Global Oil Outlook to 2025

Address by Dr. Hasan M. Qabazard, Director, Research Division, to the Annual General Assembly of the International Chamber of Commerce – Vienna, Austria, 22 June 2006

[Slide 1] Ladies and gentlemen,

Let me start by thanking Dr Richard Schenz, the President of the International Chamber of Commerce (ICC) in Austria, for inviting me to address this Annual General Assembly here in Vienna. OPEC appreciates the importance of sharing its views with business leaders, such as those of you here this evening, and given that Vienna has been the location for the OPEC Secretariat since 1965, it is always pleasing for myself, or any OPEC representative, to address a gathering in the Organization’s home city. A short train journey is also greatly preferable to an airport check-in and a long flight!

The topic I have been asked to focus on today is the ‘Global Oil Outlook to 2025’, which offers me a broad remit of topical oil industry discussion points. However, I am conscious that this gathering is representative of the ICC; the voice of world business championing the global economy as a force for economic growth, job creation and prosperity. So I will look to interweave some of the issues directly relevant to the ICC and the audience before me.

I am sure that, if I opened the floor to questions, the first one for many of you would be: why are oil prices at their current level? It is a topic that has provided journalists with many column inches and I am sure it has been much discussed amongst business leaders the world over. Therefore, let me begin by addressing the price issue.

[Slide 2] It has been well documented that energy prices have risen to unexpectedly high levels over the past three years. In June 2003, the OPEC Reference Basket price stood at approximately $27 a barrel, but today it has risen in nominal terms to about $65 a barrel. I would like to point out, however, that in real terms, prices have been lower than the levels seen in the early 1980s, when the OPEC Reference Basket — projected backwards — reached over $85 a barrel in today’s prices. In the gas market too, prices have risen considerably over the past three years and I understand this has been a significant concern to many European Union (EU) countries. It should also be noted that over the same period there has been a strong increase in non-energy commodity prices, sometimes at rates greater than that of oil. This fact is often overlooked.

[Slide 3] With recent oil prices in mind, what I would like to point out is that for the last two years the oil market has been very much out of kilter with what has gone before. Prior to 2004, there was a relatively simple rule of thumb. If commercial stocks in consuming countries, particularly OECD countries, were high, then prices would generally fall. If these stocks were low, then the opposite was normally true. This rule of thumb is part and parcel of what the industry terms ‘the oil market fundamentals’. This was very much in evidence seven-to-eight years ago when petroleum-exporting countries suffered from very low oil prices, due in part to high levels of OECD commercial stocks. During that period the OPEC Reference Basket Price fell below $10 a barrel.

[Slide 4] Today the level of OECD commercial stocks is also high, in fact at a five-year peak, yet as we all know the price of oil remains on the high-side. It begs the question: what are the key drivers impacting the recent oil price rises? The movements have in fact been influenced by a convergence of factors: the exceptionally strong economic growth and, in turn, oil demand growth, with a global increase of 5.4 million barrels a day (mb/d) over the three years to 2005; tightness in the downstream refining sector, where utilisation rates have exceeded 90 per cent in most regions; speculative behaviour – indeed, contract volumes for crude oil on the NYMEX have almost doubled since 2003; as well as additional issues concerning geopolitical tensions and some major natural disasters.

[Slide 5] OPEC continues to play its part in keeping the market well-supplied; its Members have increased production by around 4.0 mb/d since 2002, but the factors currently impacting price, extend beyond its reach. All in all, OPEC is not comfortable with prices at the present very high levels, because they are not supported by oil market fundamentals and contain within them the seeds of further volatility. Extreme price levels, whether too high or too low, as was the case in the late 1990s, are detrimental to both producers and consumers.

[Slide 6] Nevertheless, despite the recent high price levels what I should highlight to this audience is the continued resilience of the world economy. Last year, growth rates were substantial and rates of core inflation remained under control despite higher oil prices. It is estimated that since 2002 the impact on global GDP of the rise in oil prices has been less than one per cent.

This year, OECD economies are expected to see little impact, as financial conditions remain accommodative, and solid increases in business and household incomes should permit the advanced economies to absorb higher costs. Improvements in energy efficiency and globalisation have also reduced the impact of higher oil prices, relative to such occurrences in the past.

While the impact on developing countries is varied, the healthy momentum of world trade and strong commodity prices can be expected to support growth in most economies. In some cases, the removal of fuel subsidies has pushed up inflation, and poorer economies may suffer from increased balance of payments deficits. In this regard, OPEC is concerned that higher oil prices may affect the prospects of developing countries, and so it will continue to closely observe developments. Globally, the world economy is expected to continue its sustained growth this year, at a rate similar to that of 2005, but again we understand that this needs to be closely monitored.

[Slide 7] Talk of the global economy leads me onto the role of energy in our everyday lives. It is no secret to anyone here this evening that energy is required to support both economic prosperity and social development; whether it be at the individual, business, country, continent or global level. And it is no less a secret that oil has been, and will continue to be, the most significant fuel in the global energy mix. By 2025, the share of oil is expected to be 39 per cent, down one percentage point from today, but still well above gas, which is expected to have the second largest share in 2025, at about 28 per cent.

[Slide 8] For many here, I envision the response to these long-term figures might be, ‘this is all well and good, but are the resources available to meet future demand in the coming decades?’ OPEC’s unequivocal response to this question is undoubtedly: yes. There is no physical shortage of the necessary resources to meet the demand in today's developed and emerging economies, as well as other economies that are expected to reach take-off point in the early 21st century.

Estimates of global ultimately recoverable reserves for conventional oil have been increasing, due to such factors as technology, successful exploration and enhanced recovery from existing fields. Indeed, US Geological Survey estimates of ultimately recoverable reserves have practically doubled since the early 1980s, from just 1,700 billion barrels to over 3,300 billion barrels. On top of this, there is a vast resource base of non-conventional oil to explore and develop.

[Slide 9] Yet what needs to remembered in the international oil market today, as well as in the outlook to 2025, is the overall importance of market stability. As I am sure you will all acknowledge, market stability in any business environment is preeminent. This is well understood by OPEC, which has a longstanding commitment to oil market stability, as embodied both in the OPEC Statute and the recently released OPEC Long-Term Strategy. The Strategy lays out a coherent and consistent framework for the Organization’s future, with the recognition of oil’s importance in meeting future global energy demand and its significance to the future socio-economic development of OPEC Member Countries.

The specific value associated to market stability plays out in the topic on everyone’s lips today: global energy security. This topic is expected to top the agenda at the G8 Summit in St Petersburg next month and was mentioned at the US-EU Summit in Vienna yesterday. Given its importance I feel it is essential that I clarify what the term ‘global energy security’ actually means and stress the strong linkage between security of supply and security of demand.

[Slide 10] In a nutshell, the two are intertwined. It is not just a question of whether there will be enough supply to meet demand; it is a question of whether there will be enough demand to meet current and predicted supply. I am sure I am probably preaching to the converted with this statement: the basic idea of supply and demand is perhaps one of the most fundamental concepts of economics and will provide a platform for the development of most business strategies. Thus the basis for ‘global energy security’ is a balanced and mutually supportive supply and demand network at reasonable price levels to both consumers and producers. This platform built on a shared responsibility, provides the stability from which consumers and producers can develop, build on, and adapt both short- and long-term supply and demand strategies to meet the market’s needs, to the benefit of individuals and business, and to rich and poor nations alike.

[Slide 11] On the supply side, OPEC has responded to the need for additional oil. As I mentioned earlier, its Members have increased production significantly since 2002. More increases in capacity are also planned – and being implemented – for the rest of the decade. OPEC capacity growth is underpinned by more than 100 exploration and production projects totalling in excess of $100 billion. This investment is expected to further increase OPEC spare capacity to between 5 and 8 mb/d over the next five years and is a demonstration of its continued commitment to oil market stability, and security of supply.

It should also be remembered that despite the impact of Hurricanes Katrina and Rita last summer, OPEC’s assurances of healthy supply – accompanied by positive statements from the International Energy Agency – helped prevent that supply interruption from developing into a major oil market crisis.

[Slide 12] Nevertheless, as I underlined a minute or so ago, enhanced energy security must also be viewed from the demand perspective. Doubts over future oil demand translate into large uncertainties over the amount that OPEC Member Countries will eventually need to supply, signifying a heavy burden of risk. This can be seen in three consistent scenarios explored in OPEC’s Long-Term Strategy. The first of these — “dynamics-as-usual” — envisages a future following previous oil demand patterns, while the other two — “protracted market tightness” and “prolonged soft market” — look at futures leading to lower and higher rates of oil demand growth respectively. It should be remembered that in the oil industry, investment requirements are very large and subject to long lead-times and pay-back periods.

The challenges that may impact future world oil demand are laid out in OPEC’s Long-Term Strategy document. This includes expanding vehicle usage, country demographics, consuming countries’ energy and environmental policies, technology development and future world economic growth. Questions over how future non-OPEC production might evolve further compounds the uncertainty regarding how much oil will be needed from OPEC to achieve a supply and demand balance.

[Slide 13] Let me take a couple of these challenges and underline how some of the uncertainties might play out. Firstly, let me explore the anticipated growth in global vehicle usage. This is expected to be particularly high in countries that have large populations and are currently seeing rapid rates of economic growth. China and India, with healthy annual growth rates and a combined population approaching 2.5 billion very much fit into this category. In China and India today, there are just 10-to-20 vehicles per 1,000 inhabitants, compared with more than 500 vehicles per 1,000 inhabitants in the OECD region. With the transportation sector expected to be the single most important source of demand increase, there is clearly enormous potential for growth in this sector in these two countries alone.

It is important to stress, however, that the OECD region is still expected to be consuming more oil than developing countries by 2025. Moreover, there will remain large differences in consumption per head, with developing countries consuming on average five times less oil per person by 2025 compared to the OECD.

[Slide 14] Given this fact, and moving onto my second point, oil demand will also be greatly affected by consuming countries’ policies, especially OECD countries. Taxation of energy products is often seen not only as a means of raising revenue, but also as a means of controlling demand in addressing environment and energy security issues. Policies demonstrate significant discrimination against oil, involving not only higher tax rates, but also subsidies for competing fuels. Great uncertainty exists in relation to future developments of consuming countries’ policies and this is considered one of the main constraints in ensuring adequate security of demand. Scenarios developed at the OPEC Secretariat show that such policies alone could potentially introduce demand uncertainty of the order of 5-to-10 mb/d to 2025.

[Slide 15] If we return to the three scenarios in OPEC’s Long-Term Strategy, we see that the difference between the lower and higher rates of oil demand growth out to 2020 is more than 12 mb/d. [Slide 16] What this figure represents becomes distinctively more apparent when talk turns to investment. The expected range is somewhere between $230 billion and $470 billion. A range of uncertainty of $240 billion would make any industry CEO sit up and take note.

The issue of security of demand is, therefore, a very genuine one. Without the confidence that demand for OPEC oil will emerge, the incentive to undertake investment can be reduced. The possible emergence of large levels of unused capacity would put downward pressure on oil prices. This would result in huge revenue losses, and OPEC’s Member Countries, as developing countries with strong competing needs for financial resources, would be adversely affected in terms of available resources for such areas as education, healthcare and infrastructure.

[Slide 17] The investment challenge, however, extends along the entire supply chain. The downstream sector is a very important part of that chain, with current tightness in the form of inadequate refining capacity, as I pointed out earlier, putting much pressure on oil prices generally. Several factors will shape developments in this sector in the coming decade: the rising volume of crude oil that needs to be refined, the expectation of a continued move towards demand for lighter products, and the trend of product specifications towards significantly cleaner products.

[Slide 18] It is estimated that about $160 billion in downstream capacity investment will be required by 2015, with another $150 billion needed for maintenance and replacement of lost capacity. These estimates do not include the infrastructure required beyond the refinery gate, such as pipelines and terminals. A more orchestrated effort is clearly required to ensure that sufficient capacities are in place in the future. There is, therefore, a pressing need for ways to be explored that could accelerate expansion plans. Most importantly, however, it needs to be recognised that the primary responsibility for investment in this sector lies with consuming countries.

[Slide 19] Beyond the investment challenge, a critical question is whether the increasing use of fossil fuels is consistent with the ‘third pillar’ of sustainable development — as defined by the United Nations — namely the protection of the environment. Firstly we should note that the oil industry has a long history of successfully improving the environmental credentials of oil, addressing concerns of local pollution and improving air quality. These improvements are expected to continue in the future. Attention therefore turns to concerns over possible climate change. Most energy scenarios project a substantial increase in CO2 emissions throughout this century. Since well over half the emissions are attributable to power stations and industrial activities, these sectors, therefore, constitute prime targets for emission reduction efforts.

I should also like to stress that OPEC also recognises that its Member Countries need to play an active role in addressing climate change concerns. In regard to these concerns, and given that all forecasts suggest that fossil fuels will continue to provide the overwhelming share of energy for many decades to come, technological options that allow the continued use of oil and gas in a carbon-constrained world must be considered. It should specifically be remembered that fossil fuels have a major role to play in sustainable development and providing energy services to the poor. In fact, just as oil played a key role in fuelling the development of the industrialised countries in the 20th century, it should also be allowed to make a similar important contribution to supporting growth in developing world economies in the future.

[Slide 20] One promising technological option is carbon capture and storage, which could represent an affordable means of responding to climate change concerns. Industrialised countries, having the financial and technological capabilities, should take the lead in this area, by promoting large-scale demonstration projects and the application of this technology, including through the use of the Kyoto Protocol’s Clean Development Mechanism, in accordance with the principle of common, but differentiated responsibilities and respective capabilities.

[Slide 21] This principle provides a direct link into an area that OPEC places great credence on today: the issue of shared responsibility advanced through dialogue and cooperation. It is vital that we all understand the needs of each stakeholder. To this end OPEC continues to devote much effort in this direction, with dialogue now being widened and deepened in an open and constructive spirit. The most recent result of this was the establishment, last year, of energy dialogues between OPEC and, respectively, the European Union, China and Russia.

In fact much of the EU-OPEC dialogue so far this year has been carried out during Austria's Presidency of the European Union. This began with a Ministerial-level meeting between Dr Edmund Daukoru, President of the OPEC Conference and Minister of State for Petroleum Resources of Nigeria, and Dr Martin Bartenstein, President of the EU Energy Council and Minister of Economy and Labour of Austria, in Vienna in February. And just a fortnight ago, there was the Third Meeting of the EU-OPEC dialogue in Brussels, which the two parties welcomed as a further step in constructive dialogue between producers and consumers and where they reaffirmed their mutual interest in stable, transparent and predictable oil markets.

In addition, informal discussions between senior officials from OPEC and the EU took place at the World Economic Forum in Davos in January and the 10th International Energy Forum (IEF) in Doha in April. The latter brought together both producers and consumers and underscored the importance of transparency and exchange of energy data for market predictability and stability, so as to provide a more stable investment climate while supporting planning and enhancing global energy security. I am sure you all appreciate the value of having access to accurate data and information in order to make the right investment decisions.

[Slide 22] Dialogue and cooperation are obviously important to the issues and challenges I have already highlighted this evening. However, it also critical to a challenge that all industries face: that of human resources. As we all understand, the human resource is what drives business the world over. This was a specific focus of the IEF Meeting in Doha, where Ministers acknowledged the shortage of human resources throughout the energy industry as a problem that must be addressed jointly by companies and governments. Given the expected expansion of the oil market it is essential that knowledge is shared on human resource development, both within regions and globally, and between producers and consumers.

The focus should be twofold: firstly to help facilitate education and training in energy disciplines to provide specialised manpower for operational and research staffing in the energy industry, and secondly, to make the industry attractive to prospective employees the world over. This is especially true in attracting young engineers to the industry. Yet what needs to be recognised in all this is that the cost of the human resource is rising and any additional manpower to meet anticipated oil market growth will significantly impact upon a company’s bottom line.

[Slide 23] Before I close I would just like to recap on some of the issues I have addressed this evening. The ‘Global Oil Outlook to 2025’ offers both challenges and opportunities, from the supply and demand perspectives, as well as from the standpoint of both upstream and downstream, in terms of investment, and with regard to technology and the environment. The central thrust of these challenges and opportunities is global energy security for all. We should never lost sight of the fact, however, that this means different things to different people. In the developing world, the lack of basic energy services is a severe impediment to the alleviation of poverty. Halving the proportion of people in the world whose income is less than $1 a day was actually the first declared ‘Millennium Development Goal’. Bringing people out of energy poverty is a focus for us all, and the benefits for those involved are obviously huge.

As an industry we have to be inclusive: to think and plan ahead and to look at the needs of producers and consumers, as well as both developed and developing nations, not just this year and next, but over the next decade and beyond. I hope this evening I have successfully managed to enlighten you on the efforts that OPEC makes to bring about order and stability in the international market, both today and in the future, and in support of energy security and sound growth across the global economy to the benefit of all.

[Slide 24] Thank you for your attention.

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