prices to remain high
In the March quarter 2006 issue of Australian Commodities, ABARE cited a possible increase in geopolitical tension in Iran as a major upside risk to the short term price outlook. In the ensuing period, increased international tensions relating to Iran’s nuclear program have put significant upward pressure on world oil prices. Despite a marginal improvement in the balance between world oil consumption and production, crude oil prices have risen substantially in the past few months, as developments surrounding the nuclear issue in Iran have been increasingly factored into the price.
World oil prices were trading around US$63 a barrel in West Texas Intermediate terms in March 2006, largely unchanged from the average in February. Oil prices rose markedly during April, reaching a high of US$75 a barrel in late April, before easing to around US$71 a barrel in late May. In the first six months of 2006, WTI crude is estimated to average around US$66 a barrel.
Notwithstanding continued strong world economic growth (see ‘economic overview’), growth in oil consumption has eased in major oil importing countries. In the United States, the world’s largest consumer, oil consumption declined year on year by 1.4 per cent in the March quarter 2006, following a fall of 1.1 per cent in the December quarter 2005. Sharply higher oil prices are also having an impact on oil consumption in other OECD countries, including western Europe and Japan. In China, the world’s second largest consumer, oil consumption increased year on year by 2.4 per cent in the March quarter 2006. This compares with average growth of 2.5 per cent in 2005.
For the world as a whole, oil consumption rose year on year by 0.4 per cent in the March quarter 2006. This compares with an annual increase of 1.1 per cent in global oil production in the same quarter.
Looking forward, global oil prices are forecast to remain relatively high in the remainder of 2006 (averaging around US$69 a barrel in WTI terms for the year as a whole), before declining in 2007 to average around US$65 a barrel. The forecast of relatively high oil prices in the remainder of 2006 is underpinned by continued high consumption and only a modest increase in world oil production. The forecast easing in world oil prices forecast for 2007 is mainly the result of expected higher world oil production and a larger increase in spare production capacity. Reflecting an assumed easing of world economic growth, growth in oil demand is also forecast to moderate in 2007.
Looking beyond 2007, there is a distinct possibility that world oil prices could remain relatively high for a number of years. Because world oil production is not expected to increase rapidly, a sharp reduction in world oil prices appears unlikely when growth in demand is projected to remain relatively strong. Toward the end of the decade, world oil prices, in 2006 dollar terms, are projected to decline more quickly in response to higher global oil production and a substantial increase in oil stocks by that time.
If high and volatile oil prices continue beyond the next couple of years, it is likely that more resources will be devoted to research, development and production of fuels from sources other than crude oil (see the accompanying box). A combination of higher fuel prices and technological achievements will make the production of alternative fuels more economical over the medium to longer term. Increased availability and production of alternative fuels will have the effect of constraining upward pressure on world crude oil prices.
price volatility unlikely to ease
Over the past few years, world oil prices have become particularly sensitive to disruptions to production and unexpected increases in consumption. Disruptions to production can arise from strikes, geopolitical tensions and unfavorable seasonal conditions, such as hurricane activity in oil producing regions. Unexpected consumption increases are often associated with higher demand for heating and fuel oil in severe winter conditions and stronger demand for petrol in the driving season, especially in north America.
Oil price movements in the near term are likely to remain sensitive to geopolitical tensions in Iran. As the second largest producer in OPEC, with output of close to 4.0 million barrels a day, Iran accounts for around 13 per cent of total OPEC production. A significant reduction in oil exports from Iran, if it were to occur, would place substantial additional upward pressure on world oil prices.
Apart from the uncertainties associated with Iran, increased volatility in oil price movements reflects a significant reduction in spare production capacity around the world. This reduction has limited the scope of supply to respond quickly to unanticipated disruptions at a time of strong demand growth. Spare production capacity for OPEC as a whole has declined from 5.2 million barrels a day in 2002 to an estimated 2.8 million barrels a day in mid-2006.
In addition to this significant decline, there are also concerns that the spare capacity currently available in Indonesia, Iran, Nigeria and Venezuela cannot be used on a sustainable basis. Excluding these producers, the effective OPEC spare capacity is estimated to be only around 1.7 million barrels a day. The absence of a comfortable margin of oil production flexibility is a key reason behind recent high and volatile oil prices.
nonconventional liquid fuels
Higher prices for crude oil and refined petroleum products will lead to higher investment and production of nonconventional liquid fuels for transport markets. The term ‘nonconventional liquid fuels’ refers to three different product types — synthetic crude oil derived from the bitumen in oil sands, extra heavy oil and oil shales; synthetic fuels created from natural gas and coal; and renewable fuels (primarily ethanol and biodiesel) produced from a variety of renewable feedstocks. These resources become economically competitive when oil prices are sustained at relatively high levels.
synthetic crude oil
Over the past few years, two nonconventional oil resources — bitumen in oil sands and extra heavy crude oils — have been actively developed.
oil sands
The percentage of bitumen in oil sands ranges from 1 to 20 per cent. After the bitumen is extracted from the sand matrix, various processes, including coking, distillation, catalytic conversion and hydrotreating, can be applied to the bitumen to create a synthetic crude oil (commonly referred to as ‘syncrude’). On average, about 1.16 barrels of bitumen is required to produce 1 barrel of syncrude.
The world’s largest oil sands deposits are in Canada, accounting for around 80 per cent of the known reserves. Economically recoverable bitumen deposits in Canada are currently estimated to be around 315 billion barrels.
Generally, syncrude production from oil sands is economically viable when crude prices exceed US$30 a barrel (EIA 2006). The variable costs of producing syncrude from oil sands have declined from around US$22 a barrel in the 1980s to US$10 a barrel in the late 1990s and are currently estimated to be around US$5 a barrel. However, syncrude from oil sands tends to yield poor quality distillate and petroleum products because of its low hydrogen content. Refineries processing syncrude extracted from oil sands need more sophisticated conversion capacity (and hence higher capital costs) to create quality fuels suitable for transport markets.
extra heavy crude oil
Extra heavy oil is crude oil with significantly lower specific gravity and higher viscosity than conventional crude oil. One large deposit, representing the majority of the known reserves, is located in the Orinoco oil belt of Venezuela, with an estimated 270 billion barrels of currently recoverable reserves.
Production of extra heavy crude oil from the Orinoco area was around 430 000 barrels a day in 2003. However, there is considerable uncertainty about whether the projects in Orinoco will continue to attract significant capital investment to sustain production growth. Relationships with foreign investors have been strained over actions by the Venezuelan Government to renegotiate existing contracts, leading to lower potential returns to foreign investors.
shale oil
Global resources of oil shale base are estimated at a minium of 2.9 trillion barrels of recoverable oil, including 750 billion barrels in the United States (Dyni 2003). Based on an estimated yield of around 25 gallons of syncrude from 1 ton of oil shale, the US Department of Energy estimates that reserves in the United States, if fully developed, could supply more than 100 years of US oil consumption at current levels.
Development of oil shale, however, requires relatively high oil prices to be economically viable. Bartis et al. (2005) estimate that crude oil prices would need to be in the range US$70–95 a barrel for an initial shale oil operation to be profitable, although the required oil prices could decline to between US$35 and US$48 a barrel after a relatively long period of experience based learning.
synthetic fuels
Synthetic fuels (referred to as synfuels) can be produced from coal and natural gas through chemical conversion into syncrude and/or synthetic liquid products. These processes are commonly referred as ‘coal to liquids’ (CTL) and ‘gas to liquids’ (GTL) technologies.
coal to liquids
The CTL process transforms coal into liquid fuels. There are two leading technologies for converting coal into transport fuels and liquids — direct coal liquefaction and indirect coal liquefaction. In the direct coal liquefaction process, coal is reacted with hydrogen under high temperatures and pressures to produce a syncrude that can be refined into liquid petroleum products. In the indirect coal liquefaction process, coal is first gasified to produce synthetic gas (syngas). Synthetic fuels are then produced from this syngas.
CTL is generally competitive economically at an oil price of around US$40–45 a barrel and a coal cost in the range US$20–30 a tonne. A CTL plant requires several decades of coal reserves to justify construction. Capital expenses are estimated to be in the range US$50 000–70 000 a barrel of daily capacity. This compares with the cost of a conventional petroleum refinery of around US$15 000 a barrel of daily capacity. The coal handling portion of a CTL plant accounts for about half of the capital cost.
In response to rising domestic demand and high and volatile world oil prices, there has been significant interest in CTL technology in China. With its extensive coal deposits, China is developing CTL technology as an alterative source of liquid fuels to increase its energy security.
proven reserves
crude oil
billion barrels
Middle East
734
– Saudi Arabia
263
– Iran
133
– Iraq
115
Europe and central Asia
139
Africa
112
World
1 189
oil sands (syncrude)
billion barrels
Canada
272
extra heavy oil
billion barrels
Venezuela
270
shale oil
billion barrels
United States
750
World
2 900
natural gas
trillion cubic metres
Middle East
72.8
– Qatar
25.8
– Iran
27.5
Russian Federation
48.0
Europe and central Asia
64.0
Africa
14.1
World
179.5
coal
billion tonnes
United States
247
Australia
79
Russian Federation
157
China
115
World
909
Sources: BP (2005); EIA (2006).
Shenhua Group Corporation, China’s largest coal producer, is constructing the world’s first commercial direct coal liquefaction facility in the Inner Mongolia autonomous region. An estimated US$850 million investment in the initial phase of the project is expected to transform 7110 tonnes of subbituminous coal into 20 000 barrels of ultraclean, low sulfur, diesel and gasoline a day by 2007. Two trains are planned for the first phase, with an additional seven trains in the second phase and a total investment in excess of US$5 billion (Fletcher et al. 2004).
gas to liquids
GTL is the chemical conversion of natural gas into a range of petroleum fuels. The process begins with the reaction of natural gas with oxygen in a reformer to produce syngas, which is used for further conversion to produce liquid fuels. Distillate is the primary product, accounting for 50–70 per cent of the total yield.
Capital costs for GTL plants are estimated to range from US$25 000 to US$45 000 a barrel of daily capacity, depending on production scale and site selection. The capital costs have declined significantly over the past few decades, and there is scope for further reductions in capital costs, largely depending on the progress of technological improvements.
The economies of GTL are extremely sensitive to the cost of natural gas feedstocks. Given the strong correlation between movements in oil and gas prices, higher oil prices will lead to higher gas prices, offsetting at least partly the incentive that higher oil prices provide for GTL production.
Presently, there are at least nine commercial GTL projects at various stages of planning and development for the period 2009–12 that could bring to market an estimated additional capacity of 580 000 barrels a day. Six of the nine confirmed GTL projects are located in Qatar as joint ventures.
renewable biofuels
Biofuels are generated from biological sources including grain and sugar crops, cellulosic materials (including grasses and trees) and municipal solid waste. The most widely used transport biofuels are ethanol and biodiesel. In 2003, world ethanol production was approximately equal to around 0.5 per cent of global oil consumption (Gielen and Unander 2005).
Ethanol is the most widely used renewable biofuel. Popular feedstocks include sugar beets (mainly used in Europe), sugar cane (Brazil) and corn (the United States). Capital costs for a corn based ethanol plant can range from US$22 000 to US$35 000 a barrel of daily capacity, depending on the scale of production and plant location. Manufacturing costs can be as low as US$0.75 a gallon, as demonstrated by the low cost production in Brazil.
Biodiesel is produced from a variety of feedstocks, including soybean oil (mainly used in the United States), palm oil (Malaysia) and rapeseed and sunflower oil (Europe). Capital costs for biodiesel production facilities are similar to those for ethanol production. On a gasoline equivalent basis, production costs in the United States range from around US80c a gallon for biodiesel from waste grease to US$1.14 a gallon for biodiesel from soybean oil (EIA 2006).
A range of technologies also exists or are being developed to reduce the dependency on oil in transport fuels. These include natural gas fueled vehicles, hydrogen in fuel cell vehicles and gasoline–electric hybrids.
references
Bartis, J.T., LaTourrette, T., Dixon, L., Peterson, D.J. and Cecchine, G. 2005, Oil Shale Development in the United States: Prospects and Policy Issues, Rand Corporation, Santa Monica, California, p. xiii (www.rand.org/pubs).
BP 2005, ‘Putting energy in the spotlight’, BP Statistical Review of World Energy, British Petroleum (www.bp.com/statistical/review).
Dyni, J.R. 2003, ‘Geology and resources of some world oil–shale deposits’, Oil Shale, vol. 20, no. 3, pp. 193–252.
EIA (Energy Information Administration) 2006, Annual Energy Outlook 2006 with Projections to 2030, US Department of Energy, Washington DC, February.
Fletcher, J.J., Sun, Q., Bajura, R.A., Zhang, Y. and Ren, X. 2004, Coal to clean fuel — the Shenhua investment in direct coal liquefaction, Paper presented at the Twenty-First Annual International Pittsburgh Coal Conference, Osaka, Japan, September.
Gielen, D. and Unander, F. 2005, Alternative fuels: an energy technology perspective, Paper presented at the International Energy Agency Workshop on Technology Issues for the Oil and Gas Sector, Paris, 13–14 January.
Apart from the uncertainties associated with Iran, increased volatility in oil price movements reflects a significant reduction in spare production capacity around the world. This reduction has limited the scope of supply to respond quickly to unanticipated disruptions at a time of strong demand growth. Spare production capacity for OPEC as a whole has declined from 5.2 million barrels a day in 2002 to an estimated 2.8 million barrels a day in mid-2006.
In addition to this significant decline, there are also concerns that the spare capacity currently available in Indonesia, Iran, Nigeria and Venezuela cannot be used on a sustainable basis. Excluding these producers, the effective OPEC spare capacity is estimated to be only around 1.7 million barrels a day. The absence of a comfortable margin of oil production flexibility is a key reason behind recent high and volatile oil prices.
seasonal factors could affect price movements
In the remainder of 2006, there are a number of seasonal factors that could lead to significant oil price movements. Specifically, the ‘driving season’ in north America (June–August) has the potential to result in an increase in demand for petrol that is significantly higher than currently expected. This, in turn, could lead to considerable upward pressure and volatility in oil prices.
From July to October, hurricane activity in the Gulf of Mexico region will be an important factor, with the potential to adversely affect oil production. Last year, hurricanes Katrina and Rita hit the Gulf of Mexico region in August and September respectively, causing significant damage to regional oil production and refining facilities. Despite reconstruction efforts, around 15 per cent of regional crude oil production facilities remained shut down at the end of May. In the nine months ended May 2006, the cumulative loss of oil production as a result of these two events was around 162 million barrels — equivalent to around 30 per cent of average annual regional production.
world oil production continues to rise
Global oil production is forecast to rise by 3 per cent to 86.4 million barrels a day in 2006, before increasing by a further 2 per cent to 88.2 million barrels a day in 2007.
… with OPEC production consistently above quota in early 2006
In the first half of 2006, OPEC crude oil production was consistently above the quota of 28.0 million barrels a day announced in mid-2005. In the March quarter 2006, OPEC crude oil production averaged around 29.9 million barrels a day, a rise of 2 per cent from the same quarter a year earlier.
OPEC production is forecast to increase by 2 per cent to 30.3 million barrels a day in 2006, before increasing by a further 2 per cent to around 31.0 million barrels a day in 2007. Key contributions to these forecast increases are expected to come from a number of projects. These include, for example, expansions at the Al Dabbiya, Rumaitha and Shanayel fields in the United Arab Emirates since late 2005. In Nigeria, there has been a gradual increase in crude supply, as production losses of 20 000 barrels a day from power outages at the Yoho field have been restored. Production in Qatar, Libya and Venezuela also increased during the first half of 2006.
In a recent statement, OPEC ministers have expressed concerns about the sharp increase in crude oil prices, as higher oil prices could foster policy changes in oil importing countries toward alternative transport fuels. However, although conservation and alternative fuels will have an impact on oil prices over the medium to longer term, the scope for a significant reduction in oil consumption appears to be limited in the short term.
spare production capacity in OPEC to increase only gradually
In the next eighteen months, spare production capacity worldwide is expected to increase only gradually. There was an increase of around 1 million barrels a day in OPEC’s production capacity in 2005. This increase was underpinned by projects completed during 2004, as well as those undertaken during 2005. OPEC committed new investment of around US$20 billion in 2005 to expand production. Further capacity expansion is under way in Saudi Arabia, the United Arab Emirates, Libya and Algeria. In addition to ongoing redevelopment and complementary infrastructure projects, plans for additional new investment are expected to total US$15 billion in 2006.
In Saudi Arabia, the recent expansion at the Haradh oil field became operational in late March, raising the country’s production capacity by 2.7 per cent to around 11 million barrels a day. This facility is the latest addition in a five year US$14 billion program to increase production capacity to around 12.5 million barrels a day by 2009.
For OPEC as a whole, spare production capacity is forecast to rise by a further 1 million barrels a day in 2006 and 0.7 million barrels a day in 2007. By 2010, OPEC production capacity is projected to increase by around 4 million barrels a day.
non-OPEC production to rise
Over the past few years, a significant proportion of the increase in world oil production has come from non-OPEC producers, especially those in the non-OECD region. Producers that have contributed significantly to this increased production include the Russian Federation and countries in Africa, the Caspian Sea region and Latin America.
In non-OPEC regions, recent global oil industry surveys indicate that there has been an increase in exploration expenditure and investment spending on production facilities. For non-OPEC producers, expenditures on drilling and well completion increased by around 20 per cent in 2005. In response to continued high oil prices, exploration and investment spending is expected to rise by a further 15 per cent in 2006. Deepwater projects have taken a growing share in new investment.
In 2005, disruptions, such as unplanned shutdowns, hurricane activity in the Gulf of Mexico and industrial action, led to non-OPEC production remaining largely unchanged. In the first half of 2006, non-OPEC production is estimated to have increased year on year by 0.7 per cent to 50.7 million barrels a day.
Under the assumption of average seasonal conditions, production by non-OPEC producers is forecast to continue to rise in the next eighteen months. While production in the OECD countries is expected to remain relatively stable, higher output is forecast for the Russian Federation, Africa and Latin America.
non-OPEC producers
United States
Oil production in the United States declined year on year in the March quarter 2006, mainly as a result of lower production in the Gulf of Mexico region and Alaska. Oil production in Alaska has been adversely affected by the BP pipeline spill in Prudhoe Bay in early 2006.
Looking forward, oil production in the United States is forecast to increase. Despite ongoing reports of a substantial portion of production facilities remaining shut-in in the Gulf of Mexico region, production performance from regional facilities back in operation has been running ahead of schedule. In Alaska, the leak on the Prudhoe Bay pipeline was caused by a buildup of bacteria that reduced the effectiveness of corrosion impeding chemicals. Production loss was restored by around 70 per cent in late April by rerouting the supply via an alternative pipeline. US production is forecast to increase by 0.7 per cent to 7.3 million barrels a day in 2006.
western Europe
In western Europe, both scheduled and unscheduled maintenance resulted in a decline of 7.5 per cent in oil production to 5.6 million barrels a day in 2005. In the short term, European oil production is forecast to continue to fall, mainly reflecting declining production from maturing oil fields.
In the United Kingdom, an increase in production is expected to come from Nexen’s Buzzard field, which is scheduled to begin production in late 2006. An initial production target of around 100 000 barrels a day, if it is achieved, could temporarily halt the decline in oil production in 2007.
In Norway, scheduled maintenance from June to September 2006 appears to be less than in the same period a year earlier. In addition, new production has started from the Kristin and Ringhorne East fields, which is expected to help lessen the production declines in 2006 and 2007.
Oil production in western Europe is forecast to average around 5.4 million barrels a day in 2006, a decline of 4.3 per cent on 2005.
Russian Federation
Oil production in the Russian Federation increased year on year by around 1.7 per cent to 9.5 million barrels a day in the March quarter 2006. This growth in production occurred despite unfavorable seasonal conditions, which suggests that further growth is likely in the remainder of 2006.
More importantly, recent data indicate that output from facilities formerly held by Yukos and Sibneft have been growing for the first time since 2004. These facilit
jammie penm and stuart kinsella