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Petroleum Review Editorial November 2006
Opec goes for $60 minimum price
Opec, at its 19/20 October EGM meeting in Doha, agreed to aim for a new minimum oil price of $60/b, backing the intention with a planned 1.2mn b/d output cutback to a collective 26.3mn b/d (excluding Iraq), effective from 1 November 2006. Ali Naimi, the Saudi OIl Minister, even added that a further cut might be necessary at Opec’s December meeting in Abuja, Nigeria. There are good reasons for thinking Opec will probably succeed in establishing a $60/b floor.
Although there will probably be some ritualistic denunciation of Opec and its $60/ floor, most oil companies and most governments will be relieved that a price floor has been established. The reason is that if alternative energies are to be developed, a sustainable price around this level is needed to justify investments. Cost escalation in the Canadian tar sands developments, for example, have now reached the point where financial analysts are saying $50/b oil is necessary to justify new investment. The development of difficult deepwater areas like the sub-salt Lower Tertiary in the Gulf of Mexico also needs high prices, as much-hyped discoveries such as the Jack field will only be developed against high prices. Opec governments are starting to need higher oil prices as their budget costs rise (see graph on p43).
Opec’s decision can be taken as confirmation that we have moved out of the era of low prices into one in which energy will be more highly valued. The next challenge is to ensure the timely development of future energy resources. Michel Contie, in his address to the EI’s Autumn Lunch (p42), tackled the current challenges facing the international oil companies as they seek to deliver the new oil and gas supplies that the world needs.
The real danger of the Opec cutback is that it may come into play just as the market retightens after the US refinery turnarounds finish in November, and we may get a damaging upward price spike.
The latest (October) Oil Market Report from the International Energy Agency (IEA) clearly shows that the cause of the recent price falls are almost entirely US based. The run up in stocks is predominantly in the US; the slowdown in demand is also predominantly in the US; the hurricanes that didn’t happen are a US phenomena; as is the aggressive selling of US gasoline futures. In the rest of the world there were no significant changes to established and predicted trends.
In terms of global production, Opec output has been virtually flat for the last 18 months, with 3Q2006 output being just 0.52mn b/d above 2005 levels. Non-Opec OECD production continued to decline, with 3Q2006 some 390,000 b/d below the 2005 average. Reasonably strong growth in non-Opec, non-OECD output ensured that 3Q2006 non-Opec production was only 50,000 b/d below average 2005 levels. Taking processing gains and other biofuels into account, the IEA records a 1.24mn b/d growth in liquids supply. This has to be set against a 700,000 b/d increase in demand over the same period. A mismatch, but hardly of the order of magnitude to produce a 20% price fall – especially just ahead of the northern hemisphere winter. So, what the price falls really reflect is how unstable the oil supply system has become now that there is little or no spare capacity in the world.
Dangerous dependence
Although US demand may have moderated slightly, there is little evidence of the US moderating its addiction to oil or its ‘dangerous dependence on foreign crude’ as President George W Bush put it. According to the API (American Petroleum Institute), US crude imports hit a record 10.9mn b/d in September. In the same month, crude and product imports accounted for 69% of total US oil demand – well up on 2005’s 65.2% and above the first nine months of 2006 average of 66.7%. Now, September’s exceptional figures may be reflective of aggressive buying while prices are a little lower, but US dependence on imports appears to be set on a steadily rising path.
If the immediate challenge for the US is oil imports, for Europe it is both oil and gas imports. The meeting in Finland between the leaders of the EU countries and Russia’s President Putin as Petroleum Review went to press, promised to be a difficult one – mainly because the EU countries have different attitudes to Russian oil and gas imports (see p13). Following this January’s cut-off of Russian gas supplies to Ukraine and the consequent impacts around Europe, all the importing countries have become eager to increase their security of supply, particularly for gas. Unfortunately, there are two distinct, but diametrically opposed, approaches. The UK, the EU Secretariat and, to a lesser degree, Germany and the Netherlands broadly believe in open access, competitive markets and ‘leaving it to the market’. The rest of Europe believes in a more dirigiste approach – national champions, controlled markets and long-term deals. In short, for them, competitive prices come second to security of supply.
In the business briefing ahead of the Energy Institute’s Autumn Lunch, one of speakers – a keen advocate of the UK-style open markets approach – presented a graph showing how, to the end of 2003, UK gas prices had been below continental European prices. However, since the start of 2004, UK prices had been much higher as falling UK production had to be replaced with high-priced and unpredictable imported supplies.
For those with no ideological commitment to pure market economics, the lessons are clear. In a well or oversupplied market (such as the UK gas market pre-2004), market mechanisms work very well, prices are driven down and usage expands. By 2004, the UK had the second highest share of gas in its national energy mix (after the Netherlands) and gas actually had a bigger share than oil in the UK. This was a great strength while supplies were freely available.
Even if imported gas supplies become freely available to the UK, barring some global gas glut, prices will be much higher as there will be direct competition from all the other importers. With reports that virtually all LNG availability is pre-sold out to 2010 or even 2012, the ‘wall of LNG’ approaching Europe that some analysts foresee could be greatly delayed.
Chris Skrebowski
The opinions expressed here are entirely those of the Editor and do not necessarily reflect the view of the EI.
ERRATUM – In last month’s editorial, the oil price was printed as $620/b. It should have read $60. Apologies for any inconvenience this may have caused.
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