OPEC Oil: meeting consumer needs in the early 21st century
A Speech by Dr. Adnan Shihab-Eldin, Director, Research Division, Acting for the Secretary General - 13th Annual Middle East Petroleum & Gas Conference, Dubai, 4 April 2005
[Slide 1 — title]
Excellencies, ladies and gentlemen,
Two thousand and four was an unusual year for the international oil market. Some people even describe it as a unique year. Whether or not it was unique is open to debate. However, the real question facing us today is: “Was it a landmark year?”. When we look back over the past 15 months or so, can we detect a fundamental change in the market’s behaviour, in the way, for example, that it responds to external impulses?
[Slide 2] There is certainly some compelling evidence to support such a contention. Prices that rise dramatically, even though the market remains well-supplied with oil. The pressure that downstream bottlenecks are putting on upstream prices, particularly in the United States of America, where refining margins are large and the differential between West Texas Intermediate and the OPEC Reference Basket has been growing steadily. A fulcrum shift in energy demand towards Asia, especially China and — to a lesser extent so far — India, and the sheer potential volumes involved in this for the future. The feeling that, for the first time for many years, non-OPEC producers are feeling the pressure in trying to keep up with incremental demand. And the market’s reluctance to react adequately sometimes to OPEC’s market-stabilisation measures, however rigorously such measures have been derived and applied.
Another significant influence on prices over the past 15 months has been geopolitical in nature, and this has affected some of the key producing areas across the world. There are two observations here. First, some of the geopolitical tensions that have occurred during this period — even if they have had, or are still having, a discernible impact on world prices — are nevertheless temporary in nature and cannot be seen as constituting a shift in fundamentals. But secondly, are we detecting the earliest signs of an easing of tensions in certain areas of the Middle East at the present time, in a manner that could affect oil market fundamentals in the not-too-distant future?
These are all points that demand our attention. On the other hand, however, certain realities remain unchanged. In the final analysis and with the appropriate passage of time, the international oil market is still subject to the basic laws of supply and demand. It experiences cyclical movements on all time-horizons, and these — when examined carefully in the proper historical setting — indicate underlying trends. And, of course, it is necessary to ensure that there is always enough oil around to meet consumer needs at any one time, and this, in turn, requires sound investment strategies.
In the light of all this, I am grateful to have the opportunity to address you here today at the 13th Annual Middle East Petroleum and Gas Conference, and I wish to thank the organisers for their kind invitation. While I cannot provide a definitive answer to the question I posed — “Was 2004 a landmark year?” — the elements I have introduced in seeking to assess this matter at least provide the grounds for stimulating discussions among the distinguished panellists and audience. Perhaps we shall have to wait another five or ten years to know the answer to my question, to a time when we will be able to view the situation from a broader historical perspective.
In looking at the recent market performance, two important points spring to mind.
[Slide 3] The first concerns real prices. Let us put the present price levels in their proper historical context. Today’s prices, although high in nominal terms, 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 4] If we look at OPEC’s price band, which was suspended by our Conference in January so that it could be reviewed in the light of the current unusual market developments, we see that, in real terms, if the band is adjusted for exchange rates and inflation, its limits would be between around $28/b and $36/b now, instead of the original $22–28/b at the time of its introduction in the year 2000. It should also be noted that, during the first three full years of the band’s use, 2001–03, the average annual nominal price of our Reference Basket was close to the middle of the range of the band.
And the second point concerns OPEC’s actions and its commitment to stability. It is all-too-easy to refer to OPEC’s market-stabilisation measures in a matter-of-fact manner. But, if we step back and think for a moment, this is a group of the world’s leading oil producers — all developing countries — taking it upon themselves to see that the international oil market performs in a manner which is orderly, stable and secure, to the benefit of producers and consumers alike.
Our Member Countries recognise that they are an integral part of the global economy and have a responsibility to ensure that their oil makes an effective, smooth and meaningful contribution to industrial, commercial and domestic life, in both the industrialised and — increasingly — developing worlds. This can best be done in a sustainable manner if every effort is made to remove excesses and volatility from the market. We are in the market for the long term. The oil revenues we receive play an important part in developing our domestic economies, for the benefit of our present and future generations. Accordingly, we know where our priorities lie — stability, security, sustainability.
This brings me directly onto the subject of production capacity. The availability of sufficient production capacity at all times is like a passport to the future of a viable oil industry. It is necessary: 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.
“Capacity” appeared to be one of the most heavily used words in the oil market last year! It seemed to have as much importance to the psychology of the market, as to the physical quantities involved. Perhaps this goes some way to explaining why prices kept rising, even when the market was well-supplied with crude. It was, in this sense, about perceptions. Classical Keynesian economics! The mere possibility of a shortage of crude in the near future could be enough to drive up prices.
Let us look at the situation now.
[Slide 5] Oil prices, after returning to a more moderate average of just under $36/b in December — very much in response to OPEC’s market-stabilisation measures — began to rise again early in the New Year. [Slide 6] They reached record levels for OPEC’s Reference Basket in March.
[Slide 7] However, these record levels are still not far above the upper limit of the price band, if the band is expressed in real prices, with the base month of June 2000 — and this is during a period when prices have been affected by such an unusual combination of pressures.
We put the high prices down to mainly: continued strong oil demand, led by a solid world economic performance; the late and lasting cold spell in the Northern Hemisphere; increasing market anxiety over forward capacity tightness, coupled with geopolitical tensions; and the expectation of the strong demand outstripping non-OPEC supply growth in the medium term. The resultant bullish bias was exacerbated by the rising activity of non-commercials, in particular pension and index funds, leading to further upward price spirals.
Nevertheless, global oil supply — particularly OPEC output — remains adequate to meet expected demand. OPEC’s spare capacity, which, at one stage, dipped to around five per cent in 2004, now stands at more than 2 mb/d, or eight per cent, and is expected to exceed 3 mb/d by year-end. However, the extent of this will depend upon the level of demand during the year.
[Slide 8] Our latest forecasts show average annual world oil demand rising by 1.9 million barrels a day to 84.0 mb/d in 2005. However, non-OPEC supply — which includes OPEC natural gas liquids and non-conventional oils in this analysis — will not keep pace with this, with a projected increase of only 1.3 mb/d, to reach an average of 55.0 mb/d. This means that there will be a difference of 29.0 mb/d for OPEC crude to fill. This average difference is 0.6 mb/d higher than that for 2004.
[Slide 9] To illustrate the difficulties facing non-OPEC supply in keeping up with incremental demand, let us take a snapshot of what we thought would happen in the market in 2004 and compare it with a snapshot of what really happened. To do this, I shall compare the forecasts that appeared in the March 2004 issue of OPEC’s Monthly Oil Market Report with the early estimates of what happened that appeared in the March 2005 issue, exactly one year later. In the earlier issue, average annual world oil demand was forecast to rise by 1.4 mb/d in 2004, from 2003, compared with the preliminary estimate of 2.6 mb/d which actually occurred last year. In other words, the actual rise in world oil demand was almost double the expectations of one year ago. However, in spite of this, non-OPEC supply, which was forecast, 12 months ago, to rise by 1.6 mb/d, instead actually grew by less than this amount, 1.4 mb/d. To complete the picture, the difference between world oil demand and non-OPEC supply increased by 1.2 mb/d, rather than decreasing by 0.2 mb/d, as had been forecast in March 2004. The difference is met by OPEC supply, as well as through stock level movements.
[Slide 10] For the forecast of the difference between world oil demand and non-OPEC supply in 2005, there has been an almost unbroken series of upward revisions over the past nine months, from 27.4 mb/d in July 2004 to the present figure of 29.0 mb/d.
But the situation involves more than just the upstream. Although the physical crude oil market is, at present, well enough supplied to meet demand and allow the continued rise in stocks to their five-year-average days of cover, downstream strains — stemming mainly from capacity tightness to match strong light-product demand with more stringent quality specifications — are expected to continue exerting pressure on both product and crude prices.
On the economic front, 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.
In Asia, the spotlight is on both China and India, due to their high levels of growth in 2004. [Slide 11] 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. 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. 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, early forecasts see a halving of the rate of oil demand growth in China, 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.
[Slide 12] Indeed, oil plays 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.
More generally, as I mentioned earlier, 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.
[Slide 13] 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.
Let us now look at the longer term, using 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 14] 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 15] 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 16] 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 17] 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 oil demand in the transition economies, more than four-fifths in the OECD and close to half in the developing countries.
[Slide 18] 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. Not only are we talking about conventional oil, but also there is also unconventional oil, such as tar sands. There is also vast potential for making new discoveries, as well as increasing the yield from wells when they are on-stream.
[Slide 19] As the cumulative amount of oil that has been produced, by definition, rises with time, so does the size of the world’s total resource base. Sometimes the gap narrows and sometimes it increases. Even by 2025, if the resource base remains the same as it is now, we should still have used less than half of it. But, with advancing technology, enhanced recovery from existing fields and the development of new ones, often in remote areas, the resource base is expected to continue growing, with the passage of time. In the light of this, the world’s oil resource base should not be seen as a constraint, in meeting future demand.
[Slide 20] 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.
Thus, in the light of all this, 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 21] One of the basic challenges facing OPEC — and other oil producers too — is to ensure that sufficient, but not excessive, production capacity will be available at all times to help meet the forecast rise in oil demand. This brings us onto the subject of investment.
[Slides 22 and 23] The required global investment will be large, although it will not necessarily be different in magnitude to that observed in the past. Also, 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.
These are all big challenges facing the oil industry. Can it cope?
The industry has experienced radical change since the early 1990s. The spate of mergers and acquisitions — at all levels — has sharpened the industry’s competitive edge, through enhanced efficiency and cost-cutting measures. There has been a comprehensive repositioning of the industry, with better financial capabilities and continued advances in technology. Oil companies have, in general, broadened their base, evolving into corporate energy units.
How does all of this affect OPEC’s Member Countries? In such an evolving landscape, our national oil companies must increasingly face new challenges and opportunities. At the same time, our Governments and Petroleum Ministries will continue to adapt to these new realities.
The way in which our Member Countries respond to this varies, in accordance with their individual economic, social and political dynamics and values, while, at the same time, they seek to adhere to OPEC’s objectives and decisions as best they can. This can prove to be a delicate balancing act.
The receipt of steady, reasonable levels of revenue offers significant potential benefits for these countries. The challenge has been — and remains — to use the oil revenues, or rent, to develop and diversify their economies through investment in physical and social infrastructure, as well as growth in the non-oil sector. In other words, it is to diversify their economies and prepare for a smooth transition to sustainable development for the post-oil era, whenever that occurs in each individual case.
On top of this, there are potential advantages at a broader, international economic level, whereby the petroleum revenues can contribute towards providing the funds required for investment in future oil production capacity, to enable secure, stable supplies for consumers in the years ahead. Indeed, there is an obvious symmetry here, because an orderly market will in itself result in future sound revenue viability.
[Slide 24] However, when we look at the future, we find ourselves many uncertainties, making it very difficult to produce meaningful forecasts that will help us with our investment plans, even for the short and medium terms. These include future non-OPEC production levels, economic growth, government policies and the rate of development and diffusion of newer technologies. 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.
[Slide 25] 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 26] 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. Meetings such as this play an important part in the process, by enabling people from across the industry to mix with each other, discuss issues of topical interest, exchange ideas and establish contacts which could be of mutual benefit in the future.
While it is too early to say whether we are experiencing a period of fundamental change in the industry, at least our deliberations here this week are providing us with the opportunity to reflect upon these matters, and this, in itself, will enhance our vision as we plan for the future of the industry.
[Slide 27] What we can say with assurance, however, is that there is enough oil around to meet the world’s growing energy needs for decades to come and that it is up to all of us to ensure that it is brought to the market in an orderly, secure and stable manner at all times.
[Slide 28] Thank you.
