oil insecurity – current trends & the economic impact simon wardell director – global oil...

Oil Insecurity – Current Trends & Oil Insecurity – Current Trends & the Economic Impactthe Economic Impact

Simon WardellDirector – Global Oil

Global Insight

Copyright © 2006 Global Insight, Inc. 2

Oil Insecurity

• Oil Industry Trends: Fundamental Changes• Security & Oil Prices• Oil Prices and the Global Economy• Conclusion


1. Oil Industry Trends: Fundamental Changes


0

20

40

60

80

100

120

1990 1995 2000 2005 2010 2015 2020 2025

Mil

lio

n B

arre

ls a

Day

FSUAfricaMiddle EastAsia/PacificS. AmericaE. EuropeW. EuropeN. America

-2

0

2

4

6

8

10

12

NorthAmerica

WestEurope

EasternEurope

SouthAmerica

Asia/Pacific

Middle East

Africa FSU

Mil

lio

n B

arre

ls p

er D

ay

Others

Power Generation

Transportation Petrochemical Feedstock

Industrial Sector

Domestic Sector

Accelerating Global Demand

Global Oil Demand by Region Oil Demand Growth (2005-25)


Supply Growth Lagging Behind

-3000

-2000

-1000

0

1000

2000

3000

4000

2003 2004 2005 2006 2007 2008 2009 2010

non-OPEC Supply (MBOPD) OPEC Supply (MBOPD) non-OPEC Decline (MBOPD)

OPEC Decline (MBOPD) Demand Growth (MBOPD) Net Capacity Change (MBOPD)

Data Sources: IEA, EIA, OPEC,Company Reports, Trade Press, ECG

?

Note: Assumes Iraqi production stays 2 MMBOPD through 2010

2006 includes 250 MBOPD of restored GOM production


• Acceleration can perhaps best be illustrated in areas with relatively little new field development

• Aging fields, better technology and rate acceleration economics appear to be the culprits behind the acceleration of decline rates 0

2000

4000

6000

8000

10000

12000

14000

16000

18000

20000

19961997 19981999 200020012002 20032004 20052006

MB

OP

D

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

Yea

r-o

n-Y

ear

Dec

lin

e (%

)

Source: EIA (USA lower 48 and Alaska), Canada Onshore-Light, Oman, Syria, Indonesia, Egypt, Australia),

One reason for non-OPEC production’s

struggle to grow has been the acceleration

of decline rates

Accelerating Declines?


-

50

100

150

200

250

300

350

1990 1992 1994 1996 1998 2000 2002 2004 2006

Ind

ex 1

990=

100

F&D

Steel

Brent

The Upward Push of Costs on Prices

Nominal Terms: F&D Costs, Steel Prices, & Brent Crude (Index 1990=100)Nominal Terms: F&D Costs, Steel Prices, & Brent Crude (Index 1990=100)


Full Costs & Required Oil Price to Achieve 13% ROCE

0

10

20

30

40

50

60

Mid 1990s F&D Costs$4/barrel. Requires oil price

of $18/barrel

2001-2003 F&D Costs$7/barrel. Requires oil price

of $28/barrel

2006 F&D Costs $13/barrel. Requires oil price

of $48/barrel

$/B

arre

l

Net income to achieve 13% ROCE

Income tax @ 40%

Depletion (DD&A) (= F&D)

Operating (Lifting) costs

Production tax

Differential to average well-head price


OPEC Spare Capacity Falls = Increased Market Sensitivity

Relationship Between Price and Spare Production Capacity

0

10

20

30

40

50

60

70

80

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

WT

I (U

S$)

0

1

2

3

4

5

6

OP

EC

Sp

are

Cap

acit

y (m

ln b

/d)


Futures Markets – Chickens & Eggs

0

100000

200000

300000

400000

500000

600000

700000

800000

1999 2000 2001 2002 2003 2004 2005 2006 2007

Lo

ts

0

10

20

30

40

50

60

70

80

90

$/B

arre

l

Lots

WTI spot (RH axis)

NYMEX Crude Oil Non-Commercial Open Interest vs. WTI


Expected Net Oil Production Growth to 2020 (EIA)

Russia

Western Europe- 16%

FSU35%

Middle East37%

North America6%

South & Central America65%

Asia & Oceania6%

Sub-Saharan Africa89%

+5.3m bpd

+4.1mbpd

+0.92mbpd

+11.38mbpd

+4mbpd

- 1mbpd

Source: EIA

+0.46m bpd


Geographical Shift = Increased Political Risk

• Global Insight Risk Ratings:

OECD Risk = 1.50

‘New’ oil territories = 3.42 (significant risk)

• Concentration of supply in Middle East• Oil consumers incrementally more dependant on

exports from more distant producers• Longer supply chain, more chokepoints = more risk of

supply disruptions


2. Security & Oil Prices


Changing Oil Industry More Vulnerable to Attack

• Tight supply/demand balance = supply risks exaggerated

• Shift in production = more opportunity for attack• Value of oil revenues = more damage caused by attack

• Consequence: Insurgent/terrorist groups recognise vulnerability and target oil installations where possible. Success of insurgent groups leading to copy-cat attacks from criminal gangs


Oil Industry is a Target

• 2001/02: Colombia – frequent guerrilla attacks on pipelines

• 2003/04: Sudan – threatened attacks on oil facilities• 2002: Yemen – Limberg attack, kidnappings• 2003-Present: Iraq – pipelines specifically targeted to

cause financial damage• 2004-Present: Nigeria – Southern Delta • 2001-Present: al-Qaida – Abqaiq attack, threats

made to Saudi Oil• 2007: Mexico – Rebel groups attack pipelines


Nigeria

• Ijaw community grievances: Lack of employment Environmental degradation Lack of investment in social welfare (state revenue control)

• Unhappiness spawns militant activists (MEND) Oil industry is attacked through disruptive activities System of “pay-offs” develops (political talks, social spending) Ijaw community does have a stake in continued oil extraction (economic

future) – maintains low-level violence• Stability of low level politically-motivated violence now changing

Political groups fractured – lacks unifying set of demands or organisation

Criminal gangs have taken over – ransoming workers and bunkering oil (guerrilla entrepreneurs)

Payment of ransoms/protection simply exacerbates the problem• Where IOCs could move on before, now they stay – and shut-ins result


Middle East

• Threats to, and attacks on, domestic oil sector in MENA almost entirely politically motivated Exceptions: Iraq (some bunkering), Yemen (kidnapping for financial

gain) Motivations are politico-religious: designed to put pressure on regional

governments (Saudi Arabia, Algeria) Clear link to wider international issues – Abqaiq attack took place on

Saudi soil but true target was the global economy Local governments have greater ability to counter threats

• There are wider geo-political security threats in the region Iran-Saudi tensions Iraq fracturing Iran-US

• Oil installations are an obvious target in the event of any military clash (Kuwait, Iran-Iraq, Iraq war precedents)

• The likelihood of attacks low, but the potential damage far greater


Security Trends

• The oil industry is a more tempting target now than in the past because: Oil resources much harder to access

• IOCS more exposed to unstable regions

• IOCS more resilient in face of attack – negative feedback loop

• Attacks have wider significance – publicity for political causes or…

• …Attacks designed to target wider economy

• No reversal of this trend in immediate sight

• The transformation from political to criminal violence the most worrying

• But Most important installations can be protected It is still difficult to cause significant damage to the oil industry


2527293133353739

$/b

Iraq Pipeline Attacks: Cumulative Increase

Kirkuk-Ceyhan 1st major attackKirkuk-Ceyhan 1st major attack

Kirkuk-Ceyhan 2nd major attackKirkuk-Ceyhan 2nd major attack

Kirkuk-Ceyhan 3rd major attackKirkuk-Ceyhan 3rd major attack

Kirkuk-Ceyhan 4th major attackKirkuk-Ceyhan 4th major attack


Price Spikes and Volatility

3637383940414243

$/b

4849505152535455565758

02/2

2/05

02/2

4/05

02/2

6/05

02/2

8/05

03/0

2/05

03/0

4/05

03/0

6/05

03/0

8/05

03/1

0/05

03/1

2/05

03/1

4/05

03/1

6/05

03/1

8/05

03/2

0/05

$/b

Khobar BombingKhobar Bombing

Foiled Attack on Abqaiq oil facilityFoiled Attack on Abqaiq oil facility 32

34

36

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40

42

44

$/b

Yanbu ShootingYanbu Shooting

•Oil market sensitivity to Saudi security is heightened due to reduced spare capacity


Nigeria: Ongoing Attacks; Ongoing Volatility

52

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58

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62

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66

68

02/15/06 02/22/06 03/01/06 03/08/06 03/15/06 03/22/06

$/b

Nigerian military attacks MENDNigerian military attacks MEND

MEND hits Shell’s Forcados exportsMEND hits Shell’s Forcados exports

ENI pipeline hit by MENDENI pipeline hit by MEND

ENI declares ‘force majeure’ENI declares ‘force majeure’


Quantifying Price Impact: “Risk Premium”

• “Proportion of oil price not attributable to supply/demand fundamentals”

Supply/Demand $15

Risk Premium $15

Marginal Cost $48


Security and Oil Prices

• Ultimately it’s always a question of supply and demand

• Security/geopolitical risks = future supply

• ‘Risk premium’ exaggerated by lack of spare capacity

• Difficult to isolate security threats within crude price

• If quantified security ‘risk premium’ approximately 20-30% of oil price at present (best guess)


3. Oil Prices and the Economy


Debate Over High Oil Prices and Economy Rages

• 1970s & 80s: High oil = inflation, recession• 1990s & 00s: High oil = lower growth• Western economies less oil dependent now• Energy diversification• Growth in service sector has helped sever direct link

But

• Oil still underpins global economy• Transport industry heavily reliant on crude• Oil does still impact broader economy, but more lag


Demand Responding to Price?

World Oil Demand Growth Moving Average vs. Crude Oil Price Moving Average 1999-2007

-0.5

0

0.5

1

1.5

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2.5

3

3.5

0 10 20 30 40 50 60 70

NSD $/barrel

Oil

dem

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2005

2006

2007


Declining Oil Intensity of the Global Economy

Oil/gdp - b/d per 1000$

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035

Annual decline averages around 2% since first oil price

shock in 1973

Fuel substitutionEfficiencyGrowth of service sector


Global Economy More Resilient to High Prices

• Incremental oil demand/gdp nearly half the level of 10 years ago

• For many OECD consumers, the price of crude oil is a small fraction of their fuels costs

• In some major emerging markets, energy prices are subsidized and consumers do not ‘see’ higher prices

• Petro dollars are being recycled more quickly through investments and financial flows

• There has been an absence of inflationary pressures thanks to increased global and domestic competition

• For US retail fuel prices to match European levels a $200/b price would be needed


How High Can Price Go Before There is a GDP Impact?

• Global Insight sensitivity analysis of an oil price ‘shock’ on the global economy

• WTI price over $100 for two months and over $70 for six months and over $50 for an additional year.

• Slight negative impact on global GDP in the first year, no impact in the second and positive impacts in the following years.

• Price impact shaves 0.3 – 0.4 percent off growth for China and India in year 1 and 2.

• What price is too high?


Impact of $100 Oil Shock on World Growth

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Global Insight Scenario Model

Perc

en

t C

han

ge i

n R

eal

GD

P

Base Case Oil Shock


Conclusion: The Causal Chain

• Security > oil prices > economic consequences• Psychological impact of ‘oil jitters’ on wider economy hard to

quantify• Oil industry trends will only accentuate impact of supply

threats, and the threats themselves• ‘Risk premium’ pales in comparison to impact of significant

strike on oil infrastructure

• Mitigates:• Big oil price movements require big actions – still rare• Economies less oil dependant than in the past• Government stocks can act as a buffer if expanded


Conclusion: Final Thought

• Can we quantify the cost of oil insecurity?

• Assuming:

• World GDP 2007 = $55.0trn• $20/b average above trend = -0.85 GDP Growth• ‘Risk premium’ accounts for 30% of higher price...• ...and 50% of ‘risk premium’ is due to security fears

• Then oil insecurity will cost the global economy...

$233,750,000,000 per annum in lost growth

Thank you for listening

Simon Wardell, Director – Global Oil, Global [email protected]

oil insecurity – current trends & the economic impact simon wardell director – global oil...

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