by Matthew R. Simmons
Chairman and CEO
Simmons & Company International

The U.S. airwaves are now filled with economic stories like: "The Dangers of High Oil Prices," "Gouging at the Gas Pump," "Oil Prices Are Silent Price Hike." There is a widespread belief that a fast end to the Iraq war will bring prices back to normal, thereby jump-starting our weak economy. That high oil prices hurt and low oil prices are wonderful are the "twins" that underpin most economists (including most energy economists) view of the energy world today.

I have scoffed at this notion for years, though I have never put real numbers to my general feeling that this thesis makes no sense! We now need to look at some rough numbers and see what they tell us.

My view on the prices for all forms of energy be it oil, natural gas, electricity or something else is that they need to be high enough for "the piper to be paid." If prices are lower than they need to be, it leads to instability and high spikes. There is no "Fairy Godmother of Energy." The major energy forms are extremely capital intensive. Once a new "energy factory" is built (an energy factory being defined as a new oil or gas field, coal mine, power plant, refinery, etc.), the incremental cost of energy becomes very low for some period of time if you ignore a return that needs to be paid to the factorys builder. This return cannot be ignored, however, since the investor needs to be "lured back" to build other energy factories, and losses deter capital investment. This is Capitalism 101.

For a few years after a new energy factory is built, its maintenance costs are minimal, so "break-even" rents are purely the cash costs to create energy, plus the return on investment to the investor who put up the money for the "plant."

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