Thursday 29th May, 2008


The oil surge: High prices, same output

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A snapshot of last week’s global energy news:

President of the Organisation of Petroleum Exporting Countries (Opec) Chakib Khelil warned that high oil prices would continue to rise. He blamed the soaring price of oil on speculators, geopolitical problems and the weakness of the dollar, all “factors beyond the control” of Opec.

Russian Prime Minister Vladimir Putin approved a tax-cut which is expected to stimulate Russia’s oil production to 12 million barrels a day. Russian oil production fell to 9.72 million barrels a day in April, the lowest in 18 months, due to rising costs to develop ageing fields and pursue new projects in remote areas.

High fuel prices have affected motorists around the world with few exceptions.

In the Caribbean, tourism-dominated and energy-dependent islands have become reliant on PetroCaribe, a facility offered by Venezuelan leader Hugo Chavez. Under PetroCaribe, Venezuela supplies oil to the region at preferred prices, for which part of the payment is deferred.

And in T&T:

A sum of $1.1billion went to the Energy Ministry to offset the cost of fuel to motorists. It is estimated that total subsidies on petroleum products will be $1 billion more than the anticipated expenditure for the year submitted during preparation of the 2007/2008 budget.

bpTT chief executive Robert Riley said that T&T must follow the gas price, not the oil price. “The price of gas has not been moving as the rate of oil. We are a gas economy with some oil production,” said Riley.

T&T has buffered surging oil prices by subsidies which Energy Minister Conrad Enill admitted are not properly targeted.

However, he said that the Government may have to make special arrangements to ensure the benefits of the subsidies reach the people they were intended to help.

“It’s unfortunate that we have placed ourselves in this position as far as the fuel subsidy is concerned. We are between a rock and a hard place. The cost continues to rise, but so does the inflation rate so that we need to find even now a way in which the cost of fuel to the average consumer would more reflect market prices,” said economist Ronald Ramkissoon.

Finance Minister Karen Nunez-Tesheira pointed out that oil is retailed locally at US$32 despite high oil prices of more that US$100 a barrel.

“A lot of the oil companies like Petrotrin are importers of oil, so they have to pay the market prices for oil. The Government has this arrangement that regardless of the price, we must sell it using the US$32 a barrel rate.

“At the Finance Appropriation Bill, $1 billion of that appropriation came from that fuel subsidy. What do you do? If you remove that, you are looking at dealing with the inflation, which is clearly our challenge,” she said.

Ian Narine, centre director, wealth management at Scotiabank, said, “Given where oil prices are right now and where oil prices will go in the future, that subsidy is set to increase and even increase exponentially if you are talking about US$200 (a barrel) oil.”

The Government has been conservative.

Last year’s budget was pegged at an oil price of US$50 and $3.55 per million metric British thermal units (mmbtu) for gas. And the Heritage and Stabilisation Fund will soon reach $13 billion.

Current oil reserves amount to 621 million barrels (proven), 404 million barrels (probable) and 1,688 million barrels (possible).

Petrotrin’s reserves are estimated at 424.3 million barrels: 254.5 million barrels in Trinmar, 162.3 million barrels from land fields and 7.6 million barrels from joint ventures.

But while T&T benefits from the high prices, it’s a small sum.

T&T distinguishes itself as a gas-based economy, says Nunez-Tesheira, and consumes about four billion cubic feet of natural gas a day.

Oil has now become the byproduct of future exploration. The Government has subsequently initiated an oil audit.

Riley believes that the Government should reconsider its programme of incentives where oil is concerned.

He said oil is a high-value product and T&T must take the lead in enhanced capital recovery incentives.

He also noted that his company would continue to produce 500,000 barrels of oil equivalent a day, but does not expect to discover any huge gas finds.

“As we scan this playing field of global and regional petropolitics and energy security, the obvious question is, can it last?

“The current reality is that Russia’s flexing, Iran’s command of the world’s attention, China’s fascinating outreach and President Chavez’s frequent flyer mileage are still about the energy security that only a barrel of oil can provide,” according to Professor Anthony Bryan, senior associate at the Americas Program Center for Strategic and International Studies.

Bronwen Brown of the Economic Intelligence Unit of the Economist magazine said last week that the Economist’s forecast for natural gas and oil growth was 16 per cent and 45 per cent respectively, for 2008 which should augur well for the energy economy.

Brown noted that T&T’s gas subsidy, which was about $2 billion last year, was amazingly low in the Caribbean and, by extension, the rest of the world.

“At some point, T&T will have to bite the bullet,” she concluded.

She said it was costing the Government a lot to subsidise the price of gas, but that a decision to remove the subsidy would not be popular. She forecast that the subsidy would remain in the medium-term, but it needed to change.

Surging oil prices

Managing editor of Energy Industry and Management for the Economist Intelligence Unit, Tony McAuley, pointed out that “surging demand,” often cited to explain current high oil prices, cannot explain price increases.

He said that global oil supply has also increased substantially since last November and has been running in surplus to demand globally since the start of the year.

“Obviously, some of the price rise can be attributed to the weak dollar; last time I checked, oil prices had risen by about 30 to 40 per cent less in euro terms than US$ terms since the start of 2007. Part can also be explained by the rush into commodities after the financial crisis last summer, when speculators were looking for new places to invest,” he said.

In his view, the most important factor for the rise in oil prices since about 2003 was the unexpected rate of oil demand growth from China coupled with the realisation that the industry had massively underinvested during the 1990s and into the early 2000s.

Sharp declines expected

“Oil prices were, remember, US$10 a barrel just a decade ago. There is still underinvestment because now there is also rampant inflation in the oil services sector and related costs (the price of leasing oil rigs, for example, is up 9-10 fold, the cost of skilled labour is up huge, if you can get it).

“The IEA talks of ‘potential’ demand and ‘potential’ supply—as opposed to actual—as a way to explain the irrational price reaction. People are worried that the amount of spare capacity (probably less than three million barrels a day and almost all in Saudi Arabia) is not sufficient to meet potential demand if prices fall. Much, however, depends on how key situations unfold—Nigeria, Iraq, for example.

“Also, a change in attitudes of some countries to allowing foreign oil companies to enter and reverse declining production, particularly Mexico and Russia,” he said.

He said that oil companies are in a difficult position to find places to invest their capital.

“There has been a strong move toward nationalism, if you like. In Venezuela, for example, where international oil companies are getting frozen out, they have been replaced to a large degree by Indian, Chinese companies or government-to-government deals, which is a lot of what Venezuela has been doing lately.”

McAuley said the notion of energy security is difficult to encapsulate.

“In the later part of the century, the world wars have been about competition for oil resources.”

Two other factors that affect energy security are climate change and energy sector inflation.

“What you’ve seen in the long term is that demand has been rising slowly and constantly for decades, but what has been coming down is the spare capacity in the world.

“There is no direct link between spare capacity and prices because it’s been coming down pretty constantly and prices have been going up and down that period, but now we’ve come to the point where there is virtually no spare capacity.

“It’s like 2.5 million barrels a day out of the total demand of about 82 million. It’s very small and it rests entirely in the hands of Saudi Arabia. Sauda Arabia, it could be said, essentially controls the oil price right now and they have no intention to increase.”

Two weeks ago, US President George Bush visited Saudi Arabia to beg for an increase in production. The Saudis rejected the request.

Last week, US Energy Secretary Sam Bodman told Congress that crude oil prices have reached record-high levels of US$135 a barrel because global oil production has failed to keep pace with demand.

“The high-priced energy environment is being driven by the fact that demand has outstripped supply,” Bodman testified earlier this week at a Congressional hearing looking into the Bush administration’s energy policy and the cause of high oil prices.

Bodman’s belief is that part of the long-term solution to America’s energy problems is increasing domestic oil production, and that Congress should allow drilling in Alaska’s Arctic National Wildlife Refuge that have been off limits to oil companies for more than 25 years.

A report issued by the Federal Energy Information Administration (EIA) said that if the refuge were opened to drilling this year, oil from the area would not be available to the market until 2018 and would do little to lower crude oil costs, pushing down the price of oil by just 75 cents a barrel in 2025.

The stockpile holds about 703 million barrels of crude at four underground storage sites in Texas and Louisiana.

High oil prices

McAuley believes there is no reason for the oil price to be as high as it is.

“In the short term, we’ve seen world oil demand decline in this first quarter. Everybody talks about surging demand, but actually there is no surging demand. In 2006, over the last three years, world oil demand growth has been roughly 1.2 to 1.3 per cent, and over that time period, the price of oil has tripled.

“Lack of supply slack is not the explanation. Last year, demand was running ahead of schedule because Opec had restricted supply, but they have put that supply on the market since last November. Since then we’ve actually been running in surplus.”

McAuley added that in 2008, it has averaged about 1.2 per cent a year up to the end of last year.

A comparison of the fourth quarter of 2007 with the first quarter of 2008, found that global demand had actually fallen, according to the IEA. During that latter quarterly period alone, oil prices were up 60 per cent.

But the EIA’s forecast is for oil to average out at $93 a barrel.

As a result, McAuley predicted that “pretty sharp declines in oil prices are expected.

“That’s what Opec sees. Not everybody does. Goldman Sachs sees US$200 oil forecast.”

However, he gave the assurance that this is entirely speculative as oil price forecasting is almost never correct.

“S&P’s was a bit better when they came out with an oil price of US$93 give or take US$50. That’s very measly of them, but is probably accurate in terms of what we can say is going to happen in the world.

“In February, China went through a horrendous winter, which disrupted power generation and industry. In adjusting to the new situation, there was a surge in demand.

“With the earthquake at the Siuchin province and Olympics in Beijing in August, one of the effects is that they are hoarding diesel and other products.

“Import growth in China is running about 11 per cent higher than last year. But if they are hoarding it for the Olympics, then we might well see a decline after the summer Olympics.

“China has seen growth and demand, but it has been erratic, therefore, that makes it difficult to predict. Also, we have a lot of new production capacity coming on in the Middle East. Again, most in Saudi Arabia.”







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