383. THE FALLING COST OF PRODUCING OIL

Peak oilers are a restless bunch, working round the clock to turn anything and everything into another reason why we're doomed. You'd think that a massive $100 dive in the price of oil, and an ever-growing glut of the substance, would shut them up for five minutes, but no such luck. First we were doomed because of high oil prices. Now it turns out we're doomed because of low oil prices. Yup, the latest doomer talking point is that the plummeting price of oil will make it uneconomical to produce the "expensive" oil, so we're in big trouble.

This view has a couple of problems. First of all, if the price is dropping, that means there's no demand for the expensive oil. Ergo, it's no big deal if we don't produce it. In fact, it's better all around if we don't produce it because that will: (a) save more oil for later, and (b) reduce pollution and CO2 emissions.

Second, and more important, is the erroneous assumption that "expensive" oil is somehow inherently expensive, and that high costs will stay high as the price of oil drops.

In fact, high oil production costs have been driven primarily not by geology or EROEI, but by the same bubble dynamics that made the price of everything go up. Numerous projects were cancelled in the last year or two because the industry was overheating. Rigs, steel, white collar expertise, manual labor, materials, shipping -- everything was too expensive, and project budgets were ballooning out of control. Now that the bubble has popped, construction costs will come back down to earth. The smart players will do their project construction now, at bargain basement prices, and reap the benefits in the next cycle of high oil prices. That's the secret to riding the oil wave: build when costs are low, and pump when prices are high.

The peak oilers are fretting as if oil prices going down the toilet is some kind of new phenomenon. They still haven't caught on: oil is a cyclical business. Always has been for the last 150 years. As previously noted, the grizzled veterans have seen it all before:

"We're a cyclical business," David J. O'Reilly, chief executive of ChevronTexaco, the second-largest American oil company, said in a telephone interview, "and at the high end of the cycle it makes sense to get the company in good shape and strengthen our balance sheet. "History tells us that what goes up also goes down."Source

Consider the oil sands. In 2006, the average cost of producing a barrel of oil in Alberta was 32USD. Here's the breakdown (click to enlarge):


Up through the summer of 2008, costs in Alberta skyrocketed due to the fever of speculative bubblenomics:

"Labour shortages and increased material costs have created a hyper-inflationary environment within the oil and gas industry in Alberta. With the sheer number of oilsands projects, together with the future Arctic pipelines and conventional oil and gas developments in Alberta, labour demands in Canada will be pushed to their limits," he said.Source

The "high costs" we keep hearing about were actually driven by hyper-inflationary conditions, and are now coming down. Contrary to the naive view, production costs are not fixed. In Alberta, the primary drivers of high costs are steel and labor:

Five years ago [i.e. 2003], the capital cost of building a project that mined bitumen and processed it into high-quality crude was around C$40,000 per barrel of production, reckons Andrew Potter, a UBS Securities analyst. The same project today could cost C$180,000 per barrel, or around C$18 billion for a typical 100,000 barrel-a-day development.
Soaring raw material prices, notably for steel, have played a big role. Oil sands will likely find some relief here: Steel prices have slumped three-quarters from summer highs as major consumers - China in particular - rein back demand amid fears of a global economic slowdown. But the main culprit is labor.Source

Steel is already down the toilet, and wages aren't set in concrete, particularly in a time of deflation and surging unemployment. The only reasonable conclusion is that the cost of producing in the oil sands is (or will soon be) rapidly dropping, together with the price of oil.

And that's when the smart firms kick into gear:

The collective impact of project delays may work out rather well for companies that still decide to push ahead.

Through its affiliate Imperial Oil Ltd. (IMO), ExxonMobil is still sticking to schedule for the C$8 billion Kearl oil sands mine.

"[While] some of the other oil sands projects may be slowing down or whatever, that could actually provide some benefit to us in respect to lower cost, both for raw material and services," David Rosenthal, ExxonMobil's vice president of investor relations, said on a conference call Thursday.Source

And (hat tip to OilFinder):

6. Is there a benefit for Hyperdynamics to have a lower oil price?

My Answer:

Yes. I don't think the price will drop to lower levels than we have seen in years past and so I will take it either way at the moment. Actually, I would prefer the price of oil to stay lower until we make a discovery, and then I would like it to go up for the benefit of Guinea and our shareholders. I know this is a capitalistic statement and I apologize to any Socialist reading this. The lower the price of oil, the easier it is to secure some of the critical resources necessary to do the exploration work, such as drilling rigs. Moreover, we can secure the resources at lower costs. Obviously, if the price of oil is $147 per barrel, drilling rigs are receiving a premium and are working continuously. A lower price of oil could actually allow us and our partners to obtain a rig sooner and at more reasonable cost. This is especially true for us due to the economics of our prospects. The potential volumes in our prospects can make up for much of a lagging price of oil.Source

It reminds may of a famous saying by Konosuke Matsushita (founder and former President of Panasonic):

好況よし、不況さらによし

Good times are good. Bad times are even better.

by JD