Oil

Alan Copeland

In mid-June 2009, oil prices in West Texas Intermediate (WTI) terms, traded above US$70 a barrel, compared with US$135 a barrel a year earlier. Recently, oil prices traded as low as US$35 a barrel in February 2009, but have subsequently increased, being supported by lower OPEC production and expectations within financial and commodity markets that there may be a global economic recovery in late 2009 or early 2010. In addition, it is possible that the recent increase in prices has been supported by increased investment or speculative demand for commodities and the depreciation of the US dollar against other major currencies.

In the second half of 2009, the interplay of several factors could result in the oil price experiencing significant volatility. Global oil demand in the second half of 2009 is forecast to be significantly lower than the corresponding period in the past few years and OECD stocks are at their highest levels on record. This is expected to place downward pressure on prices. Conversely, the US dollar could continue to depreciate which would place upward pressure on oil prices, which are denominated in US dollars. On balance, oil prices in the second half of 2009 are expected to average around US$70 a barrel and average US$60 a barrel for 2009 as a whole.

In 2010, oil prices are forecast to average around US$70 a barrel, 17 per cent higher than in 2009, but similar to the level forecast for the second half of 2009.

Weak growth in global oil demand in 2010 and a supply overhang associated with high levels of OECD stocks are likely to continue to place downward pressure on oil prices. These factors may dissipate during 2010 as the global economic recovery gathers pace.

While oil prices are forecast to average around US$70 a barrel over the course of the second half of 2009 and 2010 as a whole, there could be significant volatility around this price. The volatility will reflect the interaction of downward pressure associated with economic fundamentals (weak demand and increased supply) and upward pressure from financial drivers such as increased investment demand for commodities, including oil.

OECD stocks at record levels

At the end of March 2009, OECD stocks were equivalent to 98 days of consumption, the highest level on record. Industry stocks were at 62 days of consumption, which is a 15 per cent increase from the corresponding period in 2008. The high levels of stocks in OECD economies should act as a buffer from unanticipated supply disruptions or spikes in demand.

Uncertainty around future OPEC production

Effective OPEC spare capacity, which excludes Iraq, Nigeria and Venezuela, was more than
5 million barrels a day in May, the highest level since August 2002. Since July 2008, spare capacity has increased by a factor of three and a half as OPEC reduced production in response to falling prices. OPEC has stated its intention to influence the world supply-demand balance, implying that official production quota increases will be in response to changes in demand and stocks. OPEC is unlikely to change production quotas in response to higher oil prices driven by investment or speculative demand. However, as prices increase, some OPEC members are likely to be tempted to exceed their production quotas, in turn increasing world supply. Over the short term, official OPEC production quotas may not change significantly. However, the extent to which quotas are adhered to by individual members may depend on the extent to which oil prices rise.

US dollar movements could affect oil prices

The recent devaluation of the US dollar against other major internationally traded currencies has supported higher prices for commodities such as crude oil.

Because the world oil price is denominated in US dollars, a depreciation of the US dollar against other international currencies will lead to a higher oil price denominated in US dollars, as a weaker US dollar will lead to an increase in purchasing power of other world currencies (assuming other factors remain unchanged). There is the potential that the US dollar could depreciate more significantly than currently assumed in the short term, which in turn would lead to higher oil prices.

Because the world oil price is denominated in US dollars, a depreciation of the US dollar against other international currencies will lead to a higher oil price denominated in US dollars, as a weaker US dollar will lead to an increase in purchasing power of other world currencies (assuming other factors remain unchanged). There is the potential that the US dollar could depreciate more significantly than currently assumed in the short term, which in turn would lead to higher oil prices.

Today’s reduced investment a medium-term issue

Historically, economic downturns have led to cuts in exploration and development budgets. There are already indications that the recent downturn in oil prices is flowing through to planned capital expenditure, particularly exploration and development expenditure.

For example, the Oil and Gas Journal’s recent annual upstream capital investment survey, found that exploration and development expenditure in the United States was expected to be 29 per cent less in 2009 than in 2008. Further evidence of reduced development expenditure can be found in the Baker Hughes worldwide drilling rig count. In April 2009, the Baker Hughes rig count fell below 2000 for the first time since May 2003. This compares with a rig count of 3500 in mid-2008.

The lower exploration and development expenditure is unlikely to have implications for oil production within the next 18 months given the current spare capacity. However, the slow down in investment could result in demand growth exceeding supply growth over the medium term, if the world economy recovers rapidly.

World oil consumption to grow in 2010

In 2009, world oil consumption is forecast to fall by 3 per cent to 83.4 million barrels a day. Non-OECD oil consumption in aggregate is forecast to remain at a similar level to 2008, while OECD consumption is forecast to fall by 5 per cent to 45.1 million barrels a day. World oil consumption in 2010 is forecast to increase by 1 per cent to 84.5 million barrels a day. An assumed modest recovery in world economic growth in 2010 is expected to limit any significant growth in world oil consumption, particularly in OECD economies.

Non-OECD economies to underpin world growth in 2010…

For the remainder of 2009 and 2010, growth in world oil consumption is expected to be centred on non-OECD economies, particularly China and countries in the Middle East.

In 2009, China’s oil consumption is forecast to increase by less than 1 per cent. The modest growth reflects reduced consumption in the first half of 2009 offset by increased consumption in the second half of the year. Falling oil demand was underpinned by lower consumption of naphtha and gasoil, two petroleum products predominantly used in industrial processes such as chemical and plastic manufacturing and electricity generation. With China’s economic activity assumed to pick-up in the second half of 2009, oil consumption is expected to increase, offsetting the decrease in the first half of 2009. For 2009 as a whole, China’s oil consumption is forecast to average 7.8 million barrels a day.

In 2010, economic growth in China is expected to gather pace, resulting in oil consumption increasing by 3 per cent to an average of 8 million barrels a day. A significant proportion of increased demand is expected to come from the transport sector, which could result in increased consumption of gasoline and diesel.

Oil consumption in the Middle East is forecast to average 7.2 million barrels a day in 2009 and then increase in 2010 by 4 per cent to 7.5 million barrels a day. Higher oil consumption is expected to be underpinned by the continued use of oil as an energy source for heavy industries such as chemical manufacture and mineral processing, and for electricity generation when gas shortages arise.

…as OECD demand continues to fall

OECD oil consumption is forecast to fall in 2009, reflecting the severe recession in most OECD economies. Oil consumption is forecast to increase modestly in 2010 to 45.3 million barrels a day as economic growth resumes at a modest rate in North America and Japan.

In North America, oil consumption in 2009 is forecast to decline by 3 per cent to 23.3 million barrels a day. In the first quarter of 2009, oil consumption in the United States fell by 5 per cent. However, during the second half of 2009, oil consumption is expected to increase, compared with the first half of the year, being underpinned by an improved economic performance. In addition, higher consumption is anticipated during the 2009 driving season (July to mid-September), reflecting lower gasoline prices. Despite stronger growth in the second half of the year, US oil consumption is forecast to average considerably lower in 2009 which reflects the effect of a severe recession on demand for aviation fuel, diesel and gasoline. In 2010, higher oil consumption in North America is expected to be supported by the resumption of economic growth.

The European Union’s oil consumption is forecast to decline by 4 per cent in 2009 to 13.8 million barrels a day. In the first quarter of 2009, oil consumption fell by around 3 per cent, which reflected lower demand for transport fuels. Partially offsetting this was strong demand for heating oil associated with below average winter temperatures. In the absence of support from heating oil demand, European oil consumption is expected to continue falling throughout 2009.

In 2010, weak economic activity throughout the European Union is expected to be the major influence on oil demand and hence growth is forecast to be relatively weak in 2010, at less than 1 per cent.

Japan’s oil demand in 2009 is forecast to fall by 15 per cent to around 4 million barrels a day. There are three factors underpinning lower oil consumption: a contraction of Japan’s economy is expected to result in lower demand for petroleum products such as gasoline, naphtha and gasoil; the restart of nuclear power generation capacity during the year will reduce the need for oil fired electricity generation; and, third, above average temperatures during the recent winter have reduced the demand for fuel oil and direct burning crude oil.

In 2010, oil consumption is forecast to grow moderately, reflecting modest economic growth and the assumption of average winter temperatures.

World production to fall…

In 2009, world oil production is forecast to decline by 4 per cent, as producers reduce output in response to falling world demand. Production is forecast to average around 83 million barrels a day, which is equivalent to the quantity produced in 2004. Oil production in 2010 is forecast to increase by 1 per cent to 84.5 million barrels a day as producers respond to increased demand and higher prices.

...as OPEC bears the brunt

OPEC is expected to account for the majority of falling production, reflecting decisions in late 2008 to cut production. The decisions were made in an effort to support falling prices. OPEC’s general adherence to these reduced quotas has resulted in its production falling by around 10 per cent year on year in the first quarter of 2009.

Saudi Arabia accounted for the largest fall in production, however almost all OPEC producers, bound by quotas (except for Iraq), produced less crude oil in the first quarter of 2009 compared with the corresponding period in 2008. This is significant because a number of OPEC producers have a history of not adhering to quota reductions.

While uncertainty surrounds its future production quotas, OPEC has the potential to significantly increase production during 2009 and 2010. In addition to high levels of spare capacity at existing fields, a number of new fields, particularly in Saudi Arabia, are scheduled to commence operation or increase production.

In Saudi Arabia, the Khursaniyah field could increase production to 500 000 barrels a day, while the Khurais development (capacity 1.2 million barrels a day), Nuayyim field (100 000 barrels a day) and Shaybah expansion (250 000 barrels a day) are scheduled to start production over the next 18 months.

In Iraq, production and exports continue at a strong rate. Since late 2007, oil production has averaged around 2.4 million barrels a day, compared with 1.8 and 1.9 million barrels a day in 2006 and 2005 respectively. There is the potential for Iraqi production to increase further in the second half of 2009 and for 2010. Recently, the Iraqi Government and Kurdistan Regional Government reached an agreement to allow crude oil from the Kurdish-controlled Tawke and Taq Taq fields to flow through the Kirkuk Ceyhan pipeline. This could enable exports at a rate of up to 250 000 barrels a day within the next 18 months.

Non-OPEC production flat

Non-OPEC production in 2009 and 2010 is expected to be similar to 2008, reflecting additional production from new fields being offset by production declines at mature fields.

In North America, higher oil production in the Gulf of Mexico is expected to offset falling production in Mexico. Increased oil production in the Gulf of Mexico, in the second half of 2009 and in 2010, will be supported by production from new fields such as Thunder Horse (capacity of 250 000 barrels a day) and Tahiti (125 000 barrels a day).

Mexico’s production is expected to be lower as a result of the natural decline in production from the Cantarell field, which is the world’s second largest producing field.

The United Kingdom and Norway’s oil production is also expected to continue falling. A number of field outages in the North Sea, planned and unplanned, in the first half of 2009 are expected to result in total 2009 production from the regions falling by 9 per cent to 3.6 million barrels a day. Reflecting natural field decline, production from the North Sea in 2010 is forecast to fall by a further 5 per cent to 3.5 million barrels a day.

Brazil is expected to be one of the fastest growing oil producers in 2009 and 2010. Production growth in 2009 will be underpinned by fields which started during 2008 and are ramping up to capacity during 2009. The start-up of new fields such as Jabuti (100 000 barrels a day) and Piranha in 2010 will support further crude oil production growth. In addition, first production from the Tupi field is due in early 2010 at a rate of around 30 000 barrels a day.

Australian production to fall

In 2008-09, Australia’s production of crude oil and condensate is estimated to increase by 6 per cent to 27 gigalitres. The increased production reflects the start-up of the Angel (capacity 50 000 barrels a day) and Vincent (50 000 barrels a day) fields and the ramp up of capacity at the Stybarrow field (80 000 barrels a day). A fire on the floating, production, storage and offtake vessel at the Vincent field in April halted production for much of the June quarter and limited further increases in crude oil production.

In 2009-10, Australia’s oil production is forecast to decline by around 4 per cent to around 26 gigalitres. The only significant addition to production is expected to come from the Pyrenees oil field, which is scheduled to start during the first quarter of 2010. Despite the Pyrenees field being large by Australian standards (peak production of 96 000 barrels a day), initial production is expected to be offset by natural decline from mature fields.

Reflecting increased production in 2008-09, Australia’s crude oil and condensate exports are estimated to increase by 3 per cent to 16.5 gigalitres. It is assumed a significant proportion of production from fields in the Bonaparte and Carnarvon Basins has been exported given their proximity to Asian refining markets. In 2009-10, Australia’s crude oil export volumes are forecast to decline by 4 per cent to 15.9 gigalitres, reflecting lower production. The value of crude oil and condensate exports in 2009-10 is forecast to increase by 2 per cent to $9.1 billion.

Oil outlook
		2008	2009	f	2010	f	% change
World
Production	mbd	86.5	83.4		84.5		1.3
Consumption	mbd	85.7	83.4		84.5		1.3
Trade weighted crude oil   price	US$/bbl	94.60	58.00		67.57		16.5
West Texas Intermediate crude   oil price	US$/bbl	98.62	60.75		70.93		16.8
		2007-08	2008-09	s	2009-10	f
Australia
Crude oil and condensate
Production	ML	25 537	26 977		26 020		– 3.5
Exports	ML	15 975	16 517		15 872		– 3.9
– value	A$m	10 484	8 970		9 121		1.7
Imports	ML	26 223	24 665		26 502		7.4
LPG
Production	ML	3 971	3 880		5 550		43.0
Exports	ML	2 589	2 523		3 218		27.5
– value	A$m	1 182	1 082		1 306		20.7