A Down Market's Ripple Effect

If Oil Prices Fall, Will Interest in New Energy Sources Wane?

Exactly three months ago, as oil prices touched $78.40 a barrel, people wondered where the ceiling was. Investment dollars flowed into a raft of alternative energy projects, and famous oilman T. Boone Pickens talked about $100-a-barrel crude oil and $4-a-gallon gasoline.

Since then, oil prices have dropped 25 percent, to $58.57 a barrel, leaving people to speculate about where the price floor is. OPEC ministers are fretting, some hedge funds are losing billions of dollars on bad market bets, and Pickens now mumbles about $70-a-barrel crude oil. Others are talking about half that price.

These wide-swinging cycles have long characterized oil markets, and the resulting uncertainty has served to discourage some of the big-money, long-term investments in new drilling, more-efficient refining techniques or alternative energy sources that could more easily meet growing demand. Now that prices have pulled back from the $70 range that held for much of the past year, industry watchers are worried that the urgency to invest in new supply may dissipate.

"Only high prices can turn around two decades of sluggish investment in exploration, production and refining capacity," Leonardo Maugeri, author of "The Age of Oil" and senior vice president for strategy at the Italian oil giant ENI SpA, said earlier this year. That is, the only cure for high oil prices is a high oil price.

Suddenly, the talk of the oil-producing countries is how to prop up prices, not how to ease the supply squeeze and calm political tensions that had kept oil prices stubbornly high. Yesterday the Organization of the Petroleum Exporting Countries held an emergency meeting to negotiate production cuts. But energy experts who have put little faith in OPEC's efforts to hold the line on supply and prices are bracing themselves for a downward whoosh of another boom-and-bust cycle.

"When you're told that 'this time is different,' that is usually the time for warning bells to go off," said Daniel Yergin, author of a history of the oil industry called "The Prize" and chairman of Cambridge Energy Research Associates. "There's no reason to think that cycles have been abolished."

OPEC produces about 40 percent of the world's 85.4 million barrels a day of oil. Despite OPEC's new commitment to cut production by 1.2 million barrels a day, the politics of the organization -- such as the traditional rivalry between Iran and Saudi Arabia or the need in populous Venezuela and Nigeria to keep up revenue to contain domestic social pressures -- make it hard for members to agree on how to share the burden of output cuts. Until now, international oil traders have been unimpressed by the countries' efforts.

Even with the plunge in prices over the past three months, no major company has yet backed off investment plans announced when oil was $20 a barrel higher.

ConocoPhillips Co. and EnCana Corp. are still planning to spend the $10 billion they announced this month to tap and refine thick Canadian tar sands. Cambridge Energy Research Associates estimates that a new Canadian tar sands project needs oil prices of at least $35 a barrel to be profitable, much more than most conventional oil projects.

Chevron Corp. and its partners are still committed to tapping oil reserves in the deep waters of the Gulf of Mexico, where they paid more than $100 million to drill a single exploratory well. Oil firms are also circling reserves in deep water off Angola, where their investments will pay off if oil costs as little as $20 to $30 a barrel.

At this point, oil costs are still high enough for these investments to make sense. "This price is the level we had just four or five months ago. This is not a collapse," said Doug Leggate, oil analyst at Citigroup Inc. "A collapse is $20 oil. This is a pullback."

Earlier this year, BP PLC chief executive John P. Browne said that his planners expected prices to drop no lower than $40 a barrel and that the company will therefore continue exploration and investments that would be profitable at that price.

Though experts agree that wide swings will persist in the oil markets, some think the price floors will never reach, say, $20 a barrel, last seen in March 2002. "We have to face the fact that prices are rising," said James R. Schlesinger, former secretary of defense, secretary of energy and CIA director and now head of a Council on Foreign Relations task force that warned this week that oil dependency is compromising U.S. foreign policy. "There is an illusion in the body politic that we can go back to an era of cheap oil, and that's just not feasible."

Some analysts think prices will stay high because there's only a limited amount of oil in the ground and production has peaked. Even those who disagree think much of the "easy oil" is gone. Yergin said oil supplies will keep pace with demand and increase to 110 million barrels a day by 2015. He said that because of high prices, "nontraditional liquids" -- oil sands, ultra-deep water and liquid fuels produced from natural gas -- will be a bigger portion of that total.

Investors in alternative energy supplies have also been lured by high prices. Some of these projects can be profitable at lower price levels. One executive in search of funding claims his firm can turn organic waste into ethanol for less than $1 a gallon. Other projects -- including wind, solar and hydrogen -- depend on continued high prices.

"Fuel prices can slip and put a lot of people out of business," Richard Branson, the British music and airline tycoon, said last Friday in Washington. Branson has said he will invest $3 billion in other fuels, such as ethanol. If oil prices fall, he said, "I have an advantage because I'm in the airline business. At least I can balance the books by saving money for my trains and planes." Others might not be so lucky.

World oil demand can also alter the long-term dynamics of the market -- and it's another unknown factor. After the 1979 spike in oil prices, energy use fell much more than conventional wisdom thought possible. Now analysts are trying to measure the impact of more than a year of high prices. The International Energy Agency says global oil demand will be 84.6 million barrels a day this year, a bit lower than the agency's earlier forecasts but still up 1.2 percent from last year. The increase is driven almost entirely by China and the Middle East; consumption in the developed countries belonging to the Organization for Economic Cooperation and Development declined. The IEA expects world demand to rise 1.7 percent next year.

"The real change is long term," Yergin said. "When people buy their next car, what do they buy? Fuel economy, which had fallen off the charts, is very much back on the charts now." Yergin notes that after the 1979 spike in oil prices, it took five to seven years for consumer responses to fully show up.

"It comes down to what this does to turnover of the nation's basic capital stock, from cars to factories," he said. "At a certain point, you notice and you start reengineering your factories. I think that's what's happened here."