Are Commodity Prices Threatening Energy Investments?

AMSTERDAM (ResourceInvestor.com) -- Current high crude oil prices, combined with an exponential increase of other commodity prices, has brought unexpected windfalls to the oil and mineral producing countries around the world.

OPEC members and other oil and gas producers are currently filling up their coffers with hydrocarbon profits of unknown order. Crude prices are breaking one record after the other, currently hovering above $70 per barrel. First analysis shows that economic growth in these countries is above expectation, giving enough leeway to diversify their still mono-culture based economies.

The future looks bright. But some oil analysts are indicating, however, clouds are emerging on the horizon. More and more oil producers, including international private oil and gas companies are warning that continued high energy prices are having an effect on commodity prices, which threatens to reduce this prosperous trend.

High energy prices have seen petrodollars flooding in to the coffers of many Middle East, North and West African countries as foreign demand continues to outpace supply, and the oil price is buoyed up by geopolitical tensions.

The substantial amounts of cash rolling in to countries such as Saudi Arabia, Kuwait, Oman, Iran, Libya, Egypt, Algeria, Angola and Nigeria should provide their governments with an opportunity to diversify their economies. Still, indications are emerging that the goose with the golden eggs is starting to constrain other developments at the same time.

In a statement made to Dow Jones, the former chairman of Libya's National Oil Corporation (NOC), Abdallah Al-Badri, stated that soaring commodity and raw material prices could stifle much-needed development.

Instead of having increased the potential for economic development and possible diversification, several OPEC countries are complaining that most of their infrastructure, power, gas and even oil projects are to be delayed. Heightened oil and commodity prices are blamed as constraining investment projects. The surge in metal and other commodity prices has negatively influenced the overall cost price of most energy projects around the world.

Al-Badri noted that, "the kind of prices we are seeing today are a real concern for us, we are feeling the high cost of everything from spare parts, to new equipment for drilling and development."

The official went on to note that, at current levels, oil majors maybe forced to put on hold oil exploration and development work. He blamed commodity traders and oil service companies for taking advantage of this situation.

The latter situation is not only the case on the African continent, as Gulf producers are venting the same opinion.

Abdullah Al Attiyah, Qatar's Minister of Oil, stated in Paris that "our costs have tripled from two years ago, due to high (commodity) prices. And it's not just that, it is also contractors who have tripled their prices."

The Qatari official warned senior executives at international contracting firms that there will be negative repercussions if rising development costs continue at the current pace. He indicated that projects have to be viable on both sides otherwise it will kill the projects. According to leading OPEC countries, it has become impossible to estimate what new projects will cost as long as commodity prices continue their current price rally.

First negative results of this are already visible. The much needed construction of rigs, pipelines, refineries, ships and other transportation has been slowed by the high price of commodities. Commodity analysts have warned for months that a meltdown in the sector is in the offing. In the initial stages of the crude oil price hikes, the upwards pressure on commodity pricing was reduced by increased revenues from energy companies.

However, while these have stabilised over the last six months, oil service contracts are still going through the roof.

A number of OPEC countries have already set up committees to keep an eye on these developments. Libya, Saudi Arabia, Qatar and Iran have indicated that there could be a point at which projects will be put on hold when prices simply go too high.

Not just oil (and gas) producing countries are feeling the brunt of their own success. Operators such as Shell [NYSE:RDS-B], ExxonMobil [NYSE:XOM], or independents such as Heritage Oil [TSX:HOC], Woodside [ASX:WPL], Energy Africa or Kufpec have been complaining of the lack of available services, such as rigs, vessels, pipeline steel, etc. All the latter have also shown price increases above current project estimates.

In the current situation, most projects are still viable and will be put in place, but if the price rallies continue, more and more projects will be put on hold. Most small oil and gas minnows have to consider the fact that increased debt will negatively affect their own performance in the end. If the latter is combined with slightly lower crude oil prices (a.k.a. lower profit margins), share prices could tumble at the same time. Should no commercial reserves be found, these inflated costs will have to be born by those parties taking part - which could mean the end to several oil operators.

The time is near that high crude oil prices will start to slow down investments and new capacity coming on-stream. At that time, not only will demand growth again start to outpace supply increase but it could also hit most other economic sectors too.

The current share price rally at the respective stock exchanges could also be under pressure, as oil and gas companies' profits become flat. A slowdown on the stock markets is not what is needed at present; investor confidence is needed to sustain current growth.

Conclusion

Maybe it is time to assess the situation and force the oil and gas sector to end their historical investment strategy of investing in a booming market. Market parties should force oil and gas investors to continue investing even at lower price levels than what currently is the case. A pro-active strategy could prevent a new meltdown.

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