Global Oil Outlook, future economic development and investment requirements for OPEC Countries
A Speech by Dr. Adnan Shihab-Eldin, Director, Research Division, Acting for the Secretary General to the 2nd African Petroleum Congress, Algiers, Algeria 16-17 February 2005, Session: "Oil Revenues", 16/2/05.
[Slide 1 — title]
Excellencies, ladies and gentlemen,
Let me begin by thanking His Excellency Dr Chakib Khelil, the Minister of Mines and Energy for Algeria, for this invitation to participate in the Second African Petroleum Congress. I should like to extend to His Excellency the greetings of the President of the OPEC Conference and Secretary General, His Excellency Sheikh Ahmad Fahad Al-Ahmad Al-Sabah. His Excellency Sheikh Al-Sabah has instructed me to address the Congress on his behalf.
Let me now say a few words about the current market situation, due to its present importance.
We have just experienced an unusual — if not unique — year for the oil market. [Slide 2] Following four years of relative stability within the OPEC price band, now suspended, we saw a rapid rise in crude oil prices, as a result of an exceptional combination of factors — in particular: the demand surge in Asia and the United States; refining and distribution industry bottlenecks; natural and man-made temporary supply disruptions; and geopolitical tensions. All of this was compounded by speculation in the futures market. In mid-October, the OPEC Reference Basket price hit a record high of US $46.6 per barrel. All this happened in spite of the fact that the market always remained well-supplied with crude; indeed, there was never any occasion when there was a shortage.
In response to the increases in demand, the OPEC Conference met on no less than five occasions in 2004 — including once in this beautiful city of Algiers — and increased its official production ceiling by a total of 3.5 million barrels a day during the course of the year, resulting in an average rise of more than 2 mb/d from the year before. This contributed significantly to the subsequent easing of oil prices, with the Basket remaining close to $35/b for much of December, and allowed commercial OECD stocks to build to around their five-year average. Furthermore, some of our Member Countries sped up the implementation of their capacity expansion plans, so as to enhance further the Organization’s ability to cope with possible future supply disruptions. OPEC spare capacity now stands at more than two million barrels a day and is expected to reach more than 3 mb/d by year-end.
However, at the beginning of this year, prices resumed their increase, with the Basket climbing past $40/b by the second week of January, although they have since slipped back below this level. The rise has been due mainly to seasonal characteristics, such as the expected shift towards colder weather in the Northern Hemisphere, which is leading to increased demand in the first quarter, amid supply concerns, following disruptions in the North Sea, the Gulf of Mexico and Iraq. Nevertheless, global oil supply — particularly OPEC output — remains adequate to meet expected demand.
At our most recent meeting in Vienna, we decided to maintain our present agreed production levels. At the same time, we temporarily suspended the OPEC price band, because the recent market developments resulted in price levels that rendered the limits of the band unrealistic and ready for re-evaluation, which is now underway.
When our Conference next meets, in the Islamic Republic of Iran on 16 March, we shall review the prevailing market outlook, to see how it matches up with expectations for the second quarter of the year, when demand traditionally declines. In the meantime, OPEC will continue to closely monitor market developments.
Let us now look further into the future, in accordance with the long-term orientation of this session. We shall use the reference case from OPEC’s World Energy Model, “OWEM”, to see how the situation may develop in the oil market in the first quarter of the 21st century.
[Slide 3] 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 4] 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 per cent. OECD countries will continue to account for the largest share of world oil demand.
[Slide 5] 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 6] 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 the transition economies, more than four-fifths in the OECD and close to half in the developing countries.
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 should not be seen as a constraint, in meeting future demand.
[Slide 7] 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.
OPEC will increasingly be called upon to supply the incremental barrel. [Slide 8] 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 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.
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.
[Slide 9] This will involve the use of sound investment strategies. Investment is needed: 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. [Slide 10] 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. [Slide 11] 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.
[slide 12] The economic fortunes of OPEC’s Member Countries have been heavily dependant upon their oil revenues since at least the establishment of the Organization in 1960, or their joining it in the following decade or so. Oil revenues, indeed, have accounted for a sizeable proportion of OPEC’s collective GDP over the years, although the degree of this has fluctuated in accordance with the prevailing oil market conditions. There are, naturally, big differences among the Member Countries.
If we look at the situation in terms of oil export revenue as a proportion of total export revenue [slide13], we find that, for the Organization as a whole, this averaged 68 per cent in 2003, with a wide spread for individual Member Countries, from just 16 per cent for Indonesia to as much as 95 per cent for the Socialist People’s Libyan Arab Jamahiriya. Iraq — at 99 per cent — is understandably a special case at the present time.
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.
The potential gains extend even further than this, however, as the record of the highly successful OPEC Fund for International Development will attest; since its establishment in 1976 as a specialist aid agency for developing countries, the Fund has made commitments totalling nearly US $7.5 billion, two-thirds of which has already been disbursed.
Well, as we all know, with regard to domestic development policies and oil market investment, the actual performance fell well short of expectations for much of our Membership in the 1970s and early 1980s — for already well-documented reasons that lie beyond the scope of this address and relate to events that occurred in an era of wide-ranging economic and political readjustment in the international community at large.
But we all learned important lessons from those experiences. Essentially — and in accordance with each country’s domestic policies and philosophies — they revolve around the need to make our economies more competitive and outward-looking, to allow for more private sector participation and investment, and to develop domestic financial markets. The current economic structures and macroeconomic policies in our Member Countries are, by and large, conducive to sustainable economic growth and allow for the more efficient use of their oil resources.
From a market perspective, we have become aware of the central importance of order and stability and the need to manage volatility and extreme price levels, both high and low. Volatility and extremities are damaging to all parties. OPEC knows this well, from, among other things, the personal experiences of its own Member Countries. We only have to examine the GDP/ capita movements over the past 35 years to see that [slide 14]. After an initial steep rise in the early 1970s, there was a near-similar decline in the 1980s, so much so that, by the end of the 1980s, GDP/capita was not much higher, in real terms, than it had been two decades earlier. While, in absolute terms across our Organization, GDP may have grown by an annual average of 3.4 per cent since 1970, in per capita terms, we are looking at just one per cent growth. Even last year, real per capita/GDP was still below levels reached in the late 1970s.
High levels of volatility and uncertainty can severely prejudice plans to invest either in domestic economic and social development or in future oil production capacity, with wider ramifications for the global economy at large. We need to ensure that we put the lessons of the past to good use, so that a more orderly, predictable and equitable market environment will emerge in the future, that will help eradicate past deficiencies and lead to enhanced security and stability, both domestically and in the industry.
When we look at the future, we find ourselves facing a wall of uncertainty, making it very difficult to produce meaningful forecasts that will help us with our investment plans, even for the short and medium terms [Slide 15] This is partly due to the wide range of feasible demand growth scenarios, but it is also reinforced by contrasting views on the potential evolution of non-OPEC production, as well as future costs. Uncertainties over future economic growth, government policies and the rate of development and diffusion of newer technologies are among the main factors that lie behind this. The oil price path is also important, reinforcing the need for sustained market order and stability.
Let us not forget that over-investment may result in excessive, costly, idle capacity, leading to downward pressure on prices; while under-investment may lead to a shortage of crude and higher prices. In both cases, the losses, especially for producing countries, and the possible, broader associated damage, such as to the world economy, can be significant.
[Slide 16] 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.
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, from such large-scale international ministerial gatherings as your important Second African Petroleum Congress to other bilateral or regional contacts in this continent.
I am confident that we can all rise to the challenges of the early 21st century, not only to meet the growing thirst of the established developed nations, but also to support the emerging economies of Africa, Asia and Latin America, as they set out on the path of sustainable development.
[Slide 17] Thank you.
