Petroleum Review Editorial December 2007
On the cusp – but of what?
At intervals, the environment in which the oil industry operates becomes very difficult to analyse because there are so many contradictory signals. Oil prices at the time of writing are about to reach the totemic $100/b for WTI. But what is this measuring? Is it really a record price and, if it is, why has there been so little economic impact?
At the moment the sustained slide in the value of the dollar is the main driver of oil prices. Unsurprisingly, all sorts of financial funds are buying oil as a hedge against the dollar’s weakness. If oil prices are converted into Canadian dollars, euros, sterling or gold, the oil price is up a little – but nothing spectacular. Indeed, $100/b oil is only €67.6/b at the latest exchange rate of $1=€1.48.
So, despite the fact that oil is denominated in dollars and largely paid for in dollars, in the currencies that many of the world’s fuel buyers use, prices are only up a few percent.
There are claims that $100/b oil will represent an all-time high for oil prices. There are, however, reasons to be sceptical about this. If official inflation figures are used, the 1980 record price of $39.50/b translates into roughly $90–$95/b for Brent and $96–$102/b for WTI. However, 1980 is nearly 30 years ago and inflation series tend to become fairly unreliable over long periods.
In 1980 there was only a fairly rudimentary and illiquid oil spot market, particularly compared to today’s sophisticated and highly liquid markets. An interesting analysis has been done by a group that claims to independently track financial data to give a truer picture. (Their basic claim is that official statistics are biased to the most favourable interpretations.)
Using their much higher inflation rate, the 1980 record oil price becomes over $200 in contemporary dollars. Now, if this analysis is even half-way true, it would go some way to explain the lack of reaction to ‘high’ oil prices – so far. By lack of reaction, we mean there has so far been limited economic impact in the developed world – car sales appear unaffected, there’s no great pressure for greater fuel efficiency and public reaction has been more ‘moaning at the bar’ than changing behaviours.
This, however, contrasts with the very real impacts seen in the developing world (see p11), where social improvements are reversing in the face of costly fuel for cooking and lighting, and rising electricity prices.
Economics undoubtedly works, but not always in the way the textbooks suggest. In the case of the oil industry, many western governments espouse great faith in the economic theories, only to be disappointed by the market realities. High prices – or relatively high prices – have so far not produced a significant supply response. In fact, the supply response is being blunted by project inflation, project delays and a profound lack of skilled manpower. Although all these will ameliorate over the longer term, it could take 10 years to rebuild capacity and give new entrants to the industry the necessary experience.
However, there has also been a lack of supply response from Opec, According to the International Energy Agency’s (IEA) latest Oil Market Report (13 November), Opec production in the first three quarters of 2007 was actually slightly less than the 2006 average. Opec production (including NGLs) rose 900,000 b/d between August and October, but this appears to have done little to damp prices. In November, the United Arab Emirates was expected to take 600,000 b/d offline, with a major maintenance programme for the offshore Umm Shaif and Zakum fields.
Non-Opec production growth, despite the price incentive, has also been subdued and the IEA anticipates 2007 production being just 600,000 b/d above 2006 levels.
Both these statistics suggest a tight market and continuing high prices. However, the other recent feature has been mounting concerns about an economic slowdown in the US
and in Europe, with possibly wider economic impact.
The Opec monthly magazine and the IEA are now projecting slower oil demand growth in 4Q2007 and in 2008. At some point this should show up as weaker prices – but, so far, there is little sign of this.
Thus we have a great paradox. The economic signs appear to point to some sort of slowdown. The oil prices and oil demand show little sign of a slowdown. We know the role of oil in economic growth and as a percentage of business costs is much lower than in 1980, but clearly there is some limit to oil price rises without real economic impact.
We are pleased to be providing our second Future Refining supplement with this issue. The supplement features both overview articles and more detailed examination of various refining topics. A key theme is the challenge of integrating biofuels into current refining and distribution networks.
The special feature in this issue of Petroleum Review is Australasia oil and gas. This provides a great deal of good news. New Zealand exploration and development is clearly picking up and the offshore is attracting increased interest. In Australia the news that the Woodside-operated Stybarrow/Eskdale fields have come onstream several months early came too late for inclusion but, as with New Zealand, there is a clear revival of activity going on. The IEA’s latest Oil Market Report (November) has Australia providing a 120,000 b/d output gain for 2008 over 2007, a notable turnaround from recent years of output decline.
This year’s EI Autumn Lunch was addressed by Tony Hayward, BP’s new CEO. He spoke to the title ‘The role of today’s international oil company’. His clear explanation of the special talents and skills that IOCs bring to the industry suggest that he has a clear vision of IOCs’ future role (see p38).
It only remains to thank readers for their loyalty and interest in Petroleum Review, and to wish you all a Happy Christmas and a prosperous New Year.
Chris Skrebowski
The opinions expressed here are entirely those of the Editor and do not necessarily reflect the view of the EI.
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