The Responsiveness of Global E&P Industry to Changes in Petroleum Prices: Evidence From 1960 – 2000

Abstract

Perhaps no industry has witnessed a more cyclical activity than the petroleum industry! Oil and natural gas account for a substantial part, over 70 percent, of world energy demand and utilization beside the worldwide application of its by-products. It is the main source of foreign exchange earnings for many developing economies. Crude oil price volatility, especially in the recent past, has made decision-making and strategic planning extremely difficult for oil companies. Oil companies have responded to the low oil prices by reducing research and development budget, capital spending, and employment pattern. The operators are even more cautious than ever before in capital spending and expansion despite the current rising trend in crude oil prices. This paper uses the basic laws of demand and supply and the concept of elasticity as well as user cost relations to evaluate the responsiveness of oil industry activity to changes in oil and natural gas price from 1960 to 2000. It relies on some E&P industry performance measures to evaluate the state of the oil and gas industry in response to crude oil price variability and instability. The results show that the profit margin of the major operators have been on the decline since the advent of OPEC and so is the demand for labor in the industry. The consequences of price instability have led to mergers and acquisitions and internal re-organization in order to attempt to maximize profit in the past few years. Finally, the paper attempts to forecast future oil and gas prices and evaluate their effects on oil industry activity over the next decade using economic impact analysis and the economic concept of price elasticity. Introduction The cyclical nature of the global oil and gas market has adversely affected several facets of the petroleum business. Petroleum is a major source of global energy supply to both developed and developing nations. It is also, a major source of income for several developing nations accounting for between 60 to 90 percent of the per capita income in some countries. The cyclical nature of petroleum activities has created caution among young entrants into the profession. The result is that young entrants would rather study allied engineering courses to give room for professional flexibility. Investment pattern in the industry has been equally cyclical. Every business venture requires a favorable and stable economic environment to encourage investors. The upward and downward swings in the petroleum industry have encouraged diversion of capital investment to the electronic and internet businesses. The last two decades have witnessed the lowest number of drilling rig construction in the history of the petroleum business. The number of cold-stacked rigs due to inactivity was also highest in the last decade. The corollary is the decrease in profit margin of operating companies leading to a significant reduction of workforce and mega mergers witnessed in the past few years. Ironically, the world is yet to find a suitable alternative source of energy to petroleum, which is economically viable. The increasing environmental concerns on global warming, however, may place some constraint on petroleum as the world major source of energy in the distant future. Environmental concerns on nuclear wastes and pollution by coal energy sources do not also help the evolution of an alternative source to petroleum. This paper applies the basic laws of demand and supply and elasticity as well as the user cost concepts and simple linear regression analysis to evaluate the responsiveness of oil industry activities to changes in oil and natural gas prices since 1960.

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