OIL PRICE OUTLOOK
Andrew McKillop
Founder
member, Asian Chapter, Internatl Association of Energy Economists
Former
Expert-Policy and programming, Divn A-Policy, DGXVII-Energy, European
Commission
Introduction
The perspective of increasing
fragility in the world oil supply chain, combined with small and low annual net
increments of both oil and gas supplies, must be contrasted with a changing
demand context. The present context for world oil and gas demand is firm. It is
underpinned by increasing growth rates of
import demand in several key countries and regions, this demand pattern
being reinforced, rather than weakened by generally higher and much more
volatile traded oil and gas prices. The price outlook will increasingly depend
on the price strategy and price policies chosen by producers, and respones or
reactions by consumer nations and groups or blocs of nations.
There is little or no effective
and real truth in the ‘received wisdom’ that producers only seek to increase
prices and recoup or obtain the maximum possible rent from their capital
investment and natural resource drawdown. There is likely considerable truth,
however, in the affirmation that import dependent consumer countries generally
seek to minimise the price paid for oil and gas imports, due to the ‘received
wisdom’ that high oil and gas prices either reduce economic growth rates or
increase inflation, or both. Despite this economic policy ‘imperative’, the
clear imperative for oil and gas producer corporations, and gas transport
infrastructure developers, is for higher and more stable prices, in order to
finance very large capital spending needs in the immediate and short-term
future.
At the world market level, price
trends and price relations for traded natural gas and traded oil and oil
products show increasing convergence. The price differential in favour of oil
on an energy equivalent basis (traded at 6 dollars or 4.75 Euro per Million
BTU, natural gas is energetically equivalent to oil at about $ 35 or € 27.50
per barrel) has considerably shrunk, and even reversed in certain markets, at
certain periods in recent years. Likewise, for the oil market, there is
increasing convergence of prices (or reduction of differentials) for heavier
and lighter crudes, and crudes from various geographical origins relative to
nearest major importer country refining centres. In real terms, and taking
account of the US dollar’s world purchasing power after the ‘creeping
devaluation’ of late 2003-early 2004, actual prices are about one-third to
one-quarter their price levels of the early 1980s. This being the case, price
levels for both oil and gas have had little real and immediate impact on global
economic trends, which in fact is a continuation of real trends through the
last 15-20 years. The reverse is more likely the case: oil prices (and natural
gas prices since 2000) are more likely affected and entrained by global
economic trends. When global and regional economic growth trends move up, oil
and gas prices tend to follow, after a delay that itself is tending to shrink
as ‘supply pinch’ begins to exert more effects on a generally tightening
context. The most important factors swaying prices, both upward and down, is
economic and geopolitical policy and strategy of the older industrial-urban
OECD countries, led by the USA.
Recent trends, both for demand
and supply, indicate that strong, even runaway upward bidding in oil prices
could easily occur. Under a worst case scenario, economic recession through
defensive interest rate hikes might be triggered as a response to runaway
prices. Conversely, firm and stable oil prices at levels about 1.5 times
current could well stabilize and strengthen oil industry investment and
planning for an emerging supply environment that is increasingly tight. In the
real world, however, given the preference by the Bush administration to
demonstrate the so-called ‘hyperpower status’ of the USA, the use of military
force to either pre-empt oil price rises, or ‘respond’ to runaway oil price
rises with military force is by far the most likely outcome.
Recent OECD IEA and US EIA data,
and information supplied by oil industry majors and oil industry analysts
suggest that world demand is around 78 to 78.5 Million barrels/day (Mbd) on an
all liquids base, and that this average daily demand has held since at least
June/July 2003. Growth on a year average daily demand basis at the world level
is likely well above 2% annual.
Broken down by region, South and
East Asian energy demand growth continues to be strong; year average growth
rates for consumption of oil and natural gas have shown absolutely no ‘price
elastic’ effect (falling demand growth with increasing prices) in these 2
regions over the period early 2002-end 2003. Depending on country, growth rates
of demand for oil and natural gas extend from about 5% annual to over 15%
annual. This incompressible growth of consumption (matched or exceeded by
growth rates for imports of oil and gas) easily compensates slow growth or
stagnant demand trends in several European markets and Japan.
US oil demand, accounting for
about 26% of world consumption averaged about 20.1 Mbd in late 2003 and has
shown an overall growth rate on an annual basis of at least 2%. This growth is
surely bolstered by fuel switching away from natural gas whose stepwise price
rise to levels of around $6.25/million BTU now makes $35/barrel oil
competitive: probably 0.25 Mbd of the 0.6 Mbd growth in US oil demand through
the first 6 months of 2003 can be attributed to fuel switching. Thus, despite
the erratic moving US economy, now claimed to be achieving or attaining growth
at above 7% on an annualised base, oil demand by the US economy is without any
question very firm. Improvements in US equity markets due to better economic news
can almost surely underpin national oil demand and maintain its growth at an
annual rate well above 2%. We should also note, however, that through the first
two quarters of 2003, in which real economic growth of the US was running at
below 2% on an annualised basis, US oil import demand, and natural gas
consumption was growing at nearly 3% annual (oil) and over 4% (gas). Import
requirements of the US for both oil and gas are growing much faster than the
rate of consumption growth, due to continually falling national production.
Domestic oil production is falling at about 2.5% annual in net terms, while gas
production is falling at about 3% to 5% annual. Consequently, oil imports have
shown quarterly growth rate peaks of more than 10%. In the case of the European
Union countries, oil import requirements are surely increasing, but the most
dramatic change will be increasing gas import requirements, starting from 2006
at the latest and continuing in an upward spiral.
In S and E Asia, growth trends
for oil imports by China, India and Pakistan are above 10% annual, with
quarterly peaks well above 25% through 2003. In addition, slow growth of oil
and gas demand by certain regional players like South Korea and Taiwan are now
at an end due to better economic outlook in the US and improving export market
potentials in Europe on the back of a very strong Euro. Declining virulence of
the SARS epidemic, at one time slated to trim Asian oil demand by up to 0.4 Mbd
in 2003, will likely further bolster consumption and import demand growth in
this region of increasing capital investment and robust, sometimes extreme
economic growth.
Despite these real world trends,
both the IEA and EIA continue to offer world oil supply/demand forecasts for
the 2003-10 period with a 1.6%-1.8% average annual growth factor. The N°2 world
oil company, BP Amoco, continues to claim that world oil demand is growing at
an “underlying rate”, described by BP as a long-term trend, of about
1.3%-per-year. This is despite growth trends on a world basis and through
1990-2003 always varying from year to year, and generally tending to increase
in nearly all regions from at latest 1995-96. Annual growth at or above 2.25%
is in no way unusual or impossible, and in fact is likely the real underlying
or ‘trend’ rate for 2003-04, in the absence of major and intense economic
recession. (See Table at end of article).
Depending on the average annual
growth rate retained, from 1.3% (BP), through 1.7% (IEA and EIA), and up to
2.25% (actual trends), we obtain annual world oil demand increments that range
from below 1 Million barrels/day, to
about 1.8 Mbd. In general terms, this large variation also applies to natural
gas demand forecasts made by various agencies, and real world trends.
The levering up of growth rates
for oil consumption, due to continuing high economic growth rates, can at least
partly be explained as due to rising oil prices. From their low around $10/bbl
in late 1998, to prices evolving in a sometimes erratic band from $28-$36/bbl
since 1999-2000, the impact of higher oil prices on world macroeconomic trends
and notably on relative pricing terms between real resources, on one hand, and manufactured goods and services on
the other, is on balance pro-growth, at the global (that is world) level. The
relatively low real interest rates now available to many borrowers is a
complementing economic growth factor. Another is increased world liquidity
simply due to higher volumes of payments for world traded oil and gas.
Taking the low end rate used by
the IEA and EIA, of 1.6% annual, this gives only 1.2 Mbd increase in demand for
2003, using a base of forecast world oil demand averages made by these two
agencies until last quarter 2003 (despite the fact that the IEA has issued oil
market reports from late May 2003 indicating demand peaks of close to, or above
79 Mbd). If we take just 78 Mbd as the 2003 year average, but apply a demand
growth factor of 2.25% we have a demand increase of 1.75 Mbd. Under almost any
scenario, we are likely to see a year average growth of at least 1.6 Mbd for
2003. World oil demand at year end 2003 can easily surpass 79.5 Mbd.
All downside action in oil
pricing since March-April 2003, when prices shaved the $40/bbl ‘psychological
barrier’, can be traced to over optimistic interpretations of Iraqi production
and export potentials in the short- and longer-term, continuing optimism on
Russia’s net oil export potentials,
bolstered by incorrect and unfounded analysis of world oil demand trends
going forward. Recession trends notably in the US, German and Japanese
economies were overvalued, while the pro-growth impacts of generally higher oil
prices as a factor in economic growth were underplayed or ignored. Oil prices
were marked down to the $25-per-barrel range following Baghdad’s capture but
have significantly rebounded since. Under almost any reasoned scenario, net
exports of oil by ‘liberated’ Iraq are unlikely to regain prewar levels (about
2 Mbd official, and 0.4 Mbd ‘grey’) before 2006 or 2007 and will very likely be
highly volatile due to sabotage attacks and armed resistance to military
occupation, also bolstered by increasing domestic demand due to reconstruction
and the presence of very energy intensive vehicle fleets of occupying forces
(needing about 0.35 Mbd).
Net exports by Iraq are at
present struggling to exceed 1.25 Mbd, and could at any time fall, if gathering
resistance to military occupation continues, and social chaos does not abate.
As oil production difficulties for New Iraq become better known it is now clear
that world supply has lost at least 1.25 Mbd at a time when demand is
increasing by about 1.6 to 1.8 Mbd per year. At the same time, it is unsure
that OPEC supply can easily be maintained at more than 27.4 Mbd, despite claims
by some analysts, and by the EIA and IEA that OPEC exports in November-December
2003 were close to 28 Mbd. Pricing policy decisions of Saudi Arabia and Russia,
and their actions concerning a full and formal switch to the Euro for oil
purchase settlements, as well as continuing difficulties for Venezuela and
Nigeria to maintain (let alone increase) export capacities all contribute to a
perspective of OPEC supply being set at an effective maximum not significantly
larger than 28 Mbd, that is far below EIA and IEA claims that OPEC’s capacity
can be ‘rapidly increased to over 31 Mbd’.
There can be legitimate concern
that over-rapid and overlarge oil price rises might trigger a defensive strategy
of interest rate hikes, to strangle economic growth and oil demand in the OECD
countries. However, the real world, real economy impacts of the effective 230%
price rise for traded oil through 1998-99, followed by fast rising natural gas
prices in the US market, underlines the simple fact that effective and real
energy prices are far below any ‘recession trigger’ level. The fragile oil
supply environment is itself a permanent risk of runaway price rises when or if
there is a supply interruption or cut of no more than about 3 Mbd, that
continues for more than a few weeks. Taking the 3-year period of 2002-2005, the
maintenance of current average growth rates for oil demand (about 5 Mbd in 36
months) will certainly outstrip OPEC production raising capacities, resulting
in Russia becoming the only possible ‘wild card’. In the present context it is
highly unlikely that substitute supplies could be made up: prices might be bid
up through successive ‘barriers’ such as $50/bbl and $75/bbl, before defensive
interest rate hikes were decided.
In this context it is interesting
to note that recently declassified British government secret documents reveal
that in 1973 the Nixon-Schlesinger duo were actively considering invasion and
occupation of Saudi Arabia to ensure the ‘free flow of oil at reasonable
prices’. From the base of occupied Iraq it could be much easier to take this
action, today, in response to runaway oil prices, only needing the right number
of ‘Saudi related’ terror incidents to start the invasion process.
Much better, both for world
economic growth and for avoiding a likely major, even terminal conflagration in
the Middle East and Islamic world, and also enabling increased investment in
the world oil and energy industry, stabilized oil prices in a range of around €
27 - € 33 ($36-$45) per barrel could be the focus of concerted discussion and
analysis. This pricing level, it can be noted, held in the 1975-78 period,
expressing barrel prices of that period in today’s dollars with their current
purchasing power. Suggesting a price level that held more than 25 years ago is
difficult to call ‘radical’, more especially because economic growth rates for
major oil importer and consumer countries at that time were around 2 – 3 times
higher than today, while inflation was about 6%/year on average for the G-7
economies.
Moving up to this new price band
can be the focus of serious and committed international attention to the risks
facing both oil producers and consumers at this time. Considerably higher and
stable oil and gas prices could also be hoped to provide a ‘price signal’ for
energy transition away from almost complete fossil energy dependence. Runaway
price rises in a free-for-all bidding process following supply loss of no more
than 5% (less than 4 Mbd) , leading to US invasion and occupation of Saudi
Arabia can legitimately be considered as a logical but worst possible scenario.
Concertation and communication based on economic reality and emerging
challenges to world oil supply from depletion are the only positive and
pro-active responses to increasing needs for resetting oil and gas prices.
* * * * * * * *
TABLE Recent and current world oil demand and demand growth
trends
|
Year |
Percent growth on year before (percent change in
average daily demand) |
Real demand growth (year average daily demand) Mbd
|
|
1994 |
2% |
1.4 |
|
1995 |
1.7% |
1.15 |
|
1996 |
2% |
1.5 |
|
1997 |
2.6% |
1.8 |
|
1998 |
0.5% |
0.8 |
|
1999 |
2.9% |
2.3 |
|
2000 |
2.4% |
1.9 |
|
2001 |
-0.2% |
- 0.08 |
|
2002 |
0.3% |
0.2 |
|
2003 |
2.2% |
1.7 (minimum forecast) |
Sources/ BP Statistical Review of
World Energy and OECD IEA