The International Energy Agency released its World Energy Outlook yesterday. The headline number is that the IEA predicts oil prices will rise to $200/b by 2030. The agency cites rising demand from the developing world and "surging costs of production" as oil is getting more difficult to pump out of the inhospitable places where we’re now finding it (the Arctic, the deep water ocean).

Taking a look at the IEA’s cost projections for extracting oil don’tpaint a pretty picture for prices going forward. The Oil Drum has pulled out a chartthat shows the long-term supply cost curve. The cost of extracting oilfrom the Middle East and North Africa tops out at about $30/b, whilemost other conventional oil extraction will hit about $40/b. But otherextraction methods get costly fast, most rising to $65/b or more.

A quick back-of-the envelope calculation shows that Exxon Mobil(NYSE:XOM) incurred production costs of more than $40/b for the thirdquarter. The same is true of ConocoPhillips (NYSE:COP) and Apache Corp.(NYSE:APA).

The IEA chart indicates that the recent drop in prices is certain toreverse. Getting oil out of the ground is simply getting more and morecostly. Crude prices much below $60/b for any extended period of timewill simply kill oil company profits.

When that happens, the companies pull in the exploration for newdeposits. Then when prices rise again, there are few new wells ready tomeet growing demand, the price rises, and governments start threateningto impose excess profit taxes.

Oil company stocks are up today on news that crude has risen above $57/b. The companies better hope it goes even higher.

Paul Ausick
November 13, 2008

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