Energy Supply and Demand Security

A Speech by Mr. Mohammed Barkindo, Acting for the Secretary General, delivered by Mr. Mohamed Hamel, Head, Energy Studies Department at EUROPIA Conference, London, England, 15-16 February 2006

(Slide 1)
Ladies and gentlemen,

Let me begin by thanking the organisers for this timely invitation to address you on the issue of energy security. This important issue has recently re-established itself high on the political agenda in some influential consumer circles, as witnessed just a fortnight ago in the US State of the Union address delivered by President George W. Bush.

What lies behind this increased consumer concern about security of supply? The line of reasoning appears to be as follows.

There has been the perception of shifting fundamentals in the global energy demand/supply balance, brought on by the unexpectedly high levels of demand growth in the developing world, especially in China and India, which became particularly apparent in 2004, after three years of relatively high market stability. Within a short time, this drew attention to a broader-based issue, in the eyes of these consumers — whether the world has enough energy resources to meet the levels of energy demand growth that have been forecast for the coming decades, affecting not just today's developed and emerging economies, but also other economies which are expected to reach take-off point in the early 21st century.

These consumer concerns have arisen at a time of heightened tensions affecting several regions of the world. On top of this, there have been some major natural disasters with which the market has had to cope at short notice. Inevitably, political opportunism has been at play too, with influential interest groups putting out alarmist theories about the world running out of oil soon or about natural disasters occurring with greater frequency in the future, and generally tying all of this in with unsubstantiated fears about unreliable sources of supply.

In speaking to you today, therefore, I should like to put your minds at ease about such matters and, more generally, about the outlook for the oil market and the role that OPEC and other producers play in it.

The commitment to security of oil supply lies at the heart of OPEC's existence. Our Organization's very first resolution, adopted at our formative meeting in Baghdad in September 1960, refers to the assurance of "an efficient, economic and regular supply" of petroleum to consumers. (Slide 2) This principle is enshrined in the OPEC Statute, which was adopted in 1961 and has remained a guiding light for our Organization ever since.

But this is not just altruism. The revenues oil-producing developing countries receive from petroleum sales are essential for financing their economic and social development, to an extent that may not be fully appreciated by industrialised nations. This is in addition to the part that must be reinvested in the upstream to meet rising demand. It is, therefore, in the best interests of these producing countries to ensure that every possible measure is taken to support market stability and supply security at all times.

Furthermore, for OPEC and all producing countries, there is another equally important parameter — the assurance of steady, predictable demand. This is often overlooked by consumers; but, for producers, it is as important and as basic as security of supply. Security of demand goes hand-in-hand with security of supply. OPEC's Second Solemn Declaration, which was signed by our Member Countries' Heads of State and Government in Caracas in the year 2000, emphasises "the strong link between the security of supply and the security and transparency of world oil demand." The Long-Term Strategy adopted by OPEC last September refers to "the security of regular supplies to consumers, as well as the security of world oil demand."

The OPEC Statute of 1961 also outlines other central objectives of our Organization, including "the stabilisation of prices in international oil markets" and "the necessity of securing: a steady income to the producing countries; … and a fair return on their capital to those investing in the petroleum industry."

To see how OPEC's longstanding commitment to security of supply works out in practice, we need only look at our Organization's actions in the volatile international oil market of the past two years. In doing so, we can see that, throughout this period, the market has remained well-supplied with oil and that other factors have been driving-up oil prices, such as downstream bottlenecks, geopolitical tensions and increased speculation in futures markets.

(Slide 3) First, OPEC's Member Countries have increased production by around 4.5 million barrels a day since 2002. This has, in turn, led to a steady rise in OECD commercial oil stocks, which are now exceeding their five-year average.

(Slide 4) Secondly, where possible, our Member Countries have accelerated their plans to bring on-stream new production capacity to meet continued demand growth and to re-establish a comfortable level of spare capacity. This spare capacity — which is now at 2.0 mb/d — will be more than adequate to cover oil demand growth throughout 2006, when the call on OPEC oil is expected to be slightly lower than in 2005. (Slide 5) More increases in capacity have been planned — and are being implemented — for the rest of the decade. Together with the expected growth in non-OPEC supply and OPEC natural gas liquids, this means that cumulative world oil production capacity will rise by around 12 mb/d or more over the next five years — well above the expected cumulative rise in demand of 7–8 mb/d over the same period.

And thirdly, at a time when severe downstream bottlenecks in some major consuming countries have been putting pressure on not just product prices, but also crude prices, especially light, sweet blends, OPEC's Member Countries, although traditionally associated more with the upstream, have themselves taken the initiative to invest in downstream projects; this has been on their own and in partnership with others. Currently, 0.6 mb/d of refinery capacity is under construction, with an additional 1.9 mb/d planned and a further 1.4 mb/d under consideration, to make a total of 3.8 mb/d by 2010. However, all of this does not escape the fact that downstream investment is primarily the responsibility of the domestic and international oil companies in consuming countries.

Clearly, such actions as these come from an Organization that is committed to security of supply. This involves careful analysis of the market outlook, detailed planning and considerable upfront investment, perhaps diverting funds from other worthy domestic causes, in order to make absolutely sure that there is enough oil on the market. I will return to investment later.

The year 2006 has begun with a significant rise in prices, even though the market remains well-supplied with crude and commercial oil stock levels in the OECD are healthy. This, once again, is primarily the result of refining bottlenecks and other non-fundamental factors. However, the continued price volatility is, as ever, a matter of much concern to us, in particular the impact it may be having on the global economy and, especially, developing countries. The OPEC Secretariat in Vienna continues to monitor the situation carefully.

(Slide 6) Nevertheless, looking further into 2006 and at the forecast supply/demand balance, we believe in general that the market supply will remain ahead of demand and that spare capacity will even increase.

Generally speaking, OPEC desires prices that reflect market fundamentals and that are acceptable for producers and consumers alike. Only in this way can our Organization provide the stability and the sustainability that is so important to the steady growth in supply that is needed to support the rising levels of demand that have been forecast for the opening decades of this century. I shall return to the subject of market forecasts in a minute.

Price stability is, indeed, a realistic prospect, but it is something that must be worked on by all the players in the market, and not just by certain committed groups, if it is to be sustainable over long periods. Stability is the responsibility of all parties. High levels of volatility can be very damaging to the market; they can destabilise other sectors of the global economy; they can be prey to rampant speculation, which, in itself, can then add to the volatility; and they can severely hinder investment strategies in future production capacity.

(Slide 7) And finally, on the subject of prices, let me put them in their proper historical context by pointing out that, although oil prices are high in nominal terms, they are nevertheless below those of the early 1980s in real terms. The relative resilience of the global economy to the recent price increases is in part because considerably less oil is now used to produce each dollar of national income, when compared to the past. For example, OECD oil intensities have fallen by almost 60% since 1970. Even developing countries are using less oil per unit of GDP. In addition, what has gone hand in hand with this decline in intensities, of course, has been the falling share of energy in the consumers' budget, as their wealth has increased. We should also remember that the recent rise in oil prices was accompanied by a strong increase in non-energy commodity prices (Slide 8). For example, since the beginning of 2002, steel, copper, iron, lead, nickel and zinc prices have all roughly doubled, while rubber and uranium prices have tripled. These price rises are generally viewed as being driven by the strong synchronised economic expansion over this period.

Let us now look at the long-term prospects for the oil market, since OPEC's commitment to market stability and security is as valid for the long term as it is for the short term. (Slide 9) Demand for energy will continue to grow, as a result of demographics, (with an expected 1.6 billion additional people on the planet within the next 25 years), increases in incomes, continued urbanisation and globalisation. Firstly, we should note that, not only has oil been in the leading position in supplying the world's growing energy needs for the past four decades, but also that there is a clear expectation that this will continue at least for the next two decades. Gas will continue also to grow at fast rates, becoming by 2025 the second most important fuel, ahead of coal. Hydro/nuclear/new renewables will flatten out, despite the extreme high growth rates for some new renewables; however, the rather low initial base makes the growth in absolute terms rather limited.

(Slide 10) According to the reference case scenario from OPEC's World Energy Model, "OWEM", world oil demand is expected to continue rising in the early decades of the 21st century, with annual growth averaging 1.5 per cent up to 2025, when demand will reach 113 mb/d. A startling 80 per cent of the increase in global oil demand will come from developing countries. However, despite this growth, oil use per capita will remain far below the levels seen in the OECD. The transportation sector is particularly important for this growth, with the huge potential for increases in vehicle ownership in developing countries. Asian countries, home to half the world's population, are forecast to experience annual economic growth of over 5 per cent over the next two decades, and, coupled with this large potential for growth, will remain the key source of oil demand increases in the developing world.

Over the coming years, non-OPEC output is expected to continue to grow and reach a plateau of 55–57 mb/d after 2010. (Slide 11) This will mean that the call on OPEC oil will increase substantially, with the Organization's output, including natural gas liquids, rising to 57 mb/d in 2025, compared with 33 mb/d in 2005.

Let me emphasise here that, although we are envisaging higher levels of demand in the future, the global resource availability is not a constraint to meeting this in full. Proven reserves continue to grow on account of new discoveries, as well as reserve growth resulting from advances in technology and improved recovery techniques. This is not to mention the huge potential from unconventional oil resources, such as tar sands. In fact, estimates of ultimately recoverable reserves have been increasing over time. OPEC possesses nearly four-fifths of the world's proven crude oil reserves, and these are sufficient to meet the growing oil requirement for decades to come.

The scale of investment required to meet the expected demand growth over the next few decades runs into billions of dollars, although globally it will not be significantly different to past investment. This is due to the gradual shift away from higher cost non-OPEC supply to lower cost OPEC oil. Of course, oil prices will need to be at a level conducive to supporting the investment required. But there are many uncertainties which make sound investment planning a hazardous business. Future economic growth rates, consumer government energy and environmental policies, technological advances and the oil price path lie at the heart of these uncertainties (Slide 12). Given the role that OPEC plays in supporting market stability by supplying the residual barrel, this uncertainty naturally translates into a wide range of possible levels of future oil supply that will be required from OPEC. With a high growth and low growth case, a range of well over 10 mb/d opens up for the possible amount of oil that OPEC might have to supply by 2020. Over-investment implies heavy costs to be borne by producers, while under-investment will lead to severe price movements (Slide 13). Thus every effort must be made to reduce uncertainties and share the risks among the various parties in the oil industry — OPEC and non-OPEC, producers and consumers, and the international oil companies and other intermediaries.

Importantly, as the President of the OPEC Conference, Dr Edmund Maduabebe Daukoru, said a fortnight ago: "We all have to work together towards global energy security." He advised against consuming countries taking a unilateral approach to handling global energy issues.

(Slide 14) The need for enhanced energy security has to be seen from both supply and demand perspectives, which are mutually supportive. Uncertainty over future demand translates into large uncertainties over the amount of oil that OPEC member countries will eventually need to supply, signifying a heavy burden of risk. Investment requirements are very large, and are subject to considerably long lead-times. It is in this context that there is a call for a "road-map" for oil demand, reflecting the need for security of demand as a legitimate concern for producers, just as consumers express concern over security of supply. With more transparency in the evolution and implementation of policies, better assessments will be possible as to how future demand is likely to evolve. This, in turn, would lend support to making appropriate capacity expansion decisions that would meet both the increased demand for OPEC oil but also offer an adequate level of spare capacity, while at the same time not wasting precious financial resources.

I would like to turn attention to the downstream sector. (Slide 15). This is a very important part of the supply chain, with the current tightness in the form of inadequate refining capacity putting pressure on oil prices. Several factors will shape developments in this sector in the coming decade. The first concerns the rising volume of crude oil that needs to be refined. Another element is how the oil product demand structure will change, with the expectation that there will be a continued move towards lighter products. At the same time, product specifications are moving towards significantly cleaner products that will require substantial reductions in sulphur content, driven by environmental concerns. Therefore, the downstream sector will require significant investment to meet growing product demand and to address emerging mismatches between crude slate, product demand and product specifications.

Considering recent relatively high refinery utilisation rates, distillation capacity expansion might be expected to at least keep pace with growing demand. However, a review of known refining expansion projects does not support this. From the current perspective, investments to the refining sector are coming at a considerably slower pace then is warranted by expected growth in demand: a more orchestrated effort is clearly required to ensure sufficient capacities are in place in the future.

To meet the future challenges about $160 billion in capacity investment will be required by 2015 and another $150 billion needed for capacity maintenance and replacement of lost capacity. The emerging investment trends suggest that the downstream sector could very well remain a source of market instability over the coming years. It is therefore a pressing area for discussion among all parties, and ways need to be explored that could accelerate expansion plans.

(Slide 16) OPEC has devoted so much effort towards encouraging dialogue and cooperation in the industry over the past two decades. As you may know, the most recent result of this was the establishment, last year, of energy dialogues between OPEC and, respectively, the European Union, China and Russia. In two months' time, producers and consumers will meet at Ministerial level at the tenth International Energy Forum in Doha, in order to discuss at length the latest developments affecting the industry. We are firmly convinced that such dialogue is the way forward for the industry, if it is going to evolve in an orderly manner in the opening decades of this century and successfully meet the challenges that lie before it, including the continued assurance of security of supply and demand.

(Slide 17) Thank you.

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