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Costly crude not the end of the story for oil majors

While oil companies welcome predictions that oil prices will remain high for the next few years, high prices alone do not guarantee enhanced returns for energy companies.

A significant factor behind the higher prices this year is the fear that the global oil industry is close to capacity. The squeeze is seen all along the supply chain - from drilling to transportation and refinement.

Jeffrey Currie, managing director of global investment research at Goldman Sachs, said the capacity concerns follow almost two decades of underinvestment in the sector, which was in part because the energy sector provided relatively poor returns.

The investment bank estimated in a recent report that the oil industry spent $113bn last year on upstream oil-related projects, just over half the $200bn per year it estimates will be spent over the next decade. On the downstream side, the industry spent about $30bn last year, well short of the $45bn a year that Goldman Sachs estimates is required.

However, it is not just western oil companies that need bigger budgets. More than half the world's oil production is controlled by Opec and Russia, where the presence of western oil companies is negligible.

Goldman Sachs estimates that Opec has not increased capacity since the early 1970s, while Russia's near-doubling of oil output in the past five years is merely restoring capacity that was first built in the early 1980s.

"For the large integrated oils, the increased spending on next-generation projects, higher tax rates on production and the need to build infrastructure are already beginning to be reflected in the financial performance of energy companies relative to the price of oil," the investment bank said.

It added that the returns for the major integrated oil companies generated in 2003 at $30 a barrel were the same as those generated in 1996 at $22 a barrel.

"We estimate that $4 per barrel of that rise resulted from increased production taxes, while much of the rest resulted from the capitalisation of the required increase in spending."

Despite the high oil price, the global rig count is currently about 3,000, around half its 1981 peak.

Energy analysts estimate the capital expenditure budget for oil and gas of the top 20 oil companies at a little more than $100bn this year, compared with about $71bn in 2000.

However, Peter Nicol, energy analyst at ABN Amro, said the level of capital expenditure will vary from company to company. He said Royal Dutch/Shell Group was likely to increase its spending more than most because it had underspent relative to its peers over the past decade.

Mr Nicol said further spending on refining was likely to result in incremental additions to existing refineries, as petroleum margins had not remained high enough for long enough to make companies feel more comfortable about building new refineries.

Global refinery margins were squeezed for most of the 1990s because of relatively low oil prices and excess global refining capacity, but in the past two years margins have returned to attractive levels and helped boost the bottom line of refiners.

Goldman Sachs said the increased capital expenditure for oil companies also came with more risk.

"While the large projects of the 1970s were located in places such as Alaska and the North Sea, the next-generation projects are located in places such as Africa, the Caspian Sea and Siberia, which increases the likelihood of cost overruns, delays and political risk," it said.

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