October 30, 2008

Long-Term Capital Needs, Broken Markets

One of the most marked features of the energy business is how long it takes to develop large scale projects. A decade, give or take a few years, is required virtually across the board.

Yet the world capital markets are in a state of serious disorder. The 2008 financial crisis took a huge toll on resource companies. We will survey the carnage in a later chapter, but it was pretty spectacular.

It's not much of an exaggeration to summarize the situation as follows: Energy needs long term capital. The capital markets are broken.

One aspect of this problem follows from the price of oil. The chart above shows West Texas Intermediate Crude, one of the key benchmarks. As you see that chart rise to $145 a barrel in July 2008, then plummet back to earth, consider the following questions:

At what price level do other forms of energy become viable? In the short term, other forms of energy (natural gas, wind, solar, nuclear, coal) do not compete with oil, whose use is concentrated in transportation, but in the longer term and at the right price most of these could definitely muster some competition.

Energy development requires access to the equity and debt markets; if companies have too much leverage they can go bankrupt if prices fall suddenly. Expectations of profit and debt repayment are inherently uncertain. Many companies might be profitable if oil averages around $75 a barrel, extremely profitable if it averages a $125, and bankrupt if it averages $50.

The gyrations of the oil price in 2008 show how difficult it is in the energy sector to do that which is most required of thee. In this domain, that is neither to do justice nor to love mercy, but to walk humbly in estimating the future price of oil. On that your whole enterprise depends. And it is vastly uncertain. That is one signal that we emphatically get from the markets.

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