Oil & Gas Journal: Optimistic outlook for oil industry [PART 2]
Oil supply
On the supply side of the oil market equation, the key
question over the forecast period is the volume of oil
needed from OPEC. OPEC's ability to maintain
production at levels close to market requirements will
be a key to sustaining industry growth.
OPEC continues as the supplier of last resort and
continues to face stiff competition from other
producers. In recent years, growth in non-OPEC
production has helped to meet rising demand and
prevent OPEC from boosting market share. This has been
in spite of slumping oil production in the U.S. and
FSU.
The decline in FSU output has been matched by the drop
in demand in that region, and other non-OPEC output
gains have more than offset the decline in U.S.
production.
OPEC production has not kept pace with the market
expansion, and member countries have not been able to
recover revenues lost during periods of sharp price
decline that resulted from increased production
volumes.
But OPEC still has the ability to greatly influence
the market. OPEC overproduction in 1997 and 1998 led
to a supply glut and a sharp drop in prices, followed
by a curtailment of much industry investment. And in
1999, the willingness and ability of OPEC to set
quotas and curtail production balanced the market and
helped to boost prices and revive industry activity.
During the next 3 years, OGJ expects oil demand to
continue to grow, but non-OPEC output will not keep
pace. The widening gap between growing oil demand and
non-OPEC production growth will have to be filled with
OPEC oil.
OPEC production
OPEC output of crude oil and natural gas liquids
represented more than half of the world's production
in the 1970s, but this dropped to only 30% by 1985.
Overly aggressive pricing by the group discouraged
demand and stimulated production elsewhere. Demand for
OPEC oil fell from more than 31 million b/d in 1979 to
17 million b/d in 1985.
During 1988-98, OPEC's production and market share
have risen. OPEC's total liquids production averaged
21.43 million b/d in 1998 and climbed to 30.73 million
b/d in 1998. Its share of total world production was
33.9% in 1988 and 42% in 1998.
Rising OPEC output caused problems for the group and
the industry in 1997-98. OPEC boosted output as demand
growth stagnated due to the financial problems and
economic downturn in the developing countries of Asia
and Latin America. Higher OPEC and non-OPEC oil
production flooded the market with volumes far in
excess of demand, and prices plummeted.
In the face of the lowest oil prices in more than a
decade and falling oil revenues, the OPEC countries
enacted a new quota agreement. In March 1999, OPEC
members agreed to slash oil production to 22.972
million b/d. The quota excludes Iraq. According to OGJ
data, OPEC oil output at the time had averaged 27.772
million b/d-excluding Iraq, an average of 25.662
million b/d. Adherence to the new quota would reduce
world output by 2.7 million b/d.
The quota action by OPEC accompanied by restrained
production by a majority of members, coupled with some
resurgence in demand in the developing countries
tightened the market in the second quarter of 1999.
This put upward pressure on prices, and refiners
scrabbled to lock in supplies. As a result, crude oil
prices have risen to their highest level since the
Persian Gulf crisis in 1990-91.
Looking to the future, there are two potential problem
areas for OPEC. Iraq is not part of the quota
agreement and has plans to increase production as
rapidly as possible. Iraq has tremendous reserves
potential and may be able to boost output rapidly when
United Nations sanctions are lifted.
In addition, OPEC has a history of member countries
violating quota agreements. It is questionable whether
the current restraint will last over an extended
period. Higher prices will stimulate competition as
new non-- OPEC supplies are developed. OPEC will then
see some of its market share erode. This is a cycle
that OPEC has had to contend with over the past 2
decades.
Non-OPEC production
Over the past decade, crude oil and condensate output
has fallen dramatically in two of the world's largest
producing areas, the FSU and US. FSU output peaked in
1988 at 12.6 million b/d and has fallen steadily since
then. Total FSU liquids output averaged 7.36 million
b/d in 1998. U.S. total liquids production averaged
9.765 million b/d in 1998 and fell to 7.995 million
b/d in 1998. Together, output from these two non-OPEC
areas fell by 7 million b/d over the past decade.
This drop has been more than made up by production
gains in other non-- OPEC areas, which increased by
7.5 million b/d from 1988 to 1998. Non-- OPEC liquids
production, excluding the FSU and US, increased from
19.485 million b/d in 1988 to 27.02 million b/d in
1998. Total non-OPEC output averaged 41.845 million
b/d in 1988 and 42.375 million b/d in 1998.
There were significant increases in North Sea
production, which helped to fill the gap left by
falling US and FSU output. The most dramatic increase
was in Norway, where production moved up from 1.195
million b/d in 1998 to 3.215 million b/d in 1998. UK
production increased from 2.29 million b/d in 1988 to
2.8 million b/d in 1998. There were also significant
increases in other non-OPEC countries: Canada, 670,000
b/d; Mexico, 625,000 b/d; Argentina 410,00 b/d;
Brazil, 415,000 b/d; Colombia, 385,000 b/d; Angola,
310,000 b/d; China, 465,000 b/d; and Malaysia, 185,000
b/d. And there were significant but smaller increases
in many other countries.
These increases in producing areas throughout the
non-OPEC world have frustrated past OPEC attempts to
capture a growing share of the world market and regain
influence over oil prices. Higher prices will
stimulate exploration and production throughout the
world. This may again be a problem for OPEC.
Reserves
Over the longer term, additional demand for crude oil
will have to be satisfied primarily by increased
production from OPEC countries, because that is where
the vast majority of the world's oil reserves lie.
At the start of 1999, OPEC crude oil reserves totaled
800.5 billion bbl (OGJ, Dec. 28,1998, p. 38). This was
77.4% of total world oil reserves. World reserves
totaled 1.0347 trillion bbl.
At the 1998 rate of production, total OPEC reserves
represent 79 years of supply.
Non-OPEC reserves at the start of 1999 were 234.2
billion bbl. At the 1998 rate of production, non-OPEC
reserves represent only 16.6 years of supply.
Estimates of proven reserves are sensitive to both
economics and new technology. Higher prices tend to
increase the volume of reserves that can be exploited
profitably. And new technology increases the
percentage of recoverable reserves in place.
Therefore, it is anticipated that that the reserves in
the non-OPEC areas will be able to yield production
gains over the forecast period. At more attractive
price levels, investment in the development of
non-OPEC reserves will increase. It is expected that,
over the forecast period, prices will be high enough
to stimulate investment in these areas, and non-OPEC
production will compete strongly with OPEC for crude
oil markets.
Future capacity
Crude oil production capacity is expected to increase
over the forecast period in both OPEC and non-OPEC
countries. A number of OPEC countries have the
reserves and plans to boost capacity when the market
warrants the action-among them Saudi Arabia, UAE,
Iran, and Venezuela.
Lifting the UN embargo that restrains Iraq output will
unleash development in that country. Iraq has huge oil
reserves and vast unexplored areas. It is expected
that output will increase rapidly in the future, with
production climbing to well over 3 million b/d, and
possibly much higher.
Outside of OPEC, production capacity will continue to
climb in a number of regions, including the North Sea,
Latin America, West Africa, and Southeast Asia. These
increases in non-OPEC output will be partially offset
by the continued decline in US production and minor
declines in other mature areas.
OGJ is projecting a 4.4% increase in worldwide liquids
capacity by 2002, to 85.2 million b/d. This will be an
increase of 3.6 million b/d. OPEC capacity will move
up another 6.2% to 37.7 million b/d, and non-OPEC
capacity will increase 3% to 47.5 million b/d.
The efforts by OPEC in 1999 to control output has
increased the excess worldwide shut-in capacity. OGJ
estimates that excess capacity amounted to 9.6 million
b / d in 1999. This is 11.8% of total worldwide
capacity and 13.3% of the demand for oil and NGL.
It is expected that demand will move up slightly
faster than capacity over the forecast period. This
will reduce the excess capacity worldwide to an
OGJ-estimated 8.25 million b/d in 2002. That will
represent 9.7% of total world capacity and 10.7% of
expected 2002 demand for petroleum.
The capacity figures represent production capability
under ideal conditions. Since excess capacity of an
estimated 6-7% is needed to accommodate maintenance
downtime and other contingencies, the estimated
surplus is not extreme. Any excess capacity tends to
moderate prices. However, the closing of the excess
capacity gap indicates that there will be a lessening
of potential downward pressure on prices over the
forecast period.
Future output
OGJ is projecting that both OPEC and non-OPEC
production will rise over the forecast period, in
response to rising world demand for petroleum
products, but OPEC output is expected to move up at a
faster pace. Total world production will rise 6.9%
over the forecast period to an average 76.95 million
b/d in 2002.
Non-OPEC output, including the FSU, is expected to
move up 1.95 million b/d from the 1999 level, to 44.25
million b/d in 2002. After a decade of decline, FSU
production is expected to climb modestly over the
forecast period. FSU output is projected to increase
by 350,000 b/d to 7.65 million b/d. There is
significantly more output potential in the FSU, but
organizational and political problems are expected to
restrain rapid growth.
Production from the other non-- OPEC countries will
move up by 1.6 million b/d to 36.6 million b/d in
2002. More countries are offering favorable terms and
encouraging development investment by major
international oil companies.
OPEC output will move up 10.1% over the forecast
period to 32.7 million b/d in 2002. This will increase
OPEC liquids output by 3 million b/d.
A continuing question is how the OPEC countries will
finance all of the expansion of production capacity.
Social programs and infrastructure investments begun
in the era of high crude oil prices now drain
producing-- nation- cash flow from oil operations.
Increasingly, OPEC members have to look outside their
borders for investment capital.
Some OPEC members 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 repeatedly appealed for international
cooperation to guarantee markets for crude oil and
investment sufficient to ensure steady development of
their reserves. This appeal has met with little
success.
This year, OPEC has successfully manipulated supply to
boost prices. But there are perils associated with
this strategy. Contrived price increases can
discourage future demand and encourage consuming
countries to take retaliatory market or political
measures. If prices move much higher, there will
undoubtedly be a political reaction from the major
consuming countries. And that may not be in the
long-term best interests of the OPEC countries.
Drilling activity
Worldwide drilling activity will increase during the
forecast period, as exploration and production
spending rises in response to higher oil prices.
The number of active drilling rigs outside of the U.S.
and Canada is projected to increase from an estimated
610 in 1999 to 770 in 2002.
The U.S. rig count will also move up over the next 3
years, but the increased activity will be spurred
mainly by natural gas drilling. The U.S. rig count
will move up from an estimated 610 active rigs in 1999
to 780 in 2002.
Drilling in Canada will also rise over the forecast
period. Active rig activity is expected to move up
from an estimated 260 in 1999 to 340 in 2002.
The increase in drilling activity will not reflect the
total increase in investment over the forecast period.
A growing share of upstream investment is dedicated to
non-drilling activities, such as sophisticated
geological and geophysical analysis.
Refining
As demand for oil products plummeted in the 1980s,
worldwide refining capacity fell from 78.5 million b/d
to 73 million b/d in 1985. As demand recovered in
subsequent years, refining capacity started to climb
once again. During 1988-98, worldwide capacity
increased 9.8% to 80.44 million b/d in 1998.
Efforts today are aimed at rationalizing capacity in
mature markets and adding capacity in growth markets.
Generally, rationalization means bringing capacity in
line with a profitable utilization rate. When
utilization rates are low, unit operating costs are
high and refining margins are reduced. Boosting the
utilization rate reduces costs and improves margins.
In addition, there are efforts by refiners to replace
old units with new equipment, reduce operating costs,
and improve yield patterns to match changing product
demand.
Shifts in capacity over the past decade changed from
region to region. The largest increase was in the
Asia-Pacific region, where capacity moved up 55.2% to
19.39 million b/d in 1998. Capacity in Central and
South America increased 11.8% to 6.465 million b/d in
1998. Middle East capacity increased 32.6% to 5.935
million b/d in 1998. Capacity in Africa moved up 15.3%
to 2.935 million b/d. Capacity in North America
increased 2.4% to 19.4 million b/d. Over the same
period, capacity in Europe slipped 2.6% to 16.305
million b/d. And FSU capacity fell 18.5% to 10.01
million b/d in 1998.
OGJ is projecting growth in worldwide refining
capacity during the forecast period. With the
utilization rates high in some regions, additional
capacity will be needed to meet the expected increases
in demand.
The growth will be regional, with the most significant
increases coming in the developing countries, where
demand growth is the strongest. New refineries will
appear in growth markets where costs of compliance
with environmental regulations are not prohibitive.
There will be incremental additions to existing
refineries in the U.S. as demand grows.
Some of the capacity growth worldwide will be offset
by declines where there is currently excess capacity.
This will occur in mature areas in Europe, where
significant demand increases are not expected, and in
the FSU, where capacity has not yet adjusted to the
lower demand.
OGJ projects that total worldwide refining capacity
will increase 3.3% over the forecast period to 83.7
million b/d in 2002.
Crude oil throughput will climb even faster in order
to meet rising demand for petroleum products. As a
result, the overall refinery utilization rate will
also climb, improving refinery operating margins.
Crude oil throughput at refineries is projected to
increase 6.3% to an average 72.7 million b / d in
2002. The worldwide refinery utilization rate will
move up from an estimated 84.4% in 1999 to 86.9% in
2002.
Prices
The economies of a number of rapidly developing
countries in Asia ran into financial problems, and
their economic output dipped sharply in 1997-98. That
resulted in a sudden slowing of the pace of growth in
world oil demand. Oil production capacity and output
during that period was based on expectations of much
higher demand. As a result, the market was flooded
with available crude oil, and that put severe downward
pressure on crude oil prices, which plummeted to their
lowest level since 1986.
The average price of world export crude oil fell from
$20.04/bbl in 1996 to $18.38/bbl in 1997 and then
plummeted in 1998 to $11.92/bbl. All of the other
price series followed this trend.
The price continued to slide in 1999, reaching an
average low of $9.47/bbl for the second week of
February and $9.87/bbl for the month. The OPEC
ministers met in March to set a new production quota
level that, together with similar production cuts by a
few key non-OPEC nations, they thought would help
tighten the market and boost prices.
There was an almost immediate price reaction to the
new quotas and the apparent adherence by member
countries. The average price of world export crude oil
started to climb and moved up to an average $14.90/bbl
for April. Prices climbed slowly at first, $15.27/bbl
for May and $15.45/bbl for June. But as demand
increased and refiners began to lock in crude supplies
for the coming winter, the pace of the increases
accelerated, and world export crude prices jumped to
an average $18.08/bbl in July and $19.88/bbl for
August. The price climbed to $21.73/bbl the second
week of September. This was up 129% from the low point
in February.
This higher price level is dependent upon tight supply
in the crude oil market and continuing strong demand.
It is doubtful that OPEC will be able to sustain this
tight production discipline for an extended period. In
addition, higher prices will help to stimulate
increased investment in non-OPEC production capacity
and output. Those two developments could put some
downward pressure on prices by next spring.
But over the forecast period, OGJ is projecting
conditions that appear favorable to support an
acceptable price level, consistent with increased
investment in new capacity. Demand growth is expected
to be strong. And although there will be additional
production capacity added over the forecast period, it
is not expected to keep pace with demand. That will
reduce the level of worldwide excess capacity and
reduce potential downward pressure on prices.
There may be some volatility in prices over the
forecast period, as OPEC struggles with a consistent
policy for handling excess capacity. However, the
success that the group had this year should make it
easier for members to adopt new quotas that adjust the
market balance whenever prices weaken.
[Author note]
Robert J. Beck Managing Editor-Economics and Special Projects
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