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21 Feb 2005
World economy: Our outlook for oil
COUNTRY BRIEFING
FROM THE ECONOMIST INTELLIGENCE UNIT
Global crude oil prices have remained strong in 2005, with Europe’s benchmark, dated Brent, averaging US$45/barrel since the beginning of the year. High prices reflect stronger-than-expected demand in both industrialised and emerging markets, plus an OPEC production cut of more than 700,000 barrels/day and minor supply disruptions in various non-OPEC countries.
Both the International Energy Agency (IEA) and OPEC analysts have made downward revisions to non-OPEC production in 2005, while at the same time raising forecast demand levels. This has resulted in a tightening of the projected global oil supply-demand balance for this year and an increase on the call on OPEC production. Furthermore, OPEC members have formally suspended the cartel's US$22-28/b price target and have tightened compliance to its 27m b/d production limit—suggesting that they now expect (and indeed are working towards) higher prices. We are therefore making a minor upward adjustment to our short term price projections for 2005 from a previous annual average of US$36/b to US$37.5/b.
Demand
On the oil demand side, we are currently forecasting global growth of 2.2% in 2005. Although this is a slowdown from the heady 3.4% growth achieved in 2004, it is still significant when compared with the average annual growth of 1.5% since 1990. Oil demand in 2005 will average 84m b/d compared with 83m b/d in 2004—almost 10m b/d higher than the ten-year average of 74.8m b/d. Demand proved to be remarkably inelastic to the surging oil prices of last year and there is little reason to believe 2005 should be any different. Demand from industrialised, or OECD, economies is set to grow by 0.7% as growth in North America (and to a lesser extent) Europe, is offset by declines in the Pacific. Non-OECD demand will rise by 6.3%.
Much of the upward revision in the IEA's global consumption number is due to a larger estimate for Chinese demand (based on a more robust outlook for their naphtha demand) which is expected to rise by 6.3%, against the 16% increase seen in 2004. We believe this to be too conservative, and expect growth of 7.2%—closer to its expected 2005 GDP growth rate of 9%. Oil consumption rose by a higher-than-expected 9.5% in the fourth quarter of 2005 and strong growth is anticipated for 2005. China is expected to build another large strategic oil reserve later this year, while rumours persist of on-going power shortages—implying that once again, diesel-fired generators could be needed to meet electricity needs, in turn requiring large fuel imports. (In January, 21 Chinese provincial power grids were forced to shut-down as a result of surging demand for electricity).
Furthermore, China’s three main drivers of oil consumption—energy, transport and petrochemicals—are all continuing to grow rapidly, implying continuing strong demand for oil. In anticipation, China's major oil companies have been busy securing longer-term energy supplies. Sinopec and PetroChina have been in talks with several investors in Canada's oil sands and are securing ties with various suppliers in the former Soviet Union for pipeline construction, possible acquisitions and oil supplies.
Supply
With oil demand expected to remain healthy, the key factors underpinning our price outlook focus on how readily supply will be able to meet this increase, or if it will once again get "caught short", as it did in 2004. Our base case view is that suppliers will be better prepared this year to meet the projected increase in demand following a gradual rebuilding of both stocks and spare capacity. Global oil production is expected to rise by 3.2% (or 2.66m b/d) in 2005, to 85.6m b/d.
Output from non-OPEC suppliers will amount to just over 51m b/d of this growth, equivalent to a year-on-year increase of 2.1% (or 1m b/d more than in 2004). This represents a modest slowdown from the 2.3% growth seen in 2004, which is surprising given that prices are expected to remain high this year. There have been a number of downward revisions to non-OPEC production for 2005 that reflect declines in the North Sea, Australia and the non-OPEC Middle East (Oman, Yemen, Syria and Egypt). While these declines will be offset by growth in the former Soviet Union, Latin America and parts of Africa, substantial downward adjustments have been made here as well.
Russia, which has been the driver of non-OPEC supply growth in recent years (accounting for 75% of the growth last year), has been experiencing a sharp decline in growth rates in recent months. Year-on-year production growth peaked at 12% in summer 2003, easing down to 10% through spring 2004. But since December 2004, growth has slowed to around 6%. This trend reflects flat production from the main Yukos assets, the struggling transport and infrastructure, and the increasingly uncertain regulatory and fiscal environment (not least for foreign investors). The IEA has therefore revised Russian production for 2005, and now expects it to average 9.58m b/d, an increase of 3.8% from 2004 (compared with 8.7% growth in 2004). This slowdown in growth will be maintained into 2006, on the assumption that oil companies in Russia will curb investment until business concerns such as production taxes are clarified.
OPEC
The downward adjustment to non-OPEC production (coupled with the upward revision to demand) has led to prospects of a tighter global market and to an upward revision to the call on OPEC for 2005. However, according to OPEC, the oil market is currently facing global oversupply. With this in mind, January saw key OPEC members cut production, causing output in OPEC-10 (that is excluding Iraq) to fall by 610,000 b/d, to just over 27m b/d—the stated upper limit for OPEC production. Saudi Arabia cut output by 350,000 b/d to 9.1m b/d, Kuwait by 100,000 b/d to 2.3m b/d and the UAE by 90,000 b/d to 2.4m b/d. Smaller reductions were made by Iran, Qatar and Libya, while synthetic crude output rose in Venezuela. Output in Nigeria made a partial recovery from the December disruptions. In Iraq (where quotas do not apply), despite relatively successful elections in January, production fell again; our forecast is that output will remain stagnant at around the 2m b/d level in 2005, as Iraq struggles to overcome repeated disruptions to internal refinery operations, northern pipeline problems and loading delays at southern ports.
We believe that OPEC will by and large try to stick to a level just above its 27m b/d quota over the course of 2005. Its decision to rein in production in December 2004—at a time when its basket of crude prices had fallen to a "low" of US$40/b—and its subsequent decision in January to suspend its reference price target of US$22-28/b, suggests that the cartel is now targeting higher oil prices. The decline in the value of the dollar (which has shed more than 50% of its value against the euro since February 2002) is continuing to undermine oil revenue, adding further incentive to achieve higher prices. For Saudi Arabia in particular, higher oil prices have become a necessity in order to address domestic fiscal and social issues. According to OPEC members, the twin effects of adjusting the oil price for inflation and converting prices to euros cuts the OPEC Basket price to close to the old $22-28/b price band. We now believe OPEC will try to defend a floor of US$35/b. We do, however, include the possibility of quota indiscipline among OPEC members, and have factored in a gradual increase in OPEC production from the second half of 2005, which will help put some pressure on prices.
OPEC is concerned that stocks could rise too much in the second quarter, when seasonal demand falls. OCED commercial stocks are now at or above their five-year average, while the US's latest weekly stockpile data indicate that crude inventories are 8% higher than last year and gasoline supplies up 7%, at the highest level since 1999. As these stocks make their way to the market over the course of the year, we expect prices to ease from current highs, and by 2006 we expect an annual average price of $33.5/b for dated Brent. This is an upward revision from our previous forecasts and reflects the sharper and prolonged slowdown expected from Russian production, coupled with OPEC's new high-price strategy.
Medium term outlook and upside risks
In 2006-2009, prices will weaken as demand decelerates, while higher stock levels are rebuilt and investment is made towards expanding global spare capacity. The extreme conditions of 2004, when the major oil producers were caught with low spare capacity (leaving the world vulnerable to supply disruptions and contributing to increased volatility and high prices), should continue to ease as we move into the forecast period.
Prices will settle in the US$28-29/b range over the medium term.
We do, however, caution that there remain a number of significant upside risks to our base case price scenario. On the demand side, there is the possibility that global demand will rise faster than currently projected. This is certainly possible in China and other emerging non-OECD markets. China remains the wildcard in our demand outlook; its low per capita oil consumption and huge potential for further industrial growth could have major implications for oil demand growth.
On the supply side, we remain concerned that the world is short of good upstream opportunities and that not enough investment in long-term expansion is being made. Declines in mature producing regions, such as the North Sea, non-OPEC Middle East and Australia, are limiting the effect of large supply increases elsewhere. As Russian growth slows, gains from (often expensive) new deep-water and offshore projects will be crucial in keeping non-OPEC supply growth near the averages of the past few years. There is little evidence that the recent windfall revenues enjoyed by the major international oil companies are being ploughed back into further exploration and production spending, with most firms preferring instead to invest in share buy-backs and other schemes.
Cheap oil resources are increasingly concentrated in countries that are remote, extremely protective of their national bounty or hostile to foreign capital. This will have a negative effect on our projections for future growth of oil supplies as well as spare capacity. In a situation of slower non-OPEC supply growth and higher world demand, market power would rest largely with OPEC, which has yet to decide how fast to develop its resources.
Finally, there remains the ongoing risk of periodic price spikes in the event of supply outages—whether related to politics, as in Venezuela or Iraq, labour disputes, as in Norway and Nigeria, or adverse weather conditions, as in the Gulf of Mexico. We also include here the possibility of some military action against Iran (which has huge oil reserves, second to Saudi Arabia’s). The US government is likely to take an increasingly hard-line stance towards Iran as it continues ahead with its nuclear programme. While a full-scale invasion and occupation is unlikely, economic sanctions or bombing of selected targets in the country could seriously affect Iran’s oil exports. The loss of oil from any one of these producers would substantially reduce the world's cushion of spare capacity, creating another shortage of immediately available production. If this happens at a time when demand is rising strongly, prices could shift sharply higher.
Source: ViewsWire London
http://www.viewswire.com/index.asp?layout=display_article&doc_id=1478056747
