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Depletion - the missing demand element?

At the time of writing (August 2004), West Texas Intermediate (WTI) has just breached $47/b, with Brent nudging $44/b. Oil prices are already at all time nominal highs and levels, in real terms, only exceeded in the 1980-1985 period. Cambridge Energy Research's (CERA) recent press release indicated that there was a 50:50 chance of oil prices exceeding $50/b within 50 days. This now looks to be a racing certainty.

The question that everyone would like answered is: 'Do these prices reflect underlying supply/demand imbalance or have they been driven to these levels by panic and speculation?' If the former, we are in a new world of high oil prices with new capacity and economic slowdown the only brake on the upward momentum. If, however, panic and speculation are key components, then the expectation would be that prices would ease back once a more balanced assessment takes hold. Those that hold the 'panic' view contend that current supplies should be enough to meet demand and rebuild supplies. Some are already questioning why stocks are not already building.

There is an old saying that one should plan for the worst and hope for the best. Companies, at least in private, are good at examining the dire scenarios and checking that they can survive. Governments and international agencies are, however, more reluctant to examine the worst cases. This is largely because they operate more publicly and so are very reluctant to examine extreme or unlikely scenarios for fear of public or market reactions.

In the case of the International Energy Agency (IEA), which is ultimately charged with sharing out available oil supplies (stocks) in the event of a major shortfall, we find that it is publicly reluctant to even mention the impact of depletion. Is this the reason, or part of the reason, that demand has been revised upwards nearly every month this year?

In the July edition of the Oil Market Report, the IEA showed how demand growth was met by a combination of non-Opec supply growth and the call on Opec + stock change (see table). However, the missing element is depletion and, as we showed in the August issue of Petroleum Review, this is now running at over 1.1mn b/d.

Now growth in oil demand is actually made up of two elements - the increased usage of oil and the amount of outright depletion in various countries that has to be offset by production expansion in other countries. Unfortunately, the IEA does not explain how it deals with depletion. So, if for example, we take the 2003 data, according to the IEA demand growth was 1.6mn b/d, met by 1mn b/d of non-Opec growth and a call on Opec + stock change of 0.6mn b/d.

However, from the re-presented BP statistics (August Petroleum Review) we know that depletion was running at 1.1mn b/d and global production grew by 2.7mn b/d. It seems more than a coincidence that when we add 1.1mn b/d of depletion to the IEA's 1.6mn b/d of demand growth we get to the 2.7mn b/d of actual production growth recorded by BP. (There being little significant stock change in the period.)

On the basis of planning for the worst - or rather examining the worst case. we present the table below where depletion as identified in the BP statistics is added to the IEA's demand to get what we have called 'real' demand. We have also done this for the IEA's estimates for 2004 and 2005. Depletion is treated as a positive number as it is effectively additional demand.

While this analysis may not be perfect, it does indicate that depletion can boost demand dramatically. Surely it is time that depletion was treated explicitly rather than being buried in the statistics?

Year Demand growth Non-Opec supply growtha Call on Opec + stocksa Depletionb 'Real' demandc*
2001 0.6 0.9 -0.3 0.5 1.1
2002 0.3 1.7 -1.4 0.4 0.7
2003 1.6 1.0 0.6 1.1 2.7
2004d 2.5 1.6 0.9 1.3 3.8
2005d 1.8 1.6 0.2 1.5 3.3

The impact of depletion on demand
Sources: a IEA Oil Market Report, 13 July 2004; b Petroleum Review, August 2004; c Petroleum Review calculations; d estimates

Chris Skrebowski

The opinions expressed here are entirely those of Chris Skrebowski, Editor of Petroleum Review, and do not necessarily reflect the view of the EI.

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