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The future costs of energy

Simmons & Company, Houston, Texas, U.S.

Corresponding author: msimmons@simmonsco-intl.com

Matthew R. Simmons will be one of the seven distinguished panelists of the TLE Forum V: "Globalization of the Energy Business," at the SEG Annual Meeting in Denver, Monday, 11 October 2004, at the Colorado Convention Center.

The first 20% of the full text of this article appears below.

Our current economy and lifestyle are a byproduct and prime benefit afforded us from our ability to explore, develop, and deliver secure energy resources at reasonable prices. Coal initially fueled the industrial revolution from the 19th century up to the early 20th century. When oil displaced coal as the primary fuel of choice in the 20th century, global growth in mechanization, industrialization and transportation rapidly accelerated. The energy infrastructure we have today has created a 21st century miracle in which the world's general population has access to potable water, more food, and much improved lifestyles. However, the foundation and sustainability of this energy infrastructure on which we have depended so heavily, and for so long, is now vulnerable due to over two decades of unsustainable low oil and gas prices.

To obtain a barometer on the future costs of energy, it is essential to understand the principles about how important goods are priced. We know from Economics 101 that products are priced based on supply, demand, and the perceived added value. Long-term prices must create adequate returns for producers and suppliers; otherwise, suppliers lose money and go out of business. Safe and stable returns allow markets to manage debt wisely, resulting in lower product prices. Thus, long-term contracts at fair prices eventually lower the cost of any valued product. Why? Because low-cost debt safely anchors the total investment, AAA-rated debt is extremely inexpensive, and a 15% return on equity is a great deal! Most brick and mortar companies are financed by long-term debt.

Conversely, higher risk and price volatility inevitably result in higher product prices. Moreover, high-risk projects always demand higher returns. Long-term contracts, the elixir of stable and fair prices, are rare when volatility is high. Too often, in this unstructured environment, key products end up being priced on . . . [Full Text of this Article]