Big Oil: Boom or Bubble?

Today, the Senate Judiciary Committee called a meeting with executives from the biggest oil companies – Exxon Mobil (XOM), ConocoPhilips (COP), Shell (RDSA.L), Chevron (CVX), and BP America (BP) – demanding to know why gas prices are so high. Most of the executives cited the laws of supply and demand. As long as people continue to consume oil faster than it is being produced and bought in the US, prices will continue to rise.

Furthermore, oil prices set a new record above $134 today when the Energy Department’s Energy Information Administration reported that crude inventories fell by more than 5 million barrels last week, even though analysts had expected a modest increase.

The Boom

The five largest US and British oil companies together only account for 11% of worldwide output. The bulk of the world’s current and future production comes from the Middle East, and possibly recent discoveries such as those in Brazil. The American oil companies are not dictating the price of oil; the global market is. It just happens to be their turn to profit.

Global Supply and Demand

China is the world’s second-biggest oil consumer after the U.S., and is the world’s fastest-growing oil consumer. However, whether or not China is really consuming all the oil it is buying and producing is anyone’s guess. China does not report consumption, thus analysts guess this number from production, trade, and inventory data that may not have been accurately reported.

In terms of supply, the 13 nations in OPEC are unreliable in their output reports and may be producing above their quotas in hopes of being allowed bigger quotas.

The Bubble

Because worldwide supply and demand numbers are so vague, much of oil price direction is controlled by speculation. Every time the Energy Department reports a drop in crude inventory, the oil market rallies, driving crude oil prices up to a new record. In a very disproportionate way, oil prices are still following the laws of supply and demand.

The Reality

According to Larry Chorn, chief economist of the energy information unit of The McGraw-Hill Companies [1], even the most expensive wells in the world today can produce oil for $70 to $80 a barrel, which includes the cost of finding and developing the oil fields and a 12-15% profit margin. However, the big oil companies (outside of OPEC) are already producing oil at their maximum rate.

Two decades ago, when oil prices were low and profit margins were slim, big oil companies merged, cut capital spending, and sold off thousands of wells. These large companies seemed to still be stuck in this mindset even as oil prices rose in the last few years, and until recently were hoarding their profits instead of increasing spending to invest in new exploration and drilling.

The Future

It can take over a decade to bring a new oil field online, and the big oil companies are behind. Last year, oil production from the top five oil companies fell 3%. As long as supply and demand numbers remain unknowns, the market will have to rely on speculators to bring oil prices back down. This will likely only happen if local inventories increase. With Big Oil output steadily falling, smaller companies will need to step up to account for the deficit. Last year, the publicly traded energy companies excluding the big five increased their oil production by 16%.

To put numbers in perspective, crude oil imports have averaged 9.86 million barrels a day this year. US crude oil production has averaged 5.10 million barrels a day. Average crude oil consumption in the US has been 20.69 million barrels a day. [2]

While the big oil companies will continue to enjoy inflated profits for some time, the true winners in the next few monhts will be the smaller companies that have invested heavily in production and are just beginning to ramp up their output.

Some of my favorite small oil companies include:

W&T Offshore, Inc. (WTI)

Occidental Petroleum Corporation (OXY)

Anadarko Petroleum Corporation (APC)

Noble Energy, Inc. (NBL)



3 Responses to Big Oil: Boom or Bubble?

  1. Ruth says:

    InvestTalk ( has an interesting take on the Bubble theory.

    Found here:

    “It is interesting that a slowing economy has not pulled down the commodity prices. Over the last few years trading in commodities on the futures market has exploded. That is a sign of dramatic speculation. Gasoline prices are not going to fall any time soon until some of this speculation is taken out. No one knows how much of the cost of a barrel of oil or a tank of gas is due to traders’ speculation, but it is significant. There is currently an adequate supply and the supply is actually growing as the demand for gasoline in the U.S. is falling. Drivers are changing their habits to reduce consumption; despite that prices are still increasing. The perception is world demand is going to outstrip supply sometime in the future; that is not likely to happen. Both supply and demand are elastic; as prices rise more supply will be found and demand will reduce. Currently oil producers are using about $50 per barrel as the price to justify new projects. With the price near $125 there will be pressure to find, drill and pump more oil. There is plenty of oil but the easy stuff has already been found. Now it is oil sands, oil shale and deep water deposits that are being exploited. These are very expensive projects so high oil prices are needed to justify them.”

  2. tao2death says:

    There are definitely more macro factors at work beyond supply and demand.

    At best, your view leaves out much of the demand side currency issues related to the weak dollar. At worst, you discount the rate of return a speculator would find in the oil markets relative to other inflation hedging market devices. $150/barrel relative to $135/barrel is not the same as $135/barrel relative to $80/barrel. But what needs to be examined is how that plays out relative to the bond and treasury market when (and if) the credit markets start flowing again.

  3. bumpstart says:

    I’m not trying to explain the oil market, and don’t claim to. I’m just examining the investment prospects in the Big5 oil companies.

    There are plenty of articles out there explaining the other factors driving the market. Perhaps you can even write one of your own 🙂

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