OPEC threw down the gauntlet a week ago, as promised then by OPEC President Sheik Ahmed Fahd Al Ahmed Al Sabah, if prices remained high, the oil cartel would take some action. Even major producing nations such as Norway admit that only middle eastern sources have the ability to ramp up capacity in relatively (months) short time frames. If price stability, or indeed reduction, is the goal, the only meaningful action is of course to increase supply. The sixty-four thousand dollar question is, can they? And can they increase supply quickly enough to satisfy demand increases for this year and next?
Demand Growth
Source: EIA
Several factors are contributing to the expectation of continued high crude oil prices. First, worldwide petroleum demand growth is projected to remain robust during 2005 and 2006, although not as strong as in 2004, despite high projected oil prices. Worldwide oil demand is projected to grow at an annual average of 2.1 million barrels per day in 2005 and 2006, representing a 2.5-percent annual average growth rate compared with 3.2 percent growth in 2004. Chinese demand growth, which averaged about 1 million barrels per day in 2004, is projected to be slower but still robust at an annual average of 600,000 barrels per day in 2005 and 2006 (this is a slight downward revision from the previous Outlook). Second, expected growth in non-OPEC supplies is not expected to accommodate worldwide demand growth. Non-OPEC supply is projected to grow by an annual average of 0.8 million barrels per day during 2005 and 2006, below annual average growth in the 2002 through 2004 period. Third, worldwide spare crude oil production capacity has recently diminished; in practice, only Saudi Arabia has any available spare production capacity.
Three Countries, 40% of World Consumption
The US, China, and Japan are the top three consumers of oil, accounting for 40% of annual world oil consumption. Today lets look deeper at the demand picture in US and China, since Japan’s oil consumption has actually been decreasing in recent years.
U.S. petroleum demand growth in 2005 and 2006 is projected to average 300,000 barrels per day, or 1.5 percent, per year, down from the 480,000 barrels-per-day, or 2.4-percent, increases in 2004. In 2005 and 2006, annual motor gasoline demand growth is projected to average 145,000 barrels per day, or 1.6 percent, similar to that of last year. Jet fuel demand is expected to rise by an average of 2.8 percent per year, similar to the 2.5-percent growth in 2004, and distillate demand is projected to climb by an average of 1.9 percent, steady growth but well below the average rate of 3.3 percent recorded for 2004. (Source: Energy Information Agency)
One gets the sense that demand is higher than forcasts. Now mid-way through 2005, we can use data I extracted from EIA Weekly Petroleum Status Reports for 2005 (to date) to see if those projections mean anything:
Actual Demand Growth % by Fuel Type Week Ending Gasoline Distillate Fuels Jet Fuel 2005 Projection 1.6 1.9 2.8 January 7 1.8 4.5 2.0 January 14 1.7 0.6 1.9 January 21 1.3 -1.1 3.7 January 28 1.1 0.8 2.3 February 4 1.5 0.3 0.8 February 11 1.7 2.5 1.2 February 18 1.5 1.1 -0.7 February 25 1.5 -0.6 1.2 March 4 1.6 -0.3 2.9 March 11 2.0 0.6 6.8 March 18 2.0 3.2 10.8 March 25 2.0 4.6 10.8 April 1 1.9 4.6 9.4 April 8 1.4 3.8 4.2 April 15 1.2 3.0 4.3 April 22 1.5 2.1 1.2 April 29 0.9 2.2 2.5 May 6 0.9 1.4 5.0 May 13 0.9 2.7 1.7 May 20 0.9 3.5 4.1 May 27 1.8 5.2 5.5 June 3 2.4 6.6 3.4 June 10 3.0 6.5 4.6 June 17 2.5 6.9 3.4 Avg to date 1.625 2.695 3.875
Based on actual monthly demand to date in 2005, and trends to date, demand growth in jet fuel and distillates are likely to substantially exceed Department of Energy projections. Current delta over EIA projections, to date:
- Gasoline: 1.56% over projections
- Distillate Fuels: 41.89% over and trend is higher
- Jet Fuel: 38.39% over projections
Rough conclusion: US demand growth is ahead of projections, and likely closer to 500,000 bbl/day increase.
To give some additional perspective to these numbers, in an average month approximately 60% of total demand is for motor gasoline; 29% for distillates including diesel and heating oil; and 11% for jet fuel. Transportation accounts for the lions share of oil utilization in the US, but electrical energy and chemical production also figure prominently.
Growing A Dragon-Sized Appetite
Before launching into details on China’s changing demand picture, consider this slightly off the wall thought: why would
CNOOC (China National Offshore Oil Corporation) make a bid for Unocal at this time, and for that matter, why would Chevron bid for Unocal, when crude (and energy company stocks) are trading near record prices? CNOOC made an all cash offer, Chevron’s bid is supported by CVX stock.
Two things spring to mind – testing the waters, or buying before valuations head even higher.
That China should want to invest in energy is a no brainer. It is already one of the largest foreign investors in the US via hundreds of billions invested in US government debt; why not test the waters for more controversial investment and see how US lawmakers react? It could prove very useful for China, which has a stated goal of doubling its GDP output by 2020, to learn whether free-traders or protectionists rule the roost in the United States.
The other premise builds on the first – if China is serious about doubling its GDP output by 2020 (simply requires an average 9% growth in GDP between now and then, and recent trends suggest it may be possible) Chinese planners must also know their energy consumption will increase on a similar parabolic curve well into the next decade. CNOOC is a state-owned entity, and as such, must have available to it the most reliable inside information on China’s growth forecasts. One would assume that if there were any significant slowing in growth to be expected out of China, they’d hang back and seek assets when decelerating growth sends the oil patch into a nose dive as such an event invariably would.
What’s known about China’s energy appetite today is startling. In 2004, Chinese oil consumption rose 15.8% year over year, and this is off a big base number as China is already the second largest single country consumer of oil on the planet, consuming 8.2% of annual world crude output. Only the US ranks higher, drinking up a 25% share of world output, but US demand growth in 2004 was a moderate 2.8%.
From May 6, 2005 China Daily:
The demand for energy has grown much faster than gross domestic product (GDP) in recent years. For example, in 2000, China’s power consumption grew 9.5 per cent, 1.5 percentage points faster than GDP. In 2001, 2002 and 2003, power consumption grew, respectively, 1.1, 3.3, and 7.2 percentage points faster than GDP.
That fast-economic growth has helped deplete already-strained supplies of power, coal and oil. Brownouts and blackouts have been common across China particularly in the economically advanced coastal regions in recent years.
Shortages of power, coal, oil and transportation last year created major bottlenecks in many sectors of the Chinese economy.
Massive power cuts have been in place, nationwide, for more than two years. In 2003, 19 provinces acknowledged they lacked sufficient supplies of power. Last year, the number rose to 24 provinces.
China’s power shortage reached 30 million kilowatts last year. The nation lost an estimated 0.5 percentage point of GDP growth due to its lack of power.
Meanwhile, Chinese residents have been using increasing amounts of energy. In 2002, residents consumed about 170.33 million tons of standard coal, which accounted for 10.4 per cent of the nation’s energy consumption.
More specifically, the percentage of oil used by residents grew from 2.4 per cent in 1990 to 6 per cent in 2002. Power consumed by residents accounted for 7.7 per cent of the total in 1990, and 12.3 per cent in 2002.
The stage is set. China, and other developing nations or so called “transitional economies”, needs more fuel for its economic growth engine. How much more oil?
Using statistics from British Petroleum’s 2005 Statistical Review of World Energy, I calculate the average (over a 10 year period) consumption growth for China (7.904%) and the US (1.484%), and extrapolating demand growth using these numbers, China will surpass the US as the worlds largest energy consumer by 2023.
This startling outcome seems unlikely as China’s GDP will still fall far behind the US at that stage. Yet Chinese demand growth doesn’t have to increase at such a rate to put a severe strain on world crude capacity. Even nominal energy consumption growth suggests that China and the US collectively each new year will require an additional 600 thousand to 1.2 million barrels per day.
Note we’ve only been talking about one rapidly developing economy – China. We’ve not said word one about India. And what of other nations, some of them net exporters now – what happens if Nigeria or Brazil decide that energy should be used to within their own borders to kick start economic growth? Already protectionist and nationalist drums are beating around the globe in Bolivia, discomfort grows with Venezuela, and Russia’s nationalization of former energy giant Yukos and other Russian energy concerns.
Where’s The Oil Going To Come From
We know today that the world is unable to quickly add the capacity increases we can easily forecast. To this point, Saudi Arabia and other middle eastern sources have been seen as the last great swing producers. Indeed, Saudi oil ministers continue to suggest that they will be able to meet any demand thrown at them, although just this month OPEC’s president repeated an assertion that OPEC cartel members are not blessed with additional significant capacity at this time.
Russia, whose annual crude output is currently second only to Saudi Arabia, has in the past been seen as a potential saviour in the short term. And then… Yukos became front page news. The defacto nationalization of Yukos oil assets, forced by a crushing back-tax bill, was a wake up call for foreign investors in Russia.
Uncertainty and lack of investment have Russian oil production in decline, off 11.1 percent in 2004. The remaining assets of Yukos figure prominently in current shortfalls, with the company struggling to output 400 thousand barrels per day, off sharply from 1.6 millions bbl/day as of the year prior.
OPEC to the Rescue?
Deciphering pronouncements and signals from OPEC has become a high-stakes game second only to understanding what Federal Reserve Chairman Alan Greenspan is uttering on any given day.
At their June 15 meeting, OPEC cartel members concluded that the market was already well supplied, but raised their production quotas by 500 thousand bbl/day to to 27.5 mb/d in an attempt to reduce market prices and volatility.
Crude traded higher almost directly following the announcement, closing at 55.57 that day. Seven trading sessions later, crude closed up more than 4 dollars per barrel at 59.85.
Anticipating this reaction, OPEC members:
authorized its President, after consultations with Heads of Delegation, to announce an additional 500,000 b/d increase in the ceiling, until its next Meeting, should oil prices remain at current levels or continue to rise further.
Accordingly, last week OPEC announced that consultations had been initiated. Reading between the lines, it would appear that OPEC is making a bet that oil traders will blink first:
KUWAIT CITY, 26 June 2005 ¿ OPEC¿s president said yesterday he had contacted the Saudi and Qatari oil ministers as part of consultations with the grouping¿s members to study measures to calm soaring oil prices. Kuwaiti Oil Minister Sheikh Ahmad Al-Fahd Al-Sabah told reporters he had started contacts on Friday with his Saudi and Qatari counterparts, Ali Al-Naimi and Abdullah ibn Hamad Al-Attiyah. ¿On Friday, I contacted Attiyah and Naimi,¿ said Sabah. ¿I think we have to wait for a while to see exactly what the behavior of the prices is.¿
On Saturday, Sabah, who did not wish to give a timeframe for the ongoing consultations, said ¿we have to consult everybody and to (monitor) exactly¿ the price fluctuations before taking the decision to raise output.
Sabah noted previous ¿up and down¿ movements in oil prices which had also approached the 60, but after that, it came back to the normal situation to $50–51 for Brent crude,¿ he said. (Arab News)
Also noted in other press reports, Shabah added “We’ve already started consultations but the prices now started to come back to normal and this is what we were thinking (would happen).”
It may be traders may decide to take on Shabah and OPEC and continue to press their case, since even a rate increase decision will not see new physical increases in deliveries for some time, and any actual increase (as opposed to quota increase rhetoric) will further take away from OPEC’s already tight spare capacity buffer. There is growing suspicion that Saudi Arabia has less ability to increase production than it claims. Earlier this month, Algerian Oil Minister Chakib Khelil suggested that OPEC was already running at full capacity, stating “We cannot produce more”.
Show me remains the plan, as the secretive Saudi kingdom has always played its cards close to the vest, and there are too many cross currents among OPEC members to get an accurate read on the picture.
If history is any guide, oil prices will keep on climbing. Back on September 15 2004, OPEC raised its production quota by 1 million barrels per day. Taken at their word, they increased supply. Crude should trade down on such news, but in fact traded higher for the following five weeks.
An excerpt from OPEC¿s liquidity trap
Sep 17th 2004, The EconomistIn Vienna, the oil companies pressed their suit with renewed urgency, arguing that OPEC members must let them in now if they are to meet the world’s much-expanded demand for oil in ten years’ time. OPEC ministers were unmoved.
This reluctance is partly explained by fear: members recall the lessons of the early 1980s, when overcapacity in the industry threw the cartel into disarray, and of the Asian financial crisis, when fear of a deep world recession prompted OPEC to pump too much oil.
The situation should improve this year and next. Two new oilfields in Saudi Arabia will be ready to pump 800,000 bpd by the end of September, according to the kingdom¿s oil minister. These new developments were commissioned to replace ageing facilities elsewhere, the retirement of which may now be postponed. Both Kuwait and Algeria will also inflate OPEC¿s supply cushion by the end of the year, according to their oil ministers.
But the new fields and wells touted on Wednesday will still fall short of what is needed to restore OPEC¿s power over the oil price. By its own calculations, it would now need more than 3m bpd of spare capacity to function as a genuine swing producer, able to hold the price down as well as push it up. Until then, the physical limits on OPEC¿s oil production will bite before the cartel¿s quotas do.
In Case of Supply Interruption, Break Glass
Its hard to know just how seriously to take the apparent fragility of the current supply/demand balance. In a timely report, we learn what professional worriers – former CIA Director Robert Gates among the group – think about the situation:
Simulated oil meltdown shows U.S. economy’s vulnerability
The economic effects of unrest in faraway Nigeria are immediate. Crude oil prices soar above 60 a barrel is a distant memory. A gallon of unleaded gas now costs 75 to fill a mid-sized SUV.“A million or a million and a half barrels of oil a day off the market is a very realistic kind of scenario. You can think of a dozen different countries around the world… where you can see that happening. Or even a natural disaster could do that,” [Former CIA Director] Gates said in an interview. Former CIA chief Woolsey described as “relatively mild” the scenarios that the National Commission on Energy Policy and the advocacy group Securing America’s Future Energy simulated. Both groups are pushing for reduced dependence on conventional oil.
Conclusions
There’s little new in this slew of information, yet I wanted to share some of what has been crossing my desk in case it is useful to you.
In the end a chart will tell us what to do and when to do it, but having an appreciation for the nature of risk here might help us be mentally ready and agile to take certain trades as the opportunities present themselves.
05.06.26 09:01 #