WORLDWIDE ADDICTION TO PETROLEUM
Nicolas Sarkis
WHAT is behind the current steep rise in oil prices? Is it temporary and linked to the economic and political climate, or the start of a cycle that will bring a long-term increase in energy prices? Is it, as some fear, the prologue to another oil crisis caused by the inability of supply to keep pace with demand?
These questions are legitimate. Some observers thought that the invasion of Iraq by the United States in March 2003 would lead to a quick rise in Iraqi output and a drop in oil prices to about $20 a barrel. But two months later the oil market came to the boil and has been bubbling ever since. This spring the unexpected rise in prices speeded up despite a seasonal drop in world demand of about 2m barrels a day.
The drop in prices after the last meeting of Opec (1) on 3 June and the announcement of an increase in US reserves did not dispel concern. World demand is expected to rise again in the immediate future and the underlying factors that boosted prices to more than $40 a barrel have not gone away. The key factors are the global political situation and market forces.
The price hike would not have been as sudden if conditions in Iraq were different and Saudi Arabia not vulnerable to terror attacks. Widespread insecurity and recurrent sabotage of oil facilities in Iraq dragged production there down to 1.33m barrels a day (bpd) in 2003, compared with 2.12m in 2002. Production rose to 2.3 bpd in May 2004, but that is still well below the levels in 1999-2001.The new authorities have frozen contracts negotiated or signed by the Ba’athist regime with international companies to exploit new oilfields, which were expected to double output within six to eight years. Recent terror attacks in Saudi Arabia, which is the world’s largest exporter, especially an attack that targeted a petrochemical facility and wells, were a serious shock.
The current frequency of attacks makes people fear that they will be a recurring feature in Saudi Arabia, Iraq and other Gulf states, with the possibility of lasting disruption of exports. The big difference from the crises of 1973 or 1979 is that the basic problem then was an embargo instituted by the governments of Opec countries or a change in political regime (as in Iran after the Islamic revolution). Now unpredictable attacks by unknown groups are the problem, plus the threat of the destabilisation of the Saudi regime that undermines that country’s ability to continue its central role in supplying world demand.
Tensions caused by the deterioration of the situation in Iraq and Saudi Arabia are mostly responsible for the latest price rise, called the risk premium. This runs at $6-10 a barrel, depending on circumstances, and covers both higher insurance charges and the impact of speculation on futures markets (major investment banks have allocated tens of billions of dollars to these).
Geopolitical tension and speculative buying have amplified a bullish trend rooted in a change in the balance between supply and demand. Three main factors demand our attention. The first, often overlooked, is the impact of ethnic conflicts and strikes on Nigerian oil production. (The strike that paralysed the oil industry in Venezuela in 2003 also led to a substantial drop in output.)
The second problem is that refining bottlenecks are common in countries with the largest consumption. After inadequate investment in recent years, global capacity currently totals 83.6m bpd, slightly more than the 82.5m bpd peak in demand in February. The structure of refining capacity is unsuited to the current demand for refined products, particularly in the US, which uses 9.6m barrels daily; a petrol shortage in May caused prices to rise steeply. When the price of refined products rose, crude oil prices followed.
The third problem is that on 10 April Opec decided to reduce its production ceiling to 23.5m bpd; this led to a sharp protest in industrialised countries, adding to tension and exacerbating the rise in prices. In practice Opec members have not reduced real output, and overall supply is still sufficient to cover demand.
Oil market statistics are fuzzy. Surprisingly, Opec members publish production figures three months late, maintaining the confusion between their theoretical production quotas and actual output, which generally exceeds quotas. Operators and observers play hide-and-seek, attempting to track tankers as they leave loading ports and consulting secondary sources to assess, as far as possible, the daily production of oil. A lack of transparency does not only apply to real output figures but affects data on production capacity and variations in unused capacity in exporting countries. This is very important at times of low unused capacity, as at present.
The most reliable estimates are that unused capacity is now about 2.5-3m bpd worldwide. Most of this is in Saudi Arabia; production is at full capacity in non-Opec and most member countries. A major disruption in Saudi or Iraqi exports, or a strike or serious accident in another main exporting country, could cause a shortfall in supply, driving market prices up again. This risk contributed to the latest price hike; the expected increase in world demand in the second half of 2004 will stretch the meagre resources available.
Another void in oil statistics centres on the doubts about official data on proven reserves and the reliability of medium- and long-term forecasts of global supply and demand. When an international company such as Shell, with shares quoted on stock exchanges, cuts its reserves forecast by about 25% in a few months, it is hardly surprising that figures published by other large corporations should be queried.
Official statistics on proven reserves in Russia and the main Opec members, which are not checked by independent bodies, have prompted serious doubts for many years. There is a major problem here. The reserves of the eight largest national companies in Opec countries theoretically amount to 662bn barrels, compared with only 57bn barrels held by the top eight international companies. The recent controversy after the Simmons report (2) on the state of the Saudi oil fields and the scope for developing the reserves of Saudi Aramco (the national oil company), which amount to almost a quarter of the world total, exacerbated concern.
World demand, currently at 80.3m bpd, is expected to rise to almost 120m bpd by 2025, roughly twice the level of the 1970s. Can supply follow? Only the Middle East can provide the bulk of it, which means output must more than double to avoid shortages. In the medium term obstacles to this are mostly political. To increase output will require huge investments in the region, estimated at $27bn a year. But for that to be possible there must be a favourable political climate, which is far from the case. Beyond that lies the big unknown, in the Middle East and elsewhere: when production will peak, in one country after another, before irreversible decline.
The Association for the Study of Peak Oil international conference in Berlin in May 2003 was not reassuring. Disregarding claims of both optimists and pessimists, the number of new finds is falling, as is their volume. Only one giant oil field, Kashagan in Kazakhstan, has been discovered in the past 30 years and new finds do not compensate for the oil extracted every year. A geologist says that oil exploration is now like a hunting expedition on which hunters have improved the perform ance of their guns through better technology but game is small and scarce.
We should not ignore another grim reality: by 2025 the steep increase in world demand and decline in reserves and output in industrialised countries will increase their dependence on imported oil. US imports will rise from 55.7% to 71%, western European imports from 50.1% to 68.6%, and Chinese from 31.5% to 73.2%. This growing dependence, in a sector as vital as energy, explains the oil wars that the big powers and their com panies are waging to gain control of reserves in the Middle East, Africa (3), Central Asia and Iraq (4). There has been serious reason to question the interpretation of the current rises - are they the first sign of a crisis caused by the imbalance between steadily rising demand and inadequate production capacity?
The expansion of production capacity over the next few years depends just as much on political stability, particularly in the Middle East, as on the volume of reserves available. Longer term the slow but inexorable exhaustion of reserves means that a gradual switch to other energy sources is inevitable. Besides political stability this transition requires sufficiently attractive energy prices to allow global investment in energy production, a sum estimated by the International Energy Agency at $16,480bn (at 2000 prices) between 2001 and 2003.
Oil and gas industries will need money, and more will be needed to develop other energy sources. The fears caused by the rise in oil prices may help end the torpor made possible by adequate supplies and oil prices which, even at their current level (adjusted for inflation), are no higher than the record set 25 years ago.
* Nicolas Sarkis is director of the Arab Petroleum Research Centre and editor of ’Le pétrole et le gaz arabes’
(1) Opec’s 11 members are Saudi Arabia, Iraq, Iran, Kuwait, Qatar, United Arab Emirates, Algeria, Libya, Nigeria, Venezuela and Indonesia.
(2) Matthew Simmons, president of the Simmons & Company international investment bank, advises the US vice-president Dick Cheney and was the brains behind the new US energy policy.
(3) See Jean-Christophe Servant, "The new Gulf oil states", Le Monde diplomatique, English language edition, January 2003.
(4) See Yahya Sadowski, "No war for whose oil", Le Monde diplomatique, English language edition, April 2003.
Translated by Harry Forster
