OPEC's perspective on oil market developments

A speech by Dr Adnan Shihab-Eldin, Acting for the Secretary General, to the 7th APEC Energy Ministers' Meeting, Gyeongju, Republic of Korea, 19 October 2005.

[Slide 1] Excellencies, ladies and gentlemen,

Let me begin by thanking the organisers for inviting me to address this important Seventh Meeting of APEC Energy Ministers.

The theme of the meeting — “Securing APEC’s energy future: responding to today’s challenges for energy supply and demand” — is a very topical one, bearing in mind recent oil market developments. The volatility and high prices have focused attention on what many people see as being the fundamental issue of acquiring secure energy supplies at affordable prices over a long period.

[Slide 2] This reaction is understandable, in particular in such a vast, diverse and energetic region as the Asia-Pacific. On a purchasing power parity basis, the Asia-Pacific houses the world’s three largest economies — the USA, China and Japan. Even on the more established market exchange rate basis, it is USA one, Japan two and, climbing steadily, China five. As the world’s most economically dynamic region, the Asia-Pacific now accounts for around 60 per cent of both global GDP and energy demand. Specifically for oil, the region’s demand of nearly 49 million barrels a day is 59 per cent of the world total of 82 mb/d.

The region already produces large quantities of its own energy, in all the major commercial forms. Indeed, some APEC economies, such as Canada and Russia, are major exporters of oil and gas, which dominate the global energy mix.

[Slide 3] Nevertheless, so large is the region’s energy demand that, overall, it is a net energy importer, and it will become even more of one as demand continues to rise during the first quarter of the 21st century, led by sizable growth in demand for oil in China and in other emerging developing economies in the Asia-Pacific. This contention is substantiated by the big imbalance, in proportionate terms, between the region’s proven hydrocarbon reserves — estimated at 13 per cent of the world’s crude oil reserves and 38 per cent of its gas — and its current production — of around 37 and 58 per cent of global oil and gas respectively.

Such factors highlight the need to respond effectively today’s challenges for energy supply and demand in the Asia-Pacific, and such high-level meetings as this have an important role to play in this process.

For my part, I should now like to present OPEC’s views on this issue and to provide reassurances about the oil supply system to the Asia-Pacific for many years to come. Of course, one of our Member Countries, Indonesia, comes from the region, where it is a prominent producer, as well as consumer, of both oil and gas.

When looking at the current market situation, we see that an unusual combination of factors has been at work over the past couple of years, leading to the persistent price rises and volatility. We have also observed a shift in the focus from the upstream to the downstream.

[Slides 4–6] The spotlight was initially on the upstream, with the unexpectedly high oil demand growth in 2003 and its acceleration to exceptional levels in 2004. This was connected, in particular, to the high level of economic growth of two APEC members, China and the USA. It was exacerbated by a notable development on the supply side, when the growth in non-OPEC supply started to fall behind that of world oil demand, reversing earlier trends of matching or exceeding demand growth. However, during the course of last year, it became steadily apparent that the destabilising forces lay more — and increasingly — in the downstream than in the upstream, and this trend has continued to the present day.

[Slide 7] Indeed, this year, while demand growth has remained at healthy, though more modest and sustainable levels, the challenge of providing adequate crude supply is being met successfully. This has been largely due to OPEC’s actions, raising its production by more than 4.5 mb/d since 2003, as part of its market-stabilisation measures. This has, in turn, led to a steady rise in OECD commercial oil stocks, which are now exceeding their five-year average.

[Slide 8] OPEC has also been acting on a second front. Recognising that the high levels of oil demand growth — of about 1.5 mb/d per year — are likely to remain at least in the medium term, our Member Countries have sought to accelerate their plans to bring on-stream new production capacity. [Slide 9] This is to re-establish a comfortable level of capacity and help calm markets during the present troubled period. This means that spare capacity — which is now at 2.0 mb/d — will be more than adequate to cover oil demand growth throughout this winter and in 2006, with the call on OPEC only slightly higher than in 2005. Furthermore, much of OPEC’s new capacity in the coming years will consist of lighter crudes, which are much in demand in the market. More increases in capacity have been planned — and are being implemented — for the rest of the decade.

Also, next year is expected to see non-OPEC oil supply growth recover to 1.3 mb/d from the exceptionally low level of 0.5 mb/d witnessed this year — and, as with OPEC, there will be a focus on lighter crudes. [Slide 10] On balance, we expect annual average growth of around 1 mb/d in non-OPEC supply up to 2010, slowing thereafter. Combined with the planned increase in OPEC capacity from 32.5 mb/d to more than 38 mb/d by 2010 and an additional 1.5 mb/d increase in natural gas liquids over the same period, this means that cumulative world oil production capacity will rise by around 12 mb/d or more, over the next five years. This will be well above the expected cumulative rise in demand of 7–8 mb/d over the same period, and thus it will more than cover the forecast growth in demand.

Also, the fact that the market has, over the past two years, experienced and successfully handled a serious spare capacity limitation, together with the fact that the greater revenues generated by the recent higher oil prices have allowed more funds for reinvestment in the industry — compared with the under-investment in new capacity that occurred previously when prices were much lower — is a very positive sign for the assurance of crude oil sufficiency well beyond the opening decade of this century.

[Slides 11–12] There is a different picture downstream, however.

The continued serious downstream bottlenecks in some major consuming countries — due mainly to a lack of timely investment and to increasingly stringent product specifications motivated by environmental concerns — have seen refineries operating at near capacity to keep pace with rising demand. Not only is this putting pressure on product prices, but its effects are also felt subsequently on crude prices, especially light, sweet blends. Indeed, we saw last month how world crude oil prices were far less affected than product prices by the disruptions caused by Hurricanes Katrina and Rita to the US Gulf Coast. Clearly, the industry at large must pay more attention to the downstream part of the supply-chain, in the interests of overall market stability. [Slide 13] In particular, concrete measures should be taken on the part of the governments in consuming countries, to create an enabling environment to encourage rapid, sizeable investments in the refining sector, especially in conversion capacity, which has persistently lagged behind market requirements.

Downstream investment, however, is primarily the responsibility of the domestic and international oil companies in consuming countries. Without adequate and timely measures from that side of the industry, today’s high and volatile oil prices are likely to remain a feature of the market. [Slide 14] In this context, it should be noted that the recent large revenue increases of the international oil companies have not yet been visibly translated into substantial additional investment, and this includes the upstream, as well as the downstream. Here I refer to reports of refiners’ returns more than tripling over the past 12 months, compared with 45 per cent gains for crude producers.

[Slide 15] OPEC’s Member Countries, although traditionally associated more with the upstream, have themselves taken the initiative — on their own and in partnership with others — to invest in downstream projects as well. Nevertheless, looking at the overall picture, as it stands now, it does not appear that the growth in refinery capacity will match demand growth before 2007.

[Slide 16] On top of all this, there has been widespread concern about possible future supply disruptions that may result from increased geopolitical tensions or other causes. These factors — taken together — have been reflected in increased speculation in futures markets, particularly through a rise in activity by non-commercials, notably pension and trust funds, which has, in turn, resulted in a rise in open commitments; both have correlated strongly with the price increases of the last two years. Without any doubt, due largely to the perceived capacity constraints, the market has become very nervous and over-responsive to external impulses.

Let me at this point make a few additional observations about the present higher prices. First, there is no doubt that part of the increased levels is a reflection of a shift in market fundamentals, and, as with any transitional phase, this may not be a totally smooth process — as has, indeed, already proven to be the case in the sensitive market environment of oil. The extent and magnitude of such a shift in fundamentals will become clearer with the passage of time. Undoubtedly, however, widely expressed concern about future supply, again fed and amplified by worries about persistent product shortages in the coming years, is itself putting upward pressure on prices.

On a broader scale, the global economy has so far shown remarkable resilience to the price rises — a fact acknowledged by such financial institutions as the International Monetary Fund. However, we must not be complacent, as signs of an impact on some economies are beginning to appear, especially on emerging economies with large fuel subsidies. And, while this is a matter of much concern to us, we must nonetheless point out that the situation is very different to what it was several decades ago.

[Slide 17] First, in real terms, crude oil prices, although high, are still well below levels reached in the early 1980s. And secondly, the world is decreasingly dependant on oil for its economic growth. Globally, oil intensity — the amount of oil required for a pre-defined unit of GDP — has fallen by around 50 per cent since 1970, due to such factors as technology, improved efficiency, government policies and changing consumer behaviour. This means, for example, that, in the world’s largest economy, the USA, consumers — even with the present high crude prices — are paying an estimated three per cent of their disposable income on gasoline and oil, compared with around 4.5 per cent a quarter of a century ago.

And last, but by no means least — on the subject of prices — it must be stressed time and time again that OPEC does not welcome prices that remain out of line with market fundamentals. These will contain within themselves the seeds of further volatility, and this will be detrimental to the steady flow of petroleum revenue that is essential for investment in domestic socio-economic development, as well as reinvestment in the industry. This is why OPEC goes to great lengths to promote order and stability in the oil market, with secure supply, steady, predictable demand, reasonable prices and fair returns for investors.

[Slide 18] OPEC’s commitment to stability applies equally to the long term. This was underlined once again in Vienna last month, when OPEC’s Ministerial Conference adopted a comprehensive long-term strategy, to provide a coherent and consistent vision and framework to guide our future actions.

[Slide 19] The strategy explicitly recognises the important role of oil in the world economy at large in the future, recalls and delineates further the objectives of the Organization, identifies the key challenges it faces now and in the future, and explores scenarios for the energy scene. In doing so, it covers such important elements as the oil price, upstream and downstream investment, technology, the role of OPEC national oil companies, multilateral agreements and negotiations related to energy, and the relationships with both producers and consumers, as well as with international organisations and institutions.

Regarding oil prices, the strategy builds upon the fundamental recognition that extreme price levels, either too high or too low, are damaging for both producers and consumers, and it points to the need to be proactive under all market conditions. It also re-emphasises OPEC’s commitment to support market stability and, in achieving this, stresses the role of other producers, as well as, especially with regard to the downstream sector, consuming countries. Hence, the dialogue among producers, and between producers and consumers, constitutes a crucial element of the strategy, which recommends that such dialogue should be widened and deepened to cover more issues of mutual concern, such as security of demand and supply, market stability, investment, technology and the downstream, as well as policy.

OPEC’s adoption of such a comprehensive long-term strategy should be highly reassuring for the market at large. This should be especially the case here in the Asia-Pacific, which, as I noted earlier, is already a net importer of energy and is expected to become even more of one in the future, as demand continues its inexorable rise.

[Slide 20] According to our own forecasts at a global level — based on the reference case scenario from the OPEC World Energy Model — world oil demand is expected to continue to rise 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. [Slide 21] During this period, non-OPEC output is expected to reach a plateau of 55–57 mb/d after 2010. This will mean that the call on OPEC oil will increase substantially, with the Organization’s output, including natural gas liquids, rising by more than 70 per cent to 57 mb/d in 2025, compared with 33 mb/d in 2005. By then, according to this scenario, OPEC’s market share will have penetrated the 50 per cent barrier, from around 40 per cent now.

[Slide 22] Even though the numbers involved are very large, the global resource availability is not a constraint. OPEC itself has the reserves to meet the growing oil requirement, to ensure that the market remains well-supplied with crude at all times, at reasonable prices that are compatible with robust growth in the world economy. However, for geological reasons, OPEC will increasingly be accessing reserves that are on the heavier side, and therefore future refineries will have to be designed and equipped to process these into the more highly demanded lighter products. The Organization is committed to maintaining and developing sound investment strategies, and it will see that these are put into effect, in a timely and sufficient manner, to provide the required production capacity for oil that is cleaner, safer and more efficient than ever before. In pursuing such strategies, Member Countries will choose the models of collaboration with the international oil industry that best suit their particular environments.

But there are many uncertainties which make sound investment planning a hazardous business, in an industry where the lead times can be very long and the capital requirements enormous. Future economic growth rates, consumer government energy and environmental policies, technological advances and the oil price path lie at the heart of these uncertainties. Over-investment implies heavy costs to be borne by producers, while under-investment will lead to severe price movements.

Massive sums can be involved in such uncertainty. We can illustrate this by looking at two contrasting, but feasible scenarios recently explored by OPEC. One is a tight market scenario, whose characteristics are similar to what we have been experiencing recently, while the other is a soft market scenario with low demand growth and high non-OPEC supply, and hence low OPEC supply and oil prices. These scenarios show differences of around 10 or 11 mb/d in world oil demand within a decade and a half, and the implications of such uncertainty for investment requirements are obvious. Thus every effort must be made to reduce uncertainties and share the risks involved. As the Saudi Minister of Petroleum and Mineral Resources, HE Ali I. Naimi, said in Johannesburg last month: “The problem we face is not one of availability, but a problem of deliverability.”

All of this is more than just a question of quantity, however. Crucially, it also involves quality. It is necessary for producers everywhere to bring the right type of oil to the market, as and when required. This includes, for example, the production and use of cleaner petroleum-based fuels and the development of technologies that address climate change concerns, such as carbon dioxide sequestration, which, when combined with enhanced oil recovery, could truly lead to a “win-win” situation.

[Slide 23] Excellencies, ladies and gentlemen,

It is the responsibility of all parties in the oil market to ensure its steady, orderly evolution in the opening decades of the 21st century. This should be to the benefit of the world community at large, to people from all nations, rich and poor. Just as oil played a key role in enhancing the development of the industrialised countries in the 20th century, so it should now also support economic growth in the developing world.

Dialogue and cooperation have an important role to play in this, together with a steadfast constructive approach to meeting the challenges that face us in the years ahead. As the OPEC President, HE Sheikh Ahmad Fahad Al-Ahmad Al-Sabah, said in Vienna last month, dialogue is “no longer with just producer and consumer; (it is) with everybody.”

[Slide 24] Thank you.

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