Global oil outlook: Challenges & opportunities for OPEC

A speech by Dr. Adnan Shihab-Eldin, Director, Research Division, Acting for the Secretary General - European Energy Forum, Strasbourg, France, 5 July 2005

(Slide 1)

Excellencies, ladies and gentlemen,

Let me begin by saying how honoured I am to be invited to address this energy dinner debate on the subject of the global oil outlook: challenges and opportunities for OPEC, here in Strasbourg tonight. The purpose of the European Energy Forum, in encouraging dialogue and the exchange of information among members of the energy community, is particularly appropriate at the present time, when there is an unusually high degree of uncertainty in the market and when timely and effective action is required by all parties to moderate the situation.

As many of you know, just one month ago, the first meeting of the newly established EU-OPEC Energy Dialogue was held in Brussels. This provided us with the opportunity to examine how the oil market challenges are viewed from the perspectives of our two organisations, and seek means of addressing them.

(Slide 2) The EU-OPEC Energy Dialogue is a natural extension of the warm relations that have existed for decades in many areas of activity involving Members of the two groups. The EU is OPEC’s main trading partner and accounts for an increasing share of our Organization’s total trade. We want to build upon this.

At the same time, there are some areas — some key areas — where a closer examination of topical issues is required, and this is where we expect the new dialogue to come into its element. Energy security issues are a case in point, where producer concerns about steady predictable outlets for their crude must be addressed with the same vigour as consumer concerns about security of supply. Energy and environmental policies, that unwittingly can have profound impacts on demand and on investments in the upstream and downstream, are another example. These and other important matters, such as collaboration in energy/oil technology and research, will feature prominently in the dialogue.

(Slide 3) OPEC welcomed the success of that first meeting. Of particular significance were the importance each side attaches to order and stability in the oil market, both now and in the future, as well as the linkages between a viable, sustainable oil sector and other broader considerations, such as economic development, social progress and the protection of the environment. Both sides are now engaged in developing the dialogue further, to make it a practical and effective process in the years ahead and an important addition to producer-consumer relations across the world at large.

Today’s dinner-debate provides us with another opportunity to share with you our assessment of the current oil market.

(Slide 4) Over the past year or so, we have seen how quickly volatility and steeply rising prices can occur, following an extended period of relative stability — even when the market is well-supplied with crude and in spite of OPEC’s measures, aimed at achieving order and stability. These have ensured, in a decisive and transparent manner, that supply growth remains above demand growth, with OECD commercial oil stocks climbing to higher levels than in the past five years.

An unusual convergence of factors has been responsible for the past year’s high prices and volatility. (Slide 5) First of all, there has been strong global economic growth and a consequent big rise in the demand for oil, especially in China, and, globally, this has led to concern about the near-term availability of spare production capacity. (Slide 6) Increasingly, however, analysts are recognising that there are serious problems downstream in key consuming regions and that these are themselves putting pressure on crude prices. These problems have been due, in great part, to inadequate past investment and increasingly stringent product specifications, and have resulted in a lack of effective global refining capacity; this is now running at close to 100 per cent in practically all regions. (Slide 7) In particular, there has been concern about possible shortages of middle distillates, in the face of the strong demand; for example, in the United States of America, distillate demand growth is again at five per cent. Adding to the market nervousness have been the geopolitical tensions in some producing areas. (Slide 8) Overall, the resultant bullish bias has led to a rise in activity by non-commercials, in particular pension and index funds in futures markets, leading, in turn, to further volatility, as well as contributing to the upward price spirals.

As we all know, there are no winners from such a situation. Volatility and high prices can have an adverse effect on activities at all levels within the market and, ultimately, have negative repercussions for both producers and consumers. Volatility can be highly detrimental to investment, either for domestic development or in future production capacity — in addition to the day-to-day workings of the market-place. If prices are so high that they cannot be sustained, they may well be followed by very low prices and reduced revenues not long afterwards.

(Slide 9) Of course, “high” is a relative term. We should remember that, although oil prices have recently reached record levels, their real value is well below historical peaks, and certainly leads to a more moderate interpretation of recent price behaviour. Also, the fall in the value of the US dollar has had an impact upon oil prices in different world regions, as well as affecting the purchasing power of every barrel sold. Furthermore, landed prices of crude paid by consumers, as well as prices that apply to exporters, are often well below benchmark levels.

(Slide 10) Indeed, analysts are asking whether there has been a structural shift in oil prices, particularly in the light of the current price strength of West Texas Intermediate, in nominal terms. Early impressions are that this may, indeed, be the case.

Let us recall that it was not so long ago that the price volatility was in the opposite direction, with prices dropping below $10 a barrel in the winter of 1998/99, brought on by the Asian financial crisis. This experience underlined the requirement for market stability and the need for measures to support this. Of course, those low prices had a big impact on the revenues available for investment in the industry and were simply unsustainable. We are still witnessing the impact of this, in terms of investment that never materialised, particularly in the downstream.

All of this explains why OPEC is committed to the achievement of order and stability in the international oil market at all times, with supply and demand that are steady and secure, and prices for consumers, revenues for producers and returns to investors that are fair and reasonable. Such principles are enshrined in the OPEC Statute, whose origins date back to 1961. Increasingly, people are recognising the wisdom behind them, because they have come to realise that, in the final analysis, the oil market is prone to volatility — as has been demonstrated repeatedly in the past and was particularly apparent in 2004 and on into 2005. This is the exact opposite of what is required from a commodity that has such a central role to play in the modern world.

(Slide 11) Of particular significance at the present time — in the light of the volatility of the past year — is the fact that OPEC’s spare capacity, from which the market has benefited for so long, provides a situation upstream that is in stark contrast to that downstream. While OPEC’s spare capacity growth has been in line with the strong demand growth, this has not been the case downstream, where it has fallen behind. It is time that more attention is paid to the downstream part of the supply-chain, in the interests of overall market stability. This is a responsibility that should be shared with consumers. It also offers opportunities to our Member Countries.

(Slide 12) Our latest projections show that the average level of world oil demand will rise by 1.8 mb/d to 83.9 mb/d in 2005, compared with 2004, (Slide 13) and that much of this will be met by increases in non-OPEC supply, which is projected to grow by 1.1 mb/d. (Slide 14) However, for the third year in a row, the growth in non-OPEC supply is falling behind that of world oil demand, and this new trend is expected to continue at least into next year. Russian supply growth, which used to account for the biggest part of non-OPEC growth, has almost vanished.

(Slide 15) In response to all of this, OPEC has acted on two broad fronts. First, it has raised its production ceiling on several occasions, by a total of 4.5 million barrels a day. (Slide 16) This has, furthermore, as mentioned earlier, led to a steady rise in OECD commercial oil stocks, which are exceeding their five-year average, in both absolute terms and in days of forward cover. And secondly, OPEC’s Member Countries have sought to accelerate their plans to bring on-stream new production capacity.

(Slides 17 and 18) Average OPEC production capacity is now expected to rise to 32.7 mb/d, and this will be well above the 29.2 mb/d which, in these projections, is seen as the difference between world demand and non-OPEC supply. 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. 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.

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

(Slide 19) Turning to the long term, the latest reference case from the OPEC World Energy Model has projections 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.

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 per cent. OECD countries will continue to account for the largest share of world oil demand. (Slide 20) However, more than three-quarters 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. The transportation sector will account for almost 60 per cent of the rise in global demand over the next two decades.

(Slide 21) 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 is not a constraint, with regard to meeting future demand. Not only are we talking about conventional oil, where there is vast potential for making new discoveries, as well as increasing recovery from existing field, (Slide 22) but there is also unconventional oil, such as tar sands and gas-to-liquids.

(Slide 23) Our reference case 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.

(Slide 24) If the projected world demand materialises, OPEC’s Member Countries, with around four-fifths of the world’s proven crude oil reserves, have both the capability and the will to continue expanding their oil production capacity to meet it. In 2025, the reference case therefore sees OPEC meeting almost half the world’s oil demand, with 55 mb/d.

The overall scale of investment required for all of this will run into many billions of dollars in the coming decades, although, globally, it will not be very different to past levels. Moreover, averaged out, a dollar of investment in the OPEC area yields more than four times as much production capacity as a dollar of investment elsewhere.

In order for oil producers to meet the growing demand for oil in the most efficient and effective manner, they require the latest technology in a form that is economically viable and ready for commercial application. This is particularly important in today’s world, where oil must be cleaner, safer and more efficient than ever before, to conform to rising consumer expectations, as well as an increasing amount of legislation and regulations. In recent decades, at an accelerating pace, application of the latest technology has helped expand the sources of oil supply, reduce costs, improve oil-use efficiency and satisfy beneficial environmental requirements, such as capturing CO2 for enhanced oil recovery — a technology that is of particular interest to OPEC and that is ideal for international win-win cooperation.

(Slide 25) Numerous possibilities for investment exist, although recently a move towards more involvement from the international oil companies in the upstream activities of some OPEC Member Countries has been observed. However, other Members might choose to meet the investment challenge through their national oil companies, or they could do it in partnership with the IOCs.

Of prime importance will be the establishment of fair and workable agreements, reached through open and transparent procedures. There will have to be adequate incentives for the investor, yet suitable protection and recompense for the owner of the resource. And there will have to be a clear commitment to sustainable long-term development by the IOCs in setting up partnerships. Every contractual legal framework and fiscal system will have its various implications on oil production policy.

The issue is extremely complex and has many dimensions. It will, therefore, be up to each OPEC Member Country to strike the right balance in whichever system they apply.

(Slide 26) Adding to the complexities surrounding investment are many uncertainties about the market outlook, on both the demand and supply sides. Notable drivers of uncertainty are future economic growth rates, consumer government policies and technological advances. Uncertainty can be a matter of great significance when we try to crystallise our investment plans. (Slide 27) If we assume economic growth to be just one percentage point lower than in the reference case, already by 2010 an estimated uncertainty of $25 billion for required OPEC investment will have emerged — and this could reach $150 bn by 2025. It can prove very costly if the industry does not get its sums right. Over-investment may result in excessive, idle capacity, while under-investment may lead to a crude shortage. Both cases can create severe price volatility.

(Slides 28 and 29) Noting that the average crude slate is unlikely to change much over the coming years, attention is being turned increasingly to investment in the downstream. No greater case could be made for this than the volatility and rising prices experienced in the oil market over the past 12 months.

A key element in this picture is how the oil product demand structure will change. The move towards demand for ever lighter and cleaner products represents a significant challenge for the downstream sector, and substantial investment will be required to meet this in the years ahead. Again, too little capacity results in refining bottlenecks, which are very much apparent today, while too much can lead to costly plants being mothballed. If the required investment does not take place in a timely manner, this sector will remain a source of volatility and tightness.

In financial terms, Asia is still expected to be the dominant region, in terms of downstream investment requirements. However, the requirements elsewhere are also substantial, because of the large expenditure implied by the need to move towards cleaner products. Also, as with the upstream, uncertainties can impede the process of determining investment strategies in the downstream.

Thus every effort must be made to reduce uncertainties. Dialogue and cooperation have a big role to play in this. But it is also important that the energy policies in consumer countries are stable and transparent, and are in harmony with the overall needs of the market.

Excellencies, ladies and gentlemen,

(Slide 30) It is clear from my remarks today that OPEC will continue to be a very active player in the international oil market well into the 21st century, with the aim of bringing steady, secure and timely supplies of crude to consumers, at reasonable prices. But to be truly effective in this requires wide support from many other parties — producers and consumers, as well as the international oil companies, financial institutions and other influential and supporting bodies, such as legislative bodies, like the EU Parliament here in Strasbourg.

That is why we welcome so much the new enhanced level of dialogue between the EU and OPEC. It plays a valuable role in furthering the global process of producer-consumer dialogue. And, at the same time, it opens up exciting new possibilities with regard to economic activities among members of the two intergovernmental bodies, not just in energy, but also in many other fields.

Thank you.


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