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Higher costs, higher prices

27 Mar 2012 By Kevin Allison, Christopher Swann

Gas guzzlers may wait in vain for a return to cheap oil. Big producing nations like Saudi Arabia, which handed out cash to restive citizens during last year’s Arab Spring, need higher oil prices to balance their books. Meanwhile, a three-fold increase in the costs associated with extracting crude over the past decade has made expensive oil more a necessity than a luxury for energy firms, according to a Morningstar study. Put the two trends together and it looks like dear oil is here to stay.

When Saudi King Abdullah promised $130 billion in extra public spending in 2011 to head off unrest following the Arab Spring it was clear that the world’s motorists and frequent fliers would pick up the tab. Estimates by Barclays Capital suggested that Abdullah’s largesse would raise the break-even price of oil needed to balance the kingdom’s budget by about a third to $91 a barrel for 2011. While the minimum price is lower for 2012, it is still far higher than before the Arab Spring.

The supermajors also need higher crude prices. The cost of finding and developing oil supplies has tripled over the past decade, to about $17 per barrel, according to Morningstar. While this might not seem much with oil at $125 a barrel, the average figure obscures the high cost of extracting so-called “unconventional” oil supplies.

Shut out from the richest zones of easy-to-reach crude, production growth for the likes of Exxon and Chevron is becoming more dependent on unconventional sources. These tend to be more expensive to extract as they’re in deep water, trapped inside shale rock or bound up in heavy oil sands. A large chunk of these new oil developments would grind to a halt if crude fell much below $80, Morningstar estimates.

These trends have consequences for oil companies and consumers alike. The increasing importance of harder-to-extract energy means Big Oil can expect to make lower margins absent corresponding increases in the oil price. Ominously for drivers, higher extraction costs may set a new longer-term floor for oil prices. With oil at $125 a barrel, today’s prices are high enough to support all but the most challenging drilling projects. Still, soaring costs for oil firms make it harder to envisage a return to an era of cheap oil.


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