Killing the Goose, or Just Plucking It?
A recurring theme in my blog over the last year and a half has been the challenges facing energy companies in getting access to the reserves of oil and gas necessary to replace their current production and expand for the future. This article from yesterday's New York Times nicely illustrates the problem, which has grown in tandem with higher oil prices. But it also provides a few hints about the potential downside for countries looking to turn the screws a little tighter on companies that are already committed to expensive projects--and reliant on the market capitalization these booked reserves generates. Neither side should forget that oil is a long-term business, and that feasts have been known to turn into famines.

The current combination of high demand, industry consolidation and limited access to new opportunities certainly gives resource-rich host countries extra leverage in negotiating--or renegotiating--contract terms with the international energy companies. For the remaining large players, Exxon, BP, Shell, Chevron, and Total, only very large oil and gas projects are big enough to materially affect their bottom lines and reserve statistics. Only a handful of countries offer such opportunities--setting aside places like Saudi Arabia and Mexico that are essentially closed to foreign investment. At the same time, Chinese and Indian firms, with rapidly growing home country demand, are keen to sign up deals at terms that would make the majors blanch.

Right now, if you are one of these big, resource-rich countries (e.g. Russia, Venezuela, Kazakhstan, etc.) the downside of demanding all sorts of extra benefits and extracting the last dollar in taxes and royalties on your contracts must look negligible, compared to the upside. This is particularly true, if you subscribe to concerns about a potential imminent peak in global oil production and see no limits on the economic growth prospects of Asia. However, in spite of all of these arguments, there might just be a case for reasonableness and honoring previous contractual agreements.

The Economist recently cited a report by Cambridge Energy Research Associates (CERA), a bunch of very smart folks, who tallied up all known global oil projects that are already committed and concluded that oil production could grow by as much as 16 million barrels per day by 2010. This neatly answers a question I've been asking since the start of my blog, about the project-by-project buildup that gets to 100 million barrels per day of production. And although I've not seen the data, CERA is a reliable enough source that I would accept it within the context of its assumptions.

What does this mean for producers and for prices? A potential glut, or if not a glut, at least a return to a more comfortable supply/demand balance with a sizeable cushion in reserve. It would take five years of demand growth over 4% to eat up this kind of additional production, while five years of 2% growth would leave 7 million barrels to spare. Prices would fall, competition for new projects would ease, and companies would have long memories about how they had been dealt with when oil was tight.

Now, if you're Russia, with arguably some of the best conventional oil prospects left outside the Middle East, that may be little cause for concern. On the other hand, if you are Venezuela, with its state-run oil industry in tatters after the post-strike layoffs and the diversion of its cash flow to social programs, relying on investments by international companies just to maintain current production, you might want to think twice before changing the terms of existing deals. And if you are Bolivia, with a little bit of natural gas and a populace apparently dead-set on taxation that approaches expropriation, you could just end up out of the game completely, for good.

Overall, companies need to recognize that they are dealing with sovereign entities with more complex needs and new alternatives, while countries should see that companies need reliable contracts and consistent terms, along with a good share of the occasional upside that offsets the lean times that have traditionally followed. Excessive greed on either side can have disastrous results, later.