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Deborah Yedlin: Oil prices should be heading north, not south

Money Talks is a daily business column from CBC radio.

By Deborah Yedlin, business columnist, Calgary Herald

It is certainly a sign of the times when the International Energy Agency publishes a study showing the risks of underinvestment in oil and gas projects around the world and oil prices respond by dropping more than $3 a barrel.

But so it is when market psychology is overwhelmingly negative and short-sighted.

The numbers released on Wednesday by the IEA demand further reflection. In a nutshell, the study says that the global energy industry must invest $26 trillion US between now and 2030 in order to meet future energy demand.

That works out to about $350 billion a year.

And here’s the sobering thought: The industry plowed back that amount in 2007, but it still fell short of what was necessary to add production and reserves.

The IEA says the major fields around the world are declining at annual rates of closer to 9 per cent, not the 6 per cent many had been using as benchmarks. This means more money has to be spent in order to keep production constant.

Compounding the problem is that a dollar spent today doesn’t yield the same results that it did five years ago. While part of this is due to the fact that costs have gone up around the globe, the other piece is that the world has run out of the easy places to find and develop reserves.

The trouble, of course, is that with oil prices falling like a stone, the last thing companies are thinking about is expanding capital expenditure programs. If anything, the current environment is about conserving cash - and even paying down debt so that balance sheets are stronger.

One of the reasons oil prices fell as much as they did on Wednesday was because the U.S. inventory report was released, along with predictions that oil demand would continue to fall in 2009 by almost 2 per cent.

While this is indeed a sign of an economic contraction, the fact is consumption in the U.S. isn’t what it’s all about any more.

The developing nations outstripped the demand growth for oil back in 2005; the future of energy consumption lies in the hands of China, India and the Middle East. The only factor that would tip the balance and chop energy use in any of these regions would be if fuel subsidies were eliminated. And that’s not happening any time soon.

The real worry, then, is that without meaningful investment the world will face a supply crunch when the economy pulls out of its current funk. This will push prices up to the point where they could consume as much as 7 per cent of GDP in the developing countries and 5 per cent in the developed world.

More dollars going to meet energy needs is never good for economic growth or inflation.

If markets had stopped to study and digest Wednesday’s IEA report, they would have realized that oil prices should be heading north, not south.

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