OGJ SPECIAL OGJ's 3-Year Forecast Strong Demand Growth Seen For Oil And Gas In 1997-99

Robert J. Beck
Associate Managing Editor-Economics

Worldwide economic expansion makes the next 3 years very promising for oil and gas companies that hitch their fortunes to market growth rather than rising prices.

Room exists for higher prices for crude oil and natural gas-but not much. During 1997-99, there will be no resource constraints on the capacity to produce oil and gas. As long as that remains so, and as long as markets are allowed to work, price increases will be moderate.

In the absence of major new taxes or other artificial limits on hydrocarbon use, and despite continuing improvements in consumption efficiency, strong market growth is nearly certain.

For the first time in many years, the worldwide economy is set to expand on all three major fronts: the industrialized world, the formerly Communist world, and the developing world. The three-front growth expected through 1999 will lift global demand for all forms of energy in a market dominated by oil and gas.

Until this year, economic growth in one or two of these broad sectors has tended to be offset by contraction elsewhere. Now, however, recession has ended in the key industrialized countries, the formerly Communist countries have stabilized, and rapid growth in the developing world shows no sign of slowing down.

With economic growth raising energy demand overall, oil and gas demand will rise enough to require additions to producing and refining capacities. It also will present the Organization of Petroleum Exporting Countries with the chance to increase its recently static share of the oil market.

During 1997-99, therefore, drilling will increase, refining capacity will expand in areas of market growth even as it stabilizes or shrinks in mature areas, and continued moderation in prices will keep cost-control at the center of operating strategies.

Also in the period, natural gas will continue to capture a growing share of the world's expanding energy market (see story, p. 60).

Economic activity

The pace and type of economic growth will determine demand for petroleum products in the next 3 years.

The period will extend trends of the past 2 years, when industrial countries recovered from recession, economies surged in many developing countries, and contraction ended in Eastern Europe and the former Soviet Union (FSU).

Although improvements in consumption efficiency have cut the amount of energy required to produce a unit of economic growth, increasing economic activity still means increasing energy use. Moreover, the fastest economic growth in the next 3 years will occur where nation-building, not energy efficiency, is the priority.

OECD recovers

Economic recovery in the industrialized world-encompassing member countries of the Organisation for Economic Cooperation and Development-thus is reviving demand growth in the world's largest petroleum markets.

During 1991-93, most of the major OECD countries and a number of the small members experienced recession, although timing varied.

In 1991, gross domestic product (GDP) fell in the U.S. by 0.6%, Canada 1.8%, and the U.K. 2%. Among small OECD countries, GDP the same year fell in Sweden by 1.1%, Finland 7.1%, Australia 1.7%, and New Zealand 3.6%. As a result, overall GDP growth for the OECD's 25 countries slowed to 1% in 1991.

In 1992, the U.S. and Canada were recovering, but GDP in the U.K. fell again-by 0.5%. Japan's economic growth that year slowed to 1.1%. And several of the small OECD countries remained in recession, with GDP declining in Finland by 3.6%, Iceland 3.3%, Sweden 1.4%, and Switzerland 0.3%. For all of the OECD, economic output rose by an estimated 1.6% in 1992.

In 1993, recession slammed Western Europe. Germany's GDP fell 1.2%, France's 1.5%, and Italy's 1.2%. In addition, Japan's output declined by 0.2%. Among the small OECD members, GDP fell in Austria by 0.1%, Belgium 1.6%, Finland 1.2%, Greece 0.5%, Portugal 1.2%, Spain 1.1%, Sweden 2.6%, and Switzerland 0.8%. For all of the OECD, the GDP growth rate slipped to 1.2% for 1993.

General recovery took hold in 1994, when all OECD countries except Turkey posted GDP gains. Group GDP that year grew by 2.9%.

Estimates for last year indicate more strong growth for the OECD. Only Mexico experienced a GDP decline. Group GDP is estimated to have increased in 1995 by 2.4%.

East Europe, FSU

While OECD members struggled with recession, countries in East Europe and the FSU were mired in transition from Communism to systems more oriented to market economics.

Much of the slowdown in these areas, which use energy very inefficiently by OECD standards, occurred in energy-intensive heavy industries. Total energy demand and oil consumption plummeted.

According to the International Monetary Fund (IMF), total economic output for these countries, which it calls countries in transition, dropped by 11.6% in 1991, 15.2% in 1992, 9.1% in 1993, and 9.5% in 1994.

Within the group, however, signs of improvement appeared in 1993. For countries of central and Eastern Europe, economic activity that year fell by only 1.9% and in 1994 grew by 2.8%.

The improvement was offset by continued contraction within the Commonwealth of Independent States (C.I.S.), where economic activity fell by 15.2% in 1994 after declines of 12% in 1991, 18.7% in 1992, and 11.8% in 1993.

IMF estimates that last year economic activity dropped by only 2.1% for all of the countries in transition. Countries of central and Eastern Europe grew by a combined 4%, while the C.I.S. contraction slowed to 4.6%.

Developing countries grow

In contrast to the sputtering economic performances of the OECD and countries in transition during the early 1990s, economies of many developing countries grew rapidly in the period, especially in the Asia-Pacific region.

Consumption of energy and petroleum has spurted accordingly. Energy conservation has not been a priority in the developing world, where economies and energy demand still tend to move in step with one another.

According to the IMF, aggregate economic output by developing countries moved up 5.9% in 1992, 6.1% in 1993, 6.2% in 1994, and an estimated 6% in 1995.

In developing countries of Asia, output increased 8.2% in 1992, 8.7% in 1993, 8.5% in 1994, and an estimated 8.7% in 1995.

For 1995, the IMF estimated economic growth of 3% in Africa, 1.8% in developing countries of the Western Hemisphere, and 2.4% in the Middle East.

The economic outlook

The stage is set for economic growth on all three major fronts-the OECD, countries in transition, and developing countries-during 1997-99.

This year, OGJ expects strong growth in the OECD and developing countries, as well as the first economic growth this decade for the C.I.S. and Eastern Europe as a whole.

Low interest rates and low levels of inflation will sustain investment levels and economic growth in industrial countries.

OGJ projects aggregate GDP growth in the OECD this year of 2.6%. The growth rate will decline in the U.S. but accelerate in Japan, Germany, and Canada. Growth is also expected to accelerate in the smaller OECD countries as a group. Growth will be slightly slower than last year in France, Italy, and the U.K.

Developing countries as a group will grow this year by 6.3%. The countries of Asia will continue to post the strongest growth rates, although improvement is also expected in Africa, Latin America, and the Middle East.

The combined economic output of the C.I.S. and Eastern Europe will move up this year by 3.4% as movement toward capitalistic systems-however uneven-begins to pay off over all of the region. The expected increase includes growth in the C.I.S. of 2.4%.

This year's gains will set consumption and investment trends that will carry through the forecast period of 1997-99. Nothing that can be foreseen now will lift energy prices enough to slow the activity.

OGJ projects OECD economic growth rates at 2.8% in 1997 and 1998 and at 2.7% in 1999.

Among developing countries, aggregate GDP will grow by 6% in 1997, 5.9% in 1998, and 5.7% in 1999.

As the political transition continues and market economics take increasing hold, the C.I.S. and East Europe will grow at the rates of 3.7% in 1997 and 4% in 1998 and 1999.

Energy intensities

Translation of economic growth projections into forecasts of energy demand rest heavily on assumptions about energy intensity, which vary greatly among regions.

Energy intensity, a measure of consumption efficiency, is the amount of energy consumed to produce a unit of economic output, usually measured as BTUs of energy consumed per dollar of GDP.

Energy intensity has declined in OECD countries since the 1970s due to investments in energy-efficient equipment and other conservation measures. In developing countries and countries in transition, investment has concentrated on raising economic output rather than reducing energy consumption and costs.

During 1984-94, OECD economies as a group grew by an estimated 29%, and energy consumption increased 18%; thus, energy consumption moved up 0.6% for every 1% increase in economic output.

In developing countries, aggregate economic output increased in 1984-94 by an estimated 65%, while total primary energy consumption increased 58%. Energy consumption thus moved up 0.9% for every 1% increase in economic output.

In the C.I.S. and East Europe, energy intensity increased as economic output fell 31% between 1984 and 1994 and energy consumption dropped by 21%. Since 1989, the year prior to the start of the economic downturn, economic output is down 41%, energy consumption down 28%.

Efficiency improvements

OGJ expects energy consumption efficiency to start improving in the C.I.S. and East Europe and to continue improving in developing countries and the OECD during 1997-99.

In the OECD, energy consumption will increase 0.6% for every 1% gain in economic activity. Countries in the region face continuing pressures to improve energy use efficiency for environmental reasons, and their economies are shifting from manufacturing to less energy-intensive service and information businesses.

Total 1999 energy demand in the OECD will be up 6% from estimated 1995 consumption.

While energy use efficiency is less of a political priority in developing countries than it is in the OECD, there will be some improvements. As the fast-growing developing nations expand output capacity, they add modern, energy-efficient capital equipment.

OGJ projects that in developing countries, energy consumption will increase 0.8% for every 1% increase in economic output. Energy consumption in the developing countries will be 18% higher in 1999 than estimated demand for 1995.

In the C.I.S. and East Europe, OGJ expects both economic output and energy demand to increase during 1997-99. Through 1999, energy demand will rise by 0.9% for every 1% increase in economic output.

In 1999 energy consumption in the C.I.S. and East Europe will be up 6% from the depressed 1995 level. This assumes that the transition to market economies encounters no major political setbacks, which would slow growth. There is much room for improvement in energy efficiency in this region but little capital available for investment in efficient equipment.

The energy mix

All the major energy sources will contribute to the consumption increase during the next 3 years, although growth patterns will vary.

Total worldwide energy demand in 1999 will exceed this year's estimated consumption by 7%. Demand will be up for the period in all three major regions: in the OECD 4%, the C.I.S. and East Europe 5%, and developing countries 13%.

OECD market shares

In the OECD, consumption will grow fastest for energy from hydro power, geothermal power, and other miscellaneous sources through 1999, although contributions from these sources will remain small. Demand growth for these sources will be 7% through 1999, but their share of total 1999 demand will be only 2.5%.

OECD coal demand will increase 3% between this year and 1999. The coal market share will slip to 20.3% from an estimated 20.6% this year.

Nuclear output in the OECD will be up 3% in 1999 from current levels, with the market share down marginally at 10.9%.

Natural gas will be the second fastest growing fuel in the OECD, with demand up 6.6% in 1999 from this year's level. The natural gas market share will increase to 22.7% in 1999 from 22.3% this year.

Energy from oil in the OECD will move up 4% by 1999. The market share will slip to 43.6% in 1999 from 43.8% in 1996.

The combined oil and natural gas share of the OECD energy market thus will move up to 66.4% in 1999 from 66.1% in 1996.

Developing countries

All major energy sources will contribute to the consumption growth expected for developing countries.

Demand for coal, which plays a large role in this group, will be 12% higher in 1999 than it will be this year. But coal's market share will drop half a percentage point to 38.4%.

Oil consumption in developing countries will increase by 12% between now and 1999. Oil's market share will slide from 41.9% in 1996 to 41.6% in 1999.

Accounting for the slight market share declines for coal and oil in the developing countries are expected gains for natural gas and nuclear power.

Natural gas demand in this sector will be up 18% in 1999 from current consumption levels. The gas market share will increase to 15.1% from 14.5% in 1996.

Demand for energy from other fuels, such as hydro and geothermal, will be up 14% in developing countries. Market share will remain at 3.2% in the forecast period.

Nuclear power output in developing countries will move up 22% but remain a small share of the market, moving up to 1.7% from 1.5% in 1996. Nuclear expansion is anticipated in China and elsewhere in the Far East.

C.I.S., East Europe

Oil and gas will account for most of the energy demand increase expected for the C.I.S. and East Europe through 1999.

In this region, consumption of natural gas will move up 4.3% to fuel expected economic growth. With demand for other fuels rising rapidly, however, the gas market share will slip to 42.6% from 42.9% in 1996.

The rate of increase in demand for oil in the C.I.S. and East Europe will depend on the ability of industry to arrest the oil production decline and sustain exports-an ability crucial to economic growth.

Over the forecast period, oil consumption will rise by nearly 9% through 1999 in the C.I.S. and East Europe. Oil's share of the market will move up to 23.9% from 23.2% in 1996.

Consumption of coal is expected to rise more slowly than that of other fuels in the region, moving up 3% by 1999. Coal's market share will dip to 26.2% from 26.7% in 1996.

Energy from nuclear power will move up 7% by 1999. Nuclear's share of the C.I.S.-East Europe energy market will move up to 5.2% from 5.1% in 1996. Energy from other fuels will move up 7% and account for 2.1% of the market.

The worldwide mix

Worldwide, the net result will be little change in the overall energy mix in the next 3 years.

Oil's market share will remain fairly constant as demand moves up at the same pace as overall energy consumption, increasing 7% by 1999. Oil will have 40% of the worldwide energy market in 1999, the same as this year.

Natural gas will capture additional market share, with 1999 consumption up 8% from the 1996 level. The market share will increase to 23.2% from 23% in 1996. The combined market share of oil and natural gas will rise to 63.3% in 1999 from 63.1% this year.

Worldwide coal consumption will increase 7% through 1999, primarily because of economic expansion in China, where coal is the dominant energy source. Coal's share of the market will slip to 27% in 1999 from 27.1% this year.

Expansion plans in the C.I.S. and Far East will boost nuclear output by 5% in the forecast period. But the growth will be slower than overall energy growth, and market share will fall to 7.1% from 7.2% in 1996.

Energy from all other energy sources is expected to grow by 10% over the forecast period due to hydroelectric power recovery in the U.S. and expansion in China and elsewhere. The world market share for this category will increase to 2.7% from 2.6% in 1996.

Petroleum demand

Demand for oil will keep pace with overall energy but lag the growth rate of economic activity.

Worldwide consumption of petroleum thus will move up 7% through 1999 to an estimated 74.2 million b/d. Of the 4.8 million b/d gain, 2.7 million b/d will come in developing countries, where 1999 demand will average 24.6 million b/d.

In the OECD, demand will increase by 1.6 million b/d to 43.2 million b/d in 1999, despite efforts in many of the industrial countries to move away from oil as an energy source.

Many developing countries have limited energy options and remain dependent on oil as the lowest cost, most convenient energy source. Oil is particularly important in countries with little indigenous energy.

Petroleum consumption in the C.I.S. and East Europe is expected to reverse the recent trend and begin to increase during the next 3 years as economies of the region gain health. After 5 years of decline in the formerly Communist area, oil consumption is expected to rise this year.

In the C.I.S., oil demand will rise in step with economic growth in the early years of recovery. As modern equipment is installed, demand will begin to lag economic growth.

The decade's trends

In some areas, future consumption patterns will extend trends of the past decade.

The British Petroleum Statistical Review of World Energy shows that during 1984-94, the decline in petroleum consumption in the C.I.S. and East Europe offset gains in the OECD, making growth in the developing countries roughly equivalent to net demand growth worldwide.

Total OECD demand in 1994 was up 15% from the 1984 level, an increase of 5.285 million b/d. In the same period, demand in East Europe and the C.I.S. fell by 42%, or 4.245 million b/d. But for the developing countries, demand in 1994 was up 7.315 million b/d from the 1984 level, an increase of 57%.

The strongest developing-country growth occurred in Asia, where demand moved up 6.2 million b/d from 1984 to 1994, an increase of 63%. This includes China, where demand for oil rose by 75%, or 1.295 million b/d during the period.

In the Middle East, demand increased by 890,000 b/d between 1984 and 1994, a 31% gain. Demand in South and Central America moved up 860,000 b/d, or 28%. African demand was up 510,000 b/d-32%.

All products up

OGJ expects demand for all oil products to increase in the coming 3 years in the OECD and developing countries. Fastest percentage growth will be in demand for middle distillates and the miscellaneous category "all other products."

Middle distillate demand outside the C.I.S. and East Europe will rise 9.5% through 1999 to 25.1 million b/d, as transport requirements accelerate with economic development. In many developing countries highway truck transport is an essential element supporting economic growth and boosting diesel fuel demand.

Motor gasoline demand will increase 6% to 19 million b/d. The number of automobiles and miles driven worldwide will increase along with the improvement in living standards, but this will be partially offset by the increasing fuel efficiency of vehicles.

Fuel oil demand in the OECD and developing countries will increase only 1% to 10.9 million b/d in the coming 3 years. Fuel oil faces intense competition from natural gas and renewable fuels as countries toughen air quality standards and otherwise try to protect the environment. In many of the industrial countries, fuel oil will be replaced by other energy sources for electrical power production. This will be partially offset by demand in developing countries, where there are few energy alternatives and fuel oil is required for increased electrical generation.

Demand for "all other" petroleum products will increase 9% to 12.3 million b/d in 1999. This category includes petrochemical feedstocks, lubricants, and asphalts. Technology constantly develops new products derived from crude oil, which keeps this category growing in volume and importance.

Demand for petrochemical products is expected to grow at least as fast as OECD and developing country economies in the forecast period. The petrochemical share of the crude oil product yield thus will increase.

Oil supply

A major supply question for the next 3 years is how much crude oil will be needed from members of OPEC.

OPEC remains the supplier of last resort but recently has faced rising competition from nonmember producers. Despite slumping production in the U.S. and C.I.S. and increasing worldwide demand for crude, gains in output from other non-OPEC sources have constrained the call on OPEC crude.

Group production thus hasn't nearly kept pace with expansion of the market, which means members haven't been able to recover revenues lost to the price declines of the mid-1980s with increases in production volumes.

The C.I.S. production slump has been more than matched by the demand drop of the region and Eastern Europe. And other non-OPEC output, especially from the North Sea, has more than offset the U.S. declines.

During the next 3 years, however, demand will continue to grow, and non-OPEC production will not grow as rapidly as it has in recent years. With the gap between worldwide demand and non-OPEC output widening, the need for OPEC oil will increase.

OPEC production

After accounting for more than half of the world's production in the 1970s, OPEC output of crude oil and natural gas liquids represented only 30% of the global total in 1985-victim of the group's overly aggressive pricing, which discourged demand and stimulated production elsewhere.

The demand for OPEC oil fell from more than 31 million b/d in 1979 to 17 million b/d in 1985.

During 1986-94, OPEC liquids production and market share rebounded. Production averaged 27.3 million b/d in 1994-41% of total world output.

OPEC has held its group quota at 24.52 million b/d since October 1993 but recently has exceeded that level by about 1 million b/d. In addition, group members have been producing increasing volumes of condensate and NGLs, which are exempt from quota and now amount to about 2.5 million b/d.

Saudi Arabia, single most important OPEC producer, has kept output at about 8 million b/d since shortly after the Iraqi invasion of Kuwait in August 1990. Although it has raised capacity since then to 10 million b/d, the kingdom has not yielded to the temptation posed by recently rising crude prices to tap its capacity cushion.

The main questions for OPEC concern resumption of Iraqi exports, demand growth, and durability of the surge in non-OPEC flow.

Iraq and the United Nations have been negotiating a limited resumption of Iraqi oil exports. But resolve of Iraqi President Saddam Hussein to accept U.N. terms remains in question.

For the purposes of this forecast, OGJ assumes that the parties come to terms and that Iraqi oil will reenter the market during 1997, with volumes increasing steadily during the forecast period.

Non-OPEC production

One of the most dramatic trends in recent years has been the sharp drop in C.I.S. production.

C.I.S. production of crude oil and condensate peaked at 12.6 million b/d in 1987 and has been declining steadily since, averaging 7 million b/d last year. But the slide seems to be ending. C.I.S. production in the second half of 1995 was up marginally from the first half level.

In the U.S., total liquids output has mostly declined since the recent peak of 10.5 million b/d in 1985. Last year, it averaged 8.6 million b/d, of which 6.5 million b/d was crude and 1.8 million b/d was NGL. The other 300,000 b/d represented oxygenates blended with refinery streams and included in U.S. production totals.

Excluding the C.I.S. and U.S., non-OPEC production increased from 18 million b/d in 1985 to 24.9 million b/d in 1995. Countries raising output include Norway, Canada, Argentina, Colombia, Syria, Yemen, Angola, China, Malaysia, and Papua New Guinea.

The most dramatic increase was in Norway, where output moved up from 820,000 b/d in 1985 to 2.79 million b/d in 1995.

According to the International Energy Agency, total world supply moved up 1.5 million b/d last year from the year earlier. OPEC liquids production increased 450,000 b/d, while non-OPEC supply increased 1.06 million b/d.

Norway led the way with output rising 220,000 b/d. Colombia's flow increased by 130,000 b/d. And China's output increased 140,000 b/d. Other non-OPEC countries boosting output significantly in 1995 were Argentina, Canada, the U.K., Angola, Oman, India, Malaysia, and Viet Nam.

These increases in producing areas throughout the non-OPEC world have frustrated OPEC's attempt to capture share of a growing market and regain influence over the price of crude.

Reserves

Over the long run, additional demand for crude oil will have to be satisfied primarily by increased production from OPEC because that's where the reserves lie.

At the start of 1996 OPEC crude oil reserves totaled 778.2 billion bbl (OGJ, Dec. 25, 1995, p. 35). This was 77.2% of total world oil reserves. At the 1995 rate of production, the OPEC reserves total represents 84.4 years of supply. The non-OPEC reserves estimate of 229.3 billion bbl represents only 17.4 years of supply at the 1995 output level.

However, over the forecast period, non-OPEC reserves will still be able to yield production gains, largely as a function of investment in development projects.

If investment outside OPEC remains at recent levels, non-OPEC production will continue to compete strongly with OPEC crude for markets.

Future supply

Crude oil production capacity is expected to move up over the forecast period in both OPEC and non-OPEC countries.

Several OPEC countries have either boosted or have plans to boost capacity. In addition to Saudi Arabia, these countries include the United Arab Emirates, Iran, and Venezuela.

Relaxation of the embargo on Iraq will have the effect of further addition to OPEC capacity, possibly reaching 2.5 million b/d by 1999. Iraq is now producing about 700,000 b/d but has facilities and reserves to eventually flow more than 3 million b/d.

Outside of OPEC, production capacity in the next 3 years will continue to climb in the North Sea, where production gains have surprised many analysts and show no sign of slowing soon. And capacity will increase in Yemen, China, Colombia, Argentina, Brazil, Malaysia, Viet Nam, and to a lesser extent in many other countries. These increases will be partially offset by continued declines in the U.S. and minor decreases elsewhere.

With Iraq reentering the market, the capacity additions are expected to exceed the increase in demand during the forecast period, increasing the worldwide capacity surplus.

OGJ projects a 7.4% increase in worldwide liquids production capacity by 1999 to 80.3 million b/d. That's a 5.65 million b/d increase in capacity against an expected 4.82 million b/d increase in demand.

As a result, worldwide excess capacity will increase to an estimated 8.1 million b/d in 1999 from 7.3 million b/d in 1996.

In 1999 excess capacity will represent 9.8% of total capacity and 11% of demand. This is up from 9.5% of capacity and 10.5% of demand in 1996.

The capacity figures represent production capability under ideal conditions. Since excess capacity of an estimated 7% of total is needed to accommodate maintenance downtime and other contingencies, the projected surplus isn't extreme. It will nevertheless be sufficient to moderate prices over the forecast period.

OPEC, non-OPEC gains

In response to rising demand, non-OPEC and OPEC production both will increase through 1999, with OPEC claiming the larger share of the gain. Total world output will be up 4.79 million b/d from the 1996 level at 73.95 million b/d in 1999.

Non-OPEC production, including the C.I.S. and East Europe, is expected to move up by 1.2 million b/d from this year's level to 42.61 million b/d in 1999.

The increase is constrained by the production problems of the C.I.S. and East Europe. Output in those areas will move up slowly, increasing 2% over the forecast period to 7.7 million b/d in 1999. This will boost flow at the end of the forecast period in the C.I.S. and East Europe to 150,000 b/d above the 1996 level.

Production from other non-OPEC countries will move up by 1.05 million b/d in the forecast period to 34.91 million b/d.

OPEC output in 1999 will be up 13% from the 1996 level at 31.34 million b/d.

An open question is how the exporters' group will finance all the necessary expansions in production capacity. Social programs and infrastructure investments begun in the era of rising crude prices now drain producing nation cash flows pinched by the stagnant prices of recent years. Increasingly, OPEC members have had to look outside their borders for capital.

Some of them, however, continue to resist direct involvement of outside companies. And some have trouble borrowing from international lenders due to political instability or poor credit ratings.

The organization has appealed for international cooperation to guarantee markets for crude and investment sufficient to ensure steady development of OPEC reserves. But it has met with little success.

As demand for OPEC oil rises, members with comparatively low reserves and intense cash needs will be tempted to manipulate supply in order to raise prices. But the move would revive perils that have hurt OPEC in the past.

Contrived price increases discourage demand and encourage consuming nations to take retaliatory market or political measures. And in recent years, price increases have mainly benefited non-OPEC producers, increasing the competition OPEC faces for markets.

Drilling activity

Worldwide drilling will increase during the forecast period as exploration and production spending rises in response to modest oil price gains and further reductions in operating costs.

The number of active rigs outside the U.S. and Canada will increase from 758 in 1995 to about 820 in 1999.

The U.S. active rig count will also move up over the next 3 years; however, the increased activity will be spurred mainly by increased interest in natural gas. The U.S. active rig count will move up to 850 in 1999 from an average 750 in 1995.

Drilling has revived in Canada, where the average active rig count jumped from only 97 in 1992 to 262 in 1994 before settling to 229 in 1995. The Canadian count is expected to average 230 active rigs through 1999.

The increase in activity will not reflect the total increase in investment since growing shares of upstream investments are dedicated to nondrilling activities, such as sophisticated geological and geophysical analysis.

Stocks

Over the past few years companies have tended to hold diminishing levels of stocks relative to demand. Trying to suppress costs and keep operations lean, they have kept inventories of crude and products at close to minimum operating levels. They thus have been reluctant to incur carrying costs necessary to hold contingency inventories.

Worldwide, the only reliable aggregate inventory statistics are for the OECD countries. But tendencies reflected in those numbers probably represent worldwide trends.

According to IEA, total OECD stocks rose from 3.57 billion bbl at the end of 1992 to 3.6 billion bbl at the end of 1995. The stock level at end 1992 represented 90 days of consumption at levels of the day, while the stock level at end 1995 covered only 86 days of demand.

Over this period, government-controlled stocks increased from 1.071 billion bbl to 1.141 billion bbl. In terms of days of forward demand, government stocks have remained at 27 days.

Company stocks moved up in 1993 and 1994 but slumped in 1995, totaling at yearend 2.5 billion bbl in 1992, 2.542 billion bbl in 1993, 2.589 billion bbl in 1994, and 2.459 billion bbl in 1995.

In terms of forward demand, company stocks fell from 63 days at end 1992 to 59 days at end 1995, one of the lowest levels on record. In the early 1980s, companies carried inventories covering 70 to 80 days of forward demand. Forward cover fell to 62 to 69 days after demand dived in the mid-1980s.

The ability of companies to reduce inventory cover reflects partly the improvements in operating efficiencies of recent year and partly the growing role governments have assumed in provision of contingency supply.

These trends cannot continue indefinitely. Companies cannot reduce inventories to less than minimum operating levels without risking costly interruptions to their operations, reduced sales, and loss of markets. And there are limits to how far governments will be willing to go in ensuring continuity of petroleum supply.

Refining

As demand for oil products plummeted in the 1980s, worldwide refining capacity fell from 78.5 million b/d in 1982 to 73 million b/d in 1985. With demand recovering, capacity then slowly rose to 75.6 million b/d in 1991.

Refining capacity fell again in 1992 to 74 million b/d due to a 2.2 million b/d reduction in the C.I.S. But rising product demand rekindled refining capacity growth in 1993 and 1994, when it totaled 75.5 million b/d after large additions in the Middle East and Asia.

The trends now are to rationalize capacity in mature markets and build it in growth markets and, to a lesser extent, sources of crude supply.

Generally, rationalization means bringing capacity in line with utilization rates. When those rates are low, unit costs are high at the plant level. Behind those trends are efforts refiners are pressing to replace old units with new equipment, which can reduce operating costs even if capacity doesn't change, and to match product output with demand patterns.

Regional trends

For the OECD and developing countries, the overall utilization rate of refining capacity was just 68.4% in 1983. For worldwide refining, including the C.I.S. and East Europe, the utilization rate was just 71.5%.

In 1994, the worldwide refining capacity utilization rate was 82.8%, despite the big capacity jump that year. For refineries of the OECD and developing countries, the 1994 capacity utilization rate reached 89.9%.

In the OECD, refining capacity dropped to 38 million b/d in 1989 but had climbed to 38.6 million b/d by 1994.

Total refining capacity in Western Europe fell from 18.1 million b/d in 1982 to 14 million b/d in 1989. Capacity in Canada and the U.S. fell from 19.1 million b/d in 1982 to 17.4 million b/d in 1989, then to 16.9 million b/d in 1994.

The developing countries, where economic growth has kept demand generally climbing, did not go through the same cycle. There, refining capacity in 1994 totaled 24 million b/d, up 27% from the level of 1985.

Capacity in the Middle East moved up 1.4 million b/d from its 1985 level to 5.3 million b/d in 1994. Asia Pacific capacity increased 2.8 million b/d to 15.4 million b/d in the same period. African refining capacity moved up 300,000 b/d to 2.9 million b/d in 1994. And capacity in South and Central America increased 455,000 b/d to 6.1 million b/d.

In the C.I.S. and East Europe, refining capacity in 1992 fell by 2.4 million b/d to 12.86 million b/d. The latest estimate has capacity at 12.85 million b/d for 1994. But the most recently available figures for demand and refining throughput imply a capacity utilization rate in 1994 of only 48%, which means further capacity reductions are in order unless demand rebounds strongly.

The outlook

OGJ projects growth in worldwide refining capacity during the forecast period. With utilization rates high overall, more capacity will be needed to meet expected increases in demand.

Growth, however, will be regional. Capacity declines are likely in the C.I.S. and East Europe and, probably, Western Europe, where a major rationalization has begun. Capacity growth in developing countries will more than offset these declines.

New refineries will appear in growth markets where costs of compliance with environmental regulations are not prohibitive.

OGJ predicts worldwide capacity will move up to 79 million b/d in 1999-a 2.35 million b/d increase from current levels.

Product demand and throughput will rise by even more, which means the worldwide utilization rate will increase. Throughput will be up 4.09 million b/d in the period. The utilization rate will grow from the current 84.2% to 86.9% in 1999.

Prices

Last year, world crude oil prices moved up after declining over the previous 2 years and most of the period since the end of the Persian Gulf crisis in 1990-91.

The world average export price of crude spurted to a monthly average of $33/bbl in October 1990 due to the conflict, its highest level since January 1983. That surge pushed the average for the year to $21.36/bbl.

But the market quickly corrected. Once the war ended in January 1991, prices fell and stabilized at a level higher than they had been before Iraq invaded Kuwait.

While supplies were adequate, due in great measure to production increases by Saudi Arabia and the U.A.E., large volumes of production capacity had been idled by war damage, in the case of Kuwait, and international embargo, in the case of Iraq. For all of 1991, world export crude oil prices averaged $17.80/bbl. The 1992 average was $17.95/bbl.

In 1993, with Kuwait having restored production to near prewar levels and production rising in the North Sea and other non-OPEC areas, the world export crude price averaged $15.81/bbl.

In 1994, the world export price averaged $15.28/bbl as demand gains lagged production increases from OPEC and non-OPEC sources.

Another year of demand growth, totaling 1.4 million b/d, pushed up prices in 1995 in spite of continued increases in non-OPEC crude output. The average price for world export crude oil jumped 9.8% to $16.78/bbl.

Strong demand, partly due to cold winter weather in the U.S., has kept prices up during the first part of this year. OGJ estimates the crude price will average $17.60/bbl for the year.

But rising demand will be partly offset by growth in worldwide capacity to produce crude. By yearend, capacity growth will outpace demand growth, which will weaken prices in the second half.

If, as assumed here, Iraqi oil reenters the export market, crude prices will weaken. The additional production and export capacity will more than offset demand gains, intensifying competition among suppliers.

Keys will be whether OPEC cuts quotas to accommodate the new supplies and the degree to which members comply. It is most likely that OPEC will make some effort to adjust, without signaling its intentions beforehand, and that the process will be muddlesome.

Anticipating a rocky adjustment and the need for crude suppliers to scramble for sales, OGJ predicts a drop in the average world crude export price in 1997 to $16.50/bbl.

With demand continuing to increase through the forecast period, however, prices will firm. The recovery will be moderated by production capacity gains not just in Iraq but in other OPEC members and non-OPEC producers as well. By the end of 1999, there will be 1.6 million b/d more excess production capacity than there is in 1996. Still, the average world export crude oil price is projected to increase to $17.50/bbl in 1998 and $18.50/bbl in 1999.

OGJ expects prices to rise in this crossfire of forces mainly because 1) so much of the additional supply must come from members of OPEC, the core policy of which still is to seek higher values for crude oil, and 2) inflation will boost costs of production in spite of the efficiencies generated by advancing technology.

But the moderate degree of price increase will help sustain demand growth, especially in developing countries and industrial countries with relatively low taxes, such as the U.S. and Canada.

In most other OECD countries, high consumption taxes on petroleum products insulate demand from the effects of price fluctuations. However, the rate of taxation varies by product, and reduced refining costs may provide room for lower prices and higher demand for some products.

The highest levies generally fall on motor gasoline and other transportation fuels. Where this is so, the main influence on demand is economic activity.

Recent IEA data on motor gasoline prices show differences by country last January: U.S. $1.12/gal, Canada $1.53/gal, Germany $3.88/gal, Spain $3.56/gal, U.K. $3.64/gal, France $4.62/gal, Italy $4.46/gal, and Japan $3.81/gal.

Excluding tax, the prices were much closer: the U.S. and Canada 73/gal, the U.K. and Germany 81/gal, Spain $1.06/gal, France 78/gal, Italy $1.08/gal, and Japan $1.76/gal.

Most fluctuation in product prices over the forecast period will be related to changes in taxes rather than changes in crude costs to refiners.