The challenge of sustaining economic growth and the expanding energy needs of Asia: the role of OPEC

A speech by Dr Adnan Shihab-Eldin, Director, Research Division, Acting for the Secretary General to the 8th Annual Asia Power Conference, Singapore, 1-4 March 2005

[Slide 1 - Title]

Excellency, ladies and gentlemen,

Thank you for inviting me to deliver this keynote speech to the 8th Annual Asia Power Conference, on the subject of OPEC’s role in meeting the challenge of sustaining economic growth and the expanding energy needs of Asia.

But, before beginning the speech, let me express, once again — on behalf of OPEC, its Member Countries and all its officials across the world — our deep sorrow over the tragic events of 26 December 2004, as well as our heartfelt wish for a full and timely recovery in the parts of this continent that were devastated by the tsunami. The terrible personal losses and suffering have created wounds that will last for many years, and we offer our compassion and prayers to all those who have lost family and friends, as well as an entire way of life.

Let us now turn to the theme of this address.

With Asia consisting of many rapidly expanding economies and possessing more than half the world’s population, the region is a key player in world markets for commodities, manufacturing and services. There is no doubt that its accelerating integration into the global economic system is offering more opportunities than ever for international trade and commerce, bringing health and prosperity to the Asian people and helping reduce poverty. Stable world markets for commodities — in particular, energy — are therefore of major importance. Asia has now become, in short, one of the main engines of growth for the global economy.

OPEC, for a long time, has recognised this and has sought to ensure that Asia’s rapidly growing oil needs will be met to the full, both now and in the future. Indeed, the region’s economic development is crucial to growth in the international oil market. We recall the events of 1997–98, when the Asian financial crisis and economic downturn were followed by a steep decline in world oil prices. Starting in 2003 and more pronounced last year, we experienced a movement in the opposite direction, when unexpectedly high levels of oil demand from China contributed to putting significant upward pressure on international prices. Therefore the challenge of smoothly and reliably meeting the region’s steadily rising energy requirement must not be under-estimated, and must be catered for at all times.

OPEC demonstrated last year how quickly and effectively it can respond to unexpected and sometimes very sudden changes in the market’s behaviour and performance. Our Conference of Oil Ministers met on five occasions during the course of 2004 — three Extraordinary Meetings, in addition to the two regular half-yearly ones — to review the current state of the market and to adjust our production target accordingly, in order to alleviate conditions that were already volatile and extreme, or were threatening to become so in the near future.

[Slide 2] Two thousand and four was indeed an unusual, if not unique, year for the oil market. It followed four years of relative stability, much of which was due to the successful operation of OPEC’s price band of US $22–28 a barrel. Prices rose steeply in 2004, so much so that the OPEC Reference Basket price hit a record high of $46.6/b in mid-October; at the same time, West Texas Intermediate rose above $56/b, also a record. This was all a result of an exceptional combination of factors.

[Slide 3] To begin with, there were higher-than-expected levels of oil demand growth, particularly in China and the United States of America; these, in turn, reflected strong growth patterns in the world economy, where estimates for the year were being repeatedly revised up. The latest estimate of 5.0 per cent compares with the forecast of 4.1 per cent made in December 2003 and is the highest annual rate since 1976. [Slide 4] China alone accounted for almost a quarter of the rise in world GDP in 2004. [Slide 5] If we look at the developing countries separately, excluding China, we see that Asia accounted for just over a half this large area’s annual increase in GDP, and India, separately, one-fifth.

[Slide 6] China has recently become the world’s second-largest oil consumer, with remarkably high rates of demand growth over the past decade.

[Slide 7] Other exceptional pressures on the international oil price in 2004 were: refining and distribution industry bottlenecks; natural and man-made temporary supply disruptions; and geopolitical tensions. Compounding the situation was heavy speculation in futures markets. But the remarkable thing was that all this happened during a year when the market always remained well-supplied with crude; indeed, there was never any occasion when there was a shortage!

OPEC’s series of Conferences saw us increase our official production target by a total of 3.5 million barrels a day, resulting in an average rise of more than 2 mb/d from the year before. This contributed significantly to the subsequent easing of oil prices, with the Basket being close to a more moderate $35/b for much of December. At the same time, commercial OECD stocks built to around their five-year average. [Slide 8] Moreover, after OPEC’s spare capacity dipped to around five per cent, some of our Member Countries sped up the implementation of their capacity expansion plans, so as to enhance the Organization’s ability to cope with possible future supply disruptions. [Slide 9] OPEC’s spare capacity now stands at more than 2 mb/d, or eight per cent, and is expected to exceed 3 mb/d by year-end.

[Slide 10] However, at the beginning of this year, prices resumed their increase, with the Basket climbing past $40/b by the second week of January; it dropped below this level a little later, before rising above it again, and it is now approaching last October’s high levels. The rise has been due mainly to the expected seasonal increase in demand in the first quarter, but there have also been supply concerns, following disruptions in the North Sea, the Gulf of Mexico and Iraq. Nevertheless, global oil supply — particularly OPEC output — remains adequate to meet expected demand.

After careful consideration at our most recent meeting in Vienna, on 30 January, we temporarily suspended the OPEC price band, because the recent market developments had resulted in price levels that had rendered the limits of the band — $22–28/b — unrealistic and ready for re-evaluation, and this is now underway.

When our Conference next meets, in the Islamic Republic of Iran in two weeks’ time, we shall review the prevailing market outlook, to see how it matches up to expectations for the second quarter of the year, when demand traditionally declines. In the meantime, OPEC will continue to closely monitor market developments.

Two questions are often being asked at the present time.

[Slide 11] The first is: “Are high oil prices here to stay?” The extent to which the changes in the oil market have been of a transient or cyclical nature, or whether, in fact, they will be more lasting, is unclear at the present time.

With regard to the near-term future, one key focus of attention concerns the prospects for future economic growth and hence oil demand growth. The cyclical nature of economic activity suggests that the current exceptional rates of economic growth cannot continue indefinitely. There is increasing concern over growing imbalances, especially in the light of the large twin deficits of the United States of America, with the potential associated risks to financial stability and world economic growth.

Here in Asia, the spotlight is on both China and India, due to their high levels of growth in 2004.

[Slide 12] In China, the authorities’ efforts to slow the economy over the past nine months have had some success, although the slowdown in industrial activity has been moderate so far; however, fiscal and monetary policies are expected to tighten in 2005. Early forecasts see a halving of the rate of oil demand growth, although this will be from an extremely high average level of 17 per cent in 2004 to a still-high level of nearly eight per cent this year.

In India, GDP growth is forecast to rise slightly to 6.5 per cent in 2005, compared with a provisional estimate of 6.0 per cent last year. Like many other countries in the region, India suffered heavily from the tsunami, but the effect of this on the country’s overall GDP is likely to be minor, according to initial reports. Conversely, one must observe that the Japanese economy has officially gone back into recession for the fourth time in a decade, although there is optimism about the country’s prospects later in the year.

In the oil sector, the new requirement to adopt stricter product specifications in Asia, in addition to those already in force in Europe and the USA, could again focus price pressure on light sweet crudes, possibly triggering a substantial widening of the spread between sour and sweet grades, as was seen in the international market in the second half of 2004. As OPEC seeks to maintain oil market stability during the course of this year, the potential for such a development arising would need to be taken into consideration.

These issues come on top of the continuing uncertainty over the duration and intensity of some of the other destabilising factors that had such a negative impact on the market last year, and to which I referred earlier.

[Slide 13] However, I think it is important, at this point, to put the present price levels in their proper historical context. Today’s prices, although high in nominal terms — and record-breaking last autumn — are less than half the levels witnessed 20 years ago, in real terms. This is when we take into account inflation and exchange rate movements. In other words, the average nominal price of around $36/b for the Reference Basket last year would, in real terms, correspond to a price of $80/b in 1982. This is in spite of the fact that oil demand is now much higher and the world — that is, the richer part — much wealthier! [Slide 14] Another way of looking at this is to examine the impact of inflation and exchange rate changes on the now-suspended price band, and this shows, by the end of 2004, the upper band exceeding $36/b.

[Slide 15] Now, this is very important when we address the second of the two questions: “How will high oil prices affect world economic growth?”. Intuitively, with real prices being so much lower now, we are already in a much more favourable position, in this respect, than we were about a quarter of a century ago. But the realities cut deeper than this.

Indeed, if there is one lesson we have learned from the exceptional oil market conditions of 2004, it is that the world economy has become less sensitive to oil price increases than it was two or three decades ago. The strong growth of the global economy last year, in the face of rising oil prices, clearly supports this statement.

A very important aspect here is oil intensity — that is, the amount of oil that is required for a pre-defined unit of real growth in GDP. Across the world at large, this has fallen by around 50 per cent since 1970. More precisely, our figures show that, on average in 1970, 1.20 barrels of oil were required for an increase in world GDP of US $1,000, using purchasing power parity and 1995 as the base year for GDP. This compares with exactly half this figure — 0.60 barrels — in 2003. Indeed, the figure has been falling steadily since the mid-1970s. Thus the world is decreasingly dependant on oil for its incremental economic growth.

The reasons for this fall in oil intensity relate to such factors as leaps in technology, improvements in efficiency, government policies and changing consumer behaviour, especially as advanced societies progress from an industrial base to a service sector base. Of course, the situation is somewhat different for those societies that are at an early stage of economic development and are moving from agriculture to industry — but even they can benefit, in the process, from the huge advances that have been made in technology and efficiency in recent decades.

How do the analysts see the situation?

While studies in the 1970s suggested that a ten per cent rise in the oil price would reduce economic growth in industrialised countries by 0.2–0.8 per cent, with many estimates clustered around 0.5 per cent, the equivalent percentage impact on economic growth is now widely considered to be about 0.2 per cent. More specifically, it is felt that the $6/b increase in the quarterly average Basket price that has occurred since the second quarter of 2004 might reduce the growth rate of the world economy in 2005 by about 0.3 per cent. Nonetheless, we should not be — and, indeed, we are not — complacent about the potential for higher prices in the future to affect economic growth.

OPEC’s awareness of these issues goes hand-in-hand with its appreciation of other underlying realities that affect day-to-day operations in the oil market, as well as the market’s ability to meet the challenges that it will face in the future.

The actions we took in the difficult conditions last year demonstrated once again our longstanding commitment to ensuring oil market stability, to the benefit of producers and consumers alike. Secure supply, reasonable prices and fair returns to investors have all been central objectives of our Organization, since it was founded in Baghdad nearly 45 years ago.

OPEC cannot act alone, of course. We require support from other major parties in the market and industry — non-OPEC producers, the international oil companies, financial institutions and, in a generic sense, consumers. When such support has been forthcoming — and there have been welcome big advances in this area since the mid-1980s — it has added significant bite to our market-stabilisation measures.

Such support, however, should not be limited to crisis management. Everyone — or nearly everyone! — will rally round in a crisis, when there is excessive volatility or prices are extremely high or extremely low. But it is equally important to maintain this unified stance on sunny days too! Throughout its history — and this is probably due to the central role oil plays in the day-to-day lives of people in the dominant consumer nations of the world — the oil market has been inherently volatile in nature. It can get out of line very quickly, if left to its own devices. Sunny days can quickly become stormy days! And this is detrimental to both consumers and producers. Therefore it is necessary for all responsible parties to maintain constant vigilance, and be prepared to act, as and when necessary, if they want to maximise the sunny days. Indeed, timely, collective, preventive measures, taken when the first dark clouds appear on the horizon, can work wonders.

Here I am referring to more than just the near term. In OPEC, we are also deeply committed to the industry’s future welfare. Let us, therefore, look at the reference case from OPEC’s World Energy Model, to see how the situation may develop in the oil market in the first quarter of the 21st century.

[Slide 16] Our projections are based on an average annual world economic growth rate of 3.5 per cent for the period up to 2025. The forecast rate of almost 5.0 per cent for the developing countries will be double the OECD’s projected 2.4 per cent.

[Slide 17] In line with this, global oil demand will rise by 28 million barrels a day to 111 mb/d by 2025 — an annual average growth rate of 1.5 mb/d. OECD countries will continue to account for the largest share of world oil demand. [Slide 18] However, four-fifths of the increase in demand over the next 20 years will come from developing countries, whose consumption will almost double. Asian countries will remain the key source of oil demand increase in the developing world, with China and India central to this growth.

[Slide 19] The transportation sector will account for almost 60 per cent of the rise in global oil demand over the next two decades. This will amount to nearly all the growth in the transition economies, more than four-fifths in the OECD and close to half in the developing countries, [Slide 20] given that vehicle intensities are lower by more than the order of magnitude.

Turning to supply, let me start by saying that the world can rest assured that there should be plenty of oil around for decades to come. The world’s oil resource base should not be seen as a constraint, in meeting future demand.

[Slide 21] Our projections for the period up to 2025 show that overall non-OPEC output will continue to increase, but more slowly, reaching a plateau of 55–57 mb/d in the post-2010 period. This represents a rise of 5–7 mb/d from 2004, although the eventual scale of this future expansion is subject to considerable uncertainty. The key sources for the increase in non-OPEC supply will be Russia, the Caspian, Latin America and Africa.

[Slide 22] If we look at the oil market forecasts for Asia specifically for the next decade and a half, we see a substantial increase in the continent’s net oil import requirement [Slide 23], since, while oil demand growth will gallop along at an average annual rate of 2.7 per cent, the situation for supply will be minimal, at 0.6 per cent. Asia’s net oil import requirement will, in fact, grow at an annual average rate of 0.71 mb/d across the region, according to this scenario. For China, the average annual rate of oil demand growth will be one percentage point higher than that of Asia as a whole, 3.7 per cent.

World electricity demand — the main focus of this conference — with its very strong link to economic growth, will continue to display higher rates of growth than total energy demand, attributing much of the increment to developing countries. While annual electricity demand growth in developing countries as a whole is forecast to average around 4.6–5.1 per cent during the next two decades, the Asian economies are expected to have the highest rates.

[Slide 24] Oil, in absolute terms, is forecast to retain its modest contribution to global electricity generation, at around 6 mb/d, but with a gradual decline in its share from eight per cent to around five per cent in 2020.

[Slide 25] Nevertheless, oil does play a significant role at peak load times or when there is an unexpectedly strong demand surge, as we have been witnessing in China recently, with the jumps in diesel demand of around 300,000 b/d and 500,000 b/d in the last two years.

Thus, in the light of all this and returning to the global outlook, OPEC will be called upon increasingly to supply the incremental barrel. OPEC has both the capability and the will to do this. Around four-fifths of the world’s proven crude oil reserves are located in OPEC’s Member Countries. Moreover, these reserves, which are mostly on land, are more accessible and cheaper to exploit than those in non-OPEC areas. In 2025, the reference case sees OPEC meeting almost half the world’s oil demand, at 49 per cent, with 55 mb/d.

[Slide 26] To provide the required production capacity in a timely and sufficient manner will involve the use of sound investment strategies. Investment is needed: to meet the forecast absolute increase in demand; to replace natural declines in production; and to ensure that oil producers always have sufficient spare capacity available to cope with sudden, unexpected shortages in supply. Also, the oil must be cleaner, safer and more efficient than ever before, and this will aided by continued steady advances in technology.

[Slide 27] The required global investment will be large, although it will not necessarily be different in magnitude to that observed in the past. Moreover, the cost of investment in OPEC oil is much lower than in non-OPEC oil, yielding more than a fourfold multiple, in terms of new production capacity for the same level of investment.

[Slide 28] However, when we look at the future, we find ourselves facing a wall of uncertainty, making it very difficult to produce meaningful forecasts that will help us with our investment plans, even for the short and medium terms. This is partly due to the wide range of feasible demand growth scenarios, but it is also reinforced by contrasting views on the potential evolution of non-OPEC production, as well as future costs. Uncertainties over future economic growth, government policies and the rate of development and diffusion of newer technologies are among the main factors that lie behind this.

Let us not forget that over-investment may result in excessive, costly, idle capacity, leading to downward pressure on prices, while under-investment may result in a shortage of crude and higher prices. In both cases, the losses, especially for producing countries, and the possible, broader associated damage, such as to the world economy, can be significant.

[Slide 29] To illustrate just how significant uncertainties can be to investment plans, if we return to our scenarios and reduce our global economic growth projections by just one percentage point, we will find that this will lower the investment requirement for 2010 from a reference case $95 bn to $70 bn — which is a big difference. In 2025, the gap will be a massive $124 bn.

Now it is impossible, of course, to predict at this stage whether the eventual outcome will be closer to our reference case scenario than to a low- or high-economic-growth scenario. But we do believe that, if there is a variance, it is more likely to be on the downside, rather than the upside. This would then have a serious impact on the revenue expectations of our Member Countries in the years ahead, adversely affecting their development and investment plans.

All of this places a premium on consistency, transparency and certainty within the international oil community — as well as a broad-based, equitable approach — when it comes to planning for the future and doing so in a manner that is in harmony with the requirements of the global economy.

[Slide 30] The industry, therefore, is much better-off if there is an underlying consensus on the means of handling the major issues of mutual concern — such as price stability, security of demand and supply, investment, environmental issues and sustainable development.

This is why we welcome and encourage the big advances in producer/consumer dialogue and cooperation that have occurred across the industry in recent years, with much of the impetus coming from Asia.

Less than two months ago, the first Round Table of Asian Oil and Gas Ministers was held in New Delhi, under the umbrella of the International Energy Forum Secretariat. [Slide 31] This constituted an important step forward in dialogue in the fastest-growing region of the global economy. The meeting concluding that cooperation between Asian producers and consumers was crucial to ensuring stability, security and sustainability through mutual interdependence in the region’s oil and gas economy.

The Forum itself has been highly successful over the past dozen or so years as an inspiration for, and organiser of, producer/consumer dialogue, and its permanent Secretariat is now set up in an Asian country, Saudi Arabia, which is a Member of OPEC. We also engage in annual dialogue with high-level energy officials and research institutes from China, Japan and South Korea, while the most recent in a series of joint meetings among OPEC and non-OPEC producers was held in Oman last October. Another notable development in this direction is the agreement to launch, as of this year, a formal EU-OPEC dialogue on a biannual basis, to further constructive cooperation on energy-related issues.

OPEC welcomes all these developments, as being indicative of a strengthening within Asia of the process of dialogue and cooperation, that is so important for the continuing healthy evolution of the oil industry in the early 21st century. Coming from deep within the heart of the fastest-growing economic region of the world, this inspires all of us with confidence about the future of the industry.

[Slide 32] Thank you.

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