The increase, widely expected to be agreed when the Organization of Petroleum Exporting Countries meets in December, could support higher crude prices for the very long run. Shorter-term, it could persuade companies to raise their highly conservative oil price projections, on which investment decisions are based.
"If OPEC moves the price band up, it will tempt the companies to move their planning assumptions. That has real implications," said energy analyst Adam Sieminski of Deutsche Bank.
Oil futures hit a new record above $54 a barrel in New York Tuesday, spurred by fears of supply disruption in Iraq and Nigeria and surging demand in the U.S. and China.
But despite a 60% increase in the price of oil this year, companies and banks use far more conservative forecasts for planning.
Companies use mid-business cycle price estimates to choose how to invest the billions of dollars needed for the 20- to 30-year life-span of an oil or gas project.
No one suggests there would be an industrywide knee-jerk reaction to a change in the OPEC target. Instead, analysts and company finance directors say it could bolster the belief that higher prices are here to stay.
"You're talking about a nearly 20% increase in the mid-cycle planning assumption. If the cash flow goes back, we could be talking about a 20% increase in capital spending," Sieminski said.
Possibly $40 billion-$50 billion in extra capital expenditure a year for the oil industry could flow in if OPEC raises its price band by $5, Citigroup SmithBarney estimates.
"It's a chunky number. One of the big issues for the oil industry is, you've now started to reap a windfall, what do you do with it?" said Aiden Bradley, an oil analyst at Citigroup SmithBarney.
Large oil companies such as BP PLC (BP), ChevronTexaco Corp. (CVX), and Royal Dutch/Shell Group (RD SC) have already revised up their price forecasts. They still see mid-cycle London benchmark Brent at $20-$22/bbl, except Shell, which puts it at $25/bbl.
Overly conservative oil price forecasts kept companies from developing production after the oil price slumped to $10/bbl in 1998, leading to the current supply crunch. On the other hand, guessing too high can lock firms into fields where they lose money because of high production costs if oil prices retreat.
A recent study by energy consultants Wood Mackenzie found that the 10 biggest listed oil companies spent $3 billion less on looking for new fields, just as prices rose. In 2003, spending was $8 billion, down from $11 billion in 1998.
At the same time, those companies poured a record $49.5 billion into squeezing every drop out of existing fields, to bolster their standing with shareholders anxious for high returns on capital. This year, companies have mostly opted to use their windfall earnings to return money to shareholders via stock buybacks.
OPEC currently says it will adjust its output to keep the price of its members' oil between $22 and $28/bbl. Analysts say OPEC started targeting $30/bbl last year to make up for the weaker dollar and pressing domestic economic needs.
Even though OPEC is pumping nearly flat out to keep pace with surging demand, prices have been far higher.
In practice, the band is more of a floor, below which OPEC won't allow prices to drop in the future.
Having 50% of the world's exports pledged to defend that floor has implications for the smaller firms that rely on project finance from banks.
"OPEC raising the band could give more confidence to people financing the industry," said Oriel Securities analyst Richard Rose.
Bank of Scotland, part of HBOS PLC (HBOS.LN) and active in lending to the North Sea oil industry, currently assesses projects using a price of around $22/bbl.
Moving the price higher could raise the value of reserves underground, but the question would be whether OPEC could maintain its discipline.
"They had their act together on $22-$28, it does come down to track record," said Graham Sturrock, head of project finance at the bank. "But I'm a lender, so I'm bound to be a pessimistic."
That pessimism is shared by some companies.
"We look at each field on its own merits, the cost of getting the oil out, getting it to market, hedging possibilities. The OPEC band is something in the background," said Tom Hick, finance director at Tullow Oil PLC (TLW.DB).
Cairn Energy PLC's (CNE.LN) Finance Director Kevin Hart is also reluctant to change assumptions based on OPEC policy, preferring to keep the debt ratio as low possible.
"We don't feel we're missing an opportunity by using a higher oil price assumption," Hart said. "Bottom line, it's clearly a factor, but I wouldn't plan based on the OPEC price band."
However, Phillip Ellis, energy analyst at Boston Consulting Group, says OPEC successfully kept prices close to $25/bbl over more than two decades, based on weekly average prices adjusted for inflation.
"The experience of last 22 years, the $22-$28 band was very, very robust," Ellis said. "If OPEC raised the band, it could be part of the changing paradigm."
Most Popular Articles