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The Coming Supply Shock

fuchengyu112908.jpgIn Newsweek, a Chinese oil official from CNOOC warns than the current low prices are causing numerous production projects to be canceled because of skewed financing pegged to $70 a barrel – naturally meaning another supply shock is on the way.

One of the many reasons that oil prices spiked to $150 earlier this year is that in the 1990s, when prices were $12 a barrel, oil firms stopped looking for new reserves. That resulted in supply shortages and, when demand for oil picked up this decade, spiraling oil price inflation.

Now the same vicious cycle may be startingagain. At a recent conference in Barcelona, Fu Chengyu, the head of theChinese state oil giant CNOOC, said that he had met with the heads of27 state oil firms, and that some 60 percent of planned exploration anddevelopment projects slated to begin in the next two years were beingcanceled because they were pegged to $70 oil (prices last week fellbelow $50). “Many [state companies] are panicked,” he said. “They don’thave enough cash to do all of the projects.”

Russiangiants Rosneft and Gazprom, which depend heavily on debt financing, arescaling back (Gazprom has canceled construction of a glitzyheadquarters in St. Petersburg). Petrobras, the Brazilian company thatlast year made one of the largest new finds in a decade (in deep wateroff Rio) has delayed its review of the new area because of the creditcrunch. No wonder the International Energy Agency has begun warning ofa second supply shock thanks to underinvestment by state companies,which now control the vast majority of reserves.