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2006: Is It 1973 All Over Again?

Figure (1)

Growth in oil comsuption in five regions over nine-year periods prior to 1974 and 2004 (‘000 b/d).

By Robert Skinner

The following points are worth noting:

1. Leading up to 1974 World oil demand was growing at 6.6% or nearly four times the rate between 1995 and 2004; annual increments of oil demand averaged 2.7mn b/d (over 3mn b/d if the 800,000 b/d decline in 1974 is excluded). From 1995 to 2004, annual growth was 1.7% or 1.2mn b/d year, essentially equal to the average annual growth over the last 40 years. However, as with most ‘averages’, this conceals much important detail.

2. The OECD region (as defined today) accounted for 85% of the growth in oil demand of these five regions pre-1974, yet only 37% of the growth post 1995.

3. China added over three times as much oil demand in the recent period compared to the pre-1974 period (3.4mn b/d vs 1.06mn b/d) when Japan accounted for over 70% of the rest of Asia’s growth in demand.

4. What is now EU 25 accounted for a third of these five region’s growth in oil demand over the earlier period; it hardly counted (8% of the five) in the post-95 period (increasing consumption by only 6%).

5. North America remains a core oil demand region – unchanged in accounting for 32% of the growth in the five regions over both periods.

6. The Middle East has become an important oil consumer.

These observations help explain the past as well as enable us to perhaps draw some propositions for the future. First of all, considering the higher oil intensity of their economies, we see why in 1974 the OECD countries may have felt the need to come together as a group of consuming nations in the face of rapidly rising oil prices. It is obvious why the US led in that initiative (particularly to develop strategic reserves), why it continues to play a central role in the geopolitics affecting global oil and especially why the original OECD Europeans along with Japan were so keen to support the US in this project – a project that for many reasons sterilized for some time any prospect of improving mutual understanding and cooperation between consumers and producers. Finally, the fact that oil is today, superficially at least, stable or declining in share in Europe’s energy balance, while gas is increasing perhaps explains why Europe’s preoccupations with ‘security of supply’ tend to focus more on natural gas – particularly given recent actions by Russia in its dispute with Ukraine.

New Technologies

The question arises whether Arab countries now face the prospect, as they did after 1974, of rising Non-OPEC supply and falling world demand. First of all supply prospects differ today. In the late 1960s, the world oil industry had just been handed a whole new scientific framework for looking at the earth’s mineral and hydrocarbon resources – Plate Tectonics. This led to a series of exploration models. New technologies such as better seismic, offshore exploration and drilling technologies and electronic data management systems permitted the industry to conceive of and pursue a series of new exploration plays that, within a higher price environment, soon added several million b/d of new supply outside OPEC, and with a demand collapse, an equal amount of OPEC capacity was idled. Some of these geological concepts are about to soon feed through to the world’s supply/demand balance, but they are unlikely to have the same relative impact as did post 1974 plays, and their pursuit was not in any way prompted by the recent rise in prices.

Virtually all the non-OPEC countries that increased production post 1974 have either stable or declining production today:

- Mexico’s production increased from 0.5mn b/d to over 3.8mn b/d, but now faces major challenges to avert decline in output.

- Alaska reached nearly 2mn b/d; it is now at less than 0.9mn b/d and declining.

- The North Sea rose to over 6mn b/d in 1999 and is now declining rapidly, particularly on the UK side.

- Other countries such as China, Egypt and India whose production contributed to the growth in post-1974 Non-OPEC output are struggling to maintain production or are declining.

However, there are new suppliers today.

Russia, while not a new player per se, has more or less returned to production levels achieved prior to collapse of the Soviet Union. Indeed, had Russian output not recovered, it is likely oil prices would have risen before 2003 as output increases in the rest of Non-OPEC did not keep up to the growth in world demand.

New continental margin and ultra deep-water plays off West Africa, Brazil and the Gulf of Mexico are yielding new production but on a relative basis they are unlikely to have the same impact as the new supply in the earlier period.

The Caspian, considered to have high potential, is increasing production, but is not expected to exceed 3.5mn b/d and is significantly delayed compared to expectations.

Unconventional oil is the only source of new supply that will continue to increase.

While new plays and new sources are certainly contributing supply they are unlikely to do so at a pace to offset decline of conventional oil from mature fields, which is faster than it was in the 1970s, nor are they apt to represent a comparable share of total production.

Turning to demand, the underlying macroeconomic conditions are markedly different for the two periods. It usually takes a year to 18 months for a price shock to feed through into lower economic growth so it is still too early to tell at time of writing (early January, 2006). Certainly, another fundamental difference today is that China and India with surging demand do not in any way resemble the inflated, energy-intensive and energy-wasting OECD economies of the early seventies, poised to shed a great deal of energy fat, particularly oil in stationary uses.

Learning Curve

What is perhaps most important is the ‘learning curve’ of principal players in the world oil market. Industry, government, consumers and producers all ‘learned’ something through the 1970’s and early eighties period of higher prices. International oil companies, responsible for about 15% of world output, implicitly do not all believe that higher prices will endure. While their level of investment has certainly increased over 2000 levels, they prefer to return most of their incremental earnings to shareholders. In the seventies on the other hand virtually all consumers and producers believed that oil prices would continue to increase and they behaved accordingly.

The list of differences is long:

- 2bn more people.

- Higher incomes and lower oil intensities today;

- Expectations today that prices will not stay high versus almost universal expectations in the seventies that prices would continue to increase (the principle of contrariety of consensus must not be forgotten – if everyone believes prices will fall, they will not invest in new supply and consumers will continue to consume in the expectation that lower prices are around the corner: prices are maintained or increase as a consequence);

- The recent price increase has been relatively gradual over nearly three years versus a quadrupling of prices in less than six months in 1973-74;

- Today’s price increase occurred as OECD economic growth was rebounding post 9/11 and Asian growth recovering from the Asian Financial Crisis in 1997-98;

- Depreciation of the dollar muted the effects of the recent oil price increase in many countries;

- Record low interest rates, although more recently increased in the US, have increased spending;

- Demographics and job flexibility in the OECD region differ – today the ‘baby-boomers’ are beginning to retire and as a cohort have relatively low debt, whereas in the seventies they were taking on debt; today the aging population is apparently consuming and generating job creation (health care);

- Active trade unions successfully demanded wage increases in the seventies, whereas unions are virtually silent today;

- Industries most affected by energy prices readily restructure and/or migrate today compared with the seventies, and those that migrated 20 years ago are generally in countries with offsetting lower input costs (petrochemicals in the Middle East and labour in Asia);

- Government expenditures are increasing today as opposed to contracting in the seventies;

- Today, producing countries in particular are directly involved in and therefore more sophisticated in their understanding of markets and more importantly better positioned to influence the market ;

- The policy responses of consuming countries have so far been muted; there simply is less scope and desire to repeat the 1970s policy errors, such as price controls, that actually compounded the problem (although many poor countries have not passed through the recent increases);

- Consuming countries have strategic stocks and they coordinate with each other and with producing countries regarding their release – even if not used, knowledge of their existence and that they could be used sends an important signal to the market;

- Finally monetary policy in the face of the inflationary effects of higher energy prices resulting from oil price shocks has evolved over the years. Today there are more central banks that are more independent and they have ‘learned’ their way through the various price shocks and now take a more measured approach to oil price increases and their inflationary effects. A significant change occurred after 1980 when the US Central Bank turned to money supply rather than interest rates to fight inflation. The economic impacts of energy price changes since have been significantly muted (see for example, J D Hamilton, 2004, Oil Prices and Economic Downturns; John B Taylor, 2002 A Half Century of Changes in Monetary Policy). An exhaustive review of this much-analysed subject is beyond the scope of this paper but new research is needed.

The global economy has changed dramatically since the early seventies. Given that market participants have a new suite of risk management instruments to deal with price volatility, there may not be such a thing as ‘conventional wisdom’ especially if that ‘wisdom’ is grounded in the seventies; or if there is, it needs to ‘catch up’ with current developments.

While OECD regions are still important, especially North America, the new players that will most influence growth and in turn impact on oil and gas markets and therefore on the Arab countries are outside the OECD, changing the world’s geopolitical landscape for these commodities. Many of these players have relatively poor economic statistics, political regimes of doubtful stability and internal tensions that could lead to disruptions, thus uncertainty is more likely to increase rather than decrease.

Robert Skinner is former Director of the Oxford Institute for Energy Studies (OIES).Its views are not necessarily those of PETROLEUMWORLD.

Editor's Note: The preceding article was first publish by Middle East Economic Survey - MEES on its Vol. XLIX, No. 15, 10-April-2006, Issue. It is an extract from “World Energy Trends: Developments Since The Last Arab Energy Conference”, a paper presented by Dr Skinner to the 8th Arab Energy Conference in Amman on 14 May.

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Petroleumworld 07/30/05

Copyright ©2006 Robert Skinner. All Rights Reserved.

 

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