Oil market stability: the role of OPEC

A Speech by Dr. Edmund M. Daukoru, President of the OPEC Conference, Minister of State for Petroleum Resources, Nigeria, to the 28th Oxford Energy Seminar, Oxford, England, 8 September 2006

[Slide 1]
Excellencies, ladies and gentlemen,

Thank you for inviting me to Oxford to deliver this address on oil market stability and the role of OPEC.

Over the past three decades, the Oxford Energy Seminar has carved a niche for itself in the international energy community as a venue for high-level debate, in camera, on topical issues affecting the industry. Without exception, debate at this renowned seminar is fuelled by contributions from politicians, industrialists, academics and other experts of the highest standing and with vast reserves of knowledge and experience, and so I feel especially privileged to be invited to address such an accomplished gathering today.

Indeed, when we look at the present situation in the international oil market — with the high level of price volatility that has characterised it over the past two and a half years — then clearly such fora as this come into their element!

[Slide 2] On several occasions during this period, crude oil prices have reached record highs, and I am sure some seasoned market-watchers in this room are themselves wondering where and when prices will peak, or whether they have done so already.

Our predecessors had similar difficulties with crystal ball-gazing! A quarter of a century ago, some acclaimed international analysts were predicting crude oil prices of US $100 a barrel by the year 2000. Instead, prices collapsed below $10/b in the mid-1980s, less than half a decade later. Similar lows occurred a decade after that, in the wake of the economic downturn in south-east Asia. Even today’s record levels are well below three-quarters of the way towards the predicted $100/b mark!

We are, of course, referring to nominal prices here. In real terms, taking into account inflation and currency fluctuations, prices are still below levels reached in the early 1980s. It is important to be aware of this.

However, while record oil prices may capture the imagination of the public at large, it is, arguably, volatility that is of most concern to the industry.

If the goalposts are constantly shifting — not just from side to side, but also backwards and forwards, and perhaps even up and down! — then it becomes really difficult to both play the game today and to make rational decisions for tomorrow.

As is well known, the volatility, that still afflicts us today, was first widely perceived in the spring of 2004, and this followed several years of relatively high stability, very much encouraged by OPEC’s production agreements of the time.

[Slide 3] The initial reaction was that something strange is happening to the market. Is this just a temporary blip, and, if so, how temporary and how extensive? Or are more fundamental factors at play? If so, what are they and how deep-rooted are they? How long will it take the market to accommodate the new fundamentals and return to a workable equilibrium? At what price level and at what supply and demand level will this workable equilibrium be?

[Slide 4] How should producers — those that have the capability to increase production capacity — react to the new dynamics, in an industry where the upfront investment is large and the lead-times are long? Should they hold their breath a little longer to see how the situation transpires, should they take, so to speak, lightweight actions to tackle a short-term development, or should they adopt rather different measures to handle a more fundamental, longer-term phenomenon? In pondering thus, we must remember that these producers face a huge burden of risk in investing heavily in capacity that may not be needed.

Such issues as these faced OPEC’s Oil Ministers when they met in Vienna on 31 March 2004. To add irony to the situation, this was happening at a time when the market appeared to be well-supplied with crude and the market was moving into the traditional lower-demand season of the year.

Furthermore, we must be cautious here in Oxford today about making judgements with the benefit of hindsight. Our closing press release in March 2004 stated that the “high oil price levels remain predominantly a consequence of long positions of market speculators in the futures markets coupled with a tightening in the US gasoline market in some regions, and exacerbated by uncertainties arising from prevailing geopolitical concerns rather than purely a reflection of supply/demand fundamentals.” It added that “structural problems and bottlenecks (were) affecting the downstream oil industry, which have been contributing to recent price movements.”

We can see here that there have been some shifts in emphasis in analysis carried out since that time about the causes of the volatility in early 2004. For example, more weight has since been placed on the impact of tightness in the downstream sector in consuming countries, which has been very much due to a lack of timely investment and increasingly stringent product regulations. Interestingly, it has emerged that, during the past two and a half years, downstream price volatility has been having a “pull” effect on upstream price volatility, rather than the more usual reciprocal “push” effect of the upstream on the downstream, as one would expect from classical economic analysis.

[Slide 5] Also, subsequent analysis has highlighted the big effect of the unexpectedly high levels of oil demand from the rapidly growing emerging economies in Asia, especially China and India, as well as from the North America. In 2004, global oil demand surged by 3.0 million barrels a day, a level of demand growth not seen since the 1970s.

[Slide 6] Furthermore, the volatility facing the oil industry in spring 2004 had analysts contemplating on its possible impact on the global economy as a whole, due to oil’s leading role in the world energy mix. There was the obvious tendency to compare the rapidly developing situation with that of the 1970s. Subsequent analysis, however, has exposed major differences to three decades ago, with a greatly reduced impact on world economic growth and oil demand. Reasons include much lower oil intensities in consuming countries, higher taxation levels, greater efficiency, a more diverse energy mix and the fact that the transportation sector, with its low price elasticity, now has a much larger share of the international oil market. Fundamentally, the present situation is essentially demand-driven, resulting from the strong economic growth, rather than supply-driven, as was the case in the 1970s.

All of this emphatically underlines the benefit of stability to the oil market and further afield across the global economy, covering all foreseeable time-horizons. Stability begets stability. If stability could be achieved and sustained in its purest, most universal form, then it would clearly be a “win-win” situation for all the responsible parties in the oil industry. But stability must be worked on by those parties for the short, the medium and the long terms.

In addition to this, stability provides another very important benefit to OPEC Member States and other oil-producing countries, particularly those from the developing world, where petroleum export revenue can account for a very large proportion of total export revenue — about 73 per cent, on average, for OPEC in 2005. The revenue oil-producing developing countries receive from oil sales is essential for financing their economic and social development programmes, 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 at all times, so that the optimal benefit can be derived from their finite oil resources and shared among present and future generations.

[Slide 7] This explains why OPEC is so committed to achieving and maintaining market stability, a commitment that goes back to its inaugural meeting in Baghdad in September 1960. OPEC’s very first resolution stated that “Members shall study and formulate a system to ensure the stabilization of prices.” [Slide 8] Several months later, this commitment was enshrined in the OPEC Statute, when it was first adopted in January 1961, and it has remained a key guiding principle of the Organization ever since: “The Organization shall devise ways and means of ensuring the stabilisation of prices in international oil markets, with a view to eliminating harmful and unnecessary fluctuations.”

It has been reaffirmed repeatedly in OPEC documentation over the years, notably in OPEC’s two Solemn Declarations, which concluded summits of Member Countries’ Heads of State and Government in 1975 and 2000, and, most recently, the Long-Term Strategy (LTS) OPEC adopted exactly one year ago. Indeed, the LTS is unequivocal in its views about oil price volatility, saying that this “renders all the more difficult the interpretation of price signals, whether they are an indication of structural change or a reflection of temporary phenomena, and thereby affecting the ability to support longer-term market stability.”

The LTS also emphasises the importance of fair prices, the security of regular supply to consumers and the security of world oil demand. This again elaborates upon the OPEC Statute: “Due regard shall be given at all times to the interests of the producing nations and to the necessity of securing: a steady income to the producing countries; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on their capital to those investing in the petroleum industry.”

[Slide 9] It also brings us onto the important issue of energy security, which is closely linked to market stability and has gained greater prominence on the international political agenda over the past year or so, in the wake of the recent market volatility. Energy security provided the central theme of the Tenth International Energy Forum (IEF) in Doha in April, it features prominently in the European Union’s Green Paper on a European Strategy for Sustainable, Competitive and Secure Energy, and it headed the agenda at the recent G8 Summit in St Petersburg.

Indeed, in the build-up to July’s summit in St Petersburg, there was an International Conference on Energy Security in Moscow in March, followed immediately by a G8 Energy Ministerial Meeting. In OPEC’s official statement to the Ministerial Meeting, we made the point that “the concept of ‘global energy security’ is so fundamental to life in the 21st century that every effort must be made to clarify its meaning, to gain a consensus on this and to ensure that its true principles are embodied in decision-making processes across the energy sector by at least the major players.”

We welcomed the broader-based approach by consuming countries to energy security — as opposed to merely supply security — that emerged in St Petersburg. At the end of the summit, the Chair stated: “We agreed that dynamic and sustainable development of our civilization depends on reliable access to energy. It is best assured by strengthened partnership between energy-producing and consuming countries, including enhanced dialogue on growing energy interdependence, security of supply and demand issues.”

The issue of security of demand is very important to OPEC and other producing countries. Security of demand must go hand-in-hand with security of supply as a means of achieving market stability, since, without the confidence that predictable, reliable demand for oil will emerge, the incentive to undertake the necessary investments can be significantly reduced.

Nevertheless, in spite of these positive developments at the G8 Summit, we feel, in OPEC, that more confidence could have been expressed by the participants at large about the willingness and the ability of oil-producing developing countries to service the growing world energy requirement in the years ahead.

So far, I have endeavoured to explain the importance of stability to the international oil market and the world economy at large, as well as OPEC’s unyielding commitment to achieving and sustaining market stability and security, from which all responsible parties can benefit. Let us now look at how OPEC goes about meeting this commitment.

A good place to start is with the present market volatility, which, as I have already remarked, has persisted for around two and a half years. I earlier tried to illustrate the mindset of OPEC’s Oil Ministers as the new situation began to unravel in spring 2004, referring to the OPEC Conference of March that year.

Let us now move onto OPEC’s next meeting — of 3 June 2004 in Lebanon — noting that, first of all, this was an Extraordinary Meeting of the Conference, rather than one of the Organization’s twice-yearly scheduled Ordinary Meetings, which are usually held in March and September.

[Slide 10] There are several significant points about the closing press release to this meeting. First of all, it contains a qualitative judgement about the market situation, with the text “the Conference noted with concern”. Then there is a reference to reviewing market developments since OPEC’s previous meeting. Next, there is an expression of “OPEC’s commitment to market stability and to maintaining prices at acceptable levels to both producers and consumers.” There is a decision for action, in this case with a two-phase increase in OPEC’s production ceiling in the following two months “to ensure adequate supply,” as well as the convening of another Extraordinary Conference in Vienna seven weeks later “to review market developments”. And finally, there is a call on “all other parties, including non-OPEC producers and consumers, to take appropriate measures to address the challenges facing the industry, including the structural changes.”

This is typical of OPEC’s multifaceted response to market developments of any shape or form and at any time, and examples of this are rife over the decades. It was apparent once again, for example, at the most recent Meeting of the OPEC Conference — in Caracas, Venezuela, on 1 June this year — when “the Conference reaffirmed its determination to ensure that crude oil prices remain at acceptable levels.”

Let me make it clear to this distinguished assembly that OPEC is not comfortable with the present high oil prices. If prices are too high — or, indeed, too low — they are not sustainable and contain within them the seeds of volatility. OPEC has been trying to moderate oil prices, even though our Organization’s influence is limited because the high levels have been due principally to factors beyond its control. In fact, the market has remained well-supplied with crude throughout the present difficult period.

Decisions taken at OPEC Conferences are backed-up by actions from its Member Countries in the ensuing months and beyond. But it must be pointed out here that market developments themselves can change very rapidly, sometimes overnight. Indeed, the very fact that OPEC has taken a particular decision may affect the market in such a way that the grounds for that decision may shift very quickly and affect the most appropriate response OPEC would have to subsequently achieving market stability.

The net result of OPEC’s decisions during the present volatile period is that our Member Countries have increased production by around 4.5 mb/d since 2002. As a result, there have been no actual supply shortages; indeed, recently, stocks have increased to levels above their five-year average in the OECD, particularly in the USA. And, where possible, our Member Countries have accelerated their plans to bring on-stream new production capacity to meet continued demand growth and re-establish a comfortable cushion of spare capacity.

Even though we have had little influence over recent destabilising factors, we believe that the very fact that we are taking such measures sends a strong signal to the market about OPEC’s views on a particular set of events, and that this, in itself, can have a stabilising effect on market sentiment. For example, last year, OPEC’s assurances of healthy supply, accompanied by similar positive expressions from the International Energy Agency, helped prevent the output disruptions caused by Hurricanes Katrina and Rita from developing into a major crisis. Over the past couple of months, OPEC has quickly taken the initiative in providing assurances about adequate crude supplies, after the outbreak of hostilities in the Lebanon region and again after the partial closure of the Prudhoe Bay oilfield in Alaska.

[Slide 11] The result of all this is that, with OPEC’s upstream capacity on course to rise to around 33 mb/d by the end of the year, against an expected average output of 29.1 mb/d for the year, our spare capacity should be at levels that are comfortable for the market. OPEC’s policy has, indeed, ensured that the trend of ample production and sufficient spare capacity will continue for years to come, benefiting producers and consumers alike and enhancing stability.

Furthermore, our Member Countries, although traditionally associated with the upstream, have also increased investment in downstream projects, on their own and in partnership with others. Present estimates show that this will result in at least 2.5 mb/d of additional refinery capacity by 2010, with more being considered. [Slide 12] However, this does not escape the fact that downstream investment is primarily the responsibility of consuming countries, and the indications are that this sector could remain a key source of price volatility for some time to come, with expansion lagging behind demand growth.

[Slide 13] This brings me onto another very important point. It is clear from all of this that OPEC has been doing as much as it can to restore price stability at levels acceptable to the market at large. Other responsible parties have also responded to varying degrees and in accordance with circumstance and capabilities. However, there are some areas where much more needs to be done, and paramount among these is speculation, which has, at times since spring 2004, inflated prices far above fundamental levels, as intuitively surmised by the consensus view among analysts at any one time during this period. Appropriate and sustainable remedial action can — and should, where applicable — involve parties far removed from the day-to-day affairs of the energy industry. But it is absolutely essential that this issue is addressed effectively soon, because speculation is causing so much price volatility and disruption within the market that it is having a serious knock-on effect in areas far removed from the industry itself.

Returning to OPEC’s self-assigned role with regard to market stability, the Organization sees this as not being confined to the present. Equally importantly, it also attends to future needs in an anticipatory manner.

Since the 1980s, OPEC has used its own World Energy Model to construct scenarios depicting possible paths of market evolution extending up to two decades or more ahead, as part of the extensive research activities that take place at its Secretariat in Vienna, Austria. The purpose of this has been to support its Member Countries in handling the many and varied challenges and opportunities they face in the industry.

OPEC shares the view of most analysts that, over the next 20 years, world energy supply will continue to rely primarily on fossil fuels, with oil retaining its leading position, which our latest projections put at close to 40 per cent during this period.

[Slide 14] A reference case scenario forecasts a 30 million barrel a day rise in demand by 2025, to reach 113 mb/d, constituting an annual average increase of 1.5 mb/d. This assumes, among other things, no dramatic changes in energy and environmental policies in consuming countries. The transportation sector will be the main source of future oil demand growth, while developing countries, especially from Asia, are set to account for four-fifths of the rise, with consumption almost doubling to 53 mb/d. However, in 2025, OECD countries will remain the dominant oil consumer and will continue to use, on average, five times more oil per person than developing countries.

[Slide 15] As is widely recognised by knowledgeable and reputable organisations, the global resource base is sufficient to deal with the forecast increases in world oil demand. Estimates of global ultimately recoverable resources for conventional oil have been increasing, due to such factors as technology, successful exploration and enhanced recovery from existing fields. In addition, there is a vast resource base of non-conventional oil to develop.

[Slide 16] In the medium term, non-OPEC supply has the potential to rise substantially, with growth projected at 6 mb/d in the present period of 2005–10. However, this is eventually expected to reach a plateau after 2015, at 58–59 mb/d.

In the longer term, therefore, it is expected that OPEC, with nearly four-fifths of the world’s proven crude oil reserves, will be relied upon to supply most of the incremental barrel of demand. Hence most of the new demand will be met by non-OPEC in the short-to-medium term and by OPEC in the longer term. Our projections in this reference case show that OPEC production levels, including natural gas liquids, would rise to 54 mb/d by 2025, which would be slightly below that of non-OPEC.

[Slide 17] OPEC’s willingness and ability to supply the incremental barrel demonstrates the seriousness it attaches to oil stability and security. However, this is by no means a smooth path. For example, uncertainties over future levels of oil demand translate into a wide range of possible levels of necessary investment in OPEC Member Countries. These are caused, in particular, by uncertainties over world economic growth, advances in technology and policy measures in consuming countries. Even over the medium term to 2010, there is an estimated range of uncertainty of $50 billion for required investment, and this increases to as much as $240 bn by 2020. Thus there is a heavy burden of risk for these countries, with the huge amounts of capital that must be committed up front.

This is why OPEC repeatedly calls for more transparency in the evolution and implementation of policies among consuming countries, so that better assessments can be made to undertake the appropriate capacity expansions and prevent waste of precious financial resources.

All in all, in strict market terms, stability has many dimensions to it, and OPEC sees its role as trying to accommodate these as much as possible.

[Slide 18] But there is more to it than just quantities. There is also the qualitative aspect, addressing the growing need for energy services to integrate better with the broader-based challenges facing mankind, in rich and poor nations alike.

To begin with, there is the issue of the environment. The oil industry has a long history of successfully improving the environmental credentials of oil, addressing concerns of local pollution and improving air quality, and OPEC’s Member Countries have been at the forefront of many exciting new developments over the years. But there is also the need to meet the challenges imposed by possible climate change, where technological options that allow the continued use of oil and gas in a carbon-constrained world must be considered.

One promising example is carbon capture and storage (CCS), applied to large stationary sources of CO2 emissions, such as power stations and industrial sites, which account for over half the energy-related CO2 emissions. CCS can also be used in conjunction with CO2 enhanced oil recovery, which offers a win-win opportunity by not only storing CO2, but also increasing oil reserves in mature fields. If CCS is to be used on a scale that would make a significant impact upon net CO2 emissions, it could develop into a significant business opportunity for the oil industry. However, we also believe that the developed countries should take the lead in the area of providing cleaner oil and gas technologies by promoting large-scale demonstration projects, including the use of the clean development mechanism (CDM) in accordance with the principle of “common but differentiated responsibilities” and respective capabilities.

Clean and safe energy is also a vital requirement for developing countries as they seek access to modern energy services in their often protracted struggle for socio-economic development, sometimes from a state of extreme poverty. Without outside assistance, many appear to have no means of escape from the poverty trap. We are constantly mindful of the fact that poverty eradication is the first UN Millennium Development Goal, and a comprehensive and balanced approach to implementing the three pillars of sustainable development — economic development, social development and environmental protection — is required. Energy security applies to all nations of the world, and the eradication of energy poverty demands urgent attention.

In order to prosper and to benefit mankind generally, these qualitative aspects require as much stability as possible in the world energy market, and this has provided a powerful additional incentive for our Member Countries to work towards this fundamental objective — oil market stability — which, as I noted earlier, was adopted at the very first Meeting of the OPEC Conference 46 years ago, was enshrined in the OPEC Statute shortly after, and has served as one of our guiding principles ever since.

Excellencies, ladies and gentlemen,

In the light of all this, OPEC is optimistic about the prospects for oil market stability in the coming years. But this optimism can only find its full expression through the widespread, practised commitment from the industry as a whole to its achievement and maintenance.

This is why we welcome so much the advances that have been made in dialogue and cooperation in recent years, involving the major players from all sides of the industry, and the steadily increasing institutionalisation of such processes. I have already referred to the IEF, and this specialist ministerial-level producer-consumer body, with its headquarters in an OPEC Member Country, Saudi Arabia, is a prime example of this. The establishment last year of three formal energy dialogues between OPEC and, respectively, the European Union, China and Russia, is another important example, and these have already begun to provide a much clearer understanding of the respective views of the all the parties involved, as well as setting up proposals to jointly examine in depth topical issues of mutual interest.

[Slide 19] Dialogue and cooperation should exist at every level of the industry and in associated areas, such as academia, if it is to be truly effective. The stakes are very high and, as I have endeavoured to make clear throughout this address, we all stand to benefit from sustained stability in this leading sector of the global economy.

[Slide 20] Thank you for your attention.

 

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