We received a note from a reader on Santos last week:

It’s interesting to note Al wonders if it is a good time to buy on the dip in stock prices for companies like Santos since revenues are up on decreased production.

Probably not.

While it is nice to see increased profit margins on current production- which is declining- the reality of finding new reserves is that a higher cost environment is putting itself in place. Costs have and will continue to increase for seismic, drilling, completion, production, gathering, refining and distribution. Real costs are up in all these areas, inflation is adding to the increases at a faster rate than in twenty years, and competition for services is increasing prices as well, leaving oil companies small and large wondering about the cost of bringing new resources to market.

Here in Canada the cost of placing one bbl. per day of increased capacity at the tar sand has at least tripled since 2002. Best estimates at the end of 2006 was about $80,000.00 per bbl. Admittedly, the cost per barrel is still quite attractive when the bbl. per day is produced for forty years, but the cost of significantly increasing production to meet the demand for export is prohibitive.

Off shore exploration and development costs have also increased significantly with best estimates of real costs between $U.S.70-80 per barrel, and procuring drilling equipment to lease is an extremely competitive market currently. with wait times of five years and up.

So, rising costs, decreasing production, difficulty in obtaining necessary services, increasingly hostile and difficult regulatory regimes, (think Venezuela, Ecuador, Bolivia), as well as tight capital markets combine to make bringing new petroleum resources on line an increasingly difficult task.

No wonder so many major fully integrated oil companies are buying back their shares. Minimizing shareholder strife may be the only way they can martial the strategic and tactical forces necessary to continue to be viable entities. The course of development is hazardous. Especially with oil prices being as unstable as they are over the last 15 years, capital development costs being as high as they are, and time lines for bringing new resources on line in the neighborhood of ten years.

On the up side the profits to the victors will be greater than ever before.

Jim Crozier

Calgary, Alberta

It’s an excellent point. In the long term, oil companies’ costs are rising.

We’ll clarify our thoughts on Santos here. We don’t necessarily think it’s a good time to buy Santos, although drillers are one way to get exposure to peak oil. But we thought the company’s earnings told a story.

Why? Well, in the long term, costs are rising. Oil is harder to find. It exists mostly in geopolitical hotspots. You’d expect oil companies to be suffering. But Santos has still managed to buck the trend.

That’s because while oil costs are moving in a steady trend, oil revenues are not. The oil price doesn’t move steadily anymore. It jagged up sharply this year. Then it jagged down again. This is how things are likely to go for the foreseeable future.

That’ll mean oil earnings will be equally volatile. There will be periods where earnings are rising. There will be periods where they’re falling. Our point is simply that we’ve just had a spot where oil companies have had it good. Even though the oil business is getting tougher.

This article is written by Allan Robinson from Money Morning. Money morning is a website that aims to give you intelligent and enjoyable commentary on the most important financial stories of the day, and tell you how to profit from them.