Tuesday, December 16, 2008

Oil Slick
Here are two articles on the drop in drilling activity. One from yesterday's Wall Street Journal and one from today's New York Times. This logically follows the huge drop in prices. Oil seems to have found a temporary floor near $45 a barrel. Experts are predicting $25 a barrel oil, but these are the same guys who said oil was heading to $200 a barrel. The next set of articles will report the drop in alternative energy investments, but that's not the point of this post.

To me, the key to the oil drilling business over the past four years was buried in the New York Times article:
One reason projects are being shut down so fast is that costs throughout the industry, which had surged in recent years, are still elevated despite the drop in oil prices. Many companies are waiting for those costs to come down before deciding whether to go forward with new projects.
Many investors who thought that oil investment was sound because of high prices did not realize that high operating and drilling expenses offset the high oil revenue. This is why so many oil and gas direct investment programs have had such poor returns in recent years. The 0perating cost of these programs increased as fast as the the price of energy. The only programs that are going to have decent returns were the ones that were able to lock in leases and drilling contracts in the early 2000s and had production with high prices. Programs offered over the past few years that are not in a position to wait until prices rebound - because eventually they will rebound - will have poor returns.

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