OPEC Middle East plans for rising world demand amid uncertainty

Ibrahim A.H. Ismail
Organization of Petroleum Exporting Countries
Vienna

The Middle Eastern members of the Organization of Petroleum Exporting Countries must plan for huge increases in oil production capacity yet wonder whether markets for the new output will develop as expected.

With worldwide oil consumption rising and non-OPEC output likely to reach its resource limits soon, OPEC member countries face major gains in demand for their crude oil. To meet the demand growth, those with untapped resources will have to invest heavily in production capacity. Most OPEC members with such resources are in the Middle East.

But financing the capacity investments remains a challenge. Some OPEC members have opened up to foreign equity participation in production projects, and others may eventually do so as financial pressures grow. That means additions to the opportunities now available to international companies in the Middle East.

Uncertainties, however, hamper planning and worry OPEC. Chief among them are taxation and environmental policies of consuming-nation governments.

OPEC output trends

OPEC's Middle Eastern members have dealt with uncertainty before, as shown by their changing production patterns of the past 3 decades.

Production by Middle East members climbed from around 5 million b/d, or 60% of total OPEC output, in 1960, peaked at 21.6 million b/d, or 69% of total OPEC, in 1977, before declining to less than 10 million b/d in 1984. Since then, production from this region has risen to about 17 million b/d in 1995 (Fig. 1 [24758 bytes]).

Fig. 2 [30795 bytes] shows how these swings affected inividual OPEC members in the Middle East. Current production from this region is still lower than the peak of the mid-1970s.

Other OPEC members' production averaged around 3.5 million b/d, or 40% of total OPEC flow, in 1960. It increased to more than 10 million b/d (43% of total OPEC) in 1970, falling to around 6 million b/d in the late 1980s, and averaging 8.2 million b/d (33% of total OPEC) in the first half of 1995. Current production from non-Middle East OPEC also remains below maximum levels achieved in the 1970s.

The call on OPEC

OPEC's base-case outlook is for an increase in worldwide oil demand from around 67 million b/d in 1995 to 72.8 million b/d in 2000, 80.3 million b/d in 2010, and 86.2 million b/d in 2020. These figures exclude processing gains and nonconventional oil outside the Organisation for Economic Cooperation and Development.

By 2000, non-OPEC production will have peaked. Total non-OPEC oil supply, including NGL but excluding processing gains, will average 41 million b/d in both 2000 and 2010, up from 39.8 million b/d in 1995, then slip to 39.3 million b/d in 2020. These projections mean that OPEC output of crude oil and NGL will have to climb from 27.6 million b/d in 1995 to 31.3 million b/d in 2000, 39.4 million b/d in 2010, and 46.8 million b/d in 2020.

Theoretically, OPEC can support any required level of production. Its members hold more than two thirds of the world's current proven recoverable oil reserves, estimated at over 1 trillion bbl. However, in practice, there are constraints, such as the future price of oil, the availability of required investment, the level of oil taxation, and environmental concerns.

OPEC's resource base is abundant when compared with non-OPEC resources. OPEC proven recoverable oil reserves currently stand at around 780 billion bbl, compared with only 260 billion bbl in non-OPEC regions. But non-OPEC crude oil production averages 37 million b/d against 25 million b/d from OPEC. Therefore, the reserves-to-production ratio (R/P) in OPEC is much higher than that outside OPEC: 86 years vs. 19 years. Non-OPEC output, even allowing for new discoveries and enhancement from technological advancement, will begin to decline much sooner than will OPEC's production.

Non-OPEC proven recoverable oil reserves of 260 billion bbl can support crude oil production of 37 million b/d. OPEC's 780 billion bbl of reserves can support more than 100 million b/d. This imbalance between the resource base and production in OPEC and non-OPEC regions is cause for concern in OPEC as its current production is inferior to its huge resource base.

Current plans, official announcements, and published information indicate that OPEC output will expand in the future to meet the expected oil demand growth. By 2000, OPEC sustainable production capacity is expected to reach 36 million b/d (including NGL), of which about 24 million b/d, or 71%, will come from the OPEC Middle East region. OPEC sustainable production capacity by 2010 will be around 44 million b/d, of which 30 million b/d, or 74%, will be the OPEC Middle East share. A further expansion to 48 million b/d is projected by 2020, of which the Middle East share will be 33 million b/d, or 77% of total.

Table 1 [43701 bytes] illustrates the details on a country-by-country basis of OPEC production capacity to the year 2020 with required investment.

OPEC has always maintained spare capacity of 5-10% as a safety cushion for any sudden fluctuations or disruptions in oil supply. That is why capacity projections in Table 1 [43701 bytes] exceed forecasts for the world's need for OPEC oil.

Financial implications

The future course of oil prices will greatly determine the amount of capital available to projects needed to increase production capacity.

Oil companies have adjusted to the oil price collapse of 1986 by restructuring, efficiency improvement, and new technology in order to cut cost, increase recovery from existing fields, and develop new ones-especially marginal fields, as in the North Sea.

For OPEC member countries, low oil prices have caused serious reductions in oil revenues and discouraged investment in output capacity expansion projects. If low oil prices persist, the result could lead to a tight situation by the beginning of the next century.

Most OPEC member countries, and particularly the major producers, are suffering from serious reductions in their petroleum revenues (Table 2 [41492 bytes]). The value of petroleum exports in 1994 was lower than that of 20 years ago.

Expansion of oil output capacity to meet expected demand will require outside capital, either through borrowing or equity sharing. Self-generated financing in OPEC member countries will not be sufficient to expand production capacity to the levels discussed above, as national oil companies in OPEC members are state-owned and must compete for investment funds with other sectors of the economy.

Thus, in some OPEC member countries, the priority for investment may not be the oil industry. For the oil industry to meet its targets, other sources of finance must be found.

Requirements of the worldwide petroleum industry for capital during 1993-2005 average around $70 billion/year, according to estimates by Petroleum Finance Co., Washington, D.C. This compares to the 1980s, when capital investment in the oil and gas industry was estimated at $1 trillion over the period, or $100 billion/year.

For the remainder of the decade, the oil industry requirement could be around $350 billion, of which $230 billion is for the upstream sector. Additional capital of $750 billion and $800 billion will be required by 2010 and 2020, respectively. The shares of upstream activities for those two periods are estimated at $500 billion and $550 billion, respectively.

The financial requirement for OPEC member countries during 1993-2005 is estimated at $170 billion. For the remainder of this decade, and in order to achieve sustainable capacity of around 36 million b/d by 2000, OPEC capital requirements are put at $100 billion. A further expansion of OPEC sustainable production capacity to 44 million b/d by 2010 and 48 million b/d by 2020 will require additional sums of around $160 billion and $215 billion, respectively.

Due to huge and cheap resources in the OPEC region, which can easily be developed and put on stream, the financial requirement is much less than in other regions. Of the total world output increase of 8.1 million b/d by 2000, OPEC's share is 72%, while the share of required investment is only 38%. Beyond 2000, the share of required investment in OPEC will be below 40%, while almost all additional increase in output will come from this region.

The worldwide upstream investment for increasing oil output in the major producing regions of the world is estimated at $260 billion by 2000, $490 billion by 2010, and $555 billion by 2020 (Table 3 [4500 bytes] ).

The problem of raising the required finance is a major hurdle facing OPEC member countries, almost all of whom are burdened with heavy external debts. Their current account balances in recent years are negative. On the other hand, a delay in upstream investment could well cause oil shortages in the future, accompanied by upward pressure on prices.

To meet its capital requirements, the oil industry has to either generate funds from its own resources, resort to external funding through borrowing or equity participation, or use some combination of the three mechanisms.

Of the three, external funding will be most important to future additions to production capacity.

In addition to borrowing on international markets to maintain capital investments in the face of falling oil revenues, many OPEC members have opened up to foreign equity participation. Some of them, such as Algeria, Venezuela, Iran, and Iraq have done so fairly recently, while others, including Indonesia, Nigeria, the U.A.E., Libya, and Qatar, sought foreign equity participation long ago. Saudi Arabia and Kuwait may follow suit at a later stage.

Opening up to foreign equity participation is not limited to OPEC members. Mexico, Brazil, China, and Viet Nam, in addition to the former Soviet Union, have attracted serious attention from abroad, and major foreign investments have started to flow.

Capital borrowing

For the nationalized oil industry, capital borrowing from abroad can be done either by the state-owned national oil company or by the government on behalf of the national oil company.

Many governments borrow from abroad to raise capital for financing domestic projects, though they may have substantial assets abroad. Some of the Middle Eastern states borrow money from abroad but have their own assets invested or deposited outside.

Many oil producing countries, particularly the Gulf states, which used to possess huge assets abroad, have started borrowing recently, and their assets abroad are gradually being weathered. OPEC members' net assets declined from $156 billion in 1980 to minus $44 billion in 1994 (Fig. 3 [18116 bytes]).

Many oil producing countries, among them most of the OPEC producers, are overburdened with debts. OPEC members, particularly those in the Gulf, can generate substantial financing from domestic sources, either by privatizing certain chains of the oil industry, such as the upstream or the downstream, or by borrowing from local private banks and financial institutions. A huge amount of private capital is currently fleeing from these countries to be deposited in foreign banks or invested abroad.

Privatizing some parts of the oil industry would attract some of this capital, particularly when enough incentives are offered by the government for the private sector.

Equity participation

In OPEC countries, equity sharing with foreigners has been limited since the oil industry nationalizations of the 1970s.

The foreign participation that has occurred has been mainly through service contracts. Recently, however, some OPEC members have joined other developing nations in becoming more open to production sharing agreements with foreign companies.

Joint ventures through production sharing agreements between national oil companies and foreign oil companies have attracted many OPEC and non-OPEC producers in recent years. This arrangement maintains the sovereignty of the state on its underground resources and raises the capital required for expansion of the oil industry. It also gives the national oil company access to modern technology.

OPEC's competitiveness

In addition to its unique function as the oil market's balancing mechanism and the current imbalance between its resource potential and production, OPEC possesses another feature that assures it of a growing role in the market: low development and production costs. This competitive advantage is greatest among OPEC's members in the Middle East. Table 4 [20106 bytes] shows the attractiveness of OPEC members in general and OPEC Middle East in particular in relation to the cost of incremental production elsewhere.

These forces will have increasing effect on the market as non-OPEC production reaches its limits and begins to fade. The projections presented here imply market share growth for OPEC from 42% in 1995 to 43% in 2000, 49% in 2010, and 55% in 2020. Table 5 [37743 bytes] highlights this growth and something else: a rising Middle East share of the OPEC production capacity needed to keep up with demand.

As the table shows, spare OPEC capacity will shrink, which means that OPEC alone may not be able to satisfy the expanding world's need for oil. Production of mature fields in several OPEC member countries will begin to decline, especially outside the Middle East. This accounts for the Middle East's rising share of total OPEC capacity.

Hindrances

Tax and environmental policies of consuming-nation governments will hinder OPEC in its efforts to meet the growing responsibility it faces in supplying oil to the world.

High and rising taxes in major consuming countries reduce security of demand for oil producers and-by discouraging investment in production capacity-security of supply, which is important for consumers.

Therefore, only cooperation be- tween consumers and producers can assure stability of the oil market.

The main constraints on OPEC, and the Middle Eastern members that must account for most of the growth in oil production capacity in the next quarter century, are oil prices and tax and environmental policies of consuming-nation governments. To the extent that opportunities open in the Middle East, international companies can expect these constraints to be major concerns of host governments.

Table 6 [34647 bytes] shows how different oil prices, all within the range that has been common in recent years, affect OPEC revenues and the ability of OPEC nations to internally finance oil production projects. Of course, prices can be too high, from OPEC's point of view. At some point, high prices discourage consumption and encourage use of non-oil sources of energy.

The concern for taxation arises because consuming nation governments now earn more from taxes on petroleum products than producing countries earn from sales of crude oil.

At the end of 1994, gasoline taxation among major consuming countries ranged from 34.4% of the total product price, in the U.S., to as high as 80.8%, in France.

The net earnings per barrel of most consuming nations are several times higher than those of OPEC countries (Fig. 4 [17544 bytes]). If this trend continues, OPEC may not be able to raise the required investment for future capacity expansion as the distribution of rent favors consumers more than producers.

Furthermore, extra tax take by consumer governments will reduce demand and discourage OPEC and other producers from investing in output capacity.

Until recently, taxes have been imposed mainly to raise money for consumer-nation governments and, to some extent, shift the financial burden of social programs from employment to energy consumption. But taxation is increasingly proposed as a tool of environmental protection.

This is especially so in the area of climate change, where even nontax measures aim at cutting global consumption of oil to reduce emissions of carbon dioxide. Depending on the CO2 target, environmental taxation could reduce projected oil demand by 2-6 million b/d by 2000, 6-12 million b/d by 2010, and 7-18 million b/d by 2020.

For OPEC, under shares predicted here, these cuts could reduce cumulative revenues by $43-252 billion by 2000, $516 billion-$1.245 trillion by 2010, and $1.168-3.403 trillion by 2020. Revenue hazards like these create huge uncertainties for OPEC and the Middle Eastern members that must account for most future production growth at the very time that they need to be planning their investments and financing strategies.

In Middle East OPEC, therefore, opportunities are available and likely to grow, but governments will remain wary of political developments in the key market regions.

Condensed and adapted from a presentation to the 9th Annual APS Conference, October 1995, in Limassol, Cyprus. The views are the author's and do not reflect official positions of the Organization of Petroleum Exporting Countries.

The Author