For many years now, oil companies have been played as the evil villain in American society. In 1989, the Exxon-Valdez oil spill wreaked havoc on the environment in Alaska which has often been cited as one of the most devastating human-caused environmental disasters and at the time was the largest oil spill in the US.
Over 20 years later, the Deepwater Horizon explosion which was drilled on the Macondo Prospect in the Gulf of Mexico devastated the environment again with massive quantities of oil flowing into the gulf. Unfortunately, these are some of the risks associated with exploration, drilling and production of crude oil.
While it may appear that these accidents are due to the greedy oil companies, there is something much bigger at play here. What I am referring to is the risk vs. return for oil production in our country. At All Clear Energy, we are proponents of clean, renewable energy, however, as a country we cannot simply abandon our most prolific source of energy overnight due to a few unfortunate accidents. This is the cost we pay as a nation for extracting and transporting the energy sources we use.
Again, it comes to risk vs. reward.
When it comes to oil production, most people outside of the industry view oil as being produced from a small number of very large corporations. While companies such as Exxon-Mobile, BP & Shell are considered the big boys, there are also tens of thousands of smaller independent oil and gas companies which explore for and produce oil and gas in the US. When developing crude oil or natural gas properties, each company, big or small has to ensure that the risk vs. reward are balanced. This is crucial to weening the country off of crude oil and into other forms of alternative energy sources.
Take this as an hypothetical scenario example. We will assume no monthly operating expenses and 100% interest using round numbers for simplicity:
Imagine an oil company has identified an oil and gas drilling prospect and is considering an investment into the project which will require an initial cash outlay of $1 Million. At the current oil price of $100 per barrel, it would take 10,000 barrels of oil production just to reach the break-even-point. Now the determination must be made based on the rate of production. Assuming a production rate of 10 barrels per day, it would take 1,000 days to reach the break even point at $100 per barrel.
While this is simple an example, it is easy to factor the rate of return based on adjusting the variables slightly. While a 1,000 day return (just under 3 years) may be a favorable return to some, imagine the return given 100 Barrels per day – that brings it down to 100 days, just under three months. On the other hand, take our original 10 barrel a day scenario with a price of $50 per barrel. This takes the original 3 year time frame and doubles it to 6 years. At $25 per barrel, it doubles it again for a 12 year return. Obviously a greater production rate at a higher price per barrel will yield a greater oil investment return and thus lower the risk.
What few people in the outside of the industry fail to understand is that it is actually LOWER oil prices, more drilling and less regulations which will spur innovation into alternative energy and renewable energy development in the future. As the price of oil continues to rise, the higher price of crude will make oil investments more attractive to investors. Of course there is the supply and demand side to consider as well. Artificially raising the price of crude will do nothing to encourage renewable energy development. Naturally occurring, organic price increases will, however spur interest in alternative energy sources when
When the price of oil reaches a point to where it is simply not able to compete with alternative energy sources, there will be a fundamental shift towards renewable energy development which will only occur with natural market conditions. Short term government interventions will help but hurt the industry and further delay the transition process to other energy sources.
Until US citizens voluntarily decide to end the use of crude oil permanently, the price will continue to rise and oil will remain a lucrative option for independent oil companies and investors.
Of course, this is based on natural conditions and any outside factors such as increased regulation on drilling and production in an effort to spur alternative energy development will essentially cripple the economy in an effort to fundamentally change how we consume and use energy. The method of higher oil prices to encourage alternative energy development will absolutely drain US companies and individuals and destroy the economy in the process.
