COMMENT

The upstream and downstream system buffers are disappearing. Inventories of oil and gas feedstocks, products, derivatives, equipment, components, and even consumables - a chain of supply that markets and buyers count on to buffer demand and price escalations are being drained (literally) from the system.

Draining the buffers

The upstream and downstream system buffers are disappearing. Inventories of oil and gas feedstocks, products, derivatives, equipment, components, and even consumables - a chain of supply that markets and buyers count on to buffer demand and price escalations are being drained (literally) from the system. There is no longer a rationale for carrying a surplus.

As a result, all along the industry value chain, buyers and commodity traders are adding a premium to purchases to reflect tightness in supply. The premium will shrink in time, but not until buyers get a better handle on transactions and distribution in the new economy.

Consumers and buyers expecting a return to normal inventory conditions, as a result of higher commodity prices, may have a long wait. People, systems, corporate structure, supplier, and contractor costs have been wrung tight over the past 10 years, and producers finally are getting around to squeezing the only thing remaining - inventory.

How extensive is the inventory dump? Let's start with the primary transaction - acreage acquisition. For larger oil and gas producers, surplus acreage is yielding to just-in-time property acquisition and drilling, accompanied by a tough prospect development grading formula that survived from the 1998 downturn. As a result, producers are trimming out entire geographic sectors from license and lease portfolios, particularly on land and in shallow water, where production volume additions are low and infrastructure costs continue to mount.

There is another not-so-subtle pressure on producers. Inventories, especially product stores above ground, all across the value chain, have an environmental cost - whether realized or potential - and producers are being pressed to recognize that hidden cost in inventory values.

Although touted for many other functions, the Internet's greatest legacy, at least for the petroleum industry, may be in removing buffers from the oil and gas economy. The result may not be quite what new economy specialists and consumers had in mind, however. The prices of oil and gas in the future should more accurately reflect true recovery and value added costs - and that might not be cheaper.

Unsavory practices

Recent US judicial victories by several major oil and gas producers to get their bonus money back are a poor reward for doing business with the US government. Unfortunately, until these companies actually see their principle returned, they cannot claim any sort of victory.

After winning oil and gas tracts in open bidding, if oil and gas producers subsequently are not allowed to explore for minerals on government lands or aquatory, what is more fair than returning their money. Without the ability to work on the leases, the transaction is incomplete. And if the money was kept for almost 20 years while the cases wind through the judicial process, then they should be paid with interest and not be forced to settle for less.

The uncomfortable reality is that a number of countries - among them the US - take the position that up-front payments are "at-risk" or "show-up" payments, and do not promise that producers will ever get the opportunity to work on a license or lease.

Another unsavory practice the US government seems to share with other nations it wouldn't normally emulate is that of inducing other governmental departments (taxation, environmental protection, labor, etc) to investigate certain undefined practices on the part of oil and gas producers seeking refunds.

The US government wouldn't do that, would it? Don't count on it for two good reasons: (1) The Clinton administration has a history of pressuring individuals and companies in this manner. (2) Federal government departments consider mineral exploitation payments as part of their budget streams, however small, and returning payments means doing without in the future.

The problem with the US government's acquisitive attitude is that when it decides to open up a new exploration area, two events will take place: (1) Small producers will decline to participate, not wanting to tie up borrowed capital for long periods. (2) Larger producers, who are self-funding, will discount bonus bids to take into account incomplete transaction risks.

Doing business badly or unfairly has its own disincentive - no one wants to play.

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