Energy for the 21st century: a cooperative approach

A Speech by Dr. Adnan Shihab-Eldin, Director, Research Division, Acting for the Secretary General - Ninth Economist Government Roundtable, Athens, Greece, 18-20 April 2005

Ladies and gentlemen,

Let me begin by thanking the organisers for the invitation to deliver this keynote address to the 9th Economist Government Roundtable.

When we address the theme of the Roundtable — “Envisaging a stronger Europe through its leaders” — it is clear that an essential condition for a stronger — and larger — Europe is a secure, efficient and effective energy system. We are, of course, at the present time witnessing a period of extensive change in the European Union, in the wake of its recent enlargement, and this in itself must be fully accommodated within the energy system, over and above the other developments which have been taking place across the region in recent years.

At the same time, in the minds of some, the recent high oil prices and volatility have focused attention on broader issues of energy security — and such concern has been heightened by the fact that the recent oil price volatility followed a period of relatively high stability, thanks in part to the successful introduction and use of OPEC’s price band concept in 2000–03. This raises the following interesting question: Have we now entered a new era, characterised by much higher prices than in the past?

In such a situation, it is inevitable that thoughts will turn to basic issues and that these will revolve around the acquisition of secure supplies of energy at reasonable prices. In some quarters, this is seen as a battle for energy dominance, which was, in fact, the proposed theme of this address. Envisaged is a future where there is vigorous competition for depleting energy resources around the world, particularly oil and gas. Such anxiety is expressed in the particular context of the huge surge in demand which is being witnessed in key parts of the world at the present time, particularly Asia and most notably China and India, with their huge populations and vast potentials for economic growth. In order to emphasise the true potential of all this for future demand, it is significant to note that they are currently consuming but a fraction of the energy per capita consumed by even the advanced developing countries.

However, we proposed the change of title to the present, more harmonious one of “Energy for the 21st century: a cooperative approach”, because we recognised that there are viable, alternative means of meeting the forecast robust growth in world energy demand — even when this is coupled with a slowdown in non-OPEC supply — if all the key players in the industry take the required measured actions in an orderly and sustained manner. OPEC, for its part, is committed to doing this.

A significant practical consequence of the past extraordinary year is that it has underlined the difficult job of making reasonably reliable forecasts, even for the short term. After all, who can seriously claim to have predicted the events of 2004 with any reasonable degree of accuracy? And yet the events of that year are already being viewed in some quarters as being of possible landmark significance. Are we truly witnessing changes in longstanding trends? Will, for example, average annual oil demand growth remain above two per cent or revert to the historical average of around 1.5 per cent?

To illustrate the difficulties of forecasting, let’s examine snapshots of the pre- and post-2004 situations. I shall compare the forecasts that appeared in the March 2004 issue of OPEC’s Monthly Oil Market Report with the early estimates of what happened that appeared in the March 2005 issue, exactly one year later. In the earlier issue, average annual world oil demand was forecast to rise by 1.4 mb/d in 2004, from 2003, compared with the preliminary estimate of 2.6 mb/d which actually occurred last year. In other words, the actual rise in world oil demand was almost double the expectations of one year ago. However, in spite of this, non-OPEC supply, which was forecast, 12 months ago, to rise by 1.6 mb/d, instead actually grew by less than this amount, 1.4 mb/d. To complete the picture, the difference between world oil demand and non-OPEC supply increased by 1.2 mb/d, rather than decreasing by 0.2 mb/d, as had been forecast in March 2004. A similar situation is unfolding for 2005.

Such difficulties with forecasting have reinforced the case for using scenarios in strategic long-term planning. The strategic planning process normally consists of ascertaining a principal objective or set of objectives, identifying key challenges, specifying the fundamental drivers that will shape the scenarios and describing how each scenario will evolve. The idea is to recognise the principal forces that will influence future behaviour, so as to reduce uncertainty and increase knowledge and the ability to influence the turn of events (scenario) through informed policies and measures aimed at achieving the desired objectives and avoiding undesirable paths.

Any number of scenarios, of course, can be constructed to depict possible future outcomes. However, for practical purposes, analysts usually confine themselves to selecting just a handful, so as to provide a sample of the interesting contrasting possibilities.

OPEC has found it helpful at the present time to envisage the energy outlook in the framework of three scenarios, covering the period up to 2025 and based on its World Energy Model, “OWEM”. We have considered two contrasting and feasible scenarios, depicting protracted market tightness (PMT) and a prolonged soft market (PSM), while the third is a central reference case of dynamics as usual (DAU).

The tighter market scenario envisages a future where the oil market is characterised by high sustained oil demand growth, coupled with relatively low non-OPEC supply growth, resulting in increasingly higher demand for OPEC crude and relatively high prices, and requiring more global cooperation across all fronts. Indeed, the oil price is assumed to remain at levels higher than those observed, even in real terms, since the late-1980s. On the other hand, the soft scenario depicts a future where the identified drivers of change are compatible with relatively low growth in oil demand and relatively high non-OPEC supply, resulting in low OPEC supply and prices. However, both these scenarios, in their extreme limits, are inherently prone to instability, and, under certain circumstances, could have serious repercussions, such as boom/bust cycles.

The central reference case scenario envisages a future where the drivers of change shaping the scenario continue their past patterns, and thus no departure from prior trends is expected. Oil demand grows at robust rates, while non-OPEC supply continues to increase, albeit more slowly, to reach a plateau after 2010. The real price of OPEC’s Reference Basket settles at long-term values similar to those observed in past decades.

Interestingly, there are some significant similarities in the features to those formulated by Shell, even though the latter’s set of three scenarios for the same period is constructed in a very different way and is based on the principle of plausible trade-offs between diverse, complex objectives. Shell’s approach to this mirrors very closely our own understanding of the key drivers that need to be noted and accommodated. In particular, Shell’s open doors scenario, where the emphasis is placed on strong, synchronised economic growth, efficiency and social cohesion, has broad similarities to OPEC’s tighter market scenario, where a readiness for cooperation and collective responsibility is central.

Over the past year, the market has moved in the direction of OPEC’s protracted market tightness scenario. However, we are still some distance from the alarming extreme variants of this scenario, which could lead to an eventual collapse into the soft market scenario, where a “battle for energy dominance” could be foreseen. Indeed, the present situation is very manageable, and well-intentioned, responsible collective actions from across the industry can ease the tightness, while maintaining robust global economic growth, in accordance with the more comfortable pattern depicted in our reference case scenario.

Let us now look more closely at the reference case scenario, in the context of OECD Europe. This sees an average annual growth rate of energy demand in OECD Europe of 0.3 per cent in the period up to 2025, which compares with a global rate of 2.0 per cent.

There is little doubt that oil will retain its leading role globally, including in Europe, for the foreseeable future. For practical purposes alone, its combination of qualities still cannot be matched by any other energy source — sufficiency, accessibility, versatility, ease of transport and, in some applications, few alternatives. Advances in technology are making oil a cleaner, safer and more efficient fuel, so that it can meet increasingly tighter environmental regulations, as well as conforming to the broader demands of sustainable development.

While oil demand will continue rising in Europe, its average annual growth rate will be slightly below that of energy as a whole in 2005–25, at 0.2 per cent, and its share of the region’s energy mix will dip from just above 41 per cent to just below it by 2025.

Gas producers share many of the challenges of oil producers — and some OPEC Member Countries are also substantial gas producers. Demand for gas is forecast to rise faster than that of oil, although from a lower base. Average annual growth will be 1.1 per cent and the share of the energy mix will climb from 24 to 28 per cent. This is the source of commercial energy that is most favoured by environmentalists, as well as being a reliable and highly efficient source of power generation. Production costs are coming down too. But the transportation of gas remains expensive, in spite of the big advances that are being made with liquefied natural gas, which are expected to turn it from being a regional to a global fuel. As with oil, there is plenty of gas around.

With regard to the other commercial primary energy sources, solids — principally coal — are forecast to witness a continued decline in demand, which will be reflected in its share of Europe’s energy mix, which will fall by almost three percentage points to 14.5 per cent between now and 2025.

Despite widespread calls within Europe for a diversification of energy sources and a growing use of renewables, benefiting from the imposition of policies to promote this and enjoying wide public support, the reality is that the overall contribution of renewables is expected to remain small during the next 20 years. Even though high — and, in some cases, double-digit — growth is likely, this will be from a very low base, and it will be many decades before renewables make a really significant impact on the energy scene in Europe. There is a similar very long-term profile with regard to notable increases in the use of nuclear and, then, this may come in the form of fusion, to generate electricity and hydrogen for transportation fuel.

Collectively, in the next two decades, while the use of hydro, nuclear and renewables will grow a little in absolute terms, its share of OECD Europe’s energy mix will dip from just above 17 per cent to just below it by 2025, according to our reference case scenario.

Nevertheless, in spite of all this, there will be plenty of time for all of us to make the necessary energy transition in an orderly manner, benefiting to the full from the use of fossil fuels, with due attention to environmental concerns, in particular for developing countries.

I shall now concentrate my remarks on oil, since this is where OPEC’s focus lies and since oil is the leading sector both in quantitative terms and in the eyes of most energy decision-makers, because developments in the oil market have an influence over other energy-carriers.

When we look at oil market projections for OECD Europe for the next two decades, one clear message emerges — the huge and growing difference between oil demand and supply within the region. According to our projections, demand of 15.6 mb/d in 2005 is set against supply of 6.1 mb/d. Over the next 20 years, while demand will continue growing — albeit very slowly — to 16.3 mb/d, supply will fall — and fall heavily — to 3.3 mb/d in 2025. Put another way, while supply now accounts for 39 per cent of demand, in 20 years’ time it will be down to just over half this proportion, 20 per cent. Thus, there will be, inevitably, a greatly increased reliance on outside sources of oil.

The situation, indeed, is much more acute in China and non-OECD Asia. In China, according to our reference case scenario, average annual oil demand will double in the next two decades, from 6.7 mb/d now to 13.4 mb/d in 2025 — but supply will remain the same, at 3.5 mb/d. In Asia, excluding the Middle East, demand will more than double in the same period, from 7.4 to 15.5 mb/d, and supply will actually dip slightly, from 2.5 to 2.4 mb/d.

Let us now look at the situation globally, drawing a distinction between OPEC and non-OPEC supply. Our projections show a strong rise in world oil demand over the next two decades, from 81 mb/d now to 115 mb/d in 2025, but only a small increase in non-OPEC supply in the same period, from 51 to 56 mb/d. Indeed, non-OPEC supply reaches a plateau in around a decade’s time. Again, while non-OPEC accounts for around 63 per cent of world output in 2005, this proportion will dip below 50 per cent 20 years later. Thus the world will come to really much more heavily upon OPEC oil in the future, since its Member Countries hold around four-fifths of prove global crude oil reserves.

However, there should be plenty of oil around for decades to come. It is OPEC’s firm view that the world’s oil resource base is not a constraint, with regard to meeting future demand. If we look at cumulative production, as a percentage of the estimated resource base, over the past four decades, we see that it has been relatively stable, and this is likely to remain the case for the foreseeable future. Over and above the world’s proven crude oil reserves, there is still plenty of oil that has yet to be discovered, in regions whose geological structures suggest a high probability of commercially viable reserves. This is particularly true for OPEC areas.

In contrast, while the international oil companies were reporting, up to not-so-long ago, that they were able to add to new reserves in non-OPEC areas at a greater rate than the depletion of existing ones, this no longer appears to be the case.

Also, it must be remembered that the current share of crude oil in total oil supply is around 84 per cent, with the rest consisting mainly of synthetic crudes, processing gains and such non-crudes as natural gas liquids. However, over the next ten years, in spite of the continuing forward march of technology, no dramatic change is expected.

OPEC’s Member Countries will, therefore, need to expand their oil production capacity to meet the extra demand for crude. The scale of investment required for this will run into many billions of dollars in the coming decades, although, globally, it will not be very different to past investment. However, investment in OPEC areas yields more than a fourfold multiple, in terms of production capacity, compared with the same level of investment in non-OPEC areas.

Nevertheless, the exact magnitude is subject to large uncertainties, in the shape of, for example, future economic growth rates, consumer government policies and technological advances. To explain the significance of this, let me point out that, if economic growth turns out to be just one per cent lower than what is assumed in our reference case, already by 2010 an estimated uncertainty of $25 billion for required OPEC investment will have emerged.

Moreover, it can prove very costly if we do not get our sums right. Over-investment may result in excessive, idle capacity, while under-investment may lead to a crude shortage. Both cases could create serious price volatility.

Now, for those people who feel uncomfortable about the size of OPEC’s role in all of this, especially with regard to the so-called battle for energy dominance, let me state the following.

Market order and stability are as much in the interests of producers as they are of consumers. This is especially the case for producers from the developing world. The economic fortunes of OPEC’s Member Countries are heavily dependant upon their oil revenues. In 2003, for OPEC as a whole, oil export revenue as a proportion of total export revenue averaged 68 per cent. The receipt of steady, reasonable levels of revenue helps these countries develop and diversify their economies through investment in physical and social infrastructure, to set them on the path to sustainable growth.

Furthermore, OPEC recognises the powerful symmetry that exists in the oil market, in that a steady, predictable inflow of oil revenues now contributes towards providing the funds required for investment in future oil production capacity, to enable secure, stable supplies for consumers in the years ahead. This, in itself, should dismiss the idea of a battle for energy dominance. Also, the international community is increasingly aware of the importance of stabilising the prices of all primary commodities, to avoid harmful volatility.

These factors alone demonstrate why OPEC is committed to the achievement of order and stability, with reasonable prices, secure supply, predictable demand and fair returns to investors. These are, indeed, all objectives that find expression in the OPEC Statute that was drafted shortly after OPEC’s establishment in 1960 and that have provided the guiding principles for our actions ever since. Moreover, they have as much validity today as they did four decades ago. They are manifested in OPEC’s decisions and actions and, most visibly, in its market-stabilisation measures.

Such measures are necessary because, in the final analysis, the oil market is inherently volatile — as has been demonstrated repeatedly in the past and was particularly apparent in 2004 — and this is the exact opposite of what is required from a commodity that has such a central role to play in the modern world. There is a pressing need, therefore, to maintain order and to stabilise prices, so as to ensure efficiency and security of supply, for both now and the future. In reaching our agreements, in a transparent manner and after careful consideration of the prevailing market outlook, we have the welfare of both producers and consumers in mind, as well as that of the global economy at large. Thus all responsible parties in the market stand to benefit from their success.

On the other hand, we are not miracle-workers. Oil prices are — and will remain — subject to a wide range of influences, and some of these are highly unpredictable in nature and beyond OPEC’s control — again, I refer to 2004, when, as a result of this, OPEC’s market-stabilisation measures were less effective than usual. However, we are constantly monitoring market developments, and the many years of experience we have had in the oil market have enhanced our ability to respond to sudden, unexpected turns of events in a timely and appropriate manner.

Nevertheless, to achieve the maximum effectiveness in this, we require the full cooperation and support of the other leading parties in the industry. There has been much welcome progress in this regard in recent years, on both a bilateral and multilateral basis.

In the context of Europe, the EU and OPEC announced earlier this year the launching of formal dialogue at a senior level. This would revolve around the interdependence between our two groups, with regard to the oil market and the flow of goods and services, and the fact that the EU is OPEC’s main trading partner. It was proposed that the scope of the dialogue would entail expanding cooperation, exchanging information and exploring the possibility of holding joint activities and technical meetings. This would come on top of the fruitful contacts that already exist among Members of our two groups, for example, the Euro-Mediterranean dialogue and the EuroGulf Dialogue for Energy Stability and Sustainability, which was launched in 2002 with the objective of enhancing cooperation between the EU and the Gulf Cooperation Council.

Let me close by looking at the current situation in the world oil market.

As you know, nominal oil prices reached record levels for OPEC’s Reference Basket earlier this month, $52.93/b, and this exceeded previous highs that were recorded six months earlier. We put the high prices down to mainly: continued strong oil demand, led by a solid world economic performance; the late and lasting cold spell in the Northern Hemisphere; increasing market anxiety over forward capacity tightness, coupled with geopolitical tensions; and the expectation of the strong demand outstripping non-OPEC supply growth in the medium term. The resultant bullish bias has been exacerbated by the rising activity of non-commercials, in particular pension and index funds, leading to further upward price spirals.

Nevertheless, global oil supply — particularly OPEC output — remains adequate to meet expected demand. Indeed, supply was ahead of for most of 2004, resulting in a tangible OECD stock-build that will continue in the second quarter of 2005.

Our latest forecasts show average annual world oil demand rising by 1.9 mb/d to 84.0 mb/d in 2005. However, non-OPEC supply — which includes OPEC natural gas liquids and non-conventional oils in this analysis — will not keep pace with this, with a projected increase of only 1.2 mb/d, to reach an average of 54.9 mb/d. This means that there will be a difference of 29.1 mb/d for OPEC crude to fill.

During the course of this year, average OPEC production capacity is expected to rise to 32.7 mb/d, as additional projects are brought on-stream, including those that began at the end of 2004, in response to the tight market conditions. Indeed, the bulk of this is expected to be ready by the second half of 2005, and it includes a range of light, medium and heavy crudes.

In proportionate terms, OPEC’s spare capacity, which, at one stage, dipped to around five per cent in 2004, now stands at more than 2 mb/d, or eight per cent, and is expected to exceed 3 mb/d by year-end. Thus, we should be looking at spare capacity levels of around ten per cent — interestingly, this reflects the experiences of much of the past ten years or so.

Peering a bit further ahead, OPEC is committed to expanding capacity above this level, and present expectations are for the addition of another 3.5–4.0 mb/d between 2006 and 2010.

This should allow prices, overall, to continue to moderate, as the oil market returns to a situation of improved stability, such as we had earlier in this decade. And, while it is difficult to know, at present, the corresponding price range for the short-to-medium term, I believe we are likely to see the price of OPEC’s Reference Basket settling above a minimum of $30/b — to ensure adequate investment — but below the level that would begin to have an impact on global economic growth or induce irreversible and undesirable policy-response measures. Given historical trends, it is hard to imagine an upper end much above $50/b for West Texas Intermediate in real terms — notwithstanding some hopefully infrequent price spikes here and there.

Therefore, we are confident that the market will continue to be well-supplied with crude throughout this year and well into the future, to support the robust economic growth that is expected during that period in both the developed and developing worlds.

Thank you.