I am sorry to inflict upon you yet another energy story, but this one is pretty big:
It’s the first time that the International Energy Agency, the body created by Western countries after the first oil shock in the 70s to advise on energy and try to prevent such shocks from happening again, has accompanied its monthly report on the oil market with a stark warning that oil supplies may not be sufficient and changes in oil demand are required.
IEA says world must turn away from oil
(see more details below)
While it is always pleasant to be vindicated by such an august body, it would be nicer if we actually did something about it… I’ve been told that I preach to the choir here. So, choir, let’s make good use of this thread: what are the smartest way to conserve? Bring your own!
Oil demand has been growing at a record pace, and the IEA is finally coming to its senses:
The rapid rise in global oil demand should lead the industrialised world to promote alternatives to oil as well as energy conservation, the International Energy Agency said on Friday.
The warning, from the West’s energy policy adviser, signals a sharp turnaround by the IEA, which has previously tried to cool oil markets by blaming prices on speculators and short-term supply disruptions.
“The reality is that oil consumption has caught up with installed crude and refining capacity,” the Paris-based agency said.
(…)
The IEA’s warning comes at a time when prices are close to their record nominal levels, a signal that high prices are not denting consumption. Brent, Europe’s benchmark oil price, hit a record high of $54.30 a barrel this week. On Friday Brent was trading at $53.25 a barrel, up 59 cents on the day. US benchmark crude prices were 66 cents higher at $54.20.
In its March report, the IEA raised its 2005 global oil demand growth forecast by 290,000 barrels a day, to 1.81m b/d, because of higher demand in the US and China, the world’s two largest oil consumers. The higher forecast gave average daily consumption for 2005 of 84.3m b/d.
At the same time, the world’s spare refining capacity has shrunk as demand for oil products has grown faster than the addition of new capacity.
Oil companies’ failure to add new refining capacity to keep up with global demand for petroleum products is exacerbating already tight oil supply conditions and fuelling the rise in oil prices to nominal record highs.
Stricter environmental laws in the US, Europe, China and India are compounding the lack of excess refinery capacity as companies invest in new equipment to reduce sulphur content at the expense of adding new capacity.
Last year’s increase of 2.65m barrels a day in global oil demand overshadowed the modest rise of 700,000 b/d in global refining capacity in 2004. This led to refiners enjoying their best margins in decades as gasoline and heating oil prices reached record highs.
The International Energy Agency, the energy watchdog for industrialised countries, sees a repeat of the pattern this year with 2005 global oil demand increasing by 1.8m b/d, and refining capacity by 1m b/d. industry,” said Jeffrey Currie, managing director of global investment research at Goldman Sachs. European benchmark crude prices hit a record $54.30 a barrel on Thursday.
(…)
Goldman Sachs estimates a total of 2.575m b/d of refinery capacity added by the end of 2010, but global oil demand growth is expected to average about 1.5m b/d for the rest of the decade. [That means 5m b/d will be missing by then – Jérôme]
Most of the new refineries are to be built in Asia, particularly China, but no new ones are planned for the US and western Europe, which have built none for three decades. This has led the US to import an ever increasing volume of oil products, and may force Europe to become a net importer of oil products.
Sat Roopra, analyst at Wood Mackenzie, said the tightness in global refinery capacity followed a period of substantial surplus capacity following a massive expansion by Asian refiners during the mid-1990s. This turned to idle capacity following the region’s currency crisis in 1997-8.
Graham Sharp, head of energy trading at Trafigura, the commodities trading group, said the quick swing from massive surplus to thin spare capacity has caught off-guard most of the international oil companies that own a sizeable share of the world’s refining capacity.
Despite the attractive margins offered by the industry, listed oil companies are reluctant to spend billions of dollars on a new refinery at a time when investors are more concerned about their replacement of reserves.
“It takes a long time before investors see a return on a new refinery, so if one of the majors was to build a new refinery, it would not go down too well with investors,” Mr Sharp said.
You may wonder why the lack of refining capacity has an impact on oil prices. Quite simple: the refiners focus on the kinds of oil that they can process best and have the best margins on (usually, the lightest “sweetest” (i.e. with the least sulphur) grades). This increases the demand for that specific kind of oil. In the Western world, the refiners have to focus on the best quality oil in order to produce gasoline and other products that respect the stringent environmental standards in our countries, and that increases the demand for these specific light oils, which, as it were, ard those used to set the benchmark world prices. That also means that poorer quality oil – which is now significantly cheaper than the sweet kind – ends up in countries with less severe norms and is used in less optimal ways, contributing to air pollution and worse energy efficiency overall…
The other important element to note is that the oil majors are NOT INVESTING. They cannot find enough opportunities to invest in oil & gas exploration and production (“upstream”), and they are not yet keen to invest in the refinery sector (“downstream”) which has been until recently a major headache for them, with very thin margins, regular tightening of the environmental norms, and major security and NIMBY issues.
In the upstream sector, the oil majors are still using a value of 20-25$/bbl to assess whether an investment is worthwhile, and have stated that they have no intention of going any higher, with some good reasons, the main one being that host countries tend to tax any revenue beyond 25$/bl in the 90-100% range, and the oil countries thus see very little of the extra revenue. It will take a lot more time with high oil prices before oil countries accept to change this tax regime and share the booty, so to speak, with the foreign industrial investors.
So the current record profits from the oil industry are not invested to produce more, and not invested in any significant way in alternative energies (this requires a political decision, the oil companies won’t go beyond the few hundred millions of dollars they are putting there to keep abreast of things) – they are given back to shareholders – who do not do a better job of investing in alernative energies themselves… Don’t blame the oil companies – they are only a mirror of our societies (and we own them, after all).
To sum up:
– the current prices reflect the strong demand growth in a context where production capacity cannot follow
– such prices are not yet high enough to trigger changes in behavior (demande reduction)
– once prices reach the requisite heights, it will still take a few years for any investments to have a real effect on supply, if any. The impact on our economies will be real
– expect more instability in oil producing countries, as their populations demand a bigger portion of the huge windfall coming their way, get used to receiving these riches, and have little tolerance whenever oil price volatility makes it difficult for their governments to deliver the same consistently. Add in the disruptive effect of being courted diplomatically or otherwise by the US, China and other oil consumers – and getting caught in geopolitical games with high stakes.
– don’t expect your gasoline prices to go down
– don’t expect your politicians to tell you the truth and make you face the hard fact that major changes in our behavior are required, and that it would be better to anticipate such changes, for instance by levying a gas tax and using it to invest in alternative energies and, most of all, conservation.
So let’s hear your smart ideas.