OPEC: Uncertainty fogs world oil outlook

July 23, 2007
Producers’ current investment decisions may be clouded by such questions as the extent to which nonconventional fuels may be produced and used in the future and the effects those fuels may have on oil demand, said the Organization of Petroleum Exporting Countries in the group’s 2007 World Oil Outlook.

Producers’ current investment decisions may be clouded by such questions as the extent to which nonconventional fuels may be produced and used in the future and the effects those fuels may have on oil demand, said the Organization of Petroleum Exporting Countries in the group’s 2007 World Oil Outlook.

OPEC’s report, released June 26, contained what it called “inherent downside risks” to demand that included governmental, environmental, and conservation policies worldwide, questions about the long-term sustainability of biofuels production, and the possibility of slowing economic growth.

Although decisions and investment must be made now for future capacity expansions that require long lead-times for planning, design, and construction, some decisions may be problematic, especially for downstream expansions.

Security of demand is shown to be a real issue “intrinsically linked to the issue of security of supply.”

The OPEC analysts said, “Without the confidence that demand for its oil will emerge, the incentive to undertake investment can be reduced, which, in turn, can exacerbate concerns over eventual sufficiency of capacity, and thereby hamper the drive towards long-term oil market stability.

“Alternatively, the emergence of large levels of unused capacity would lead to downward pressures upon oil prices, as it has in the past,” they said, adding, “This would result in a huge loss of revenues, and OPEC member countries, as developing countries with keenly felt competing needs for financial resources, would be adversely affected in terms of available resources in such areas as education, healthcare, and infrastructure. Moreover, lower revenues would, in turn, negatively affect available resources for future investment, with further subsequent market instability-a distinct possibility.”

The report looks at the supply-demand balance and attempts to determine the specific need for future investment in infrastructure and upstream-downstream capacity expansion to 2030.

In its analysis, which the analysts say is not a forecast, OPEC uses as its reference case an average global economic growth rate of 3.5%/year, on a purchasing power parity basis, and oil prices assumed to remain in the $50-60/bbl range for much of the period through 2030.

Demand to rise

World population is expected to grow by an average of 1%/year to 2030, reaching 8.2 billion, an increase of more than 1.7 billion from 2005. About 94% of this growth will come from developing countries, with North America the only OECD region set to experience any significant expansion, the report noted.

Energy demand will continue to increase for the foreseeable future, the analysts concluded, and oil will retain its leading role in meeting the world’s growing energy needs (Table 1). Oil demand will rise to 118 million b/d by 2030 from the 2005 level of 83 million b/d, OPEC estimates. This “assumes that no particular departure in trends for energy policies and technologies takes place.”

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Oil demand in Organization for Economic Cooperation and Development (OECD) countries, accounting for nearly 60% of total world oil demand, will reach 53 million b/d-a further growth of 4 million b/d-by 2030 (Table 2). Developing countries account for most of the rise in the reference case, with consumption doubling to 58.5 million b/d from 29 million b/d. Asian developing countries account for an increase of 20 million b/d, which represents more than two thirds of the growth in all developing countries.

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Nevertheless, “energy poverty” will remain an important issue over this period, OPEC said. By 2030, developing countries will consume, on average, five times less oil per person than OECD countries.

Transportation will represent the main source of future oil demand increases; the global volume of commercial vehicles will more than double.

Growth in the OECD is expected to continue to increase, although saturation effects should increasingly have an impact upon the growth in passenger car ownership.

The potential for growth in the stock of cars, buses, and trucks, however, is far greater in developing countries. For example, two thirds of the world’s population live in countries with fewer than 1 automobile/20 people. By 2030 the total stock of cars is expected to rise to 1.2 billion from 700 million in 2005.

After transportation, the main expected increase in oil use will be in the industrial and residential sectors of developing countries, which see a combined growth to 2030 of more than 11 million boe/d in the reference case. Household oil use is closely associated with the gradual switch away from traditional fuels, OPEC said-a trend expected to continue, especially in the poorer developing countries of Asia and Africa. Urbanization throughout the developing world is central to the shift towards commercial energy.

Although electricity production and consumption are expected to grow, “oil demand in this sector will experience no significant growth,” the organization reports.

Sufficient supply

Resources are sufficient to meet future demand, OPEC says (Tables 2 & 3). The US Geological Survey estimates that reserves have doubled since the early 1980s, although cumulative production during this period was less than one third of that increase. Technology, successful exploration, and enhanced recovery from existing fields have enabled the increase, along with “a vast resource base of nonconventional oil to explore and develop.”

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Non-OPEC crude oil supply is expected to rise at first in the reference case to peak around 2015. Increases from Russia, the Caspian Sea area, and Brazil and other Latin America countries will compensate for decreases in the North Sea and elsewhere to maintain a plateau until 2020, when a gradual decline will begin, as nonconventional supplies continue to rise.

In the short term, the Middle East and Africa will experience a slight oil production increase to 2010, but they are expected to plateau at almost 5 million b/d.

Canadian oil sands will provide the most significant growth in nonconventional oil supply and biofuels from non-OPEC countries. It will rise in the reference case to 5 million b/d in 2030, from just 1 million b/d in 2005.

Coal-to-liquids and gas-to-liquids production also will increase-to 1.5 million b/d and 500,000 b/d, respectively-in 2030 from about 150,000 b/d and less than 50,000 b/d in 2005. These increases will come primarily from the US, China, South Africa, and Australia, according to the report.

Biofuels supply impact

Although the use of biofuels is increasing in many regions of the world, unintended consequences from its production are beginning to appear, making a prognosis for its sustained use tenuous. “The potential growth for world biofuels must be balanced against the global impact of large-scale biomass use and trade for energy purposes in terms of land-use changes, competition with food supply and other biomass uses, biodiversity, and competition for water resources. In addition, the impact of the widespread use of biofuels on air quality in urban areas has not yet been fully assessed,” OPEC said in the report.

Therefore, uncertainty is growing over the magnitude of the rise in non-OPEC nonconventional supply. For example, the European Union recently adopted a minimum binding target for biofuels to reach a 10% share in transport gasoline and diesel consumption. And in the US, the most recent White House proposal for reduction of US gasoline usage by 20% in the next 10 years-the “Twenty in Ten” goal-anticipates that alternative transport fuels production will reach more than 2 million b/d by 2017.

Such ambitious target pronouncements “amplify uncertainties for future demand and supply volumes,” OPEC cautioned. “In total, the reference case sees more than 10 million b/d of nonconventional oil supply, including biofuels, coming from non-OPEC countries by 2030-8 million b/d more than in 2005.”

Initial increases in both crude and noncrude supply will push total non-OPEC supply up to 54 million b/d in 2010-about 5 million b/d higher than in 2005. With demand rising by only a slightly higher rate, this leaves little room for additional OPEC oil. Indeed, with OPEC’s noncrude supply, primarily natural gas liquids (NGL), set to rise to just under 6 million b/d by 2010, the demand for OPEC crude by 2010 is almost 1 million b/d below 2005 levels.

After 2010, non-OPEC crude supply, including NGL, is expected to stabilize, then eventually fall. Yet with nonconventional oil supply increasing at strong rates over the entire projection period, total non-OPEC supply actually continues to rise. The amount of oil supply expected from OPEC increases after 2010, rising, in the reference case, to 38 million b/d by 2020 and 49 million b/d by 2030.

Upstream investment

These projections underline the need for substantial investment along the entire supply chain. Expansion of non-OPEC capacity is 2-3 times more costly than in OPEC, with this gap expected to widen over time (Fig. 1). The highest cost region is the OECD, which also experiences the highest production decline rates. Up to 2030, total upstream investment requirements, from 2006 onwards, will amount to $2.4 trillion (in 2006 dollars). These estimates do not include necessary infrastructure investments.

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The oil industry, guided by the recent price trends, has mostly revised upward the business-as-usual crude oil price assumptions for medium to long-term analyses. Due to the effect of several factors, economic growth and oil demand are both more resilient to higher oil prices than had previously been thought. All these trends, in addition to rising costs, have become integral to the general perception of higher expected prices in the long-term.

Continuous downward revisions to the demand projections from organizations such as the International Energy Agency and the US Department of Energy’s Energy Information Administration are also noted. In this regard, a key question is whether this downward revision process is set to continue. On the supply side, there has been a steady rise in expectations for non-OPEC production in the longer term. Increased attention is being paid to nonconventional oil and biofuels and a discernibly higher expected contribution to supply is emerging, according to OPEC’s report.

There is much uncertainty over future demand and non-OPEC supply, which translates into large uncertainties over the amount of oil that OPEC member countries eventually will need to supply.

Because investment requirements are large and subject to considerably long lead-times and payback periods, it is essential to explore these uncertainties in the context of alternative scenarios.

Downside risks to demand are more substantial than upside potential. Energy and environmental policies in consuming countries and technological developments are important drivers that reduce demand, OPEC noted.

Uncertainties over future oil demand translate into a wide range of possible levels of necessary investment in OPEC member countries. Even over the medium-term to 2010, there is an estimated range of uncertainty of $50 billion for required investment in the upstream, increasing to $140 billion by 2015. This is partly why security of demand is a key concern for producers.

Downstream uncertainty

The expected increase in demand for oil products means an increasing volume of oil will need refining. Because the downstream sector is a key element of the supply chain and ultimately, market stability, it is important to focus attention on refining. In addition to rising demand, there is a continued move towards lighter and cleaner products. To meet this type of demand, the downstream sector will require significant investment to ensure that sufficient distillation capacity is in place, supported by adequate conversion, desulfurization, and other secondary processes and facilities, the OPEC analysts said.

The reference case for refining capacity expansion estimates that out of 14 million b/d of announced projects, over 7 million b/d of new capacity will be added to the refining system globally by 2012 (Fig. 2). Almost 70% of the new capacity will be in the Middle East and Asia-Pacific. The global reference case capacity additions from existing projects could reach slightly more than 9 million b/d by 2015 when capacity creep is added to the mix. Capacity creep is the unannounced capacity expansion through minor projects at existing facilities. The average rate of creep in the US in recent years has been 0.5-0.75%/year for crude units and 0.75-1.5%/year for upgrading units.

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However, the additions could change because of rising downstream sector construction costs and difficulties in finding skilled labor and experienced professionals. This adds to the downside risk in the reference case.

“This risk is further exacerbated by the reluctance of refiners to expedite the implementation of projects in light of the rapidly changing policies that put a strong emphasis on developing alternative fuels that compete directly with refined products,” OPEC reported. “These issues play out in the alternative ‘cost-driven delayed’ scenario for short and medium-term capacity expansion.” In this scenario, the new distillation capacity additions could be reduced to as low as 8 million b/d through 2015, “including assumed capacity creep.”

During the next 3 years, refinery capacity expansion under the reference case for refinery projects will just keep pace with the required incremental refinery throughputs. The deficit is small, but does not indicate any potential easing of refinery capacity and utilizations in the shorter term. The “cost-driven delayed” scenario for capacity additions worsens the deficit.

Nevertheless, under the reference case outlook for refinery projects, the data indicates that capacity additions should exceed requirements in 2011-12 as a range of new projects comes on stream, easing refining tightness and potentially, margins.

Under the “cost-driven delayed” scenario, the excess additions relative to reference requirements are essentially eliminated. Moreover, if global oil demand growth moves below reference case levels, an easing in the refining sector could begin as early as 2008.

The uncertainties surrounding these projections are especially relevant for biofuels. In general, biofuels projects do not take as long to implement as refinery projects. The reference case allows for a significant medium-term increase in biofuels production. Any additional increase would further reduce required refinery throughputs and margins. Consequently, policy initiatives supporting the development of biofuels may discourage crude oil producers and refiners from investing in needed capacity expansion.

Refinery tightness

“Should such a situation be followed by biofuels failing to meet the stated targets, the result could be further tightness in the downstream, and possibly the upstream, and in turn, this could have a significant impact on prices, margins, and volatility,” OPEC said.

Biofuels also raises issues over the future structure of a complex downstream business that includes both oil and biofuels. The question is how to structure it to withstand major disruptions.

“With the increasing number of biofuel producers, the chances of losing this capacity for a longer period and over a larger area, for example due to drought, could easily lead to a shortage of required fuels,” OPEC reported. Under these circumstances, the follow-up question is whether refiners should hold sufficient spare capacity to cover potential losses. OPEC member countries have offered, and will continue to offer, an adequate level of upstream spare capacity for the benefit of the world. It is equally important, however, that adequate capacity also exist downstream at all times, which is primarily the responsibility of consuming nations.

Based on the reference case assessment of known projects, by 2015 a total of almost 2 million b/d of additional distillation capacity will be required, and by 2020, a further 3.7 million b/d. “This is what is needed, on top of the assessed likely capacity additions, to bring the global refining system back into long-run balance, with refining margins that allow for a return on investment, but are not as tight as those of today.”

OPEC said that, taking into account the most likely changes in the future supply and demand structures and their quality specifications, “the global downstream sector will require 13 million b/d of additional distillation capacity in the 2006-20 period-about 7.5 million b/d of combined upgrading capacity, 18 million b/d of desulfurization capacity, and 2 million b/d of capacity for other supporting processes, such as alkylation, isomerization, and reforming (Fig. 2).”

The total required investment in refinery processing to 2020 is projected to be $450 billion in the reference case. Of this, $110 billion comprises the cost of known projects, $110 billion covers the further required process unit additions, and $230 billion comprises continuing maintenance and replacement. The Asia-Pacific area, which accounts for 68% of developing-country growth and 58% of world increases, requires the highest level of investment in new units to 2020, with China accounting for about 75% of the Asia-Pacific total (Fig. 3).

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Interregional oil trade should increase by 13 million b/d to almost 63 million b/d of oil exports in 2020. Both crude and products exports will increase appreciably, with products exports growing faster than oil exports. “Correspondingly, the reference case outlook calls for a total tanker fleet requirement in 2020 of 460 million dwt. This compares with 360 million dwt at yearend 2006,” said OPEC analysts.

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Environmentally driven regulations also play an important role in respect to the refined products quality specifications (Table 4). Clearly, this trend is set to continue in the future, creating a potential for market fragmentation unless regulations are introduced in a coordinated manner. Therefore, future quality regulations should, as much as possible, ensure the fungibility of fuels to avoid shortages and prevent unnecessary volatility in product and oil markets.