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The Cost Curry

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The world economy is in turmoil and oil prices are stubbornly keeping around the $100 per barrel mark. Countless economists have in the past pointed out that high oil prices are bad for the economy. In 2004, a European Central Bank paper brought forth again the fact through rigorous analysis that increased oil prices have a definite negative effect on economic activity and its negative effect is strongest on the US some Euro region economies.  The present global economic state only reinforces the theory of high oil price and sluggish economic growth.

At the centre of the whole debate lie the oil prices. Markets abound with forecasts and estimations on oil price. Billions of dollar ride on this number and this is no attempt to determine it. Rather the most interesting aspect of the oil price is not its certainty but the glorious uncertainties that besiege the oil price. And contrary to the popular perception, it is not politics or economics alone that determine the price of oil. Instead it is the trinity of politics, geography and economics that does so.

The 'geography' factor we are referring to here is not that our underground reservoirs are running out of oil. We're not. But we are running out of cheap oil. Most of the new discoveries are now occurring in difficult terrains such as deep sea shelves where it not only costs more to explore and commence production but it also costs more to operate. While none of the giant oil fields are being discovered any more. Fredrik Robelius explained in one of his presentations explained the giant role, giant oil fields play a in our oil supply. In terms of numbers, giant oil fields constitute only 1 per cent of all our oil fields but the top hundred giant oil fields supply nearly 50 per cent of oil supply. The discovery of the last of the top five giant oil fields occurred 45 years ago and our largest oil field discovery happened over 60 years ago. 

Not only are not striking any more giant oil fields now but the oil from the existing fields is getting costlier to pump out. Initially the oil oozes out of the oil fields on its own. Gradually as the underground oil pocket depletes, gas or water has to be pumped in for oil recovery. This increases cost of recovery.

But this doesn't alone justify the $100 per barrel price we had seen recently. A lot of oil can be economically produced below $50 per barrel including the deep sea and ultra deep sea oil as per IEA. Although that is still a lot more when compared to the production costs of $20 per barrel for much of the oil that has been produced in past. In fact during the course of my work, I've come across production costs at just $10 per barrel at fields in India yet India imports majority of the imports at costs which are much higher. It is therefore the cost at which the newer fields will produce that matters.

Not all deep sea or ultra deep sea oil will be brought under production eventually. It takes 3-7 years of time to develop a deep sea oil field and commence production. It will be atleast half a decade before a field that began to be built in 2012 will finally produce oil.  And it is here where there is uncertainty about what levels of prices shall prevail after half a decade. Even though it is difficult to imagine oil prices below $50 per barrel but as the latest news trickles in - about contracting US demand of gasoline and slower than expected growth of Chinese oil consumption - that may not be completely unlikely. It is this zone of uncertainty that is depriving the oil field development firms of the cushion of comfort they require to invest in new oil fields.  A complete meltdown of the world economy and crash of oil prices therefore remains a possibility.

In fact over 5-10 years from here a number of other market disrupting variables can arise of which we have no reasonable idea yet. As I've pointed out in my earlier columns, the development of Electric Mobility is one such wild card besides the conventional factors such as the rising demand from the emerging economies. And only if we had a fair idea of how explosive or damp squib the economic growth in emerging economies will be, would we be in a position to know the full implications of oil demand from the emerging economies.

There is a vicious cycle here. The emerging economies' oil demand requires more oil production and hence investments. But the various uncertainties as discussed above may stymie the investments. The lesser the investments in oil fields are, the lesser the forecast of future production will be, no matter what the potentials are. And any future forecasts of supply failing to match the demands can send the market into a speculative overdrive.

And this brings me to another aspect of uncertainties involved in the oil price; politics. Much of the undiscovered oil now lies in the Middle Eastern countries or other communist nations with a strong government controlled oil sector. Many of these nations are not in a position to rally the vast amounts of investments in oil fields required to keep the oil tap flowing. Many global oil companies are wary of investing in such oil fields too. If the investments in these oil fields are not realised we have a real chance of a supply crisis. Iran recently called for investments in its oil fields but for obvious reasons it is difficult yet to imagine western investments flowing into that country. This may keep pushing oil prices northwards in the immediate future.

From geography to economics and politics, a large number of interconnected factors influence the price of oil. Given the enmeshed soup of politics, geography and economics it would be not be correct to ask what drives the oil price but more correct to ask what doesn't!

Yash Saxena is a sustainability consultant with Emergent Ventures, a climate change mitigating consultancy. He also works on innovation evangelism with Techpedia
yash (dot) saxena (at) emergent-ventures (dot)com

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