Tuesday, August 18, 2009

Oil sector facing unprecedented changes, says Greenpeace

Few industries have been immune to the ongoing economic recession and oil companies are no exception. A report from Greenpeace (U.K.), however, says that when the economy picks up oil demand may not follow, leaving the return of high oil prices in question.

Alberta's tar sands, along with the Arctic and ultra-deepwater, are resources where oil is difficult to access. It is also very expensive to produce, requires long lead-in times to bring on stream and in many cases has controversial, and extremely costly, environmental and/or social impacts. The expense of bringing much of this oil to market means that oil prices must be high – dangerously close to a “break point” price. Beyond this break point, oil demand is constrained through changes in consumer behaviour and reduced economic growth. But as expensive technologies are needed to access the oil, below the break point could mean a loss of profitability.

In 2006, Cambridge Energy Research Associates suggested the break point for oil prices was somewhere between $100-$120/barrel. However, in June 2009, Tony Hayward, BP’s chief executive, said that as oil prices went over $90, consumers begin to change their behaviour. He suggested that the right range for oil prices is between $60-90/barrel – a price range Marc Brammer, head of business development for Europe at RiskMetrics Group, calls the break-even range, where room for long-term profits is slender.

In the past, the industry could always depend on expansions in cheap reserves, the report says. Today, conventional oil resources are being depleted, leaving international oil companies to fight over difficult-to-access oil. These significant challenges should be cause for concern for investors, as oil companies must readjust their business plans and make “unprecedented” structural changes, Greenpeace says.

Other threats also loom for oil companies, including future carbon regulation, and increasingly competitive alternative energy sources. “Carbon caps are going to be a reality and, at the moment, carbon capture and storage does not look cost effective or even technologically feasible at the scale necessary,” Marc Brammer told Greenpeace in an interview. The ability to pass these costs on to the customer will be limited by the same dynamics that keep general prices in check, he added.

An oil company aiming to reduce its exposure to oil price volatility should move into clean tech and renewables, said Brammer. “In general, oil companies need to start seeing themselves as energy service companies as opposed to driller and refiners.”

Investors wishing to engage oil companies should aim to get them to be open and transparent about their strategies to cope with future oil price volatility and their efforts to become energy service companies, Brammer concluded.

Download the report.

Jennifer Holloway is a writer based in Ajax, Ontario. jenholloway(at)sympatico.ca.

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