The international petroleum market and industry are highly dynamic and changing as they are dramatically affected by political, economic and technological factors. Looking at the events of the past five years, for example, would reveal the dimensions of these rapidly changing dynamics and the difficulty of predicting their future. This includes, for example:
• The surge in oil prices in mid-2008 to $147/B and their subsequent collapse before the end of the year to $36/B.
• The prevalence of the idea that oil production would peak and thereafter enter into global decline, and that Saudi Arabia’s production, for example, would begin to decline by 2008. In fact, the Kingdom’s production in 2012 reached historically high levels not seen for three decades. Nobody speaks now of peak production.
• The continued increase in global demand from emerging countries, and its continued decline in the industrialized OECD countries. In 2014, the consumption of industrialized countries will, for the first time in the history of oil industry, be less than that of the rest of the world. Industrial countries accounted for 70% of oil consumption less than 20 years ago.
• Increased production from different countries and regions of the world, perhaps the most important of which are Iraq, Brazil and Canada. Iraq has for the first time become the second largest producer and exporter of oil in OPEC and the third largest oil exporter in the world, according to the OPEC Monthly Oil Market Report.
• Following a standstill in mid-2011, Libyan oil output almost recovered in 2012.
• The Arab Spring movements, which led to the suspension or huge reduction of exports from countries such as Egypt, Syria, Yemen and even Tunisia. Moreover, conflict between Sudan and South Sudan led to suspension of the latter’s exports.
• The tsunami, which hit Japan in March 2011 led to the shutdown of most Japanese nuclear plants and a freeze on nuclear expansion plans in many countries. Some countries, such as Germany, now have plans for a total phase-out of nuclear power.
• The western boycott of Iranian oil and western pressure on various countries and banks to stop imports from Iran impacted Iranian oil exports, although to an unclear extent.
• Production of shale oil and gas in large quantities, especially in the US, turned America from an importer of gas to a potential exporter. Gas prices fell from more than $9/mn BTU in late 2005 to less than $2/mn BTU in April 2012, starting to rise again in the following months and reaching around $4/mn BTU now. US oil production increased by about 3mn b/d after a steady decline since 1985.
These major developments in a short period of only five years demonstrate the difficulty of predicting the future evolution of the oil market and industry. Nonetheless, it is necessary for government officials, international organizations, corporate officers, experts and observers to extrapolate future trends in order to make use of them or avoid their negative aspects.
On the demand side, the following are the most important factors:
• Economic growth and its impact on oil demand. This may differ from one country to another depending on the level of social welfare. In advanced industrial countries, demand for oil may not increase significantly with economic growth as a result of high taxes on petroleum derivatives and a degree of relative saturation for certain energy uses.
In emerging and developing countries, where consumers are still in need of more basic services such as lighting, air conditioning, heating and transportation, the rate at which demand for oil increases can sometimes exceed the rate of economic growth.
In addition, the population of most developing countries continues to rise, which means more demand for the various sources of energy. For this reason, demand for oil in non-OECD countries has grown steadily from 37% of world demand in 2000 to around 50% at present.
• Government policies and regulations, including taxes on petroleum products. In countries with high taxes and strict regulations on energy efficiency, oil consumption per capita is small compared with countries that sell oil at low prices. In some Gulf countries, for example, average oil consumption is about 130 barrels per thousand people per day, while in advanced industrial countries such as Germany it is less than 30 barrels per thousand people per day.
• International oil prices. Rising prices lead to a slowdown in oil demand growth, whereas falling prices lead to increased demand, though to a lesser extent. Most industrialized countries have taken steps to minimize the effects of price rises through high taxes on petroleum products, which are mostly imposed when prices decline.
These taxes are also imposed for environmental reasons, such as reducing emissions and carbon dioxide and combating global warming. Emerging countries generally have not imposed high taxes on oil, because their priority is to maintain economic growth and social welfare, to which moderate energy prices are a contributing factor.
Factors affecting supply can be summed up thus:
• Oil prices. Prices affect the supply side just as they affect the demand side, particularly in exploration and production. When prices fall sharply, as they did in the late 90s, exploration slows down and production from some high-cost fields may stop completely. When prices rise to high levels as they did during the past 10 years, exploration activities increase and production levels rise in difficult areas, such as deep seas, oil sands, very heavy oil and shale oil.
• Technology, meaning the development of new or cheap techniques for the exploration, production and refining of various types of oil. Thanks to technology, the world has not only been able to replace the amounts produced with new reserves but also to steadily enhance recovery from known reserves. Technology has helped to reduce the cost of production and to develop new reserves of very heavy types of oil in difficult areas.
• The political situation in producing countries. This has affected world oil supply since the late nineteenth century and will continue to do so. For example, the collapse of the Soviet Union caused production to fall from more than 11mn b/d in 1990 to 6mn b/d in 1995. Production then rose to its current level of more than 12mn b/d due to political stability in Russia and central Asian countries.
Output from producers such as Iran, Iraq, Libya, Nigeria, Venezuela and Colombia has been subject to sharp fluctuations for political reasons. Moreover, political instability and real or potential military conflicts in some producing areas are estimated to have contributed an additional $10-30/B to prices, even when the market is balanced in terms of its fundamentals.
OIL MARKET PROJECTIONS
I would like to discuss the oil market from this year up to 2020, assuming the absence of unexpected political, economic or even natural crises in production or consumption. These projections use data from sources such as OPEC, the IEA, oil companies and petroleum research and consulting organizations. They do not reflect the official position of Saudi Arabia.
Starting with 2013, the world economic situation will be similar to the last two years, with a growth rate of nearly 2.4%.
Asian countries will drive this growth, led by China, India and Indonesia, while some sub-Sahara African countries, Arab countries, South American countries and the former Soviet Union will experience good economic growth.
The US economy, on the other hand, will still be recovering and will manage growth of 1.5-2%. Japan may see an economic recovery in view of its new monetary policy. Europe’s economy will continue to shrink for the third year in a row.
As far as oil is concerned, it is evident from the beginning of 2013 that the market will be balanced, with prices remaining stable at close to the present level of about $100/B. European demand will continue to shrink at the same rate as in the last three years, while demand in the US will halt its decline in response to the modest growth of the economy and may even register a limited increase.
For the rest of the world, oil demand will grow at a healthy rate as a result of economic growth and improved standards of living. China will be the leader of the growth in demand, as it has been over the past 10 years.
Other major Asian countries, as well as Gulf countries and North African countries such as Libya, Algeria and Morocco, will contribute to the demand increase.
The regions where global demand will increase include Russia, Central Asian, Sub-Sahara Africa and Latin American countries. The overall increase in global demand for oil during this year is expected to be around 1mn b/d, exceeding 90mn b/d for the first time in history.
Production will rise in several countries, most notably the US and Canada. Other areas, including the North Sea, Angola and Mexico, will see a decline. Production will be entirely, or partially, suspended in countries like Syria, Sudan and Yemen.
Assuming that OPEC maintains its current production level of 30.5mn b/d, as anticipated, the market will stay balanced this year, with withdrawals from the commercial stocks anticipated in 4Q.
CHANGING ENERGY LANDSCAPE
Despite this balance, significant changes will have a fundamental impact on the oil market. Most important is the increase in the supply of US light oil, which has helped keep prices down in North America and reduced US imports of light oil from the North Sea and West Africa. At the same time, US oil imports from Arabian Gulf countries, especially of heavy and medium grades, have increased.
Many US refineries were originally designed or upgraded to use relatively low-price heavy oil grades, and their capacity has been increased to obtain better financial returns, making the US the world’s largest exporter of petroleum products at about 3mn b/d.
Although the US government bans crude oil exports, except in few exceptional cases, the US is expected to export light oil in the coming years to North American Free Trade Agreement (NAFTA) member states Mexico and Canada and other countries with which it has free trade agreements.
However, more West African production is expected to be directed to Asian markets rather than low-demand American and European markets. The picture should become clearer in 2014 and 2015, as these developments are still in a formative stage.
2014 will be important for the oil market and for the global economy as a whole. The European financial crisis is expected to end and the European economy is expected to begin a limited recovery. (In the worst case scenario, the European economic downturn will stop).
In the US, it is expected that financial problems will be addressed and internal political differences will not hinder a recovery in which the economy will grow by 2% or more. Economic growth in the rest of the world will continue at or above the current level, which means that the global economy will grow by more than 3%.
This economic growth will be reflected in demand for oil, raising demand by 1-1.2mn b/d in 2014. On the supply side, the US and Canada will continue to increase their production in 2014, while production will also increase in other countries, most notably Oman, Kazakhstan and some African countries.
At the same time low production is expected to continue in the North Sea, so that the final equation will feature an oil supply increase of 0.8-1mn b/d, which is compatible with the increase in global demand. Thus the market will stay in balance even on the assumption that OPEC countries maintain their current production levels.
Over the five years beginning in 2015, global demand will continue to grow at almost the same pace, according to most estimates – by about 1.2mn b/d, reaching 98mn b/d in 2020. At the same time, non-OPEC supply will continue to grow, particularly from North America, some parts of Africa, the Brazilian offshore and the Gulf of Mexico at an annual rate of 600,000-800,000 b/d to 1mn b /d, taking non-OPEC production to 62mn b/d by 2020. During this period, therefore, OPEC countries need to increase their production gradually to reach about 34mn b/d by 2020, assuming that they are willing to take responsibility for maintaining market equilibrium and keeping prices at their current levels – a role they have assumed over at least the last 30 years.
In this situation, OPEC spare capacity will range between 3-4mn b/d, mostly from the Gulf countries, and particularly Saudi Arabia, Iraq, Kuwait and the UAE. This is an appropriate level of spare capacity, neither so high that it puts negative pressure on prices, as it did in the latter half of the 80s, nor so low that it drives prices up, as it did in the first months of 2008.
As noted earlier, amongst the most important developments in the international energy market will be the development of shale gas and oil production. This started in the US in 2010 and is expected to increase in the coming years. It is also likely to spread to different parts of the world, including some Arab countries.
Given the importance of shale oil and gas and their future role in the global energy equation during this and subsequent decades, and given the extensive discussion of this subject at the regional and global levels, this paper will take a brief look at this topic.
Shale oil is not a new source of energy. It has been known for several decades by different names. Shale oil generally refers to small oil formations within sedimentary rocks. Its extraction requires the use of special technology with which large quantities of water, sand, and some chemicals are used under very high pressure to crack rocks and extract gas or oil.
The appearance of shale oil and gas on the world’s energy map during the last four years can be attributed to two fundamental factors: first, rising oil prices, rendering the extraction of shale oil economically feasible; and second, the development of technology, particularly of drilling techniques which allow several wells to be drilled within a short period of time.
Production of shale oil and gas is still limited to the US and Canada, due to the above factors of price and technology, as well as US excellence in commercial and technological initiatives.
As a result, US shale gas production has doubled during the last three years from 4,000 bcf to 8,500 bcf a year, while shale oil and liquefied gas production increased by about 3mn b/d and is expected to increase year on year. Production of shale gas has slowed because prices have fallen to uneconomic levels. The only solution is to liquefy and export the gas, potentially affecting gas prices at the local and international levels.
Outside the US, there are large quantities of shale oil and gas all over the world. And while US companies have pioneered the development and production of shale gas and oil and have started to invest outside the US, other international companies have begun to benefit from the US experience and technology, which means new discoveries and production in several regions of the world. China has started exploration and pilot production of shale gas, with commercial production expected during the next five years.
Other countries have awarded shale gas exploration and production concessions to national or international companies. Large quantities of shale gas have been discovered in Saudi Arabia and Jordan. There are good prospects for shale oil and gas production in Algeria, Tunisia, Morocco and elsewhere.
It should be noted that the most important obstacle to the production of shale oil and gas in most Arab countries, in addition to high production costs, is that it requires huge amounts of water. The low price of natural gas at the local level, sometimes even lower than real production cost, also hinders exploitation at present.
Although there is much talk about the existence of very large amounts of shale gas and oil in several parts of the world, the quantity, cost and geology of its production is still not clear even in the US and Canada. At least five years may be needed to determine its future in all parts of the world and its effect on the energy market.
Increases in the production of shale oil during the remaining part of this decade will be restricted to the US and Canada at under 1.5mn b/d, which is a small quantity in a market where demand exceeds 90mn b/d. Production of shale oil in other parts of the world is not expected before the start of the next decade at best.
OIL PRODUCER FEARS
There appear to be fears within OPEC and oil producing Arab countries that a huge increase in supply of shale oil may lead to price collapse and force major producers, particularly OPEC countries, to reduce production. This fear is misplaced. The positive effects of shale oil on oil producing countries, including OPEC and Arab countries, in the medium term (5-10 years), outweigh the negative effects. These positive effects may be summarized as follows:
Firstly, easing world fears concerning the future of oil supplies, creating confidence that fossil energy sources will continue to supply the world with its energy requirements, at least during this century. A short while ago, there were concerns that oil would be depleted within the next 40-50 years, necessitating a search for alternatives such as solar or nuclear energy.
Although the world is still talking about these alternatives, the discovery of large quantities of shale oil, particularly in major consuming countries such as the US and China, will reassure everyone about the future of energy supplies.
Secondly, giving the international oil market greater depth in respect of the availability, type, areas of production and future of supplies. During the last 40 years, the oil market has experienced sharp fluctuations in prices and fears concerning the future of supplies, particularly with the growth of demand for oil in emerging countries and the limited spare production capacity worldwide.
Production of shale oil will undoubtedly give the market more depth, which will increase stability and reduce price fluctuations and thus provide the market with short and long term reassurance. Some observers think that the international oil market and the energy market in general will be more stable by the beginning of 2015 as a result of the increase in world production capacity from several sources, including shale oil.
Thirdly, finding the minimum price (price floor) for oil. There are different opinions regarding the determination of the minimum price of oil. During the last 10 years, the focus has been on biofuel (ethanol) and oil extracted from very deep waters, as in Brazil and the Gulf of Mexico, tar sands oil in Canada or very heavy oil in Venezuela.
Today, however, the minimum price would be for shale oil and the heavy Canadian oil at a $60-90/B production cost. In other words, if oil prices fall to $60/B, production of shale oil and some types of heavy fuel will be cut, or drastically suspended, especially if the price reduction continues for more than 12 months. This will ultimately mean that prices will return to their previous level,
We can conclude that the world oil market will be stable during the remainder of this decade with regard to equilibrium of supply and demand. As far as prices are concerned, then, the discovery of shale oil has more positive aspects than negative ones.
‘MUST BE READY’
Of course, in a world exposed to unpredictable geopolitical, economic and technological developments which affect oil and energy, we must be ready for all possibilities.
If an economic or financial crisis occurs in major consuming countries which are considered pivotal to the increase in demand at present and in the future, and at the same time an increase occurs in the production of oil from countries and companies which may not cooperate with OPEC for various reasons, the result may be collapse in prices for a period of a year or a little more. This might be hard for several countries and oil companies to bear.
In 1997-98, when a financial crisis hit Asian countries, it affected oil demand growth. At the same time, some OPEC countries, and particularly Venezuela, increased production without coordinating with OPEC or taking into account world demand.
In the end, oil prices collapsed for more than 18 months, and everyone was harmed, including the government of Venezuela. World economic and oil market conditions are now better than they were in the last century, but the previous experience is still fresh in everyone’s mind. This should make us more optimistic about the future stability of the oil market in this decade with a price floor in the area of $70/B.
However, at the same time we should be ready for the unforeseen worst case scenarios, or the Black Swan theory of Nassim Taleb.