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  • Writer's pictureJeff Matthews

But They Won’t Drill With It…Not For Now, Anyway

A few months back, the Goldman Sachs so-called research department upped their oil price forecast from a $28 a barrel number to a headline-grabbing “super-spike” range of “$50 to $105 per barrel.”

I wrote about it—see “The Goldman Gurus: Two Years Too Late” from April 1—in my “rambling and sarcastic” way, and my point was this: for one thing, Goldman was coming very late to the energy shortage party that had been more accurately and more profitably predicted by Marc Faber in the pages of Baron’s; and for another, the price range itself was ridiculous—being large enough to drive a Hummer through.

Naturally enough, oil prices spiked to $58 on the Goldman excitement and reversed the next day—and the reversal did not stop for seven weeks before bottoming at $47.

But you can’t keep a good raw material in shortage down, and oil is back above the Goldman-giddy levels. And will likely go higher over the next year or two or three, if the spending plans of the major oil companies are any indicator.

I have pointed out before how the U.S. majors, including Exxon Mobil Corp, remain cautious about the long term price of oil—because they do not want to get caught up in another boom-bust cycle. So they are returning much of their cash flow to shareholders rather than to the drilling companies.

Exxon Mobil, for example, generated $40 billion in cash flow last year, and spent $12 billion drilling—but paid $7 billion in dividends and spent $10 billion on share repurchases.

Now, over the July 4th weekend, comes a report from the British press that the two largest foreign oil companies, British Petroleum and Royal Dutch Shell, will “hand back $60 billion” to shareholders over the next two years in the form of share buybacks and dividends. This amount is, according to the reports, “equivalent to Bulgaria’s gross domestic product,” which, while interesting, is a less-than-meaningful way of thinking about the money.

The meaningful way to think about that $60 billion is that it represents 6 to 12 billion barrels of crude oil that will not be found over the next two years by BP and Royal Dutch. And that is because oil exploration costs as much as $5 to $10 a barrel of reserves in large (usually deepwater) fields.

6 to 12 billion barrels of new oil that could (assuming the exploration is successful) be added to the world’s supply in a two year period are nothing to sneeze at when you consider that every two years the world consumes 60 billion barrels of oil.

Meanwhile, it’s summer here in Rhode Island and the driving is heavy. The big headline in today’s Providence Journal reads: Gas prices hit record high in R.I. The sub-heading reads: But soaring prices so far have failed to reduce demand.

Seems that a gallon of regular unleaded hit $2.289 a gallon yesterday, beating the previous record set in May—just after that Goldman Sachs report and its $50 to $105 a barrel “super-spike” forecast.

The Providence Journal reports that $2.289 is not so horrible in relation to years past: adjusted for inflation, that same regular unleaded went for $2.89 a gallon 25 years ago. Which, the paper notes, explains the strong demand in the face of rising prices.

After all, the Journal says, quoting a Hofstra professor, gasoline demand is “inelastic” and requires a more sustained and dramatic price increase to influence demand.

But so long as British Petroleum and Royal Dutch, not to mention Exxon Mobil and the rest of the world’s major oil exploration companies, prefer to give surplus cash flow back to shareholders rather than spend it in the ground, we may just see oil at $100 after all.

And then we’ll see how “inelastic” the demand for gasoline becomes.

Jeff Matthews I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.

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