Oberon Houston: The time for action on fuel duty was 2005

Oberon Houston is currently in charge of developing one of the most prospective oil provinces in the world, West Africa, and is an external examiner at the Heriot-Watt Institute of Petroleum Engineering.

Oil prices are soaring and people are hurting, we all recognise that, but where does the solution lie, with government or with industry? Well, in the long run, with both really, but I’m going to argue that the time for effective measures has already passed. Reacting to large fluctuations in supply and demand in the oil industry is something that takes a generation to correct. To understand why, one needs to appreciate that the oil price cycle can only react slowly to major and sustained price changes. To illustrate, let us look at the last major fluctuation...

Oil prices crash (1996-1999)

Supply is outstripping demand, prices are falling to record lows, and the effects were severe for oil companies. Costs were slashed, a complete halt to long-term investments initiated, drilling contracts cancelled, exploration plans shelved, offices closed and redundancies imposed, scything down staff numbers. Many experienced professionals leave the industry for good, leaving behind a rear-guard consisting mainly of (cheaper) graduates and inexperienced engineers and geoscientists to struggle on.

During this period, revenue for governments with petro-economies is also reduced, especially within OPEC, meaning severe difficulties were experienced in agreeing to reduce production quotas, as this would double-whammy fiscal budgets in the short term, and therefore there was a brief, but devastating, war of attrition as OPEC members bust their quotas to offset lower revenues, hammering prices further. The effects of all this were largely hidden from consumers in Britain as reduced fuel prices were offset by the government increasing fuel duty rapidly to compensate.

Rising prices (2004 onwards)

Just because prices are rising, doesn’t mean that the oil industry can immediately increase output. The years of slash and burn during the downturn have made their mark. From about 2004, oil bosses felt able to begin investing at significant levels again, but how long before the impact is felt?

• one year to get into a government licensing round somewhere around the globe to explore for new oil fields
• then shoot seismic and process it, this takes a year to get the survey done, another year for the geophysicists and geologists to make some sense of it, hundreds of square miles will need to be analysed
• once a promising target is found, a drilling rig needs to be found, another year at least for this, sometimes just drilling the well takes a year in difficult conditions
• discovery doesn’t mean profit, more wells need to be drilled to find out how big the field is before confidence can be gained that its economic, another couple of years for this
• add on three years to then design, build and install the complex facilities required to produce it all

Where are we then for a typical medium sized oil field? Over a decade usually from entering an exploration play to first oil, as the example above shows. Now this can be less if the discovery is near existing infrastructure in active license blocks, say three years for a small North Sea discovery, but the problem is that these fields are very small (i.e. insignificant). Giant oil fields are the beasts that can really increase supply, but there is a need to find dozens of these, and to keep finding dozens to suppress prices to any extent. But they remain undiscovered in these numbers because the oil companies can’t get to them due to technology limitations or the huge extraction costs involved. More years of profit are required to accumulate the funds to develop them. It's only recently that the income to oil companies has become significant enough to seriously look towards the gigantic investments needed to increase supply from these areas. Ironically, this has been further hampered by governments scrambling to increase their tax take, including Britain (twice), or by even nationalising and kicking out the oil companies in breach of international law, for example as Venezuela did. The most prospective regions currently for multiple giant discoveries lie on either side of the Atlantic in deep waters off the east coast of the Americas and West Africa, and despite years of steady price rises, it's only recently that exploration and development plans for these areas are gaining real momentum, note that these fields will only really increase supply during the period 2015-2025.

So the ability for the oil industry to increase supply in the short term is limited to the point of being negligible, rendering Gordon Brown's recent visit to Aberdeen to ‘engage industry’ either naive or simply an exercise in news management. Furthermore, ‘talking tough’ at the G8, as he has also promised, will make little difference, it's simply not possible to increase output to the point where prices will tumble, many OPEC countries cannot increase production anyway, some cannot even make their current quotas. The ability to take action in these matters lies domestically, and more modestly, by ensuring that the nation’s finances are healthy during periods of growth to ensure that the effects of a downturn can be smoothed out. Oil prices will ease when demand eases and supply increases, which will only occur when growth slows down and the new big production regions can replace dwindling stocks elsewhere.

So how could government have helped? Well it's not that difficult believe it or not, if one has a petro-economy, like Britain does, increased oil prices mean increased revenue from oil industry profits, which in turn can be passed onto motorists in the form of a cut in fuel duty as the former is much more than the later. What did the government actually do though? Well, in the March 2005 budget, an extra 10% was levied on oil industry profits, representing a massive increase of revenue for the Treasury, but no cut in duty was made. Public spending and borrowing now accelerated wildly in the run up to the General Election. In a coordinated move, Labour then began attacking Conservative manifesto plans to slow the rate of public spending. They ran huge advertising campaigns which misled people into thinking slower growth in public spending represented a cut in services (I wrote about this two and a half years ago). Now, three years on, at a time of record borrowing and taxation; in a climate of roaring inflation and with a faltering economy; the cost of winning that election for Labour looks high, but that’s neither here nor there, more importantly, ordinary Britons are now paying a terrible price for Labour’s dishonesty. Contrary to the spin emanating from Downing Street, the current mess we are in really is all Brown’s fault.