Hindsight always throws up some interesting questions, and this is certainly apparent in reviewing the international oil market in 2006. Who would have thought the OPEC Reference Basket that had been on the rise since 2Q 2004 would have fallen by more than $19/bbl in only two months, from a peak of $72.7/bbl on Aug. 8? This is the sharpest drop since 1991. Who could have predicted this past year’s geopolitical concerns in the Middle East or the partial closure of BP’s key Prudhoe oilfield in North America? It would be easy to go on.
What all these events underline is the greater than ever significance attributed to energy security. It is an issue that is increasingly topping the political agendas of countries around the world. There is no doubting that amid such volatility and risk, uncertainty and challenges abound, but it should also be stressed that so too does opportunity. To meet the challenges and embrace the opportunities, the goal for all of us is market stability. If stability can be attained and sustained, it is clearly a “win-win” situation for all stakeholders.
From OPEC’s perspective, this plays out in its support for stable prices, a balanced market, steady revenues to producers, efficient, economic, and regular supply to consumers, and fair returns to investors. To sum this up succinctly, OPEC’s oil market commitment focuses on “stability, stability, stability” where security of supply and security of demand are components of the same equation. The key is a balanced and mutually supportive supply and demand network at reasonable price levels to both consumers and producers.
This all looks easy on paper, but in practice it requires continuous monitoring and the readiness and capability to take timely remedial actions to maintain stability, from both supply and demand perspectives, as and when necessary.
Take the present market situation. The past few months have witnessed a significant u-turn in the trend of protracted upward pressure on prices, which has been a prevailing feature since spring 2004. This is indicative of an over-supplied market. Additionally, and very much as a result of OPEC’s production increases in recent years, commercial crude oil inventories in the Organisation for Economic Cooperation and Development (OECD) have risen to comfortable levels, well above the five-year average. Also, with the winter season upon us, seasonally important middle distillate stocks in the US also remain high.
Overall, these 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 might otherwise be expected. 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 global economic growth and encourage investment in capacity to meet current and future demand, particularly in an industry with long lead-times and high financial risks in an environment of rising costs.
World oil supply and demand growth (MMb/d).
This informed the decision of the special Consultative Meeting of the Conference OPEC held in Doha, Qatar, on Oct. 20. After reflecting on the outlook for the rest of 2006 and all of 2007, the conference decided to realign its production by 1.2 MMb/d to 26.3 MMb/d of oil, with effect from the beginning of Nov. 2006 to help stabilize the market. It also helped inform the recent decision taken by the OPEC Conference in Abuja, Nigeria, in December, where it was decided to reduce OPEC production by 500,000 b/d, with effect from Feb. 1, 2007, in order to balance supply and demand. Here, the Conference further reiterated the organization’s determination to take all measures deemed necessary to keep market stability by maintaining of supply and demand in balance for the benefit of producers and consumers alike.
The Doha Conference effectively marked a turning point for OPEC in line with the changing market outlook. After a two-year period in which OPEC had focused its efforts on increasing production levels and accelerating capacity-expansion plans to counter the exceptional, volatile upward pressure on prices at that time, the organization responded to the evolving new need to resist, at its early stages, a possible heavy downward price spiral, which was as potentially damaging to the market at large as the upward trend.
So where does this leave the oil market for 2007? With regard to demand, the picture 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 robust momentum in the global economy. Demand growth for 2006 is expected to be around 1 MMb/d of oil, and reach 1.3 MMb/d in 2007, although this requires a rebound from current trends.
On the supply side, the outlook for non-OPEC has changed dramatically. In 2006, non-OPEC supply increased by 0.9 MMb/d and it is expected to grow in 2007 at 1.8 MMb/d, the highest rate since 1984, pointing to a clear imbalance between supply and demand. Growth in non-OPEC supply is expected to exceed growth in world demand by around 0.7 MMb/d in 2007, indicating the need for measures to rebalance a market already awash with stocks. As a result, the demand for OPEC oil will be 28.1 MMb/d, around 1.4 MMb/d lower than total OPEC production in Oct. 2006. The years prior to 2006 had seen non-OPEC supply growth fall behind world demand growth and led to OPEC unexpectedly meeting the bulk of rising demand, to the tune of around 4.5 MMb/d since 2002, while also accelerating plans to expand production capacity.
As mentioned earlier, these figures are continually monitored in light of the presented challenges. For 2007, these are broad and varied, but what should be highlighted is that the majority of challenges are long term. It is not just about this year; it is about looking many years ahead. These long-term challenges include: the future role of OPEC and non-OPEC supply; the expanding role of national oil companies; environmental considerations; new technological developments such as carbon capture and storage (CCS); the role of biofuels and other alternatives; and as 2006 has underscored, the unseen challenges that often take the market by surprise.
These challenges are all critical going forward, but the issue that merits more in depth focus is investment. It is investment that is the focal driver for all oil industry developments, and to put investments in context it is also appropriate to look to the long term.
Three scenarios for cumulative OPEC investment.
OPEC’s reference case scenario puts average annual oil demand growth at 1.6% for the period from 2005 to 2025. This is a sizeable 36% taken across the entire 20-year period. Projections also show that OPEC production levels, including natural gas liquids, will rise to 54 MMb/d by 2025, which will be slightly below that of non-OPEC. It is not difficult to see how this points to the requirement for large amounts of investment.
Nevertheless, the key investment dynamic is the fact that there are doubts over this future oil demand reference scenario that translate into large uncertainties over the amount that OPEC member countries will eventually need to supply, signifying a heavy burden of risk. Over the next 15 years, for example, scenarios developed highlight that the amount of oil required from OPEC could genuinely range by close to 10 MMb/d. When talk turns to extrapolating this out in terms of investment, the figure takes on a very worrying look. The expected range is somewhere between $230 billion and $470 billion, a huge amount for OPEC member countries, all with competing needs in such areas as health, education, and infrastructure.
Indicative infrastructure cost increases since 2003. Source: Goldman Sachs, OPEC Secretariat.
It is important to add that OPEC crude capacity expansion plans already in place are expected to result in almost 38 MMb/d of crude capacity by the end of 2010, an increase of nearly 5 MMb/d, underpinned by more than 100 projects totaling $100 billion. These projects are in addition to energy infrastructure investments.
Keeping on the theme of investment, a further challenge, and one that is providing an increasing amount of discussion among industry players, is the cost of infrastructure, such as offshore rigs and tankers, as well as the cost and availability of human resources.
Upstream costs have increased by 50% since 2003. This can be viewed in the fact that rig rates and the costs of steel and other raw materials are shifting significantly upwards. In the area of human resources, the industry is experiencing a shortage of skilled labor for engineering, procurement, construction, and operations, which is underscored by the fact that the number of students enrolling in petroleum engineering courses has shown a significant decline since the mid-1980s. As a result of this shortage, wages have trended upward. In 2005 alone, wages in the industry increased by about 15%.
Taking the oil market as a whole, it is important that the downstream is not forgotten. Here, tightness in the form of inadequate refining capacity in some leading consuming countries has been putting a lot of pressure on oil price levels and differentials over the past couple of years. Despite the number of new major refining projects worldwide, the long construction lead times, combined with typical delays and project terminations, will most likely mean that the existing refining tightness will not ease until at least 2009 or 2010.
An estimated $160 billion in downstream capacity investment will be required by 2015, with another $150 billion needed for maintenance and replacement of lost capacity. In a sector that is essentially and traditionally the domain of consuming countries, however, present commitments leave a shortfall of around $100 billion.
The scale of investment should not only be viewed as a challenge, but as an opportunity. It is not something to shy away from, but something that needs to be effectively and efficiently embraced. What needs to be recognized is that “stability, stability, stability” and in turn, global energy security, requires global action. Neither the public nor the private sector, nor any one country, region, or organization can act alone.
From OPEC’s perspective, this is being pushed to the fore in the Organization’s commitment to enhanced dialogue and cooperation. The most recent result of this was the establishment, in 2005, of energy dialogues between OPEC and the EU, with the 3rd OPEC-EU Ministerial Meeting being held in July 2006, as well as with China and Russia. In the US, OPEC’s conference president, Dr. Edmund Daukoru, spent three days in March 2006 meeting senior Energy Administration figures, members of Congress, and oil executives in Washington, DC, and has since made four further trips to the US.
In light of all this, and though it is never easy to make predictions, OPEC is optimistic about the prospects for oil market stability in 2007 and in the coming years. The focus must be on understanding the needs of each stakeholder, viewing the entire energy market holistically, and making sure this leads to market stability at the local, regional, and global levels.
Mohammed Barkindo
Acting for the OPEC Secretary General
