EAST ASIA NOW IMPORTANT FACTOR IN OIL WORLD

Hugh Norton BP Asia Pacific & Middle East Singapore On one level the countries of East Asia are vital components of the global energy equation and are directly affected by the common issues that face the entire world. But equally they are independent nation states with their own particular energy characteristics, making each country worthy of specific consideration. There is not necessarily a regional dimension to every energy issue facing the countries and one must be careful to avoid facile

Oct. 21, 1991

15 min read

Hugh Norton
BP Asia Pacific & Middle East
Singapore

On one level the countries of East Asia are vital components of the global energy equation and are directly affected by the common issues that face the entire world. But equally they are independent nation states with their own particular energy characteristics, making each country worthy of specific consideration.

There is not necessarily a regional dimension to every energy issue facing the countries and one must be careful to avoid facile generalizations about the region.

For the purpose of this article, East Asia will be defined as Japan, the newly industrialized economies of Hong Kong, Singapore, Taiwan, and South Korea; the "industrializing" economies of Malaysia, Thailand, Indonesia, and the Philippines, and the remainder, excluding the Indian subcontinent, but including China, Burma, and Viet Nam. Together these countries contain some one third of the world's population and produce around a fifth of the world gross domestic product (GDP). For the past 3 decades, they have made up the fastest growing economic region of the world.

However, East Asia cannot be considered in isolation from the Middle East. No examination of any energy topic can ignore the importance of that area.

IMPORTANT REGION

East Asia in particular represents a microcosm of the world as a whole, at least in energy terms. It includes one of the world's most significant industrialized nations and one of its most hungry energy consumers (Japan).

It is a region where there are energy resources to be developed-although East Asia is currently, in per capita terms, deficient in energy resources. While supporting a third of the world's population, East Asia contains only some 4% and 5% of world oil and gas reserves, respectively.

Also, it is a region which has yet to confront challenges-particularly, environmental challenges-that are already prevalent in Europe and the United States, and which are set to become more important both for the West and for East Asia itself. Here, I am thinking specifically of the need to demonstrate how economic growth, and the consumption of energy associated with it, can exist happily alongside policies that are designed to protect and improve the environment.

Such policy questions as, for example, whether and how rapidly to encourage exploration and production; whether or not to restrain consumption; whether the current energy "mix" is correct or out of balance; whether refinery capacity is too great or too small.

In short, they are the questions expected to dominate oil and gas discussions throughout the world over the next decade and that arise with equal relevance (and perhaps greater urgency) within the regions known as Asia Pacific and the Middle East.

How the countries of the region respond to these questions is of global significance. Potentially, East Asia-as the fastest growing region of the world-has for many years held out greater prospects for expansion than the relatively stagnant economies of the West. It would be incorrect to assume that East Asia's economic growth will continue unabated, come what may. But equally, it is hard to contradict the assertion that East Asia is firmly on course to becoming one of the most important and exciting areas in the world to do business.

This is underlined in the energy sphere. Already, oil consumption in the broader Asia Pacific area exceeds that of Western Europe, and on current trends the gap will widen.

Obviously, the presence of Japan within the region is a major factor in this development.

East Asia is now a major player on the energy scene. Its decisions and choices affect the decisions and choices of everyone else. Major policy decisions by the East Asian private sector, state energy companies, or governments could affect the options open to the rest of the world. The energy issues facing East Asia are not parochial.

If this fact is combined with the crucial importance of Saudi Arabia, and the decisions of Organization of Petroleum Exporting Countries (OPEC) as a whole, then an article centered on East Asia and the Middle East is in fact centered upon many of the energy drama's key characters. As consumers, the U.S. and Western Europe remain at the heart of the drama. While they will continue to influence it strongly, many of the levers of power are also to be found in the region under discussion.

This is why the oil and gas industries are devoting more intense attention towards the region than ever before when formulating their plans and priorities. The emergence of an East Asian oil "major" over the next decade or two is not beyond the realm of possibility.

THE SUPPLY PICTURE

Although East Asia is, in per capita terms, short of oil and gas resources, the region is relatively underexplored. When yet-to-find potential is considered, its share of world oil and gas approaches double digit figures.

Taking Asia Pacific as a whole, Australia, New Zealand, Indonesia, Malaysia, Thailand, and the Philippines have for many years been established centers for upstream investment. In these countries, there have been no outright access restrictions. A number of other countries, for example, Burma, Mongolia, Kampuchea, South Korea, and Viet Nam, have become accessible to the international private sector. One potentially substantial prize which remains elusive is the onshore Tarim basin in China.

But by and large, the region as a whole is becoming a more welcoming place for investment, and presents some challenging opportunities.

Looking at the broader Asia Pacific region, it is estimated that there are some 30 billion bbl of oil yet to find (YTF); and about 17 billion bbl oil equivalent YTF gas. China, Indonesia, and Malaysia collectively contain over 90% of the region's oil and gas reserves and YTF hydrocarbons. Together with Brunei, these countries constitute the region's net oil exporters. Burma and Viet Nam are almost self-sufficient; the rest import almost 100% of their oil needs.

The major growth which is expected in gas markets, particularly in Thailand and Indonesia, is matched by major reserve potential. But as often with gas, it is not always plentiful where it is most needed. For example, Thailand may have to supplement its indigenous supply from Malaysia or Viet Nam. Indonesia's markets are distant from proven reserves-indeed, its main market (Java) will be in deficit. Nevertheless, the potential for gas is considerable.

The speed with which natural gas is developed to take a growing share of the market will depend, as elsewhere, on a mix of factors: the distance of reserves from the markets, the degree of deliberate encouragement of new domestic markets for pipeline gas, the degree and pace of environmental pressures on fuels preferences, and-in the case of LNG-the ability to control costs in immensely complex projects.

Looking at the total picture, many of the region's most prospective hydrocarbon provinces can be characterized as frontier areas such as offshore and northwest China, Viet Nam, Burma, and eastern Indonesia.

But, of course, the preeminence of the Middle East is unshakable in oil resource comparisons.

It must also always be remembered that OPEC has control of the lowest cost oil. This fact, together with its abundance, means that OPEC production capacity and capacity utilization remain-despite recent events-major determinants of the oil price.

THE DEMAND PICTURE

The reserves picture is therefore relatively straightforward compared to demand. And while the Middle East dominates supply patterns and trends, it is East Asia that does the same for consumption.

East Asia accounts for 17% of world primary energy demand, 5% of gas demand, and 14% of oil demand. There is no sign of this trend softening, and limited reserves makes the region a significant net importer of energy, almost all of it in the form of oil: 11 million b/d in 1990.

Japan is the world's second largest oil importer after the U.S. and the largest importer of LNG and coal. Incremental oil demand in East Asia between now and 2005 could well exceed that in the U.S. and Western Europe combined.

Japan and China currently dominate demand, accounting together for 80% of regional energy and 70% of oil demand.

But over time, the newly industrialized and Asean-4 countries (i.e., Malaysia, Thailand, Indonesia, and the Philippines) will diminish this supremacy because of the rapid demand growth they are expected to undergo. As with the U.S. and Europe, the more mature economies of the region, Japan, Singapore, and Hong Kong, will contain energy growth lower than corresponding growth in GDP.

For different reasons, the same is true of China. Here, energy demand growth is severely constrained by the availability of indigenous supplies.

But otherwise, Taiwan and Korea can expect energy demand and GDP growth to be roughly equivalent; and in Malaysia, Thailand, Indonesia, and the Philippines, energy growth is expected to exceed that of GDP.

SUPPLY/DEMAND BALANCE

There are some obvious conclusions to be drawn from the preceding material, as well as some more contentious ones. The obvious ones will be considered first.

The future energy situation in the Asia Pacific can be stated as follows: Energy demand is growing steadily and will continue to do so despite greater efforts directed at conservation. There are no grounds for assuming that energy supply can keep pace with this increase in demand. And hence, the region will become more and more a net importer of energy.

Western consumers will be looking to the Middle East, as well. An important question, therefore, is whether Middle East producers will be both able and willing to deliver.

The answer is that they should be able to, but only with help.

Many of OPEC's producing fields are now fully mature and clearly will start to decline at some point. However, production can be raised both through increased exploration and development expenditure, and by OPEC's willingness to accelerate the rate of depletion of its developed reserves; in other words, by developing additional production capacity and also by spending sustaining capital to maintain current production levels.

At today's oil price levels, this is a formidable investment challenge.

In the Middle East, we are talking in terms of around $100 billion, possibly more, over the next decade (although this figure is modest when compared with the expected oil revenues over the same period).

Nevertheless, while the oil price remains around its current level, the sums needed are unlikely to be met out of cash flows alone.

Neither is it just a question of funding. After more than a decade of low-intensity investments, OPEC's ability to increase production capacity is also likely to depend on the involvement of leading edge western technology and good management skills for increasingly complex projects.

There does not seem to be any reluctance on the part of OPEC producers to increase their capacity. Indeed, the feeling of interdependence between consumer and producer is stronger than for many years past. Not every OPEC country, however, is as well placed as others to attract the necessary capital and expertise.

OPEC's readiness to increase its capacity still begs the question of whether or not it is wise for consumers to increase their dependence upon a single group of countries for such a large proportion of their energy requirements.

The truth , however, is that they have little choice. There are many actions to be taken to diversify energy sources, but the preponderance of Middle East oil resources cannot be escaped. Policies will undoubtedly be directed, therefore, at identifying mutual benefits and seeking to capture them through long term understandings.

However, this is far from saying that countries within Asia Pacific are wasting their time by looking to both increase their own production capacity and to reduce their dependence upon oil. The contrary is true.

REFINING

Indonesia is a case in point. Its oil demand is growing by between 10 and 15% per year, and is expected to surpass 2 millon b/d by the year 2,000. Yet its production is set to peak at 1.6 million b/d in 1993.

When Indonesia's Director General of Oil & Gas, Mr. Suyitno Patmosukismo, spoke at a Pacific Conference in May, he highlighted Indonesia's policy response to this situation. It is Indonesia's intention to build more "export oriented refineries" with, by 1995, a total capacity of 500,000 b/d.

To do so requires project financing and nonrecourse financing arrangements, involving private sector participation. In effect, the cost of these projects will to a large extent be remunerated by the export and sale of petroleum products.

Indonesia, however, is not alone. The extent by which Asia Pacific is able to expand oil refining capacity is very uncertain-the availability of finance being one of many serious considerations. Nevertheless, one recent analysis has pointed to over 30 companies hoping to expand existing refinery facilities; and some 20 actually having plans to build new plants.

It is unlikely to make economic sense for every one of these projects to go ahead. The desire to reduce reliance on oil-product imports is understandable; but the experience of the industrialized nations of the West should be a warning against expanding capacity too far or too fast. It would make no sense to incur in East Asia, for example, the painful rationalizations that proved necessary in Western Europe in the early 1980s.

On the other hand, the case for refinery expansion is strengthened by the marketing logic in moving refining closer to the market in order to provide secure and competitive supplies and to maximize value of refinery output.

A future characteristic of the region is likely to be an increasing number of locational exchanges and asset swaps. From the industry's point of view, an integrated refining and marketing operation produces more secure and stable cash flows in an environment of price volatility and possible government controls of profits.

There is no doubt that additional capacity will be needed and will be forthcoming. The difficult questions are how much, where, in what configurations? In the current Asia Pacific environment, it may be in secondary and tertiary capacity, rather than in straight run distillation where the risk of overbuilding lies.

EXPLORATION

New oil and gas supplies won't be found unless new areas to explore are opened up, or oil companies are motivated to probe the more costly or technically complex possibilities in known provinces. The arguments for encouraging a vigorous exploration activity in this region remain as strong as ever.

Furthermore, the progressive opening up of the U.S.S.R. to foreign capital is bound to present an alternative outlet for discretionary investment by the international oil industry. This opportunity will be on a large scale. How rapidly the opportunity will present itself, and how attractive the prospects will be to the investor, are entirely uncertain today. What is sure is that new and large scale competition for upstream investment is on the way.

ENVIRONMENTAL ISSUES

Concern about the environmental impacts of the energy industries-whether on the daily life of neighboring communities or, on the grand scale, in global climatic effects-is no passing fashion. The necessity of choosing between competing fuels based on their environmental credentials is with us to stay. Such choices are also an expression of shared concern about man's affect on the world he and his children will have to live in. They deserve to be taken seriously. Taking them seriously means, among other things, that the science underlying environmental beliefs needs to be as totally sound and as comprehensive as our state of knowledge allows.

One of these beliefs is that gas is a more environmentally friendly fuel than oil. Whether or not the science behind that is in all respects sound, there seems little doubt that gas as a source of raw energy will become increasingly acceptable and, where economics permit, preferable to other fuels.

This, I would guess, can only be welcome to energy importing economies of the Asian region. We will see its effects not only in the increased appetite for imported LNG in the industrial economies of Northeast Asia, but in the rising emphasis on pipeline gas, which the different Asean members are investigating in several contexts.

Since the prospects for future gas discoveries in the region are as good as, or better than oil, here is another reason we can expect to see a vigorous gas, as well as oil, industry in Asia Pacific. But only, of course, so far as the laws of economics and the potentially very large cost of transport support its expansion. Oil, especially as a transport fuel, will continue to play a large and growing role in the energy consumption patterns of the entire region.

Oil and energy ministers in Asia Pacific rightly regard crude oil supply as a key element in their calculations, as this article reflects. But the sensible and economically efficient creation of the required new refining capacity also presents a formidable challenge. It is a challenge which should be addressed by policy-makers, indigenous corporations, and the international oil industry in collaboration, not piecemeal.

The task for the region is to respond in a way that will optimize its resources in terms of managerial-technical skills and timely response to opportunities.