MIDDLE EAST DUE EVEN GREATER ROLE IN WORLDWIDE OIL SUPPLY

A. Miremadi, I.A.H. Ismail
Organization of Petroleum Exporting Countries
Vienna

Oil will remain the most important source of energy not only during the decade of the 1990s but well into the next century.

However, recent environmental concerns could lead to control over the use of fossil fuels and consequently reduce future demand for them. On the other hand, world economic growth, particularly growth in developing countries, may not be achieved without cheap energy sources.

A balance, therefore, must be struck between environmental issues and the urgent need for world economic development in order to improve standards of living and to alleviate poverty.

A third energy issue, energy security, is of great concern to consumers and producers. The consumer is worried about security, of supply, while the producer is concerned about security of demand.

These three major energy issues will shape the energy market of the 1990s and beyond. Their interaction will determine future levels of demand, which at this point can only be estimated.

It is safe to say, however, that the world will need new sources of oil production, that most new sources will occur in members of the Organization of Petroleum Exporting Countries, and that most new OPEC sources of oil will be in the Middle East.

NEW RESERVES

Although oil is a finite, depletable source of energy, its proven recoverable reserves (hereinafter, simply reserves) have increased substantially during the past few decades, in particular in the OPEC countries during the 1980s.

OPEC production, despite this increase in oil reserves, fell during the 1980s due to reduction in demand and increase in non-OPEC supply. It remains much lower than it was in the early 1980s.

OPEC reserves lives stand currently at about six times those of non-OPEC reserves. Undiscovered crude oil resources are estimated currently at about 50% of reserves.

The decade of the 1980s was characterized by worldwide underinvestment in oil exploration and production and consequently underperformance in discovery of new reserves, particularly outside the OPEC region. In order to meet the projected increase in world oil demand during the 1990s and beyond, huge capital investment is required to develop OPEC and non-OPEC reserves.

Dependence on OPEC oil is expected to grow due to the availability of huge reserves in this region, which can be developed at lower cost than can reserves in other areas. OPEC's Middle Eastern members will be called upon not just to meet the world's increased need for OPEC oil but also to compensate for production declines among other members of the organization as the year 2000 approaches.

Two sets of future oil supply scenarios are discussed in this article. The first set, which consists of three scenarios, is related to future changes in oil prices. The second set, also of three scenarios, is concerned with the future impact of environmental issues on future oil supply.

RESERVES, PRODUCTION

Reserves have grown tremendously during the past 3 decades and particularly during the 1980s. Total world reserves increased from 291 billion bbl in 1960 to 550 billion bbl in 1970, 665 billion bbl in 1980, and 1.012 trillion bbl in 1990.

OPEC's share of total world oil reserves amounted to 75% in 1960 and fell to 66% in 1980 before rising to 77% in 1990 (Fig. 1).

Net additions to reserves worldwide, including the former centrally planned economies (CPEs), have totaled an estimated 721 billion bbl since 1960. Net additions during the 1960s were estimated at 259 billion bbl, compared with 115 billion bbl during the 1970s. In contrast, net reserves additions during the 1980s totaled an estimated 347 billion bbl (Table 1).

In the 3 decades ending in 1990, reserves growth has been most pronounced in the Middle East, Africa, and Latin America, with reserves in other regions shrinking or holding steady (Fig. 2).

The world's undiscovered crude oil resource is estimated at more than 490 billion bbl, of which about 165 billion bbl, or 34%, is in the OPEC area. This puts the remaining ultimate resource (reserves plus undiscovered resources) at 1.498 trillion bbl, with OPEC holding 939 billion bbl or 63% (Fig. 3).

Growth in crude oil production during the past 3 decades was also substantial. Total world production rose from 21 million b/d in 1960 to 45 million b/d in 1970 and 60 million b/d in 1980. It declined to 53 million b/d in 1985 as conservation reduced demand before rising to 60 million b/d in 1990.

Total OPEC production grew from about 9 million b/d in 1960 to 23 million b/d in 1970 and 27 million b/d in 1980. It fell to about 15 million b/d in 1985 due to reduced demand and increased non-OPEC supply. After 1985, OPEC production rose gradually to about 23 million b/d in 1990 due to abandonment of the group's fixed pricing system and increasing oil demand,

Non-OPEC crude oil production surged from 12 million b/d in 1960 to 22 million b/d in 1970 and 33 million b/d in 1980. It peaked in 1988 at 38 million b/d before declining to 37 million b/d in 1990 (Figs. 1 and 4).

Comparison of world crude oil reserves on a regional basis (Fig. 2) with regional production (Fig. 4) yields the following conclusions:

• While the Middle East contains the biggest reserves, its production is relatively small, certainly out of balance with reserves.

• Both North America and the former CPE countries have relatively steady and low reserves, whereas their production rates are much larger, particularly for the former CPES, from the mid-1970s onward, North America shows a moderate decline in reserves after the 1970s as well as in production after mid-1985.

• The Latin American region improved its reserves continuously from the late 1970s onwards, although its production remained nearly constant during the past 3 decades.

OPEC's reserves life, as indicated by the group's reserves-to-production (R/P) ratio, grew from 69 years in 1960 to more than a 100 years in the late 1980s after falling to its lowest level of about 37 years around the mid-1970s.

The non-OPEC R/P ratio was more stable, varying from 16 years in 1960 to as high as 19 years in 1980 and falling to 17 years in 1990. The average worldwide R/P ratio is 46 years at 1990 production levels (Fig. 5).

If undiscovered crude oil resources are considered, the reserves lives reach well into the next century for both OPEC and non-OPEC countries.

KEY MARKET TRENDS

The oil price rises of the 1970s suppressed worldwide demand, stimulated non-OPEC production, and stalled an upward trend in OPEC output.

The trends have reversed in response to the price slump of the 1980s (Fig. 6).

World oil demand, excluding the former CPES, fell from as high as 53 million b/d in 1979 to as low as 46 million b/d in 1985 due to conservation and efficiency gains. It gradually started to rise again after 1985, reaching 52 million b/d in 1990.

The oil price collapse of 1986 and the moderate prices since then could not fully restore oil demand growth to prior rates because some of the changes that took place in the 1980s, such as investment in non-OPEC regions, conservation, and substitution for oil in major economic sectors, are irreversible.

Also, the economies of developed nations have moved toward services and away from energy-intensive industries, which has further reduced the amounts of energy and oil needed to generate economic growth. Developing countries have partially offset this effect with strong growth in energy-intensive activities.

Furthermore, industrialized countries responded to high oil prices by encouraging investment in oil substitution, energy conservation, and exploration and production outside OPEC. Many enacted taxes that discriminated against oil and subsidized other energy sources, particularly coal. They limited use of oil in power generation, mandated oil stockpiling, and formed the International Energy Agency in 1974 to coordinate and enforce these measures.

The process has not stopped and will have a bearing on the oil market of the future.

The world economy is expected to sustain a growth rate of 2.5-3%/year through 2010. Energy and oil demand will not increase at the same rate because of further conservation efforts, especially in the industrialized countries represented in the Organization for Economic Cooperation and Development (OECD).

Demand per unit of economic growth--or intensity--will decline by a projected 20% for energy and 30% for oil in the next 15 years.

The share of oil in the world total primary energy mix is likely to fall only moderately during the 1990s. It suffered a steep drop during the past 2 decades--from about 57% in 1973 to 45.7% in 1990. Most of the possible substitution for oil has taken place in many sectors of the economy leaving transportation as the sector where oil maintains a leading role.

Security of supply is still considered one of the most important issues facing decision makers in the industrial countries and also some developing countries. This may lead to additional taxes on oil products and tariffs on imported crude oil in order to finance subsidies of other energy sources and to stimulate domestic oil production.

Environmental measures to curtail greenhouse gas (GHG) emissions and to reduce air pollution through the reduction of sulfur oxides, nitrogen oxides, and volatile organic compounds are increasingly adopted by many countries.

The processes of reducing or removing sulfur and nitrogen oxides or other pollutants are energy intensive; consequently, they may increase oil demand and prices.

SUPPLY, PRICE OUTLOOK

All these factors lead to a number of possible scenarios for oil supply and price in the years leading to 2000 and beyond.

A base case has been developed for this study in which oil prices during the 1990s and possibly up until 2010 could range between $18/bbl and $30/bbl in real terms. This case assumes that the minimum reference of $21/bbl adopted by OPEC in July 1990 for its reference basket of crudes could be a reasonable average.

Three oil supply scenarios may be proposed in relation to three oil price assumptions: $18/bbl, $21/bbl, and $30/bbl (1990 dollars) through 2010 (Table 2 and Fig. 7).

The base case scenario predicts that the call on OPEC oil will be about 32 million b/d, or 55% of the world total, in 2000 and 41 million b/d, 64% of the world total, in 2010.

Low oil prices--the $18/bbl scenario--could increase demand and reduce non-OPEC supply such that OPEC would have to produce about 36 millon b/d in 2000 and 47 million b/d in 2010. Whether low oil prices would allow such incremental production and upkeep of present capacities is doubtful.

Such a scenario means that the increased capacity investment is not subject to economic consideration, and it is hard to see how OPEC countries would justify billions of dollars for investment with such a poor prospect for returns.

If oil prices rose to $30/bbl by 2000 and 2010, oil supplies including net oil exports of the former CPEs would run about 3 million b/d more than the low price scenario and would thus keep OPEC's share of total supplies under 50% until shortly before 2010. In the low oil price scenario, OPEC's share surpasses the 50% mark before 1995.

THE ENVIRONMENTAL FACTOR

Recent health and environmental concerns could lead to some control over use of fossil fuel and reduce potential demand for them, even as economic growth increases the need for reasonably priced energy.

While there is broad agreement on the need to protect the environment, opinions vary as to the justification and effectiveness of protection measures.

In the climate change issue, for example, scientific uncertainty raises questions about the basic theory and the magnitude, timing, and distribution of the effect. The uncertainty stems largely from incomplete understanding of sources and sinks of greenhouse gases, which affect predictions of future concentrations.

Also, uncertainties exist regarding the effects of clouds, which strongly influence the magnitude of climate change; oceans, which influence the timing and patterns of climate change; and polar ice sheets, which affect pre- dictions of sea level rise.

In spite of the uncertainties, it has been suggested that carbon dioxide (CO2), a greenhouse gas (GHG), be taxed through carbon or energy levies to curtail emissions. The future impacts of such initiatives on base case oil supply and demand can be estimated in relation to two possible environmental scenarios--CO2 emission reduction and CO2 Stabilization. In addition to $21/bbl oil prices, the base case assumes average world GDP growth of 2.9%/year and world energy demand growth of 1.8%/Year during 1990-2000 and 1.6%/year during 2000-2010.

Energy intensity in the OECD is assumed to decline from 2.99 bbl of oil equivalent (boe)/$1,000 of gross domestic product (GDP) in 1990 to 2.22 boe/$1,000 of GDP in 2010. For all the world except the former CPES, energy intensity is projected to decline from 3.22 boe/$1,000 of GDP in 1990 to 2.55 boe/$1,000 in 2010. The base case scenario assumes the past and present trend of energy consumption will continue with no major environmental restriction to reduce or reverse energy demand (Table 3).

ENVIRONMENTAL SCENARIOS

The CO2 emission reduction scenario incorporates the so-called Toronto target--a 20% reduction in CO2 emissions from the 1988 level by 2005 in the OECD countries with developing countries continuing base case energy consumption trends.

This scenario assumes that an emission reduction tax would be imposed in 1992 in all OECD countries. Under these assumptions, world oil demand will decline from about 52 million b/d in 1990 to 49 million b/d in 2010. The oil share of the energy mix decline from 46% in 1990 to 40% in 2010.

Non-OPEC oil supply will decrease from 27 million b/d in 1990 to 23 million b/d in 2010, and OPEC production will drop from 25 million b/d in 1990 to 23 million b/d in 2000, then rise to 27 millon b/d in 2010--significantly below the 41 million b/d in the base case scenario. OPEC's share of worldwide oil supply will rise in this scenario from 48% in 1990 to 54% in 2010 (Table 4 and Fig. 8).

In order to reach the Toronto target by means of taxation alone, OECD countries would have to raise energy levies by $9/boe/year. Alternatively, a flat tax of as much as $110/boe (1991 dollars) would have to be imposed at once to achieve the same results.

Such high taxes are ven, unlikely. The scenario is, therefore, an academic exercise.

The CO2 emission stabilization scenario, however, assumes that CO2 emissions of the OECD countries will be held at the 1990 level by 2010, whereas the developing countries will continue their energy consumption trend as in the base case scenario.

To achieve CO2 emission stabilization by 2010 in the OECD, a much lower carbon tax of $1.50/boe or a $20/boe flat tax would be required. Total non-CPE oil demand under this scenario is projected to increase from 52 million b/d in 1990 to 60 million b/d in 2010-only 3 million b/d lower than the base case scenario forecast.

The share of oil in the total world energy mix is projected to decline from 46% in 1990 to 42% in 2010. Non-OPEC supply will decline from 27 million b/d in 1990 to 23 million b/d in 2010.

Thus, OPEC production will rise from 25 million b/d in 1990 to 37 million b/d in 2010, about 3 million b/d lower than the base case scenario projection for 2010. OPEC's oil market share will grow, according to this scenario, from 48% in 1990 to 62% by 2010 (Table 5 and Fig. 8).

INVESTMENT PATTERNS

About 80% of the world's original oil reserves were located in approximately 340 giant oil fields of more than 560 million bbl of oil reserves each. Moreover, 40% of the world's original oil is found in only 25 supergiant oil fields with oil reserves of more than 10 billion bbl each (Table 6).

There is clear evidence that many of these large oil fields, like Prudhoe Bay in Alaska, Samotlor in West Siberia, and others, are mature and have started their production declines. Additional investment could reduce the rate of decline but not halt it, and production from such fields will become increasingly expensive with time.

Since 1970, oil production outside OPEC has not been completely replaced by new discoveries; therefore, during the 1980s a large gap developed between them (Fig. 9).

The North Sea and Alaska are the only two major new oil provinces discovered outside OPEC in the last 2 decades. This is due to a steady decline in spending on exploration and development (Fig. 10).

Exploration spending by the largest 30 companies fell by 50% between 1981 and 1989 and by about 40% between 1985 and 1989. Oil field development spending also fell during the decade--from $31 billion in 1981 to its lowest level of $16 billion in 1987. The figure rose to $20 billion in 1989, still lower by about 40% than the level registered in the early 1980s.

The capital return on upstream assets of the largest 30 companies also indicated a clear decline during 1984-89. The ratio of net income to net capital invested dropped from 15% in 1984 to 6% in 1988 and 7% in 1989. The after tax cash flow from operations of the 30 companies during 1984-89 fell from $57 billion in 1984 to its lowest level of $42 billion in 1988 before rising to $44 billion in 1989.

The exploration and production reinvestment ratio (E&P capital expenditure as a share of cash flow from operations after tax) fell during the period to its lowest level of 48% in 1987 from 62% in 1984 and 64% in 1985 before rising to 64% in 1989. Although the percentage reinvestment ratio showed some recovery in the late 1980s, the actual reinvestment was declining as the cash flow' from operations dropped during the late 1980s.

Despite worldwide underinvestment in oil exploration and production and consequent underperformance in discovery of new reserves, OPEC member countries managed to add reserves through exploration and revisions in the 1980s. The organization's reserves additions in the decade are estimated at more than 335 billion bbl, or 99% of the world total.

Total world (excluding the former CPES) upstream investment rose from $41 billion in 1978 to its peak of $91 billion in 1982 before falling to $47 billion in 1987 as a result of the collapse of oil prices in 1986. Upstream capital investment reached an estimated $63 billion in 1988, $67 billion in 1989, and $83 billion in 1990 (Fig. 11).

The contribution of the U.S. to world upstream capital investment is substantial. The country's share of the non-CPE total grew from 49% in 1978 to a peak of 60% in 1981 then fell to as low as 42% in 1987 (Fig. 12).

U.S. expenditures on exploration alone rose from about 510 billion in 1978 to $31 billion in 1981 before falling to $8 billion in 1987. Production spending increased from $11 billion in 1978 to as high as $27 billion in 1985 before declining to $12 billion in 1987.

Upstream investment in the Middle East and Africa during 1978-87 never represented more than 7% of the worldwide total, indicating underinvestment in a region with more than two thirds of total world oil reserves.

THE UPSTREAM SHIFT

In recent years, upstream capital investments have shifted away from mature North America to other areas where better incentives and more opportunities are available.

Major oil companies' investment in the U.S. dropped about 12% from $14.3 billion in 1988 to $12.6 billion in 1989. Although selected independent companies--those spending at least $20 million/year--increased their investments in the U.S. in 1989 over 1988, this was not sufficient to offset the total decline in investment caused by the majors. For Canada, 1989 expenditures by the majors dropped about 9% from those of 1988--from $3.4 billion to $3.1 billion.

However, the majors and selected independent oil companies increased their investments outside North America by about 16% in 1989 over 1988--to $20.2 billion from $17.5 billion--taking advantage of the prospectively better reserve replacement rates and finding and development costs available elsewhere. If the oil industry is to meet the increase in world oil demand projected for the 1990s and beyond, it will have to invest a huge sum of capital from its own cash flow as well as from outside sources.

The required worldwide upstream investment during the next 5 years is estimated at $230 billion. OPEC countries will require investments of up to $80 billion, excluding funds needed for repairs to Iraqi and Kuwaiti oil facilities damaged in the Gulf War.

Countries outside OPEC will need $170 billion, mainly to sustain output of about 40 million b/d and to expand production from marginal oil fields in some producing or mature oil provinces.

DEPENDENCE ON OPEC

The pressure on OPEC to increase production capacity derives from members' huge reserves addition at the end of the 1980s, the huge volumes available even before then, the predicted rise in world oil demand during the 1990s and beyond, and the expected stagnation or decline in non-OPEC production beginning at the end of the decade.

The pressure is most intense in the Middle East.

Currently, OPEC holds more than 75% of total world oil reserves (in ding the former CPEs). OPEC's members in the Middle East alone hold 65% of the world's reserves.

The OPEC Middle East could require investments of $48 billion by 1995, or 60% of the total investment required by OPEC in the next few years.

The additional capacity to be added from this region is estimated at 8.5 million b/d-about 89% of the OPEC total by 1995 (Table 8).

OPEC members are expected to expand production capacity by an additional 4 million b/d to meet world oil during 1995-2000.

The contribution of OPEC's Middle Eastern members to this addition will be 4.2 million b/d since some decline is anticipated in other OPEC countries.

The estimated cost of this expansion is $60-80 billion, of which $40-60 billion--or 67-73%--is expected to be in the Middle East.

Due to loss of production from Iraq and limited production from Kuwait, OPEC's production during 1991 was very close to sustainable capacity (Fig. 13).

Therefore, any delay in investment to expand OPEC capacity could cause deficiencies in oil supply relative to expected levels of demand and consequently raise oil prices. AU the future oil supply scenarios discussed above suggest that non-OPEC supply Will stagnate and start falling during the 1990s (Figs. 7 and 8).

HUGE, CHEAP RESERVES

Future incremental oil demand must be supplied from OPEC countries, and particularly the OPEC Middle East, since the region's huge proven crude oil reserves are considered the cheapest in the world to develop.

OPEC's 77% total world reserves share contrasts with its world production share of only 38%. And the OPEC Middle East's 65% reserves share compares with a production share of only 25%. This adds to the probability that future increases in oil production will come from OPEC, especially the OPEC Middle East (Table 9).

Continued oil production declines in the former Soviet Union will further increase demand for OPEC oil. The region's production fell by more than 1 million b/d in 1991. The 1992 decline is believed to have been about as great.

The trend is expected to continue during the 1990s due to the economic turbulence that the former Soviet republics are experiencing.

Given those declines and the expected near stagnation in production elsewhere in the non-OPEC world, OPEC capacity is expected to grow to 34 million b/d in 1995, 38 million b/d in 2000, and 42 million b/d in 2005.

OPEC'S AIMS

OPEC's aims are not only to protect the interests of its members but also to maintain the supply of oil to consumers at a reasonable price. It therefore considers oil market stability one of its principal objectives.

In an effort to stabilize oil supplies, OPEC members have announced ambitious programs to expand production capacity in the 1990s. These programs, if implemented, would satisfy the expected call on OPEC crude (fig. 14).

It is believed that most of the required investment capital for future capacity expansion in the OPEC countries will come from within the oil industry itself. The rest will be raised through joint ventures with other oil companies or from financial institutions.

Whatever method is used to finance the investment, it has to be subject to normal commercial requirements for return on investment. OPEC countries are increasingly subjecting their national planning to economic justification that includes oil investments. The trend is crucial in the Middle East, where production must increase not only enough to meet non-OPEC demand but also to offset production declines elsewhere in OPEC.

If the economic justification and proper returns on scarce capital are not in place, needed investments will not be undertaken.

Copyright 1993 Oil & Gas Journal. All Rights Reserved.