3 Factors Keeping Oil Above $90 a Barrel

The gushing oil well at Spindletop Dome in Beaumont, Texas, is one of the most iconic images in the history of oil. When the well hit paydirt, oil spewed 150 feet into the air at a staggering rate of 100,000 barrels per day. 

We've come a long way since that Spindletop gusher 112 years ago, and today's industry faces greater challenges finding new sources that can be sold at a reasonable rate of return.

On a recent conference call, Core Laboratories (NYSE: CLB  ) CEO David Demshur stated that outside some of the best spots in the U.S., oil producers in the U.S. will slow down exploration if oil prices are to remain below $90 for a sustained amount of time. Let's look at a few factors that might give some credence to Demshur's claim.

1. Higher resource costs. According to Cheaspeake Energy (NYSE: CHK  ) , the average shale well in the U.S. is drilled to 7,800 feet vertically plus several thousand feet horizontally and is injected with more than 5 million gallons of water, sand, and chemicals to fracture the tight pores where the oil is hidden. All of this effort is for an average initial production rate of about 450 barrels per day. 

All of that extra work to tap a well translates into using resources -- a lot of them. The list of requirements for a new well is so staggering, even the price of food products can affect how much it costs to drill a well. in Q2 of 2012, Halliburton (NYSE: HAL  ) took a big hit on earnings because the company overspent on guar gum, a thickening agent it needs for fracking fluids. When all of these kinds of costs are added up, the average well in the U.S. today costs about $6 million to $11 million. 

It's plain and simple: Money just doesn't go as far as it used to. According to a report by Barclays, spending in the exploration and production sector increased 19% and 11% in 2011 and 2012, respectively. Over that time period, output increased only 0.1% in 2011 and 2.2% through first 10 months of 2012. The increased costs to get marginal results back will ultimately result in higher prices. 

2. Location, location, location. To add insult to injury, these higher costs are compounded by the fact that the places where we're finding oil are in remote, hard-to-reach locations. Whenever a company ventures off into one of these remote locations in search for oil, it's a higher-risk situation that involves a lot of costs.

There are two great examples of these kinds of sources to the north: the Alaskan offshore and Canadian oil sands. These two regions have been giving exploration and production companies headaches for years. Royal Dutch Shell (NYSE: RDS-A  ) has spent $5 billion over the past five years trying to tap a potential source in the Chukchi Sea off Alaska, and so far it doesn't have a drop to show for it. Also, because of high costs and slumping prices, several producers are shelving plans to build out Canadian oil sands, with French giant Total (NYSE: TOT  ) taking a $1.6 billion loss to completely walk away from the project.

What makes these projects unattractive? The breakeven costs. A Wood Makenzie study recently showed that the breakeven cost for a new Canadian oil sands project is between $65 and $100 per barrel, depending on the type of extraction. Add transportation and a rate of return, and these projects don't make economic sense unless oil prices are high. 

3. Taxes and regulation. It costs a pretty penny to do business in the oil and gas space. According to the EIA, about 11% of the price of a gallon of gas foes to federal, state, and local taxes.

Source: US Energy Information Administration.

If the recent budget proposal from the Obama administration were to pass as is, though, that could change. The additional taxes and fees for the industry could total as much as $90 billion over the next 10 years. It's very unlikely that oil companies will be happy to let these additional taxes eat into profit, so we will probably see an uptick in oil if these proposals were to be enacted. 

You also have to take into account regulation, safety, and liability costs. According to a report by Lux Research, oil companies pay about $0.70 per barrel of oil on safety regulations, but that figure could be going up. The industry is expected to spend an additional $21 billion over the next 20 years. What's more expensive, though, is a spill. It's estimated that the liability costs for cleaning up is about $8,000 per spilled barrel.

Much of the public demands that oil and gas drilling be safer, but we will have to be willing to shoulder higher oil prices if we expect oil companies conduct their business in a safer, more environmentally friendly way. 

What a Fool believes
Oil and gas prices are generally based on supply and demand, but there are also a myriad of economical, social, and political factors that can pull prices in several different directions. Of course, factors such as seasonal demand and speculation swing prices up and down rather quickly, but the underlying costs of doing business in the oil industry today are going to keep prices high for the foreseeable future.

Domestic oil and gas service companies have taken a hit in the recent past due to a slowdown in the natural gas drilling boom of the last couple of years. As this market looks to rebound, investors would be wise to consider Halliburton, one of the top companies in the business and one of those most in tune with the domestic market. To access The Motley Fool's new premium research report on this industry stalwart, simply click here now and learn everything you need to know about how Halliburton is positioning itself both at home and abroad.


Read/Post Comments (18) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 19, 2013, at 11:26 AM, toledochip wrote:

    Who paid you to write this piece of propaganda? 90 million over ten years? They made a TRILLION dollars over the last ten years! Its not even 25% of their daily profit! 90 million is like telling them they dropped a dime. Its 100% pure greed in the oil industry. And its time for our government to say enough!

  • Report this Comment On May 19, 2013, at 12:07 PM, brookarcher wrote:

    Verenium Corp. (NASDAQ: VRNM), supplier of enzymes to the ethanol industry, acts as a nice ethanol ETF. At a bargain right now @ $2.20/share. Low float stock. Featured in Buried Stocks Facebook group recently.

  • Report this Comment On May 19, 2013, at 12:23 PM, MadCityObserver wrote:

    It appears the author's economics naïveté has caused him to either completely overlook or to inexplicably dismiss the never absent fourth factor: greed.

  • Report this Comment On May 19, 2013, at 12:41 PM, Plan2Prosper wrote:

    @toledochip the article mentioned costs of $90 Billion with a B. Are there problems with the industry? Sure, but we still live in a capitalist society where much good comes from a measure of enlightened self-interest and if the profit isn't there neither will be the production. If you wish to speak of greed, why should the government collect more 'profit' than the entities taking on the risk and providing the product/service?

    You of course have a right to disagree, but why not challenge the facts of the article rather than misquote them?

  • Report this Comment On May 19, 2013, at 12:59 PM, NorCalSage wrote:

    Its the greed of the oil industry that keeps alternative energies away from us. Why has the technology of computers grown amazingly over the past 20 years but the auto industry, which had a 100 year head start, hasn't grown as much? I think magnetic power is an energy source that is limitless and cheap to produce plus can keep itself sustained. How come they are not going in that direction? We just need to leave them holding their oil in their you know wheres. They already have all the money they need for the next few lifetimes.

  • Report this Comment On May 19, 2013, at 1:54 PM, bullriders2000 wrote:

    the pump prices go up and down on a whim yet if you own a store and you jack up your price on something during a storm or bad weather you get charged for price gouging...so why the hell can the oil company's do the same thing? the USA exports a large amount of our oil, if oil producers were only allowed to export like 5 % of the oil they produce our pump prices could be 2 dollars a gallon less at the pump. there is no shortage and middle eastern oil wells has nothing to do with it. its our government in bed with the oil company's here in the USA. you can buy a gallon of gas for approx.- 40 cents in the middle east. so why our we paying 3.49 more on the gallon ?

  • Report this Comment On May 19, 2013, at 3:00 PM, consAREidiots wrote:

    pathetic excuse for a pro-oil article.

    where is OIL SPECULATORS on your list?

    the biggest factor in the 2008 price hike was oil speculation by big banks and oil producers.

  • Report this Comment On May 19, 2013, at 4:14 PM, megalo99 wrote:

    I'm going with speculation and wide spread collusion.

  • Report this Comment On May 19, 2013, at 4:39 PM, goprip wrote:

    The 3 factors keeping prices high are: GREED,GREED and hmmmm let me see. GREED!

  • Report this Comment On May 20, 2013, at 3:00 AM, jcan1701 wrote:

    Did a 3rd grader write and proof read this? It is full of grammar errors that make it hard to read.

  • Report this Comment On May 20, 2013, at 5:29 AM, ellie2634 wrote:

    GREED thats the only thing, pure and simple.

  • Report this Comment On May 20, 2013, at 5:56 AM, luckyagain wrote:

    1. Higher resource costs - 450 x 90 x 365 = $14,782,500 per year. Not too bad for a single well that cost $11 million. So an average well will pay for itself in a year and will produce for how many years?

    2. Location - all of the easy oil has been found. So every new source of oil is off the beaten track. Look at oil production in North Dakota. Cost of oil production in Saudi Arabia is estimated at about few dollars per barrel. Saudi Arabia is building solar electric industry so that more oil is available for export. So what does Saudi Arabia know about the benefits of solar electricity that people in US do not understand?

    3. Taxes is 11% of the cost of a gallon of gasoline at $3.71. So that is about 40 cents/gallon. This is the money to pay for roads and highways. What good is gasoline without having roads for cars to use?

    Money drives the oil industry. The cost of producing oil probably various from a few dollars in Saudi Arabia to $90/barrel for tar sands and everything in between. Consumption determines the price of oil. High consumption means high prices, while low consumption means low prices. A 5% to 10% decline in consumption during the Great Recession caused oil prices to drop 50%. The oil exporting countries export oil because they need the money to pay for imports of everything else. They do not export because of the goodness of their heart. Saudi Arabia cannot feed itself without importing food.

  • Report this Comment On May 20, 2013, at 5:58 AM, DiverMike wrote:

    1. Because they can

    2. It's the beginning of the annual "Summer-Screw- the-Customer Season"

    3. Obama is keeping ONE promise he made -"Energy costs will necessarily go up."

  • Report this Comment On May 20, 2013, at 10:15 AM, MiserblOF wrote:

    The world is running out of oil. The oil companies and their purchased politicians will prevent the needed research into cleaner and more sustainable energy as long as they can, and the oil prices will continue their inexorable rise. Eventually, economics will force sustainable technology IF human caused global warming, which is now an established fact, doesn't cause total collapse of societies around the world and mass death among human beings, and that is a very big "if."

  • Report this Comment On May 21, 2013, at 5:34 PM, jtmonrow wrote:

    The article's left off oligopoly, "sticky pricing." and, effectively, conspiracy.

  • Report this Comment On May 21, 2013, at 6:54 PM, jeffhre wrote:

    jtmonrow, if true still inaccurate. Things that have been priced into goods and services for 100 years will not lead to radical price changes. Your listed items are not variables. In fact you could even look at them as fairly consistent "inputs," or more classically as friction.

  • Report this Comment On May 24, 2013, at 12:15 PM, tomd728 wrote:

    In two words...........Price Fixing

  • Report this Comment On May 25, 2013, at 9:06 AM, Fracguy wrote:

    Instead of oil substitute the word gold for all your anti oil comments.

    It's the market, folks!! If you don't like the price of gasoline buy a Tesla. Or better yet buy a bike.

    Because of weather conditions beef prices are up, therefore I'm eating more chicken. Is there price fixing with all the ranchers? Are there breeds of cattle that put on weight but only eat half the feed but the big feed companies have bought the patents on these miracle cows?

    Get real, people.

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