Challenges and opportunities in the evolving oil market

March 7, 2005
In the coming era of high and volatile oil prices, the major winners will be the Persian Gulf producers and providers of alternate energy supplies and conservation technologies to the developed world, particularly in the transport sector.

In the coming era of high and volatile oil prices, the major winners will be the Persian Gulf producers and providers of alternate energy supplies and conservation technologies to the developed world, particularly in the transport sector. The principle losers will be the poorer and resource-poor countries of the developing world.

The major oil companies will face an uncomfortable paradox. They will have huge cash flows but diminishing investment opportunities. They will struggle to increase reserves as their legacy assets are exhausted and opportunities dry up outside members of the Organization of Petroleum Exporting Countries. Opportunities of sufficient scale will only be available in the former Soviet Union and the Persian Gulf.

Growing nationalism in Russia will limit material opportunities in the FSU. The majors will try to engage OPEC state oil companies in strategic alliances. The objective will be to participate in the largest and, possibly the last, conventional oil boom: maintaining and raising Persian Gulf production capacity from 20 million b/d to 50 million b/d, which will require hundreds of billions of dollars. However, the Persian Gulf producers will also be cash-rich and reluctant to relinquish control and “equity” to foreign companies. The major service companies can be expected to benefit from this reluctance.

Unless they become involved in investing in OPEC’s capacity expansion over the next decades, the majors face dwindling material, profitable upstream oil ventures. They are expected increasingly to focus on capital-intensive unconventional oil, gas, and infrastructure projects, particularly tar sands, LNG, and gas-to-liquids. Further large-scale consolidation is likely.

The expansion of OPEC production from 30 million b/d to 50-65 million b/d by 2025 and a 4% decline in existing capacity suggests the addition of 40-50 million b/d of new production capacity over the next 15 years. At well rates of 2,500-5,000 b/d/well, some 10,000-20,000 new production wells will have to be drilled, together with 5,000 to 10,000 water and gas injection wells. The drilling industry and suppliers of oil field equipment will do well.

Security of supply

Security of oil supply will become a strategic issue in foreign relations. The US, Western Europe, and the Far East countries have the intellectual and entrepreneurial infrastructure to harness alternative energy sources, develop conservation technologies, and invest for the future world where oil is scarce. The US is the largest consumer of oil and the most vulnerable to supply crises. However, it has the wealth and the power to ensure security of supply if necessary.

The developing world, particularly China and India, is less well placed. Both will be unhappy to see their economic growth curtailed by oil shortages. Bilateral upstream deals between state entities in China and India and their counterparties in the Persian Gulf will increase the competitive pressure on the majors for material upstream assets.

China’s demand for oil is poised to grow rapidly as car ownership and economic activity expand. If China’s oil demand growth follows the trajectory of South Korea and per capita oil consumption reaches 5 bbl/person/year by 2025, China’s additional demand for oil in 2025 could exceed 15 million b/d. The US Energy Information Administration expects US oil demand to be up by 8 million b/d by 2025. Additional oil demand from China and the US alone (about 23 million b/d by 2025) is therefore likely to exceed the additional supply predicted in this series of articles (12-26 million b/d by 2025).

Russia has enough oil reserves to ensure self-sufficiency until 2030 and will be able to reap the harvest of high oil prices without the pain of oil supply crises. Russian governments are expected to take an increasingly nationalistic view of indigenous oil companies, Russian oil reserves, and Russian oil production. Oil companies investing in Russia may find their contracts, equity positions, and agreed taxation structures under challenge.

Pearls and oil

It would seem that the oil-producing countries of the Persian Gulf have a rosy future. This may well be true for the next 2 decades. However, high and rising oil prices and the various crises in supply will stimulate the development of alternative energy sources and energy conservation technologies, policies, and strategies.

Native pearls used to provide much of the wealth of the Persian Gulf. The development of artificial pearls by the Japanese in the 1930s destroyed the pearling industry and wealth of the Persian Gulf virtually overnight. It was indeed fortunate that oil was discovered in the Persian Gulf.

Oil-rich Persian Gulf countries need to develop strategies and policies for the postoil age, which may occur before their oil reserves are fully monetized.