Though most of us suffer when energy prices increase, there are some who benefit greatly. Conversely, when energy prices fall precipitously, there are some who suffer massive losses of wealth and power. The part that is unfair is that the people who benefit from high energy prices have designated representatives who often get together and talk while those of us who suffer not well represented. We can change that, especially now that we have a better means of communication.
Another part of the energy market give and take that currently favors the suppliers is that they are more focused because they stand to gain or lose much more than the average person. As consumers, we are at a key stage when we can get the attention of some powerful allies of our own – the suppliers have made the mistake of allowing prices to increase so rapidly that they are threatening the survival of some of the largest companies in the world.
In 1998, many of us were quietly pleased that oil prices had fallen to a level not seen since the mid 1970s. The Asian economic crisis along with the continued improvements in nuclear power plant operational reliability had reduced marginal demand for oil and gas products to the point where oil briefly dipped under $10 per barrel and natural gas sold for less than $1.60 per million BTU. Russia, Saudi Arabia, Norway, Venezuela, Mexico and the “Seven Sisters” (the world major integrated oil companies) struggled with high debt loads, low product prices, and aging infrastructures that needed investment.
These suppliers responded in a logical, if not very nice or supportive, fashion. They each worked to increase the market demand while at the same time consolidated their holdings and shut down marginal production. They also worked hard to discourage any discussion of the use of nuclear power; the low prices that they were commanding at the time helped, but a big part of the discouragement were constant reminders that natural gas was cheap and easy. While I was still trying to get Adams Atomic Engines, Inc. off of the ground during our initial start-up phase, I found out that many of the Independent Power Producers (IPP) that I was talking to were turned off because we could not offer the kind of long-term. low-cost financing that they could get from their gas pushers (oops, I meant suppliers).
I am not alleging that there was some kind of grand plan, but I do know that energy company leaders meet on a regular basis, exchange email, read the same publications, and work together on many projects. Conspiracy is a tough word, but we all know that business leaders work very hard to get strategy right in order to maximize profits. They all think that is their only “fiduciary responsibility”. We should also all understand that the common strategy of all commodity suppliers in the face of low market prices is to work to increase the demand for their product while also restricting the supply.
Companies like Exxon tightly controlled (reduced) their exploration and drilling efforts and instead began purchasing reserves on Wall Street by buying or merging with other companies. They set high bars for internal reviews, only approving projects that showed a good marginal return with assumptions of oil prices that were far below market prices.
BP and San Ramon, California-based Chevron were among companies that spent a combined $273.4 billion from late 1998 to 2002 purchasing rivals. That’s about equal to the amount spent during those years on exploration by the entire U.S.-based oil industry. The biggest deal was Exxon’s $85.2 billion acquisition of Mobil Corp. in 1999. Three years later, Phillips Petroleum Co. purchased Conoco Inc.
“They took their cash flow and plowed it into mergers instead of upgrading their exploration efforts or refinery technology,” Bethune says. “The investments that should have been made just weren’t there.”
(Exxon, BP Rebuff Pleas to Boost Exploration as Oil Demand Soars)
Oil producers frequently made statements reassuring us all that there was plenty of oil. They paid large fees for subscriptions to market survey services like those provided by Daniel Yergin’s Cambridge Energy Research Associates (CERA), which has consistently produced public reports indicating that growth in production could continue for the foreseeable future. I would be very interested in finding out what the CERA analysts wrote in the versions only available to organizations paying in excess of $50,000 per year. Were the reports to employers different from the free reports?
Petroleum producers issued press releases announcing each new find, and major media outlets helped them tell their story.
- Oil discovery rocks Brazil
“A huge offshore oil discovery could raise Brazil’s petroleum reserves by a whopping 40 percent and boost this country into the ranks of the world’s major exporters, officials said.”
(CNN.com – November 9, 2007)
- Tests Indicate Major Oil Discovery in Gulf of Mexico
“A test well indicates it could be the biggest new domestic oil discovery since Alaska’s Prudhoe Bay a generation ago.”
(FoxNews.com – September 05, 2006)
- Discovery backs theory oil not ‘fossil fuel’
“A study published in Science Magazine today presents new evidence supporting the abiotic theory for the origin of oil, which asserts oil is a natural product the Earth generates constantly rather than a “fossil fuel” derived from decaying ancient forests and dead dinosaurs.”
- Egypt Kuwait Hldg says makes major oil discovery
“Egypt Kuwait Holding EKHO.CA said on Sunday one of its affiliates made a significant oil discovery in Egypt in the North Shadwan Concession located in the Gulf of Suez.”
(Reuters.com – February 3, 2008)
In my experience, many casual observers of the energy markets remember those announcements and think that they mean that supply worries are over.
The same companies have only quietly released complex production results that required detailed analysis to understand the steady reductions in production from existing fields. In some cases – notably in Saudi Arabia and in Russia – it is almost impossible to find accurate reserve or depletion figures. Matthew Simmons, one of the more experienced investment bankers in the petroleum business, has spent a lot of time digging through those depletion figures and trying to make sense of them. What he learned has scared me.
Along with friends in other industries, including the mainstream media where the total ad spending for major petroleum producers is close to half a billion dollars per year, oil suppliers encouraged globalization. Not only is that a system that threatens many domestic jobs, but it is an energy intensive production system that only works when there are cheap ways to move physical products thousands of miles. Globalization gives a false sense of energy efficiency to formerly industrial economies. High product consumption areas like California look better because the energy required to make the products that Californians consume shows up as an increase in energy consumption in the state or country that produces and transports the goods.
How many times during the period from 1998-2007 have you read about how we are in a post industrial economy where energy prices are just not all that important?
We have been duped and encouraged not to look behind the curtain. We have been carefully man
ipulated into expecting that there would always be enough energy to supply large automobiles, frequent air travel, large homes, and distributed production that depend on cheap transportation. Every time a leader who had a more complete understanding of the real world suggested that we might want to send better market pricing signals, perhaps through the use of consumption taxes or floor prices, the industry marketing and lobbying machine cranked up to stymie that effort.
People concerned about future supplies were often treated like party poopers. I can testify to that; my 47-50 MPG automobile used to be the butt of jokes from people who talked about putting it in their trunk or running over it in traffic. I cannot tell you how many times people have dismissed my concerns about oil and gas production limits while in internet conversations starting in 1991 (when I began posting on the USENET and AOL discussion boards as Atomic Rod).
Many of my opposition commenters have dismissed nuclear power as not being necessary since coal and gas were cheaper and easier. The people who believe we have sufficient gas for increased electrical power production have begun to disappear, but I recently read a full page add in the Wall Street Journal from the natural gas industry telling the world that there was “plenty” of natural gas to fuel a fleet of CNG vehicles.
The deep, dark secret during most of the period from 1996-2006 was that many of the world’s most important oil sources were in a declining state where their production dropped each year. Combined with the reduction in drilling efforts, the rate of increase in production capacity was much lower than the increase in the rate of consumption.
None of the major oil companies like to admit it, but their behavior shows that they expect a long period of flat or slowly declining production. They also do not like to widely publicize the fact that they have figured out how to keep a lot of money by not investing in growing their business.
“According to Matthew Simmons, 80 percent of the world’s energy delivery system is corroded – literally rusting through – and desperately in need of refurbishing. We saw the effects of this problem in March 2007, when a section of British Petroleum (BP)’s pipeline in Prudhoe Bay sprung a leak and spilled a small amount of oil.
But the public outcry and the Congressional inquiry that followed the spill almost universally failed to identify the real issue. Senators called BP’s management to task for having failed to “pig” its pipelines according to standard procedures. BP acknowledged its lack of attention to the pipelines, but never admitted that it wasn’t even trying to maintain them because the output from the fields has fallen toward the marginal low end of production. BP is just running down the clock on the capital investment and hoping that it can continue to use the pipelines just long enough to produce the last bit of oil. The company certainly would not see any financial justification for reinvesting in that infrastructure.”
(Profiting from the Peak: The End of Oil and the Greatest Investment Event of the Century John Wiley and Son, Hoboken, NJ, 2008 pp. 44-46)
In most public forums, petroleum company executives play innocent and claim that they have no control over oil or gas prices, but they also like to brag to their stockholders about how their financial acumen has resulted in another record profit.
- “In 2003, ExxonMobil delivered the strongest earnings performance in the corporation’s history. We achieved net income of $21.5 billion and cash flow from operations and asset sales of $30.8 billion. Return on capital employed stood at an industry-leading 21 percent. Our strong business performance continues to provide leading returns to shareholders while advancing the corporation’s core strategies with our ongoing investments in the business.
(ExxonMobil Annual report, 2003)
- “Our strong financial position has allowed us to return over $17 billion to our shareholders. We also made capital investments of $15.6 billion (excluding the minority share in Sakhalin). Our strategy continues to be more upstream and profitable downstream.”
(Royal Dutch Shell Annual Report 2005)
- “Net income of $18.7 billion represented a fourth consecutive year of record earnings. Capital and exploratory expenditures for the year were $20 billion, and return on capital employed was 23.1 percent. We increased the annual dividend for the 20th consecutive year and achieved a total stockholder return of 30.5 percent, approximately 25 percentage points higher than the return delivered by the S&P 500. We continued to return cash to our stockholders through stock buyback programs, purchasing $7 billion of our common shares during 2007. In September, we initiated a new program to acquire up to $15 billion of our common shares over a period of up to three years. We are committed to the capital discipline necessary to create sustainable, long-term value for our stockholders.
(Chevron Annual Report 2007)
- “ExxonMobil’s total shareholder return for 2007 was 24 percent. The Corporation distributed a total of $35.6 billion to our shareholders in 2007 through dividends and share purchases to reduce shares outstanding, an increase of $3 billion from 2006. Over the past five years, we have distributed a total of nearly $118 billion to our shareholders, including a 49-percent increase in our annual dividend. Our 2007 business results demonstrate our commitment to operational excellence, enduring business controls, and disciplined capital investment. These results also reflect ExxonMobil’s long-term industry perspective and our ability to meet the challenges of the changing global energy landscape.”
(ExxonMobil Annual Report 2007)
If oil management choices were not so damaging to the rest of the economy, or if they were a bit more open about their real expectations for the world’s ability to produce increasing quantities of oil each year, I might not be so angry. However, my analysis is that there has been a massive, well-coordinated marketing campaign to encourage high consumption at the same time that the leading companies in the industry recognized that we were nearing Peak Oil production levels.
The leaders at the major petroleum companies are smart enough to realize that increasing demand and peaking production would mean that prices would inevitably increase in a dramatic fashion, but they might not have been smart enough to realize that the rest of us did not plan to simply accept the economic pain.
Despite their best efforts, they also failed to take the nuclear trump card off of the table before they let prices get out of control. Through the increased use of uranium and thorium, we have the ability to reduce our consumption of oil and natural gas back to well within our production rate limits. Once we shift the market back to the point where there is sufficient excess capacity in the world so that we do not need every supplier’s maximum efforts, we can once again achieve some power balance between suppliers and consumers. Markets work best to determine fair prices when each side of the transaction has the clear ability to say “no” and walk away if the terms, conditions and prices are not suitable.
Of course, suppliers generally would prefer to trade in a market where the consumer has no choice but to pay whatever is asked. That is why I have occasionally remarked that former drug dealers could successfully “go straight” if they simply put their knowledge to work as oil or gas marketers.
The ability to own private jets, numerous big homes, indoor ski resorts, and private security forces must be very seductive. Those who have those things now are going to work hard to protect them. They might not even play fair.
The big risk for the rest of us is that the petroleum produc
ers are sitting on increasing mountains of cash. They have financial staying power and the ability to engineer another temporary reduction in energy prices given the long lead times needed to move from where we stand today to a world of increasing nuclear power plant production and operation. Preventing that action from slowing nuclear plant development will require a lot of leadership and focused understanding of market dynamics. There are some actions that could reduce the required lead time considerably.
I am not sure that the necessary leadership exists, but I remain hopeful that together we can make the transition to a less oil and gas dependent economy happen with the least possible amount of disruption to the general population. Of course, I have to admit that I would enjoy causing a bit of painful disruption for the suppliers. I have a small vindictive streak that appreciates a bit of revenge now and then. That recent $75 charge to fill my rather small diesel fuel tank got me even more primed for action.