Is $40-per-barrel oil a possibility in 2000? Michael Economides thinks so. The University of Houston professor and author of The Color of Oil: The History, the Money and the Politics of the World's Biggest Business is concerned that not enough investment is being made in new exploration and development projects when the world's oil supply is shrinking rapidly. Increasing oil production involves more than "opening a faucet," he told reporters during the Offshore Technology Conference in Houston. It takes time and money, and at current investment levels, Economides anticipates that a shortfall of 2.5 million barrels per day could materialize before the end of this year, despite promises by OPEC to increase output. "If this is going to materialize, I would not be surprised to see oil hit $40 a barrel before the end of the year," he said. Economides calculates the supply shortage by using a 10% annual depletion of existing production, equating to about 7.8 million barrels a day, and a 2% annual increase in demand. "For this amount of shortfall, we need about $30 billion in investment," he says. "But we don't see nearly that much. Unless the investment increases, the shortfall will hit hard soon." Crude oil supply is at its lowest since 1973, he added. He isn't predicting that oil prices will stay at $40 for any length of time, nor is he advocating such a high price. "But we need this kind of shock to spur investment." Unfortunately for some companies, the price needs to be quite high to justify investment in some parts of the world, he added. Economides uses the production activation index-an indicator of the required investment needed to add one new barrel of oil in daily production-to determine an equilibrium price, the one at which oil must be sold in order to get any kind of return on investment. For example, a typical West Texas well that costs $500,000, but produces only 50 barrels per day of oil, has an activation index of $10,000 per barrel per day. Economides relates the activation index to the discounted cash flow, production depletion, oil price, pretax operational costs, tax, and regional costs of doing business and gets the equilibrium price. For the West Texas example, that's around $21 a barrel. Not all fields fall within a range that might be considered reasonable with today's economics. "Under the currently projected CFAT (cash flow after tax, including royalties, rents and payments to the national treasury) caused by large payments to the national treasury, Venezuela would require two to three years with sustained oil price in excess of $30 to recover profitability after five years," Economides co-wrote in a paper on the subject. "[Iraq and Kuwait] would have difficulty breaking even with an average oil price above $60 for a number of years, and would require even greater oil prices to attract outside investment." So why do oil companies continue to chase projects that don't make economic sense using this equation? Economides thinks producers suffer from "quarter-itis," an inability to see past the next quarter's earning statement to grasp the longer-term picture. This is obvious, he said, because even though the price of oil has increased by 100% in the past year, there has not been a comparable increase in E&D investments. "The equilibrium price is what we call a logical price," Economides said. "But the oil business has not been operating by logic." -Rhonda Duey and Jodi Wetuski
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