Opec needs to alter its strategy and set annual production targets to ensure stability in the oil market in the long run and avert a serious slowdown in crude demand in the future, according to a top Western energy analyst.
Leo Drollas, Deputy Director of the London-based Centre for Global Energy Studies (CGES), said the global financial distress is not the only factor that caused crude prices to crash from their peak level of $147 in late July.
In a study presented to a recent energy conference in Houston, the United States, Drollas ruled out a fresh oil price spike similar to that in 2008 and said prices could settle at about $50 a barrel in the long run.
Drollas cited many factors for what he described as persistent instability in the oil market, including Opec's obsession with higher prices and inventory control, excessive reliance on crude revenues by most producers, the steady growth of derivatives market, and a drive by major consumers to cut oil consumption.
He proposed that Opec should target a reasonable price, producers reduce dependence on crude exports, oil be "depoliticised" and the 12-nation group stop its obsession of controlling global oil inventories.
"Many will view these prescriptions as infeasible – trying to put the genie back into the bottle… since this looks unlikely, the second-best solution is for Opec to set annual output targets and allow global inventories to take the strain. Opec's annual production targets should be based on independent estimates of world oil demand, non-Opec supplies and desired stock-cover, and on its own oil price aspirations," said Drollas.
"Opec's obsession with inventory control is harmful. Stocks need to regain their former role as safety valves. Opec's output should be set annually based on independent projections of supply/demand.
"History informs us that a 'residual supplier' is needed for oil price stability. But the price target must be reasonable, reflecting both current conditions and long-term trends and developments. Is this is a charming delusion."
Referring to the surge in oil prices to their highest level in late July, Drollas said Opec and other parties blamed the slackening demand caused by the global crisis for the ensuing price collapse in the last few months of 2008.
"Although there is much truth in this, forces at work since prices started to rise in 2003 helped to lay the foundations of the eventual price collapse. The effect of prices on oil demand is clear. What is not so transparent is the adverse effect of high oil prices on economic growth," he said.
"The oil industry could continue as at present, with Opec trying to keep the oil price well above true marginal costs by restricting its production.
"The result, given relatively inelastic demand, is likely to be volatility in the short run and a slow drift away from oil in the long term," he added.
"On the other hand, the industry could follow a different model – one in which oil supplies are responsive to oil prices, volume takes its rightful place next to price as a policy tool and the secular decline in oil's share of primary energy is arrested. Many may not want this, but the world still needs oil."
Drollas said a return of prices to their $147 level is "highly unlikely" to be seen for the foreseeable future nor is the price likely to settle below $30 a barrel.
He expected prices to remain volatile in the coming period, dipping to a $20 before ranging around a long-term level of $50.
According to Drollas, Opec will try to keep crude prices above $60 a barrel but that the outcome in the short run will depend on the "struggle" between the current recession and the fiscal needs of the oil-producing states.
"In the long term, oil demand growth is likely to slow considerably due to Opec's preoccupation with high oil prices, concern about the environment and technological change. The world's oil resources are ample. Getting them out of the ground is the problem. Key questions: 1) is there the desire to do so, 2) will there be enough investment by Opec and the oil companies and 3) will there be political stability?" said Drollas.
"Consumers like to know where they stand, because oil consumption entails using relatively expensive capital stock over a long period. Oil price volatility makes choosing difficult and can impose significant costs on users if they happen to be caught with the wrong kind of capital."
But he noted that producers would also like prices to be stable over long periods, because oilfield development is expensive and recovery of capital is important. "Oil-producing countries favour stable [and preferably high] oil prices, because they yield steady flows of revenues upon which they can rely to cover both their general expenditure and infrastructural spending."
Drollas cited several factors for the current instability in the oil market. They are:
- Opec thinks oil demand is highly inelastic and that restricting residual supplies of oil will ensure rising prices and growing revenues; it also does not differentiate between consumers, tending to treat them as one
- Opec also believes that the marginal non-Opec producers need oil prices above $80 today to make reasonable returns
- Opec wishes to keep oil inventories low, fearing the 'ghost of Jakarta' in 1997. Stock increases in Q406 led to an Opec-led output squeeze
- The companies are kept out of the low-cost areas with potential and are opportunity constrained as a result. Their horizons are foreshortened and they have not been investing enough, preferring to return funds to their shareholders
- Governments of oil-consuming countries, especially in the developed world, wish to reduce their dependence on oil in the longer-term; they are also fearful of rising levels of CO2 emissions and have pledged to reduce drastically their use of hydrocarbons
- The oil derivatives market has grown hugely since 2001 and exaggerates the effect of changes in fundamentals. The lessons of the past suggest that the oil industry needs to become more vertically integrated, ideally by an exchange of upstream assets for downstream capacity.
- Oil also needs to be de-politicised and the oil-producing states' excessive dependence on oil revenues reduced. The heavy taxation of oil products used in the transport sector raises similar issues in the consuming areas
Drollas's figures showed the world's oil reserves in place are massive, estimated at around three trillion barrels. They include nearly 1.091 trillion produced barrels, 1.167 trillion remaining reserves, 360 billion barrels as reserves growth and about 382 billion in undiscovered conventional oil.
But he noted that concerns about crude supply are expected to persist despite those massive resources because of continuous political upheavals, wars, trade embargoes, strikes, hurricanes and the fact that most of the supply for major consumers come from a single source – the Middle East.
"As a result, oil prices have been volatile and are expected to continue to be so, because since the nationalisations of the 1970s oil has become highly politicised and more of our oil supplies in the future will come from the unstable Middle East. The ultimate answer must be to de-politicise oil and gas and free up the energy market in general, but energy is considered too important for this to happen. What steps can be taken, then, to avoid chasing shadows," he said.
"Europe has chosen the route of reducing the demand for fossil fuels via high taxation of oil products, caps on carbon emissions [mainly by electricity generators and heavy industry] and the trading of permits."
Dollas said that until the recent election of President Barack Obama, the US preferred to stimulate the supply side and encourage greater diversity in power generation.
"Now it seems to want to emulate the EU. Meanwhile, China is going its own way by trying to use its vast foreign currency reserves to strike deals with energy producers in the Middle East, Africa and Latin America," he said.
"The only short-term practical step that can help cope with a potential supply disruption is to maintain adequate strategic reserves. In the long-term, the best way to deal with the security of supply issue is to diversify as much as possible."
Another element of insecurity cited by Drollas is that nearly a fifth of the world's oil exports pass through Hormuz Strait, the only gateway to the Gulf.
He said nearly 17 million of the 18.7 million bpd of crude exported by the Gulf countries in 2007 passed through the narrow Hormuz Strait. He noted that the exported 17 million bpd accounted for nearly 21 per cent of the global crude supply and 31 per cent of the world's trade oil.
"Saudi Arabia has three main oil export terminals. Ras Tanura in the Gulf has a capacity of about six mbpd, the Ras Al Ju'aymah facility, also in the Gulf, has a capacity of three to 3.6 mbpd and the Yanbu' terminal on the Red Sea has a loading capacity of around 4.5 mbpd for crude and 2 mbpd for NGLs and oil products. Sixty per cent of the oil exported from Saudi Arabia would have to negotiate the Straits of Hormuz."
Why oil prices rose
Ten reasons why oil prices reached record heights in 2008
- Dollar weakness, inflation
- Strong oil demand growth
- Slow growth in non-Opec oil supplies
- Speculation in oil future markets
- Opec's oil price ambitions.
- Fear that we have reached 'peak oil'
- High marginal costs
- Structure of the oil industry
- Low oil inventory cover
- Opec's low spare output capacity
Arab oil reserves remain intact
The oil resources of the UAE, Saudi Arabia and other Gulf and Arab producers have remained intact or recorded slight increase despite massive cumulative production, according to British Petroleum.
The UAE's proven resources slipped by only about 300 million bpd while Saudi Arabia's crude reserves, which account for over a fifth of the world's total proven oil wealth, swelled from about 255 billion barrels to 264 billion barrels.
Kuwait's oil rose from 94.5 billion to 101.5 billion barrels. Qatar's oil deposits jumped by nearly six times from 4.5 billion to 27.3 billion barrels in the same period, BP figures showed.
The report showed the Gulf oil wealth has remained intact or increased in some members despite a sharp rise in crude output over the past years because of a steady growth in global demand.
Official data showed the UAE pumped about 1.5 million bpd in 1998 while its 2008 output exceeded 2.5 million bpd. Kuwait also boosted supplies by at least 500,000 bpd while Saudi Arabia's oil production has sharply fluctuated given its role in most years as the world's residual crude producer.
Between 1988 and 2008, the UAE has pumped in excess of 14 billion barrels while cumulative production by Kuwait and Saudi Arabia surpassed 15 billion and 50 billion barrels respectively. Qatar also pumped above four billion barrels.
Industry experts said the increase in regional oil reserves was a result of new large discoveries and the introduction of advanced technology.
They noted that oil in place in the Gulf is far above the available resources but a large part of them is still inaccessible by present drilling and production techniques. Billions of barrels have also remained undiscovered and could largely boost the extractable crude wealth of regional states.
In the UAE, the undiscovered oil reserves are estimated at about 7.7 billion while they are believed to be in excess of 87 billion barrels in Saudi Arabia.
Kuwait controls about 3.8 billion of undiscoverable crude reserves while they BP estimated the total global proven oil reserves at 1.258 trillion barrels at the end of 2008, sharply higher than their level of 998 billion barrels 20 years ago. But they were lower by about three billion over their level at the end of 2007.
It noted that declines in Russia, Norway, China and other countries offset increases in Vietnam, India and Egypt. The 2007 figure has been revised higher by 23.1 billion barrels, with the largest upward revisions in Venezuela and Angola," BP said.
The report noted that the figures on the oil reserves at the end of 2008 does not include the Canadian tar sands of about 150 billion barrels.
A breakdown showed Qatar controlled the world's third largest gas reserves of 25.4 trillion cubic metres after Russia and Iran, whose gas resources were estimated at 43 trillion cubic metres and 29 trillion cubic metres respectively.
Gas resources were put at 7.5 trillion cubic metres in Saudi Arabia, 6.4 trillion cubic metres in the UAE, 3.17 trillion cubic metres in Iraq and nearly 1.7 trillion cubic metres in Kuwait.
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