Petroleum Review - Editorial - June 2004
Could $40/b oil really be here to stay?
Whenever there is widespread agreement on a subject it is always wise to ask 'Could the conclusion be wrong?' So, could the current view that high oil prices are here to stay be wrong? At the moment oil prices are excessively firm - nearly $42/b for WTI and over $38/b for Brent. In fact, prices are at their highest levels in real terms since the short-lived price spike during the first Gulf War (1990/1991) and the Opec glory years between 1974 and the 1985 price collapse. Before that you have to go back to the Pennsylvania oil boom of 1863-1877 for such high prices. So, if prices are at crisis levels, do we have a crisis?
The cautious answer is probably not. The caution comes because the world is now engaged in a race between the supply enhancing and demand depressing effects of higher prices on the one side, and the momentum of global economic recovery on the other. The 'wild card' is the security situation in the Middle East and the possibility of a cut-off of Iraqi supplies, or even political upheaval and supply disruptions in Saudia Arabia.
The key price driver is rapidly expanding demand caused by a near-synchronous recovery in economic activity in much, if not most, of the world. Led by booming demand in China, currently running 1mn b/d above year earlier levels, extra requirements for crude and products are leading the IEA to revise its demand figures upwards virtually every month. The May edition of its Oil Market Report now pegs global demand growth in 2004 at a staggering 1.95mn b/d, the fastest demand growth since 1988.
On the supply side, non-Opec production appears to be flat out with this year's capacity expansions virtually all grouped into the third and fourth quarters. In fact, project slippage means that little new capacity of any size has come onstream so far this year. The latest IEA estimate for incremental non-Opec production in 2004 has been revised down to 1.2mn b/d, from an earlier 1.35mn b/d.
The evidence from the April production figures strongly suggests that the Opec cut-backs amounted to 415,000 b/d and were largely confined to Saudi Arabia (-160,000 b/d) and the UAE (-150,000 b/d).
It is already looking as though the Opec cut-backs will be reversed by the end of May, but any price-depressing effects are likely to be muted. The reversal of the Opec output cuts would then take us back to the situation where the only plausible spare capacity would be in Saudi Arabia and possibly a little in the UAE. [Notional spare capacity in Nigeria is probably not accessible as a result of ethnic and religious tensions and disturbances, while Venezuelan instability and a failure to rebuild its capacity probably means its spare capacity is also notional.]
Much confusion is caused by focusing on Opec quotas, quota cheating and the like. Looking at total Opec production (crude and NGLs) we find the first quarter averaged 31.95mn b/d, reaching 32.22mn b/d in March and dipping to 31.81mn b/d in April. The last time Opec production was running at levels even approaching these was in 1973 and 1979 - the years of the first and second oil crises.
Perhaps the single most important question in terms of future oil supply is Saudi Arabia's ability to maintain, and possibly expand, high volume flows from ageing giants like Ghawar and Safaniya. A radical new development system called maximum reservoir contact, or MRC, is being used and refined in Saudi. Long horizontal wells are drilled across the top of the reservoir, with additional multilateral wells branching off from them giving drainage rather like a shallow-rooted tree. The full length in contact with the reservoir is open hole and allows very high production rates (up to 20,000 b/d in the Saudi case). The technique, while not suitable for all reservoirs, offers the possibility of large volume flows late in a field's life. It may prove to be a key technology as the industry seeks to maximise flows from mature fields.
Between the second and fourth quarters oil demand increased by 3.8mn b/d in 2002 and by 4.8mn b/d in 2003. The IEA estimates the 2004 increase will be 3.8mn b/d - a figure that is dangerously close to all the world's spare capacity and all the new capacity coming onstream combined. Crisis may be too strong a term, but a huge challenge is ahead if oil prices are not to soar.
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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