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From the August 15, 2004 Break Out Report

How High Can Oil Prices Go?
by Marco den Ouden 

The price of gas at the pump in Vancouver just topped $1.20 a liter this past week (week ending April 14, 2007). Ouch!  That's a pain in the pocketbook! And, of course, it has been good for oil and gas stocks. But can the gravy train for investors in the oil patch go on forever? Will oil prices come down again? Oil is a commodity and some believe that such commodities get scarcer and scarcer as reserves are depleted. Some wags have even talked about "peak oil", the notion that we are entering a new age of scarcity for such resources.  The article below, from the August 15, 2004 Break Out Report, begs to differ for reasons that are discussed below. The argument remains valid today. BTW, the price of oil at this writing is $63.63 a barrel.

It wasn’t the largest headline but it was the most significant one. After oil prices hit new highs on August 10th, Tuesday’s Financial Post blared in bold letters – “Oil could hit US$100 a barrel”. Oil had topped $45. Prices are up 39% from a year ago. The latest rise came when Iraq cut oil shipments after warnings of possible terrorist attacks on infrastructure.

Adam Sieminski, oil strategist at Deutsche Bank AG in London avers that if accidents, natural disasters or sabotage cut supplies in two producing countries at the same time, the price could soar to $100. This observation was tempered by the claim that such a sustained disruption was extremely unlikely and that oil held in reserves would be released to deflate the price pressures.

The last time there was talk of $100 oil was in the 1980s after the Iranian revolution. In fact, in 2004 equivalent dollars the price of oil peaked in 1981 at $84. Then it plummeted. Is today different?

The article cites Daniel Yergin, chairman of Cambridge Energy Research Associates who says there’s a 50/50 chance of oil topping $50 a barrel in the next fifty days. “The world has one of the smallest cushions ever for absorbing a loss of supply,” says Yergin, “while demand growth is the strongest in a generation.” The situation, he says, “is even tighter now than it was during the 1973 oil crisis.”

If there is a surge in price of such magnitude, it can only be temporary. Economist Julian Simon noted in his classic 1980 book, The Ultimate Resource, that commodity prices inexorably fall over the long run. Simon set out to challenge the predominant doom and gloomers of the day. Amid almost daily cries that the world was overpopulated, that our air and water was deteriorating, that food would become scarce and expensive as a result, that the world was on the threshold of ever increasing scarcity, Simon pulled out his tables of facts and figures to prove that food production per capita has been steadily increasing, that air and water are cleaner than before and improving, that the price of resources was declining and so on.

Simon challenged his detractors to a bet "that the cost of non-government controlled raw materials (including grain and oil) will not rise in the long run". In 1980 Paul Ehrlich, the fear-monger about over-population, took up the challenge. Simon let Ehrlich choose five commodities. Simon’s bet was that the commodities would be cheaper after ten years. The commodities chosen were chromium, copper, nickel, tin, and tungsten. They bought, on paper, $200 of each, then waited ten years. In 1990, Simon collected a check for $576.07, the amount by which the aggregate price of the commodities had dropped. Tin, for example, had dropped from $8.72 a pound in 1980 to $3.88 in 1990. Times have changed but the principles haven’t.

In the long run and in real terms (in constant dollars), the price of oil will come down. Factors driving it down are already in action. Witness the powerful surge in exploration, the exploration of new energy sources like coal bed methane or liquefied natural gas,  the development of alternative fuels such as the hydrogen fuel cell.  But perhaps the most powerful impetus for prices to level off and eventually moderate are Alberta’s oil sands. As oil prices climb, the impetus to develop such alternatives as oil sands and fuel cells grows. In fact, in some respects, the oil sands are already cheaper to bring to market than conventional oil.

On its website, Western Oil Sands (WTO – TSX) compares the cost of producing a barrel of conventional oil and its equivalent at the Athabaska Oil Sands Project. While the operating costs are almost half for conventional oil, when you factor in exploration and development costs and royalties, conventional oil is much more expensive as shown in the table below.


Conventional Exploration & Production

Athabaska Oil Sands Production Costs

Finding and Development Costs






Operating Costs



Total Cost



Moreover, the reserves of bitumen or oil sands deposits are staggering. Alberta has 62.0 billion barrels of conventional oil in the ground of which 1.6 billion barrels are proven recoverable and 5.0 billion probable. On the other hand, there is 25 times as much in the form of oil sands – 1.6 trillion barrels, with 174.4 billion proven recoverable and 311.2 billion probable. That’s 109 times as much proven recoverable oil sands barrels and 62 times as much probable.

In fact, if you include the oil sands, Canada is second only to Saudi Arabia in terms of world reserves of oil. And in terms of recoverable oil, Canada’s reserves are larger than Saudi Arabia’s. When you consider that 80% of Canada’s oil sands capacity is still available for exploration and leasing , Canada could, in fact, make North America more than self-sufficient in oil.

There were 1807 oil sands lease agreements with the Province of Alberta and 25 companies in production and paying royalties at the end of 2002.  Production for that year was 740,000 barrels a day. That’s a third of Canada’s total oil production according to the Canadian Association of Petroleum Producers. Production from oil sands is forecast to grow to 1.9 million barrels a day by 2010 and 3 million barrels a day by 2020.

Major players in oil sands development include such giants as Imperial Oil, Encana, Canadian Natural Resources and Petro-Canada. The largest player is Suncor, a featured stock pick of Ken’s in the July 4th issue.  Even with all the activity in oil sands exploration today, the surface has barely been scratched. With high oil prices, the comparatively high operating costs of oil sands production are proving less of a barrier to further development though the capital costs to start production are still staggering. As the industry develops, those costs will come down. The real answer to terrorist threats to Middle Eastern oil production lies right in Canada’s back yard!


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