin Roosevelt’s supposedly depression-busting “New Deal” of the 1930s, as a way of cutting emissions while also “reviving flagging economies”. Meanwhile just last week the biggest private renewable energy deal (worth €1.2bn) of the past 13 years was completed by Portugese buyout firm Magnum Capital. This takes the value of “renewable” deals completed this year to €2.4bn against just €1bn last year says The Wall Street Journal.
Where does that leave the ‘ethanol bubble’?
Far from popped, sadly. President George Bush has long been obsessed with the idea that oil should be replaced with corn-based ethanol. Around 34 billion litres of it is added to US petrol every year, reports Reuters. Barack Obama, his likely successor, is senator for the corn-growing state of Illinois and also “a firm advocate of ethanol”, says Ed Pilkington in The Guardian. So official policy is unlikely to change much after the US election. That’s a pity. Corn ethanol is energy-inefficient – just to produce it, you have to use half the energy you eventually get from it. It also places huge demands on agricultural land, with a third of US corn used in ethanol production. That means the 178 US distilleries built so far to churn it out have contributed to “a devastating rise in global food prices” and “distorted international trade”. The global crunch has put some producers out of business and a low oil price will temper demand, but it seems likely the power of the US agricultural lobby will ensure ethanol’s future as an oil substitute – for now at least.
What should investors make of all this?
Shares in oil sands companies have fallen sharply in tandem with the oil price, but it seems likely that they will see more spending cuts in the months to come, particularly if the oil price continues to fall. We would avoid the sector for now. As for ethanol, we would avoid investing directly in ethanol stocks, but if political subsidies for ethanol continue to put pressure on corn and other soft commodity prices, then agricultural stocks could benefit.