Korea Energy Economics Institute 2007 International Petroleum Workshop

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1 Korea Energy Economics Institute 2007 International Petroleum Workshop Lawrence Eagles Head, Market Analysis Oil Industry & Markets Division Seoul, 25 October 2007

2 Oil prices at record nominal highs close to record on inflation adjusted basis $/bbl 90 Benchmark Oil Prices Jan 07 Mar 07 May 07 Jul 07 Sep 07 NYMEX WTI Mth1 Dated Brent Dubai Mth1 But why? 2

3 No single cause of high prices Service sector Engineering Equipment Commodities Funds Product supply Demand growth Supply growth Investment costs Marginal cost of supply Crude prices Structure of demand growth Environmental regulations Geopolitics Upstream capacity 3 Crude grade availability OPEC policy Crude and product stocks Refining capacity

4 Recovering spare capacity from 2005 but prices continue to rise OPEC Effective Spare Capacity Iraq Ven/Nig/Ind mb/d Prices rise despite rising crude stocks and rising spare capacity kb/d 33,000 32,000 31,000 30,000 29,000 28,000 27,000 26,000 25, , Effective spare capacity (excl. Iraq/Venezuela/Nigeria/Indonesia) around 2.85 mb/d in May

5 Refining capacity constraints added to by environmental and blending restrictions Low-sulphur fuel requirements could cause refineries to shut down completely when units go off-line High ethanol RVP means gasoline blending requires lower volatility blending components Lower volumes in summer Multitude of fuel specs constrain trade 5 No surprise that easing of gasoline specs in the US following Hurricane Katrina resulted in a significant increase in domestic and imported gasoline supply

6 Cost inflation dampens investment impact (long-term futures prices remain above $60) Source: Resources to Reserve, IEA, Tight service sector causes further cost inflation - $35 to $55/barrel? Call option for speculators/opec? Marginal cost of non-opec production influential when OPEC producing flat out When spare capacity exists, price OPEC are willing to keep spare capacity off the market is the key

7 Forward demand cover falls below average days OECD Total Oil days Europe Jan Mar May Jul Sep Nov Jan Range year Average Jan Mar May Jul Sep Nov Jan Range year Average 2007 Source: IEA Oil Market Report OECD forward demand cover fell to 53.5 days in September, now below five-year average. European cover is particularly low, relative to historical levels. 7

8 $/bbl 2 Stock cover shows switch to tighter conditions OECD stock cover compared to average vs. Brent time spread Days OECD stock cover: Diff to Rlg 5yr Av (RHS) ICE Brent M2-M1

9 Medium-term demand growth still seen robust OECD vs. Non-OECD Cumulative Oil Demand Growth by Use mb/d OECD - Transportation OECD - Other Non-OECD - Transportation Non-OECD - Other (5) By 2012 demand set to grow +9.7 mb/d to 95.8 mb/d Though downside risk to robust GDP growth assumptions

10 Global demand growth, but significant regional variations OECD: demand sustained by North America 51% of regional and 30% of global demand 10 Non-OECD: Asia demand accounts for 45%, and the Middle East for 18%

11 Focus: China s petchem expansion kb/d China Asia/Pacific Naphtha: Cumulative Capacity Additions Other Countries China has ambitious plans to expand its petrochemical base and become a major global producer Naphtha demand is growing apace: +6.9% on average between 2007 and 2012, expected to reach 1.27 mb/d Already equivalent to 12% of total Chinese oil product demand; 13% by 2012

12 Focus: ME fuel oil thirst mb/d 1.8 Middle East: Fuel Oil Demand, Actual & F'Cast Facing power shortages and lacking enough natural gas to meet generation needs, the region is turning to fuel oil Economic advantages: Less urgent to upgrade refineries or process light crudes Heavy crudes can be easily converted into fuel oil Excess crude for direct burning can be exported However, risk of FO tightness in the medium-term and environmental consequences

13 Significant medium-term growth in OPEC crude capacity and NGLs kb/d 1,400 1,200 1, Annual Increments in OPEC Crude Capacity A lgeria Indo nesia Iran Kuwait Libya Nigeria Qatar Saudi A rabia UA E Venezuela A ngo la Iraq mb/d OPEC Gas Liquids Output Saudi Arabia 2007 Algeria UAE Qatar Others Nigeria Iran Angola, Saudi, UAE & Nigeria are key crude capacity contributors Assumes flat/declining capacity from Indonesia, Iran, Iraq & Venezuela Net +4 mb/d, reaching 38.4mb/d in % pa growth in off-quota condensate & NGL Saudi Arabia, Qatar & Iran are key Based on domestic gas utilisation & LNG These too are delay-prone But forecast just matches early-decade growth and implies steady gas-liquids ratio

14 Non-OPEC supplies also rise main growth in non-conventional mb/d 60 Non OPEC Supply Conventional crude Global Condensate Bitumen/Heavy Oil Biofuels, CTL etc Global NGL Refinery Process Gain Total non-opec liquids rise 2.6 mb/d by 2012, but restrained by higher costs & lack of access However, higher prices have boosted exploration

15 Non-OPEC net decline averages 4.6% pa a hugely important supply variable mb/d Net Decline Rate for OPEC & Non OPEC Supply OPEC Capacity -3.2% pa -4.6% pa Non-OPEC Supply Net Change Gross Additions Net Decline mb/d cumul Impact of Varying Net Decline on 2012 Non OPEC Supply 4.00% 3.00% 2.00% 5.00% 6.00% 7.00% Globally, 3 mb/d needs to be added to capacity just to keep production steady Sensitivity on non-opec side is the difference between an OPEC call of 31, 37 or 42 mb/d in 2012

16 Above-ground risks exceed below-ground risks currently Complex reservoirs Weather Rebel attacks Net impact is the same (lower output & higher costs) Reserve risk Accelerating decline BELOW- GROUND FORCE MAJEURE Industrial unrest Access restrictions Project complexity SECTOR MATURITY Slower capacity expansion HOST GOVERNMENT Fiscal changes Ageing infrastructure & outages Tight drilling & service capacity INDUSTRY CYCLE Labour, & raw material shortage Pipeline delays Environmental regulation but at least some above ground risks are reversible?

17 Biofuels marginal but significant addition mb/d 3.0 Biofuel Production & Capacity US Ethanol OECD EUR Ethanol Brazil Ethanol Asia Ethanol Other Ethanol OECD EUR Biodiesel Other Biodiesel Potential Capacity Global biofuel production doubles to 1.75 mb/d by 2012 Potential supply capacity even higher: 2.9 mb/d by 2012

18 Gasoline price (US $/gallon) Concerns over economic viability Profitable 2005 Ethanol Profitability /gln blending subsidy Corn (US $/bushel) Unprofitable 2007 The profitability line (net of subsidies) has been estimated to take into account the value of ethanol on an energy basis, a price premium for octane and oxygen and a price premium for the sale of co-products. c/gl CBOT Ethanol Crush Spread forward curve Forward curve from 24 Sept '07 0 Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 We maintain our cautious stance on medium-term production potential Price pressures on feedstocks (corn, sugar, soybeans, wheat, palm oil etc) Competition between first-generation biofuels and the food chain Second generation technologies look promising but depend on technological breakthroughs

19 Global refining industry -substantial growth Crude distillation capacity investment thousand barrels per day Europe FSU North America OECD Pacific 1307 Middle East China Asia Latin America Africa Middle East, China & Other Asia are 2/3 rds of the total increase OECD 1.8 mb/d, of which North America 1.3 mb./d 274kb/d linked to new upgrading units in Spain, Greece & Hungary

20 Strategic investment drives growth mb/d Crude Distillation Capacity Additions CDU capacity greater than demand growth OECD FSU CHINA A SIA M IDDLE EA ST ROW Growth is largely reliant on a few key countries Cost pressures continue to affect investment economics and timing Large proportion of projects vulnerable to margin cycle and future returns

21 Upgrading investment adds flexibility mb/d 2.0 Upgrading Capacity Additions Hydrocracking coking FCC RFCC Visbreaker Global refining system will benefit from addition of further upgrading capacity This will boost heavy sour crude processing ability Expansion focused on the addition of hydrocracking and coking capacity

22 Growth in global crude trade Net Export Growth for Key Trade Routes* (million barrels per day) +0.4 * Excludes Intra-Regional Trade OECD North America +0.6 OECD Europe China Other Asia

23 Global product balances more gasoline, less fuel oil 3000 Gasoline cumulative product balance 3000 Jet and Kerosene cumulative product balance Demand Supply Balance Demand Supply Balance 5000 Gasoil and diesel cumulative product balance kb/d 2000 Fuel oil cumulative product balance Demand Supply Balance Demand Supply Balance 23

24 Asia Pacific product balances more gasoline, less fuel oil 120 Gasoline cumulative product balance 70 Jet and Kerosene cumulative product balance Demand Supply Balance Demand Supply Balance Gasoil and diesel cumulative product balance Demand Supply Balance kb/d 50 Fuel oil cumulative product balance Demand Supply Balance 24

25 Balance tightens towards mb/ d Medium-Term Growth Balance 2.0 +/- 1% GDP Non-OPEC Growth (excl. Biofuels) OPEC NGLs Growth Wo rld Demand Gro wth Low Demand 2 Biofuels Growth OPEC Capacity Growth High Demand Adjusted call on OPEC/stock chg: +5 mb/d by 2012 OPEC spare capacity to fall from 2.5 ->1.5 mb/d

26 MENA share in world oil and gas reserves & production, 2004 Proven oil reserves Oil production Proven gas reserves Gas production 0% 20% 40% 60% 80% MENA share of global oil & gas reserves is much higher than its share of current production, suggesting strong potential for growth 26

27 Mt of CO2 Current path is not sustainable World energy-related CO 2 emissions OECD Transition economies Developing countries Global emissions grow 62% between now & 2030, with developing countries emissions overtaking OECD s in the 2020s 27

28 The future is not pre-determined Global CO 2 Emissions in the Reference & Alternative Scenarios Mt of CO % through End-use energy efficiency gains 40% through fuel switching, ren ewables and other technology improvements Reference Scenario Alternative Scenario Policies that governments are already considering but have not yet enacted would cut CO 2 emissions by 16% in

29 Energy Efficiency has a Key Role To Play and is Available In the Short Term Energy efficiency offers High-performance buildings substantial energy and greenhouse gas savings at low or negative cost Compact Fluorescent Lamps energy security and reliability benefits Least life-cycle cost appliances enhanced business competitiveness and social welfare LED traffic lights Labelling and certification A B C D E F G Super windows and daylighting Efficient information and communication technologies Reducing standby power consumption 29

30 Conclusions Oil prices are near record highs in real terms Upstream and downstream supply constraints Refining tightness could ease, but subject to cost considerations Modest build in OPEC spare capacity, but it is unlikely to last Demand seen robust, but downside risks prevail Long-term path is not sustainable A more sustainable energy future is possible with known technology. The costs are not out of reach But urgent action is needed: Overcome barriers for adoption of energy efficient technologies Enhance R&D Accelerate demonstration and deployment Provide clear and predictable incentives Collaboration between developed and developing countries essential 30

31 World Energy Outlook 2007 Detailed analysis of the energy and environmental prospects for China and India Assessment of the implications for global energy markets, climate, world economy and government policy Scenario approach: Reference Scenario Alternative Policy Scenario High Growth Scenario Development of detailed data-bases and models for China and India, including China coastal regions. Cooperation with China s NDRC, India s TERI, IMF, World Bank, Asian Development Bank, CIRED, etc.