LONDON – In the past week, oil prices have regained about US$3 a barrel after hitting a low of $45. Apart from the perennial US weather factor, positive sentiment was reinforced by IEA (International Energy Agency) data revising previous forecasts for world oil demand growth in 2005 by 80,000 barrels per day, or 0.08 million barrels/day (mbd), to the suspiciously modest figure of 1.52 mbd.
This is hard to fathom because the IEA also raised its final estimate of world demand growth in 2004 to 2.68 mbd. In percentage terms, growth in 2004 was very close to 4%, the highest for over 25 years. This number conflicts with forward planning ideas and beliefs of the IEA and other energy players – especially the world’s 10 biggest oil corporations. None of these players plan for demand growth beyond 1.75% per year. Some, such as BP and ENI, still claim that the “normal” long-term growth is about 1.3% per year.
On the consumer side, to back the notion of slow growth being a fixed paradigm, oil users are everywhere thought to show “price elastic” response to higher prices. That is, they cut their consumption as prices rise. On the supply side, the same high prices are expected to bring new and big suppliers into the market. If this does not happen, we have an oil crisis. This pre-crisis context is directly reflected in the market by rising volatility on a longer-term upward price profile. The IEA forecast of growth in 2005 dropping about 42% against 2004 is, we can surmise, purely wishful thinking.
The Organization of Petroleum Exporting Countries (OPEC) is usually wheeled into the pricing melee by saying it will now “defend” $40/barrel, after waiting until December 2004 to say it was no longer “defending” a price range of $22-28/barrel. But the question is: what spare capacity does OPEC really have? This raises the key question as to what exactly OPEC’s current 11 members (OPEC-11) produce and export. Using data from the Oil & Gas Journal on world daily average production in 2004 and 2003, only Iran, Qatar, Kuwait and Saudi Arabia are credited with production hikes of over 3% in 2004, excluding the very special case of Iraq. For Oil & Gas Journal, there was a 55% increase in Iraq’s daily average production to about 2.05 mbd in 2004, while EIA (Energy Information Administration) and the DoE (Department of Energy) figures give about 1.55 mbd, almost identical to the 2003 average output. BP places Iraq’s 2003 production at a daily average of 1.33 mbd. This is exactly half the growth in world daily average oil demand in January-December 2004.
Any production numbers for OPEC are subject to the key question: net or gross? Iraq, for example, has soon recovered pre-war domestic oil demand of about 0.65 mbd despite shattered economic infrastructure and 60% unemployment. US occupation forces in Iraq are credited with about 0.35 mbd demand. During the economic reconstruction phase that may now be about to start, Iraq’s domestic demand will certainly increase rapidly. Normal economic development in oil producer countries is of course oriented to energy-intensive activities. Saudi Arabia’s domestic oil demand in 2004, according to BP, increased by 5.5%, much more than its 3.2% hike in daily average oil production. Kuwait’s domestic oil demand, again according to BP, has been growing at over 10%/year of late (19.8% in 2003), dwarfing all increases of its national oil production.
This pattern of domestic demand increasing much faster than production is common to more than nine out of 10 oil producers, both OPEC and non-OPEC. Net exports, therefore, will always tend to grow slower than national production. Conversely, world oil import demand is significantly higher than consumption demand. In 2004, for example, world oil demand rose 2.68 mbd, but import demand growth was about 3.1 mbd.
This is related to the question of actual declines in production. For the majority of non-OPEC producers – in fact nearly all, except Russia and some Central Asian producers – rates of decline are stubbornly high despite much-vaunted technology improvements. Where the producers are also net importers (as in most cases), declining home production raises their import demand. Take the Organization for Economic Cooperation and Development’s three largest producers: the US, Norway and the United Kingdom. These are losing oil output capacity at about 4% to 5.5% per year. In the case of Norway and the UK, these rates are certain to increase sharply, despite any conceivable technology upgrade through simple geological limits. In the case of China and India, annual declines in national oil production are also tending to rise while domestic consumption grows at 5%-9% a year.
One of the biggest problems facing the IEA, the EIA and a host of analysts and “experts” who claim that “high prices cut demand” either directly or by dampening economic growth is that this does not happen in the real world. Since early 1999, oil prices have risen about 350%. Oil demand growth in 2004 at nearly 4% was the highest in 25 years. These are simple facts that clearly conflict with received notions about “price elasticity”. World oil demand, for a host of easily-described reasons, tends to be bolstered by “high” oil and gas prices until and unless “extreme” prices are attained. This is the real fundamental, on the demand side.
Supply-side fundamentals are equally clear and opposed to the notions of “unlimited” growth of supplies being achievable. The net readout from this: rising prices and the dusting off of energy conservation and renewable energy development strategies. Both of these are sorely needed to limit adverse climate change, which is now at least better understood and feared. Time, however, is sorely limited, and the push factor of much higher oil prices due to Middle East and world events will certainly play a lot bigger role than the “fundamentals” of US winter trends.
Andrew McKillop is founder-member of the Asian Chapter, International Association of Energy Economists. He can be reached at xtran04@yahoo.com
(Copyright Andrew McKillop 2005)
