Asian financial crisis to slow growth in global oil demand

Tom Manning
Purvin & Gertz Inc.
Houston

• World Petroleum Demand [54,613 bytes]
• Asia Economic Growth [53,729 bytes]
• Asia Refinery Operating Rate [62,754 bytes]

The consensus outlook for continued strong oil demand growth in Asia has been rocked by recent events.

The developing Asian financial crisis will stall or perhaps reverse a number of trends in the petroleum industry that were under way as recent as 6 months ago.

A new study by Purvin & Gertz Inc. focuses on the effects of the current crisis on both regional and world petroleum demand.

In it, Purvin & Gertz assesses the consequences of the crisis for petroleum supply, pricing, and trade patterns.

The major effects will be felt in the short term, i.e., through 2000.

World petroleum demand

Petroleum demand increased rapidly (1.7%/year) over the past decade in all regions of the world, except the former Soviet Union (FSU) and Eastern Europe.

Excluding the FSU and Eastern Europe, crude runs increased at an average rate of 2.6%/year during 1987-97.

The disintegration of political and economic systems caused energy demand and hence demand for crude oil and products to drop precipitously in the FSU and Eastern Europe.

The most rapid growth in crude runs during the preceding decade occurred in Asia (nearly 6%/year).

Product demand growth caused existing refineries to increase operating rates relative to capacity, spurring a need for new refineries to be built and planned.

Growth in refinery crude runs in the more-developed countries of the Organization for Economic Cooperation and Development has been more moderate (1.8%/year), but since the OECD nations account for such a large percentage (55%) of total runs, the increase in volume was quite large.

Unfortunately, the Asian financial crisis that started to emerge late in 1997 will delay or even reverse many of these favorable trends.

Effects on demand

Petroleum demand is directly related to economic activity, and sudden changes in energy prices will shock the world's economies as product demand responds accordingly.

The dramatic crude price increase in the late 1970s caused petroleum demand to decline in the industrialized nations, while the crude price drop in 1986 stimulated economic activity and product demand.

Collapse of the economies of the FSU and Eastern Europe in the early 1990s slowed growth in petroleum demand.

Rapid growth in oil demand occurred during 1994-97, but the Asian financial crisis will severely curtail Asian demand growth and consequent low crude oil prices will inhibit growth in the large crude-exporting countries.

Contagion will slow growth in other regions, although lower oil prices will cause demand to recover after a few years (see Fig. 1, p. 41).

Asian economies

The Asian financial crisis has shocked most, if not all, of the economies in the region.

Many countries will experience recessions in 1998-99 for the first time in over a decade.

Economic growth will merely slow down in other countries, but none will escape unscathed.

Overall, economic growth will be significantly lower in 1998-99 than previously forecast (see Fig. 2, p. 41). The Asian economies will be hit hardest, but recovery is expected by 2000, or shortly thereafter.

Indonesia, Japan, Malaysia, South Korea, and Thailand will experience recessions in 1998-99, with recovery expected by 2000.

Thailand's economy collapsed in 1997, but the economies in all five countries will register a decline of 3-5% in 1998 and be flat at best in 1999, before recovering to 4-5%/year growth by 2000.

Judicious use of financial support from the International Monetary Fund and implementation of corrective fiscal programs are required for a speedy recovery.

Each country is unique, and recovery will be uneven.

Effects on refining

Demand growth in Asia has strained refining capacity throughout the region.

Substantial additions to capacity have been completed or are under way in many countries. In particular, Singapore's industry has enjoyed many years of high utilization, even though operating rates will drop in the short term.

Significant refinery capacity expansions after 2000 will be required.

The Asian financial crisis will cause Asian demand to stagnate overall and decline in some countries, which will, in turn, reduce capacity utilization rates of refineries in the region.

Operating rates had improved in recent years to over 90% due to the combination of strong demand growth and delay in building.

Operating rates will recover shortly after 2000, and new capacity will be required before 2005 (see Fig. 3, p. 42).

The Asian financial crisis will also affect product trade patterns, because lower demand in Asia will reduce the need for imports.

Singapore refineries have already cut runs, and financial problems will disrupt product and crude oil trade by making letters of credit and other financial instruments used in the conduct of business more difficult to obtain.

Effects on oil output

Crude oil production among countries outside the Organization of Petroleum Exporting Countries (OPEC) has increased dramatically, but increasing demand in recent years has allowed OPEC crude production to increase as well.

Since non-OPEC crude is typically lighter and lower in sulfur, the level of bottoms per barrel of crude has declined significantly.

The crude price drop precipitated by the Asian financial crisis will slow oil and gas development plans in many countries, both OPEC and non-OPEC, because oil and gas companies will have less cash flow available to fund exploration and development activities.

Prior to the recent crude oil price decline, rapid growth in crude supply was being planned, but initially, some high-cost, heavy oil production in some fields in California and Canada will be cut. In addition, some stripper well production in Texas and Oklahoma will be shut in.

As refiners in Asia cut runs, oil producers in the Middle East and Africa will have to reduce planned increases and perhaps even reduce production from the levels achieved in 1997.

Longer-term developments will slow, because oil companies will have less cash flow to support drilling programs in non-OPEC countries.

OPEC producers will also have less revenue to fund development of their reserves, so their sustainable capacity will not increase as fast as originally projected.

Effects on oil prices

The price of crude oil was beginning to slip (see Fig. 4, p. 43) before the full effects of the Asian financial crisis were felt as a result of growth in non-OPEC supplies, over-production by OPEC, and the return of Iraq's oil supplies to world markets.

In early 1998, the price of crude oil had dropped by over $10/bbl from the January 1997 price.

The market will allocate crude production by reducing runs in response to demand, and crude prices could be expected to level out in 1998-99 at about the current level.

However, OPEC could cause prices to firm a bit by cutting production.

To stop the freefall in price, OPEC called an extraordinary conference on Mar. 30 in Vienna, where an agreement was announced that calls for OPEC members to reduce output by 1.245 million b/d from a baseline of 26.987 million b/d.

In addition, China, Mexico, Norway, Yemen, and Russia, among others, announced plans to cut production by a total of 300,000-400,000 b/d.

The market responded positively, and prices are back up to around $15/bbl.

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