“OPEC’s Capacity & Commitment to Meeting World Oil Demand in the Medium-Term”

Speech delivered by OPEC Secretary General, HE Abdalla Salem El-Badri, to the Middle East Energy 2009: The Politics of Investment & Supply - Chatham House, London, 9-10 February 2009

Thank you, Mr. Chairman.

Ladies and gentlemen,

Over the past few months, the world seems to have shifted beneath our feet.

A financial crisis — the worst since the Great Depression — has led to a deep recession in OECD countries and to a dramatic economic slowdown in developing countries.

This crisis has its roots in the advanced economies.

But in this globalized and interconnected world, it has spread like wildfire to all countries, including the poorest ones — those who are least responsible for this crisis.

OPEC Member Countries are no exception. They face big losses in their equity markets, lower economic output and dramatic declines in oil export earnings.

Under these exceptional circumstances, OPEC, as an organization, is still trying to maintain its commitment to ensuring a stable oil market.

But we are increasingly concerned with the impact the crisis may have on the medium- to long-term outlook.

In addition, the steep decline in oil prices is a direct threat to the long-term stability of the market.

Not only have low prices been damaging to our Member Countries, they have also created a challenging environment — in terms of dampened investments for capacity expansion projects.

And this should concern us all — not just those of us in the oil industry or from oil-producing countries.

SPARE CAPACITY

It’s essential to first highlight the importance of spare capacity — in the context of OPEC’s existing capacity and its historic commitment to meeting the world’s medium-term oil demand.

As part of its commitment to ensure market stability, OPEC has always played a unique role — with its policy of consistently maintaining adequate spare capacity.

OPEC’s capacity, in terms of its resources and immediate availability of production, has always been sufficient to accommodate the world’s oil needs. With nearly 80% of the world’s crude oil reserves, OPEC’s Member Countries represent 40% of world oil supply.

Their spare capacity has been put to effective use many times to mitigate the destabilizing effects of exceptional events on global oil supply.

In recent years, during surges in demand or unexpected transportation disruptions due to geopolitical tensions or natural disasters, OPEC supplied more than 4.5 mb/d of additional crude to satisfy market needs.

But this could not have been done without continuous and planned investments in capacity-expansion projects.

  • Last year alone, upstream oil investments in Member Countries were around $40 billion.
  • And looking to 2030, total world upstream investment requirements are expected to amount to $2.8 trillion (in 2007 dollars).

By investing in spare capacity, OPEC shields the world from the damaging effects of supply interruptions — and, more generally, from the negative impacts of extreme market volatility.

Unfortunately, some people think that any existing spare capacity must be used.

Last year, for example, in reaction to record prices, OPEC Member Countries were urged to use their spare capacity to increase production.

But this suggestion missed the forest for the trees.

  • It overlooked the “disconnect” between the paper oil market and the physical market.
  • And, more importantly, it ignored the close relationship between spare capacity — and future demand.

EXPECTED DEMAND

In 2008, with the downturn in the world economy, global oil demand started to contract for the first time since 1983.

  • Our preliminary 2009 estimates show that there will be a decline in demand for OPEC crude — about 1.4 mb/d less than last year.
  • That puts this year’s demand level for OPEC crude at an average of 29.5 mb/d — an optimistic number given the bleak global scenario.

Given this expected drop in demand levels in the short- to medium-term — and the expected growth of non-OPEC crude supplies at the same time, which is expected to be around 0.6 mb/d — overall spare capacity is set to rise over the next few years.

Nevertheless, in the medium- and long-term, we do expect demand to rebound again — especially when the global economy recovers.

  • World oil demand in OPEC’s long-term reference case, for example, is expected to increase to 113 mb/d by 2030 from around 85 mb/d today.
  • Of course, this figure of 113 mb/d will probably be adjusted down this year.
  • But, still, we expect oil to remain the leading energy source and to continue satisfying the lion’s share of world energy demand.

With all this in mind, we are currently holding more than 8 mb/d spare capacity, keeping it ready for any additional demand or unexpected disruptions.

It’s important to note that the maintenance of this spare capacity alone implies a significant cost.

Furthermore, plans to expand spare capacity — to offset decline rates as well as to prepare for expected long-term demand increases — also require funding.

But uncertain future demand has put this planned spare capacity — as well as the long-term availability of crude — at risk.

DOWNSIDE RISKS TO FUTURE DEMAND

Many future demand scenarios of course have been brought into question by the global credit crunch — and, more importantly, by the virtual “price destruction” that we have seen in recent months.

However, there are other important downside risks to future oil demand levels which are significant.

For example, there are proposed fiscal and environmental policies in several countries that aim at favouring the development of alternative sources of energy — over oil.

These strategies are risky — since such policy prescriptions will discourage companies from investing in crude oil now.

Additionally, there is the long-term risk that if alternative energy sources fail to meet set quantitative targets, crude capacity by then might be insufficient to make up any resulting supply shortfall.

Now, it is important to emphasize that we, at OPEC, welcome diversity in the global energy mix.

  • We have consistently supported the development of renewable energy sources.
  • We are active participants in various environmental forums.
  • We fully support the search for carbon-emissions-reduction technologies. Many of our Member Countries are even involved in experimental low-carbon projects.

But policymakers need to recognise that by pushing too hard for alternative energies as oil substitutes — rather than as complements — they are adding to uncertainty about future demand.

This demand uncertainty not only impacts the expected future demand for OPEC crude, it also discourages the required level of investments that need to be made now. Such uncertainty is one of the biggest challenges for making investment decisions in the oil industry.

In addition, the current low price environment poses the risk of underinvestment — which could lead to significant upward price potential.

So when oil demand does eventually start to pick-up, this could all lead to the familiar boom-bust cycles that we all remember from years past.

UNPRECEDENTED PRICE VOLATILITY

Turning to prices, I think there is no one who would consider last year’s prices to have been reasonable. And hardly anyone can suggest that it was the fundamentals of supply and demand that pushed the oil price above $147/b last July.

With ample crude supply in the market and high stock levels, OPEC found no reason for this volatility other than the speculative investments flowing in and out of the futures markets.

And for more than a year, we recommended greater regulatory oversight of commodity futures trading.

But only time will tell if policymakers decide to do something. We feel it is vital to learn lessons from what has happened.

THE IMPACT OF LOW PRICES

Today, of course, the price situation is quite different.

The worsening real economy and massive redemptions in the speculative funds industry have brought the price of oil to extremely low levels.

Recently, they have been hovering around $40/b.

This current low price environment raises several problems:

- First, current prices will not sustain the industry.

They are at about half the level required to attract investments to the industry and ensure sufficient production capacity to meet future demand.

Current prices are also well below the level needed to cover the marginal costs of many projects — effectively stalling the exploration and development of any new frontiers.

Several oil sand expansion projects in Canada, for example, have now been delayed or cancelled.

And with construction costs relative to oil prices still up, not even conventional projects are investment-worthy.

The ongoing global crisis with its dwindling credit lines has already forced some companies — both IOCs and NOCs — to cancel or delay projects, and even announce layoffs.

At OPEC, we have already seen delays in more than 35 of 150 planned upstream projects. Some of these have been postponed until after 2013. The start-up dates of many other projects are also expected to slip.

Thus, current prices threaten the very sustainability of planned investments — in both conventional and non-conventional crude — and put future crude production at risk.

- Second, current prices are also detrimental to many of our Member Countries.

They use oil revenues to finance important health, education and welfare programmes for their populations.

This low price environment is, of course, not what any of us desires. Nor is it a situation from which the world’s businesses, consumers or economies will benefit.

I sincerely believe that all of us need to recognize the fact that if the current price environment does not change, then we will all face a far more challenging energy scenario in the future.

CONCLUSION

In times of trouble, many people look the other way, avoiding difficult decisions.

We don’t have the luxury of doing this in the oil industry. We need to make investment decisions now to ensure adequate supplies in the future.

It’s not only the fate of oil-producing countries that is at stake, but that of oil-consuming nations and hundreds of industries around the world.

But sound investment decisions can only be made when signals are clear.

And for this, we need:

  • market transparency and shared industry data;
  • improved regulation of commodity futures trading; and
  • better predictability in energy policies.

OPEC has always tried to faithfully pursue its mission of ensuring stable, secure and reasonably priced crude. But the times in which we now live require new approaches.

Perhaps we should say that the current crisis offers us a chance to work together, with other stakeholders, to find ways to navigate the storm, to make renewed efforts to share data, make informed investment decisions and find common ways to ensure security of supply and demand.

The prosperity and well-being of people everywhere depend on this combined seriousness of purpose — so that when the global economy eventually recovers, we will all be ready to support the world’s engines of economic growth.

Thank you.

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