the world has been consuming oil faster than discovering it since 1986. (IHS Consulting)
[It is] "no longer tenable" to continue placing environmental issues, including climate change, "in a category separate from the economy and from economic policy" (Gordon Brown, UK Chancellor of the Exchequer – i.e. Finance Minister)
"The economy might be too strong in terms of demand growth. The question is whether the market is underestimating how much work the Federal Reserve is going to have to do" M. Mussa, IIE.
World’s growing energy thirst adds to problem caused by falling output
The Cantarell oilfield, in the shallow waters of the Campeche Bay, is regarded by Mexicans as their crown jewel. It is the second-largest oil field in the world by production,pumping 2.2m b/d, the same amount as all the Kuwaiti fields together. For that reason, Mexicans were recently dismayed when Petróleos Mexicanos, the state oil company, said that the field’s production would decline this year, signalling a trend towards its depletion. Cantarell’s difficulties are not unique.
Other mature oil provinces outside the Organisation of the Petroleum Exporting Countries, such as the North Sea or Alaska, are now suffering huge yearly declines, constraining the world’s supply of oil and helping to push up the prices.
Last year’s surge in oil prices was propelled by the biggest yearly increase in demand since 1976. But analysts say today’s high prices are the result of strong demand and a significant slowdown in oil supply growth from non-Opec countries. Barclays Capital estimates that non-Opec supply outside the former Soviet Union rose by 700,000 yearly between 1990 and 2000. But since then the growth had been roughly flat every year. T
his slower increase in non-Opec supply is boosting demand for the cartel’s oil, reducing Opec’s already low spare capacity. The market takes the reduction of this cushion against unexpected shocks as a bullish signal, sending the prices higher. "We got a lot of new capacity additions, but the problem is when you net those with the declines in mature regions, you got a flat line," said Paul Horsnell, of Barclays Capital. Among the new projects are several deep water platforms in Brazil, the BTC pipeline project in Azerbaijan, the Thunderhorse field in the Gulf of Mexico and the huge Kizomba field in Angola.
The International Energy Agency, the industrial countries energy watchdog, forecast non-Opec supply will growth this year by 900,000 b/d, but Russia and other former Soviet Union countries would account for about 60 per cent of the increase. Production in Europe, Asia and North America will decline, with significant increases only in West Africa, Brazil and Ecuador. Even non-Opec countries in the Middle East, such as Oman, Syria and Yemen, would see production declining by nearly 100,000 b/d.
At the same time, world oil demand would jump by 1.8m b/d, increasing the dependence on Opec oil for the third year in a row.
Analysts said the trend would continue because oil companies were not investing enough and also lacked the opportunity to drill in promising regions such as Mexico whose constitution barred foreign oil companies.
Lehman Brothers and Citigroup, the investment banks, forecast an increase in worldwide exploration budgets of less than 6 per cent for 2005, a significant slowdown from last year’s 12 per cent. "With increasingly depleted reserve bases, non-Opec declines are only expected to gather steam in the years to come," Washington-based PFC Energy said in a report.
IHS Energy, a leading consultancy advising oil majors on upstream operations, estimates that the world has been consuming oil faster than discovering it since 1986.
In addition, new discoveries are more expensive than in the early 1990s, as a large proportion of oil fields are found in deep waters, rather than onshore or the shallow continental shelf. In 2003, about 70 per cent of the largest oil discoveries were in deep waters, with a large proportion of that in waters more than 1,000 meters deep. A decade before, only 16 per cent were in deep waters.
With specific reference to non-Opec countries, the IEA has warned that "a rising share of production will have to come from smaller oilfields, where the unit costs are higher". For this reason, the marginal cost of production in mature basins in non-Opec countries is rising. "This may well deter investment and capacity additions in the long term," the IEA warned in its latest outlook for the oil market.
Central bankers are not worried yet:
Why the rise in oil prices does not yet threaten crisis
In contrast to the experience of the 1970s, the impact of $50 a barrel oil on global growth and inflation has been fairly limited. The rise in the oil price last year did damp growth but the expansion remains fairly healthy. While headline inflation rose last year, core inflationary pressures and, crucially, inflation expectations remain contained. Financial markets do not seem concerned that energy prices will spark higher inflation.
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According to a draft of the IMF’s forthcoming World Economic Outlook, the fund forecasts healthy world growth of about 4.3 per cent in 2005 and 2006. The slowdown from last year’s 5.1 per cent rate is explained partly by the impact of the oil price but also reflects a maturing of the global economic expansion. Separately, the IMF has "stress tested" its forecasts by assuming an oil price rise to $80 a barrel this year, falling to $50 in 2006 and then drifting to the $34 range in 2009. The conclusion is that even a rise to $80 would not be disastrous for global growth.
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This fairly sanguine IMF view of the impact on the world’s biggest economies rests on the assumption that central banks would act to prevent a rise in inflation expectations. Central bankers’ credibility was built up by the eventual defeat of the inflation unleashed in the 1970s and by the subsequent maintenance of low inflation.
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Public confidence that inflation is not about to take off makes the effects of oil price rises far less painful. While price rises have reduced profits for businesses and squeezed household budgets, there appears to have been little impact on inflation expectations and hence on wage demands. A desire to maintain hard-won credibility means that the Federal Reserve and the European Central Bank will watch closely for any rise in inflation expectations – not so much in the "headline" inflation numbers, which show the direct effect of oil price rises, but in the indirect "second-round" effects on prices and wages.
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Michael Mussa, a fellow at the Institute for International Economics in Washington, says it is still surprising that the high oil price had so little impact on growth last year. In the US, he says, the fact that long-term interest rates remained low – even as the Fed tightened monetary policy – continued to stimulate the housing market and consumer spending. "The main concern is not that the US slows down too much in 2005 but that it does not slow down enough, particularly domestic demand growth," Mr Mussa says.
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"The economy might be too strong in terms of demand growth. The question is whether the market is underestimating how much work the Federal Reserve is going to have to do," Mr Mussa says.
So expect more pressure on wages and posturing on the international stage to get OPEC to increase production, and then, as this is unsufficient, an abrupt increase in interest rates which will surprise the markets (thus causing them to fall) in addition to making debt a lot more expensive.
Meanwhile, some countries are reacting:
High oil price drives users to other fuels
As the US was putting pressure on Opec ministers to damp oil prices, other leading consumers of energy were yesterday talking about adjusting to a new reality of higher prices.
China, the world’s second largest consumer of oil after the US, yesterday said high oil prices and threats to the climate from fossil fuels were forcing it to become the world’s biggest producer of nuclear power.
Gordon Brown, UK finance minister, urged his counterparts from 20 developed and developing countries to incorporate environmental concerns into economic policymaking. "Higher energy prices are requiring industry and commerce to examine the cost and efficiency of energy use," Mr Brown told a London conference of finance, environment and energy ministers.
"In terms of policy, these challenges all point now in the same direction towards a reduction in the carbon intensity of energy production and greater efficiency in its use."
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Liu Jiang, vice chairman of the national development and reform commission of China, also urged western countries to give Chinese industry access to renewable energy technologies.
He said Beijing, as well as experimenting with advanced pebble-bed technology, hoped to "achieve self-reliance on nuclear power" by introducing advanced 1,000MW press-urised water reactor nuclear technology. "Nuclear power belongs to clean energy and nuclear power construction also serves the purpose of achieving a low-carbon economy," Mr Liu said.
He called on developed countries to manufacture renewable energy equipment – such as solar cells and wind turbines – in China.
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Mr Brown said that after "the twin objectives of high and stable levels of growth and employment", there was a "third objective on which our economies must be built, and that is environmental care".
He said it was "no longer tenable" to continue placing environmental issues, including climate change, "in a category separate from the economy and from economic policy".
"Across a range of environmental issues . . . it is clear now not just that economic activity is their cause, but that these problems in themselves threaten future economic activity and growth," he said. Mr Brown said measures to tackle climate change, such as energy efficiency and low-carbon technologies, could stimulate innovation and improve economic productivity, rather than imposing an economic cost.