A Citizen’s Guide

Alaska North Slope crude oil dropped 33 cents to $94.87 on Wednesday.

First: The Anchorage Daily News reports from yesterday’s House and Senate Finance Committee hearings, where Barry Pulliam, senior economist for Econ One, told lawmakers about the relationship between high oil prices and increasing production costs:

“He said the costs are largely driven by the high oil prices. Companies are more likely to spend money if they think they’ll be making bigger profits because of an expectation of sustained higher prices, he said.

“More activity raises cost with more demand on oil field equipment and services, Pulliam said.

“’The (profit) margins are higher, there’s more opportunity to make money and people are appropriately responding to that,’ Pulliam said.”

Then: The Financial Times out of London explains how BP and Shell bet on oil prices:

In recent years, Europe’s two biggest oil companies by market capitalisation have embodied different bets on the oil price. BP, with a much smaller refining base than its supermajor peers and its avoidance of costly, unconventional fuel sources such as oil sands, has been counting on prices falling. Lord Browne, chief executive until this summer, was banking on $40 a barrel in the medium term, falling to $25 or $30 further out. Implicitly, Shell believes in prices being stronger for longer. Since late 2004 it has gone out on a limb, developing big, long-life upstream projects, complemented by a solid downstream business that is able to process complex fuels.

The stock market, though, continues to reward conservatism, leading to a valuation gap. Shell has ploughed more cash back into its business - capital expenditure consumed more than 70 per cent of post-tax cash flow from operations last year compared with 54 per cent at BP. As a result, its valuation has consistently lagged behind by about 10 per cent in terms of debt-adjusted cash flow multiples.

Trade-off between short-term cash flow generation and production growth is a challenge for Tony Hayward, BP’s new chief executive. He has yet to outline his view on oil prices or capex, but there are some hints that he could unpick the strategy of his predecessor. A recent stray aside from a senior executive suggested that BP was eyeing a return to Qatar, which sits on the world’s third-largest gas reserves, after a 15-year hiatus. Speculation is mounting that Mr Hayward may look for a way back into Canadian oil sands - a business BP twice exited under Lord Browne, blaming insufficient returns.

The attraction of cautious long-term forecasts is understandable. But with spot oil prices almost four times BP’s current planning assumption, Mr Hayward looks likely to turn the capex tap back on.

And Finally: State consultants Gaffney, Cline & Associates Inc. show what oil taxes do to revenue and profits in time of high prices. Check pages 18 and 19.