Dealing with runaway oil
prices
By Andrew McKillop
Recent data from the Organization for
Economic Cooperation and Development's (OECD's)
International Energy Agency (IEA), the US Energy
Information Administration (EIA), leading oil
analysts concerning world production and inventory
in key consumer countries, together with
"traditional" claims by certain analysts that OPEC
(Organization of the Petroleum Exporting
Countries) is still able to "overproduce" is taken
by some commentators as offering a prospect for
oil prices sliding below the current, rising
levels in the region of about 36-45 euro/barrel
(US$45-55), perhaps by mid-2005.
Optimism
regarding non-OPEC supply growth is, however,
muted at this point, with the only major upturn to
counter non-OPEC production decline by the three
largest OECD producers (US, Norway and the United
Kingdom) coming in the shape of Azerbaijan-Turkey
pipeline deliveries from Caspian-region producers.
Deliveries are slated to build to not much above,
and probably less than, 2.5 million barrels/day
(mbd) from spring, 2005. World demand growth
remains very strong - at about 3%/year or 2.5 mbd
per year - with exceptional growth being recorded
not only in the emerging industrial superpowers of
China and India, but also in East Europe, the US
and West Asia.
World oil stocks, depending
on the country and using periodic data from the
IEA, EIA and oil analysts, in fact remain well
below the average figures for the 2000-2003
period. Combined with recent - extreme - figures
from the IEA for world oil production (well over
82 mbd), the overall reading is that world oil
markets will remain tightly supplied with
generally uptrending prices, right through the
period to 2010.
The base for this
situation is, in particular, world demand growth.
This "vintage" growth has been consistently
underestimated now for more than two years, not
only by the oil majors and national economic
forecasting institutions, but also by major oil
importer country agencies, such as the IEA and
EIA. These two agencies, in their periodic
publications and data series, have continued to
forecast slower demand growth likely to "go
forward" while publishing real figures for the
real world that show "vintage" growth in nearly
all markets.
The base for this
"surprising" growth in world oil demand, and
reason why demand is growing faster than in the
1990s, is unstoppable growth of all forms of
commercial energy demand by very fast-growing
economies, including China, India, Brazil,
Pakistan, Iran and Turkey. In addition, the type
and nature of economic growth at the world level,
also including the older, slower-growth OECD
economies, has become more oil-intensive. This is
reflected in the US (taking about 26% of world oil
output) by consistent and large oil demand growth
coming out of the 2001-02 recession in what has
essentially been a "jobless recovery".
Weather trends have become ever stronger,
even key factors in deciding price movements -
again reflecting the tightly balanced, low stock
context that is generated by world demand growth
trends moving ever further away from the "low
growth paradigm" of the early 1990s. World oil
demand has moved up with higher oil prices, which
themselves lead to faster economic growth through
raising "real resource" prices and revenues to
generally low-income exporters of non-energy
minerals, metals and agro-commodities.
Another factor tending to drag oil prices
higher is strong growth of natural gas demand in
several world regions, while supply flattens and
then shrinks. For the two largest gas consumer
regions, the US and Europe, the fast emerging
picture is one of serious shortfalls in regional
and national gas supplies becoming "structural"
pricing factors. Gas prices in the US will
certainly never return to those in the "cheap oil
interval" of 1986-99, when daily traded prices
averaged around $2/million British thermal units
(MMBTU), and oil prices held at around
$18-30/barrel. The emerging gas price paradigm for
US consumers is now in the $7-10/MMBTU range,
equivalent in energy economic terms to oil at
around $38-55/barrel.
Gas prices in Europe
are "traditionally" above US and Asian prices;
faster decline of European gas production
(depleting at 5%-6%/year) compared with US
domestic output (depletion around 2%/year) will
for some time maintain or reinforce this
differential. In turn, this will drive European
oil prices closer to price levels in the US,
negating market proximity-transport cost
differentials that tend to reduce European oil
prices relative to US. Gas at $10/MMBTU results in
oil at 40-45 euro/barrel becoming competitive and
the emergence of these price levels will push day
traders to erode residual negative price
differentials against oil, effectively raising its
price in both markets.
Oil prices and
world growth
Since late summer, 2003 and
for about four months into 2004, US economic
growth was likely running at close to its record
post-war rate of about 7.5%, last achieved for a
whole-year (12 month) period in 1984. At the time,
expressed in dollars of 2003, yearly average oil
prices were in the region of $52- 65/barrel. In
2004, through June-September, as oil prices moved
up to and beyond $50/barrel, the OECD and
International Monetary Fund (IMF) consistently
revised economic growth estimates for Europe,
Africa and Latin America. The IMF estimated that
world economic growth in 2004 would be at least
4.5%, the highest in over 10 years. World
merchandise trade growth in late 2004 was at about
15%/year, the highest in over 15 years. These
real-world, real-economy data provide a direct
challenge for those who regularly claim that "high
oil prices hurt economic growth".
As in
1984, faster economic growth in 2003-2004 is in no
way hindered by higher oil prices, and in fact is
likely accelerated by higher oil and energy prices
spinning off higher prices for non-oil raw
materials, agro-commodities and other "real
resources", and raising the purchasing power of
generally low-income exporter countries of "real
resources". In addition, higher oil and other
"real resource" prices - these resources quoted
and traded in US dollars - automatically levers up
world liquidity, which then buoys and reinforces
world solvent demand. At the same time, the
emerging industrial superpowers of China and India
have such generally low economy-wide oil and
energy-intensity (around 1/8th to 1/15th per
capita oil-intensity of the US and EU countries)
that they are easily able to absorb much higher
oil and energy prices without strain to their
balance of payments.
Over the past 39 years, the
oil price impact on world oil demand trends has
been complex and variable. In the chart and Table
1 below, I compare year-peak oil prices in
constant 2003 dollars and average demand together
with demand trends on a three-year base.
TABLE
1
World per capita average oil
demand and oil price trends
1965-2004
| Year |
World population
Year average
(millions) |
Average daily oil
demand
(Mbd
'all
liquids') |
Billion barrels consumed
per year |
Change on previous 3-year
value
(percent) |
World per capita
average (bcy) Barrels/
capita/
year |
Year
peak oil price in 2003
US$ per barrel
(light volume
crudes) |
|
1965 |
3310 |
31.23 |
11.39 |
+17.2% |
3.65 |
$9/bbl |
|
1968 |
3520 |
39.04 |
14.25 |
+25.1% |
4.05 |
$9/bbl |
|
1971 |
3750 |
51.76 |
18.89 |
+32.6% |
5.04 |
$15/bbl |
|
1974 |
3980 |
59.39 |
21.68 |
+14.8% |
5.44 |
$56/bbl |
|
1977 |
4200 |
63.66 |
23.23 |
+7.2% |
5.53 |
$39/bbl |
|
1980 |
4410 |
64.14 |
23.41 |
+0.7% |
5.31 |
$82/bbl |
|
1983 |
4650 |
58.05 |
21.18 |
-9.6% |
4.56 |
$59/bbl |
|
1986 |
4890 |
61.76 |
22.54 |
+6.4% |
4.60 |
$32/bbl |
|
1989 |
5150 |
65.88 |
24.04 |
+6.6% |
4.67 |
$32/bbl |
|
1992 |
5400 |
66.95 |
24.43 |
+1.6% |
4.52 |
$29/bbl |
|
1995 |
5610 |
69.88 |
25.51 |
+4.4% |
4.54 |
$25/bbl |
|
1998 |
5870 |
72.92 |
26.62 |
+4.3% |
4.51 |
$18/bbl |
|
2001 |
6130 |
75.99 |
27.74 |
+ 4.2% |
4.53 |
$31/bbl |
|
2004 |
~6400 |
~82 |
~29.75 |
+7.6% |
~4.67 |
$~55/bbl |
Data sources:
Population data - UN
Population Information Network (year
average or June population
estimate); World daily average oil
demand each
year: BP
Statistical Review of World Energy, various
editions; Peak annual oil
price (2 month basis) for
volume traded light crudes, world demand and
price
deflator
1965-2001, and price forecast for 2004 are by
the
author. |
The oft-repeated but unproven
claim that high oil prices hurt economic growth
also lacks proof of its logical corollary, ie "low
oil prices favor economic growth". The fast fall
in economic growth rates in all OECD countries
following the "liberation" of Kuwait in 1991 was
accompanied (in fact driven) by fast falling oil
and energy prices. In any case, cheap oil in 1991
led to no spontaneous upsurge or recovery in US or
other OECD country economic growth. The huge oil
price falls of 1985-86 did not lead to faster
economic growth in any major OECD country through
1986-88 either.
Conversely, the "Baghdad
Bounce" so often predicted by business and finance
"experts" for the US and world economy in the
run-up to the US and UK invasion of Iraq in 2003
was most certainly upward - for oil prices.
Economic growth rates, already at high levels in
South and East Asia, were either unaffected, or
marginally increased by the economic context in
which oil prices bounced upward and continued
bouncing upward as Iraq descended into chaos. From
early 2004, with continuing and strong growth of
the oil price, the "trickle down" effect of higher
oil, gas and "real resource" prices began to take
effect. Since early 2004, economic growth rates in
most world regions, including Europe, Africa and
Latin America, have been repeatedly re-estimated
upward by the European Commission, OECD and IMF.
In addition, and for about 4 months from late
2003, even the erratic US economy showed some
signs of "vintage" economic growth before falling
back to lower and more hesitant trend rates of
about 3.75% to 4.5% in mid-2004.
It
is easy to identify non-cheap oil as a cause of
this "bounce" or "rebound" of world and regional
economic growth trends outside the US, and not the
cause of hesitance and fragility in the special
case of the US economy. In end-2003 and in the
first 9 months of 2004, there were no signs,
anyplace in the world, of fast-falling economic
growth rates. This is claimed to be "despite high
prices" by the vast majority of institutions and
"experts", but it is also easy to turn this
argument around.
Real
world oil demand
According to data published
by the IEA, world oil production in January 2004
was running at over 81 mbd. By mid- to late-summer
2004, IEA estimates indicated world oil demand
running around 81.75-82.5 mbd. The same IEA source
(the "Oil Market" bulletins) indicates in previous
issues that average daily demand for 2002 was well
below 76.5 mbd (in the range of 76.1-76.4 mbd).
Growth on a 24-month basis
(2002-2004) is therefore up to 7%, and for the
36-month period (2001-2004), growth of world oil
demand was at least 7.5%. This is the highest rate
of growth for over 25 years. We can surmise that
if 2001 had not been exposed to the dotcom-telecom
crash and the 9/11 terror attacks, leading to a
fast fall in economic growth, world oil demand
growth in 2001-2004 could easily have exceeded 9%.
This underlines a central
argument for oil prices continuing their upward
trend since 1999: average three-year growth rate
trends held at no more than about 4%-4.5% through
the 1990s, with per capita oil consumption staying
flat at close to 4.5 barrels/year since the early
1980s. This has now changed quite dramatically.
Demand growth rates have increased fast, raising
per capita average oil demand, proving that
"low-oil-demand-growth-low-oil-prices" is in no
way a "fixed paradigm". This paradigm shift, we
should note, is occurring in a real world
situation of oil prices increasing while world oil
demand continues to expand very fast - a context
in which higher oil prices lever up world oil
demand.
A new paradigm, of rising per
capita rates, as experienced in the "high oil
price" period , is more than possible. This
implies a sharp accentuation of "bottlenecks" or
persistent under-supply to an ever-tightening
world oil market. It is noted, first, that world
per capita average oil demand increased fastest
through 1965-77, (table above) in spite of the
first oil shock quadrupling crude oil prices. No
"price elastic" reduction in per capita demand
followed from the first oil shock of 1973-74 (295%
increase in nominal dollar prices). The current
context is therefore comparable: oil prices are
rising, creating a context favorable for faster
economic growth (especially outside the OECD).
This reinforces world oil demand growth, which is
outstripping population growth, resulting in
recovery of world per capita average oil demand.
Going forward, three "new
paradigms" for annual average per capita demand
can be posited, as shown in the table below. All
of these paradigms lead only to one conclusion:
sharply higher oil prices. In addition, these
potential new trend rates of per capita demand and
world demand growth on a three-year base are
themselves driven by a world economic context of
faster economic growth arising in part from higher
energy and real resource prices. Any remaining
tendency for "loss of market share" by OPEC
members can only disappear with the type of
vintage growth in world oil demand that is now
under way. It is also noted that the per capita
average demand figures used (4.75, 5 and 5.25
barrels/capita/year) are in no way "extraordinary"
numbers. In 1980, with oil prices briefly
attaining $100/barrel in 2003 dollars, and a
year-round peak value for a basket of lighter
crudes around $80/bbl, world per capita
consumption averaged about 5.3 barrels.
TABLE
2
2010 world
oil demand for two population
growth scenarios and three annual average per
capita demand scenarios ('Low' and
'High' population growth;
'Low', 'Medium' and 'High' annual
average per capita
demand)
AVERAGE
PER
CAPITA DEMAND
Barrels/year |
WORLD POPULATION 2010
Millions (year
average)
HIGH
LOW |
YEAR TOTAL DEMAND 2010
Billion barrels (Gby)
LOW HIGH |
YEAR AVG
DAILY
DEMAND
Mbd in
2010 |
GROWTH
FROM
2002
Mbd
growth
(8
year growth) |
| Low 4.75 |
6900 |
6800 |
32.3 |
32.8 |
88.5-89.8 |
~
12.5
Mbd |
| Medium
5 |
6900 |
6800 |
33.8 |
34.5 |
92.5-94.5 |
~ 17
Mbd |
| High 5.25 |
6900 |
6800 |
35.4 |
36.2 |
97-99.2 |
~ 21
Mbd |
Population growth
forecast for 'Low' projection assumes UN
forecasts of slowed
annual rates of growth for
the 2020-2030 period are attained by
2004-2010.
'High'
population projection utilizes current trend of
world demographic growth
(85-90 Million/year).
World average per capita
oil demand figures: 'High' case
does not exceed 1980
average (5.3 bcy) |
Emerging and "structural"
under-supply
There can
be plenty of discussion as to what "structural"
under-supply would mean with world oil output
likely to start trending down soon, from its peak
that may be well below 90-92 mbd (according to
geologists and analysts such as Younquist,
Deffeyes and the ASPO group). The key word for
analyzing price-demand relationships and the
much-predicted but slow emerging "gas bridge to
the future" is "soon". This paper sets out to
suggest that under almost any circumstance and any
hypothesis, there will be a widening supply gap
driven - not opposed - by rising prices. The above
scenarios (Table 2) are very far from adventurous
or unrealistic. Barring major catastrophe, the
population projections for 2010 are likely to come
about, leaving only the average per capita or
demographic demand as the factor with most margin
for error. Here, we can develop the supporting
rationales for a likely increase in world average
per capita demand, as summarized below:
Non-implementation of Kyoto
Treaty - Other than the EU, Japan and Canada,
there is little likelihood of ratification and
implementation by major oil consumer and importer
countries, including the US, China, India and
other emerging industrial countries. In the
countries of possible or probable implementation,
average per capita or "demographic" oil demand is
broadly in the range of 12 (Europe, Japan) to 18
barrels/capita/year (Canada). Reductions of more
than 10%-15% from these very high demand rates are
unlikely within a period of less than 5 or 10
years from the start date of implementing Treaty
obligations (2008-12), without strong coercion and
intense economic recession, and thus have little
or no impact on 2010 forecasts.
Fast growth of oil demand by
new industrial powers - both gas and oil
demand growth by China, India and other fast
emerging industrial economies is in the range of
6%-15%+ per year (5%-9%/year for oil and
12%-18%/year for gas). Fast growing private car
fleets and development of the consumer societies
in these countries can follow the pattern set
|
