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Big Oil’s Broken Business Model

Until last fall, when the price decline gathered momentum, the oil giants were operating at full throttle, pumping out more petroleum every day.  They did so, of course, in part to profit from the high prices.  For most of the previous six years, Brent crude, the international benchmark for crude oil, had been selling at $100 or higher.  But Big Oil was also operating according to a business model that assumed an ever-increasing demand for its products, however costly they might be to produce and refine.  This meant that no fossil fuel reserves, no potential source of supply — no matter how remote or hard to reach, how far offshore or deeply buried, how encased in rock — was deemed untouchable in the mad scramble to increase output and profits.

In recent years, this output-maximizing strategy had, in turn, generated historic wealth for the giant oil companies.  Exxon, the largest U.S.-based oil firm, earned an eye-popping $32.6 billion in 2013 alone, more than any other American company except for Apple.  Chevron, the second biggest oil firm, posted earnings of $21.4 billion that same year.  State-owned companies like Saudi Aramco and Russia’s Rosneft also reaped mammoth profits.

How things have changed in a matter of mere months.  With demand stagnant and excess production the story of the moment, the very strategy that had generated record-breaking profits has suddenly become hopelessly dysfunctional.

To fully appreciate the nature of the energy industry’s predicament, it’s necessary to go back a decade to 2005, when the production-maximizing strategy was first adopted.  At that time, Big Oil faced a critical juncture.  On the one hand, many existing oil fields were being depleted at a torrid pace, leading experts to predict an imminent “peak” in global oil production, followed by an irreversible decline; on the other, rapid economic growth in China, India, and other developing nations was pushing demand for fossil fuels into the stratosphere.  In those same years, concern over climate change was also beginning to gather momentum, threatening the future of Big Oil and generating pressures to invest in alternative forms of energy.

A “Brave New World” of Tough Oil

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