Global energy industry - Current challenges and opportunities

Speech delivered by Mr. Mohammed Barkindo, Acting for the OPEC Secretary General, at the Sixth Russian Oil & Gas Week, Moscow, Russia, 30 October-2 November 2006

[Slide 1]
Excellencies, ladies and gentlemen,

Let me first thank the organisers for inviting me to address this plenary session of the Sixth Russian Oil and Gas Week. ‘Moscow week’ has now become an established part of the international energy calendar and provides an outstanding forum for high-level discussions on topical issues affecting the industry.

As a major player in the global energy arena, Russia’s views on international energy issues are, as ever, eagerly sought within the industry at large. Not only is Russia the world’s largest producer of natural gas and, increasingly, crude oil, as well as having the biggest proven natural gas reserves. But it is also having a rising influence on the consumer side, especially as one of the four ‘Bric’ countries, with large populations and high economic growth potential.

Russia has been a key figure in the global energy debate this year. In particular, its chairmanship of the G8 summit in St Petersburg in July culminated in a long-overdue, broader-based approach by consuming countries to the fundamental issue of energy security. This indicated a shift away from longstanding narrow, self-interested perceptions of energy security to a greater appreciation of its broader, more universal nature, especially with regard to the fact that security of supply and security of demand are mutually supportive. They must go hand-in-hand as a means of achieving market stability.

This breakthrough — as we consider it in OPEC — owes much to the advances in dialogue and cooperation that have occurred since late last century, and Russia has had a prominent role to play in these. Indeed, the security issue has featured in the energy dialogue established between Russia and OPEC in December last year. We have also welcomed the support Russia has given to our market-stabilisation measures in recent years.

The simple message is that, if we all want a better-performing market now and in the future, then it is the responsibility of all of us — all parties in the industry — to work towards achieving this.

This is especially pertinent to the subject-matter of this plenary session: “Global energy industry — current challenges and opportunities”, which I shall now address. In doing so, I shall focus on the oil sector, since this constitutes the core area of OPEC’s activities.

However, first and foremost, it is necessary to look at the current oil market outlook, in the light of the recent downturn in prices.

[Slide 2] The past two months have witnessed a significant reversal of the trend of protracted upward pressure on prices that has been a dominant feature since spring 2004, and this is indicative of an over-supplied market. Indeed, the scale and speed of the decline in crude oil prices has caught the market by surprise. The OPEC Reference Basket has fallen by more than $19 a barrel from a peak of $72.7/b on 8 August, the sharpest drop since 1991, as a result of changing fundamentals and easing geopolitical tensions.

[Slide 3] Additionally, very much as a result of OPEC’s production increases in recent years, commercial crude oil inventories in the OECD have risen to comfortable levels, well above the five-year average. Also, with the approach of the winter season, seasonally-important middle distillate stocks in the USA are also at their highest level since 1999, once again well above the five-year average.

[Slide 4] The demand picture for the remainder of 2006 and for 2007 appears far from robust. The strong demand growth seen in 2004 declined sharply in 2005, and this deceleration has continued into 2006. This has happened, despite the strong momentum in the global economy. Demand growth in 2006 is now expected to remain moderate, at 1.0 mb/d, and to reach 1.3 mb/d in 2007, although this requires a rebound from current trends.

On the supply side, the outlook for non-OPEC has changed dramatically, after non-OPEC supply growth had fallen behind world demand growth over the past few years — which had led to OPEC unexpectedly meeting the bulk of rising demand, to the tune of around 4.5 million barrels a day since 2002, while also accelerating plans to expand production capacity. Non-OPEC supply has already picked up by 1.1 mb/d in 2006 and is expected to grow next year at 1.8 mb/d, the highest rate since 1984, pointing to a clear imbalance between supply and demand.

Given these trends, the demand for OPEC crude in 2007 will be lower than this year. Non-OPEC supply is expected to exceed demand by around 0.8 mb/d in 2007, indicating the need for measures to rebalance a market already flush with stocks. As a result, the demand for OPEC oil would be 28.1 mb/d, around 1.4 mb/d lower than total OPEC production in September.

Overall, the recent developments have triggered a strong bearish sentiment in the market, leading to concern that the downward momentum might persist and take prices lower than otherwise might be expected. Past experience has shown that it is in the long-term interest of both producers and consumers to maintain prices at levels that both support healthy economic growth, as well as encourage investment in capacity to meet future demand, particularly in an industry with long lead-times and high financial risks and in an environment of rising costs.

In order to review the situation more carefully, OPEC held a special Consultative Meeting of its Conference in Qatar on 20 October. After reflecting on the outlook for the rest of this year and all of 2007, the Conference observed that OPEC’s actions in recent years had contributed to market stability and assured adequate supplies, benefiting all parties. It was noted with concern, however, that crude oil supplies were well above actual demand and that this situation of imbalance was destabilising the market. Thus, in order to ensure market stability, the Conference decided to reduce production by 1.2 mb/d to 26.3 mb/d, with effect from 1 November. A further review of the situation will take place at the next Extraordinary Meeting of the Conference in Nigeria on 14 December.

At the Qatar meeting, the Conference repeated its longstanding call for non-OPEC producers to continue cooperating actively with the Organization, in its ongoing efforts to achieve market stability, with reasonable prices that are consistent with robust economic growth and steady revenue streams for investors.

OPEC, of course, also looks beyond the near term and, in Vienna six weeks ago, we held the Third OPEC International Seminar. An overriding message to emerge from that event, whose participants came from the highest levels of government, industry and academia, was that fossil fuels will continue to dominate the global energy mix for decades to come and will remain vital for supporting the forecast expansion in global economic growth. This ties in very much with our own forecasts.

[Slide 5] OPEC’s reference case scenario puts average annual oil demand growth at 1.6 per cent for the period 2005–25; this is a sizeable 36 per cent taken across the entire 20-year period. [Slide 6] The transportation sector will be the main source of future oil demand growth, due to its heavy reliance on liquid fuels and the absence of viable alternatives on a large commercial scale. 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 7] The global resource base is sufficient to deal with the forecast increases in world oil demand well into the future. 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. Technological progress should also allow the development of large amounts of unconventional oil at lower cost, such as gas-to-liquids, coal-to-liquids, tar sands and heavy oil. With specific regard to biofuels, these are still expensive to produce and generally require government support to make them competitive.

[Slide 8] Non-OPEC supply has the potential to rise substantially in the medium term, but this is forecast to reach a plateau after 2015, at 58–59 mb/d. Thus, in the longer term, 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, to ensure that the market remains well-supplied with crude, at reasonable prices that are compatible with robust growth in the world economy. We are also seeking to produce oil that is cleaner and more efficient than ever before, so as to meet the increasingly stringent demands of the modern consumer in rich and poor countries alike. Our projections show that OPEC production levels, including natural gas liquids, will rise to 54 mb/d by 2025, which will be slightly below that of non-OPEC.

[Slide 9] OPEC’s willingness and ability to supply the incremental barrel demonstrates the seriousness it attaches to the future of the oil industry. However, there are obstacles, with uncertainties over future levels of oil demand translating 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 and the long lead times. 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.

[Slide 10] OPEC is also eager to address the challenges arising from the growing fears among the public at large about global warming, as articulated in the activities of the United Nations Framework Convention on Climate Change and, specifically, the Kyoto Protocol. In September, for example, OPEC participated in a couple of high-level meetings in Saudi Arabia, where the principal focus was on this very important issue — the First International Conference on the Clean Development Mechanism and the EU-OPEC Joint Roundtable on Carbon Capture and Storage. Implicit throughout was the need for a collective approach to handling the climate change issue from the world community at large, since the challenges not only transcend national borders, but they are also no respecters of continental landmasses! They are truly global.

If one is intent on reducing emissions, one must face the fact that the heavy reliance the world will have upon fossil fuels well into this century is not sustainable without carbon capture and storage (CCS). The EU, with whom we co-hosted the second meeting, is particularly strong on this issue, just as we are, and both parties recognise that the technology for CCS already exists and that what is required now is action to raise awareness of this. Indeed, CCS can also be used in conjunction with carbon dioxide-enhanced oil recovery, which offers a ‘win-win’ opportunity by not only storing CO2, but also increasing oil reserves in mature fields. Moreover, 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, 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 socioeconomic 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.

[Slide 11] Furthermore, downstream tightness in the form of inadequate refining capacity has been putting much pressure on oil prices generally over the past couple of years. In addition, there will be rising volumes of crude oil that need to be refined, as well as the expectation of a continued move towards demand for lighter and cleaner products. On top of this, it is estimated that additional desulphurisation capacity of more than 20 mb/d will be required over the next ten years. It is estimated that $160 bn in downstream capacity investment will be required by 2015, with another $150 bn needed for maintenance and replacement of lost capacity. However, present commitments leave a shortfall of around $100 bn. A more concerted effort is needed to ensure that sufficient capacities are in place, otherwise the indications are that this sector could remain a key source of price volatility. However, it must not be forgotten that the primary responsibility for investment in this sector lies with consuming countries.

[Slide 12] Another aspect is the cost of infrastructure, such as rigs and tankers, as well as the cost and availability of human resources. For example, upstream costs have increased by 50 per cent since 2003, with steel prices rising by 40 per cent since 2004. In 2005 alone, wages in the industry increased by about 15 per cent. Furthermore, the number of students enrolling in petroleum engineering courses has also shown a significant decline since the mid-1980s, and we need to make the industry attractive to prospective graduates and employees the world over.

Excellencies, ladies and gentlemen,

[Slide 13] Clearly from everything I have said, the challenges facing the oil industry in the coming decades are substantial and require a concerted effort from all parties if the industry is to evolve in an orderly, stable manner. The opportunities are there for us to meet these challenges and we must all play our part to ensure that we use them to the full, to the benefit of producers and consumers alike and of the development of mankind generally.

[Slide 14] Thank you.

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