The secretary general of the Organization of Petroleum Exporting Countries irked observers in the oil-consuming world this month with a comment taken as a reactionary threat over biofuels. According to a June 5 report in the Financial Times, the official, Abdalla Salem El-Badri, said efforts in the West to develop biofuels might push oil prices “through the roof.” His words zipped across the internet and drew scorn on radio talk shows in the US.
The popular interpretation is that OPEC will restrict investments in oil-production capacity as a political response to promotion by consuming-nation governments of biofuels. As the Financial Times reported the story, El-Badri “said the powerful cartel was considering cutting its investment in new oil production in response to moves by the developed world to use more biofuels.”
A challenge
In a political world looking for a fight over oil, these words constitute a challenge, a view fortified by timing. El-Badri spoke the day before industrial-world leaders met in Germany to discuss, among other issues, climate change. If he hoped to dissipate the political momentum behind biofuels, El-Badri probably failed and gave OPEC’s antagonists new leverage in their campaign of demonization.
But there’s another, less political context in which to assess his words. It’s the economic context, the one so frequently disregarded these days by governmental leaders acting on energy.
In the economic context, in fact, the politically charged analysis unravels. For example, the idea that OPEC invests in the ability to produce or refine oil is flawed. OPEC as a group invests in no such thing. Its members make their own investment decisions, following notably disparate strategies. Only in a political context distorted beyond reason might the suspicion thrive that OPEC can coordinate long-term investment strategies of its members to suit political goals. OPEC has trouble enough coordinating current production rates.
Indeed, El-Badri’s through-the-roof remark just extends the logic of a concern OPEC has been expressing since before he became secretary-general in January: how uncertainty over future oil demand bedevils investment planning by group members. OPEC producers with undeveloped reserves must invest heavily now to bring on stream production capacity as it’s needed to meet demand for oil years, even decades, in the future. As always, a large risk in those multibillion-dollar investments is failure of demand to reach forecast levels and the consequent costs of servicing capital tied up in unused capacity. That risk swells when consuming-nation governments disparage oil from the world’s largest exporters and aggressively subsidize costlier alternatives.
A year ago, the OPEC secretariat examined demand uncertainty in a paper presented at an energy conference in Doha. To satisfy market requirements for their oil under reference-case assumptions about demand, the paper said, OPEC members must invest $100 billion in production capacity during 2005-10, at least another $100 billion through 2015, and nearly $150 billion more through 2020. Uncertainty about demand creates large and growing differences in investment projections between low and high-growth demand assumptions: $50 billion in 2010, $140 billion in 2015, and $240 billion in 2020, when cumulative investments needed to meet high demand growth would exceed $450 billion.
The risk
The uncertainty range in this assessment thus is more than half what the high-growth investment requirement for 2005-20 would be and more than the total low-growth requirement of about $225 billion. OPEC members understandably don’t want to invest for a reference-case or high-growth market and have demand languish at low-growth levels, which would leave them collectively with tens or hundreds of billions of dollars in capital invested but generating no revenue.
While consuming-nation governments worry about security of supply, OPEC for years has been seeking attention to its concern for security of demand. The consumers now respond with a push for biofuels and repeatedly expressed distaste for foreign oil, making demand less predictable than ever. That this discourages OPEC members from making investments essential to future supply is economics, not politics. Restrained investment limits supply in a market trying to grow. In such a market, prices rise. Depending on demand, they rise through the roof.
