$100 Oil: Big Oil Struggles to Tap New Energy Amid High Costs

NEW YORK, Nov 7, 2007 (Dow Jones Newswires)

Ten years ago, a keen futurologist imagining the effects of $100 oil might have predicted a world where major oil companies, their coffers bursting with mega profits, were pumping cash into high technology and delivering new energy sources saving the world from economic meltdown in the nick of time.

Fast forward to the present and energy buzzwords like ethanol, oil sands or gas-to-liquids are certainly on everybody's lips, but they've done little to diminish the world's dependence on black gold. In fact, as oil prices edge ever closer to $100 a barrel, industry experts say the ability of the major private companies to develop new energy sources is diminishing.

The demand-driven surge in commodity prices of all kinds - whether oil, metals or grains - means blockbuster profits have been matched by soaring costs, particularly for new projects using cutting edge technologies. Meanwhile, aging plants and fields are proving less reliable, making core businesses less profitable even as oil prices hit new highs.

Light, sweet crude for December delivery vaulted to a new intraday record high of $98.62 Wednesday on the New York Mercantile Exchange, edging ever closer to the inflation-adjusted all-time high of $101.70 a barrel. New York crude futures prices are up about 60% so far this year.

Hundred dollar oil was supposed to be the time when blue sky thinking became bread and butter, but many projects using less conventional technologies have made headlines more for their problems than their promise and the share of world energy they provide remains small.

For major energy projects, cost inflation of two to three times has become common. For example, Royal Dutch Shell PLC's (RDSB.LN) budget for the construction of the 140,000 barrel a day Pearl gas-to-liquids project in Qatar has increased from $5 billion in 2003 to $12 billion to $18 billion today. Some industry observers believe the eventual cost may exceed $20 billion.

This year, uncertain project economics led ExxonMobil Corp. (XOM) and Qatar Petroleum to tear up plans for a massive plant to convert natural gas to premium road fuels. Soaring costs have cast doubt on Total SA (TOT), Shell and Repsol SA's (REP) plans to produce liquefied natural gas at Iran's South Pars field.

Projects that have pushed oil and gas production into hostile new environments - Kashagan in Kazakhstan led by Eni SpA (E) and Sakhalin-2 led by Shell in Russia - have been beset by long delays and massive budget overruns.

Plans to reduce U.S. gasoline consumption by 20% in 10 years via a sixfold increase in the use of non-petroleum gasoline, largely ethanol, have pushed up the price of tortillas in Mexico and sparked a fierce debate over the ethics of using food as fuel. But the technology for producing biofuels from non-food crops remains in its infancy.

Spiraling Costs Delays Energy Projects

To be sure, the major oil companies have benefited hugely from the decade long rise in the price of oil. Profits from the likes of ExxonMobil and Shell have been stratospheric for years, proving bumper returns to shareholders and prompting criticism from lawmakers.

But the cost of tapping new energy resources has risen just as fast. Basic drilling costs in the last two years have outpaced oil prices by 26% all over the world, while deepwater rig rates have seen a five-fold increase, said Philip Loader, Vice President of Exploration at mid-sized oil company Anadarko Petroleum Corp. (APC).

"There's a traditional rollercoaster ride of the industry," said Candida Scott, Director of Cambridge Energy Research Associates' Capital Cost Forum. "As oil prices go up, then demand for services and equipment increases and prices are increasing."

The effect has been much more pronounced than previous boom times. "This time around we've got very high industrial growth worldwide and a huge increase in demand for general industrial goods in China," she said.

The cost of labor in the energy business has also become more expensive amid intense competition for experienced workers. CERA's research suggests that by 2010 there will be a 10-15% shortage of engineering, design and project management personnel.

Costs are rising just as the profits of many oil majors are declining. The most recent quarterly earnings of BP PLC (BP), Chevron Corp. (CVX) and ExxonMobil all showed lower returns than a year ago from refining and production. Refining margins have slumped recently as the price of oil products like gasoline have failed to keep pace with rising crude. A more fundamental problem is operating costs.

Hard To Get To

As operating challenges grow, so do the political ones. International oil companies "are finding it more difficult to have access to reserves," said Bassam Fattouh, a Senior Research Fellow at the Oxford Institute for Energy Studies. Governments in resource rich countries have become more assertive and are demanding tougher terms, due in part to the extra clout they get from higher oil prices.

As access to the best resources gets tougher, the private companies are going into, "deeper water, the harsh environments, the oil sands," all of which are more expensive, said Scott.

While the rising price of oil has certainly sparked more interest in alternative sources of transportation fuels, it has also made it harder for companies to develop these resources.

"The prospect for a major new gas-to-liquids project being finalized in the next year or two looks not too good considering even tried and tested projects like liquefied natural gas and refineries are being delayed," said Alex Forbes, a senior consultant at Gas Strategies.

Higher costs have already slowed perceived production growth at a major source of unconventional oil, Canada's oil sands, said Steve Kelley, a Senior Vice President at industry consultants Purvin and Gertz in Calagary. Some companies involved in new oil sands developments are, "burning quite a lot of cash and not producing a barrel," he said.

Copyright (c) 2007 Dow Jones & Company, Inc.