Oil: New Drilling Wouldn't Cut Prices

It would be years before production hits the marketand Big Oil would have to spend heavily. Even then, prices may not drop

High energy prices are painful for consumers, but they're giving politicians plenty of rhetorical opportunities. On June 18, President George W. Bush kicked off a speech with an empathetic refrain heard often in Washington these days. "For many Americans, there is no more pressing concern than the price of gasoline," he said at a press conference. "Truckers and farmers and small business owners have been hit especially hard. Every American who drives to work, purchases food, or ships a product has felt the effect. And families across our country are looking to Washington for a response."

Bush's preferred response: lift a ban on drilling off the U.S. coast, open Alaska's Arctic National Wildlife Refuge to drilling, develop oil shale resources, and expand domestic oil-refining capacity. He echoed the views of the GOP Presidential candidate, Senator John McCain (R-Ariz.), who this week also called for more offshore drilling and new nuclear power plants. They follow the June 17 announcement by Florida Gov. Charlie Crist, who surprised many by reversing his long-stated opposition to drilling off that state's coast. "I mean, let's face it, the price of gas has gone through the roof, and Florida families are suffering. And my heart bleeds for them," Crist said, according to the Associated Press.

As U.S. consumers reel from the effects of an oil market rife with uncertainty and climbing prices, a proposal calling for more drilling at home sounds promising. In theory, if the U.S. boosted supply, prices would slip and the country would be less dependent on foreign energy sources.

Blaming Speculation

Unfortunately, the oil market is far more complex. For one thing, oil production requires enormous investment, and companies such as ExxonMobil (XOM), BP (BP), and Chevron (CVX) won't start major new projects until it is clear the project can be profitable. Any new domestic supply would take nearly a decade to tap. Moreover, much of the change in oil markets in recent years has come more from trading than fundamentals. Investors have poured vast sums into commodities, driving prices higher and causing many people to blame rampant speculation for the surges.

In other words, the President's proposals cannot have a significant short-term impact on oil prices, and only a questionable effect in the long run. "It's five months before Americans go to the polls, and both parties are trying to come up with a solution," says Stephen Schork, an energy consultant in Villanova, Pa., and editor of The Schork Report, a daily energy newsletter. "But there's no realistic near-term solution either party can offer."

Analysts say a number of obstacles are already impeding more domestic production, and lifting government prohibitions won't change the workings of the industry. There is currently a shortage of ships used for offshore drilling, which will slow oil exploration for such projects. The cost of these ships, and of scarce skilled workers for these projects, is also slowing development. Analysts say that it could be up to 10 years before supply from such sources reaches the market.

Long Lead Times

"We couldn't expect near-term price relief," says Craig Pirrong, a professor of finance and energy markets at the University of Houston's Bauer College of Business. "Drilling projects have a long lead time, not to mention tremendous bottlenecks because of high costs and a shortage of qualified engineers and geologists. Every little bit helps, but the short-term benefit would be very modest indeed."

The federal Energy Information Administration estimates that 18 billion barrels of oil are in the area covered by the moratorium, and the White House says that is enough to match current U.S. production for 10 years.

But a 2007 analysis by the agency concluded that opening up drilling in the moratorium area "would not have a significant impact on domestic crude oil and natural gas production or prices before 2030."

Congress banned most offshore drilling in 1981, and former President George H.W. Bush issued an executive order banning drilling in the wake of the 1989 Exxon Valdez oil spill in Alaska.

Stalling Production?

Critics of the oil and gas industry say that oil and gas companies are stalling energy production (BusinessWeek.com, 3/20/08) in some areas until they can better profit from it. "The oil and gas industry has millions of acres of leases that they're doing nothing with," says Erich Pica, an analyst at Friends of the Earth, an environmental group. "Even if we were to open up every piece of land in the country to drilling, these companies wouldn't necessarily produce more. They're in the business to make money, not to lower prices for consumers."

Representatives Rahm Emanuel (D-Ill.), Maurice Hinchey (D-N.Y.), Edward Markey (D-Mass.), and Nick Rahall (D-W. Va.) on June 12 announced plans to introduce legislation that would compel oil companies to use the 68 million on- and offshore acres that are currently being leased by large oil companies. The representatives said that oil companies are producing on only 20% of the acres they hold offshore and on less than 30% of the acres they hold onshore. "Big Oil seems more concerned with pumping up prices than pumping more oil," Markey says.

Oil industry representatives, who have been lobbying for increased access, dispute claims they are holding back supply. Rayola Dougher, economic adviser for the American Petroleum Institute, an industry trade group, explains that only a small number of leases explored prove suitable for production. "There's a lack of understanding about how exploration works," says Dougher. "Companies get a number of leases to explore, and production comes from a small share of them. In today's dollars, no one is holding back [from producing]. That's not a reasonable assertion."

Volatile Market

The other reason more drilling access won't cut prices is that oil prices are no longer determined strictly by supply and demand. In the past several years, more investors have entered into the commodities market to hedge against inflation and to diversify investments. Many analysts say these inflows can have more of an impact on oil prices than actual supply increases or reductions in demand (BusinessWeek, 5/29/08). For example, in the past seven months, Brazil's national oil company, Petróleo Brasileiro (PBR), has announced vast new deep-shore discoveries estimated at more than 33 billion barrels. The announcement had no effect on oil prices, which have surged 33% so far this year.

"The oil market is on steroids," says Fadel Gheit, senior energy analyst at Oppenheimer Holdings (OPY). "[Oil] is a financial game more than a physical one. Even if we lift the ban tomorrow, the best we can do is cool off some of the unprecedented euphoria in the market."

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