Financial Times: We will run short of oil for all the wrong reasons: market failure and short-termism (ShellNews.net)

By Paul Stevens

Published: September 1 2004

From Prof Paul Stevens.

Sir, Robert Mabro (Letters, August 30) correctly pointed to the problems of maintaining surplus capacity to ensure the smooth operation of the world oil industry. There is a related dimension that deserves concern.

Simple economics explain that when prices of a commodity such as oil rise, the ability and willingness of producers to invest increases, thereby raising the quantity supplied. This creates a self-correcting mechanism that limits the shelf life of any period of high prices. It was precisely this process that was the main contributor to the end of the oil price spikes of the 1970s. However, modern financial theory has since driven a wedge into this mechanism. Financial strategies of international oil companies, based on concepts such as the capital asset pricing model and its variants, argue that if a corporation's returns cannot outperform the stock market, funds should be returned to shareholders.

This is precisely what has been happening in recent years. To put it into perspective, the International Energy Agency in April estimated that some $80bn investment was required annually in global exploration and production if their expectations of oil demand were to be met. This year alone, just two leading oil companies - ExxonMobil and BP - are on track to return more than $12bn to shareholders via higher dividends and share buy-backs. These are not trivial sums leaking out of the industry's investment pool. Furthermore, as the companies use this as a means of competition, the leakage will accelerate. It is only recently that changes in Dutch law have given Shell the option to follow.

While such behaviour by the oil companies is legitimate and indeed entirely logical in a market economy driven by shareholders, it should raise serious concerns about future oil supplies. This is an industry where large investment is required just to maintain capacity, let alone increase it. There is a serious possibility that those who for many years have predicted the imminent disappearance of oil may be proved correct for entirely the wrong reasons.

Thus we will run short of oil, not constrained by geology as the depletionists have argued, but as a result of an attack of market failure and short-termism.

Paul Stevens, Professor of Petroleum Policy and Economics, Centre for Energy, Petroleum and Mineral Law and Policy, University of Dundee, Dundee DD1 4HN