The crude oil market has continually surprised in the past and it is likely to produce many twists and turns over the next decade.
Changing regional relationships, both in the crude and products markets, will be a driver for many of these changes and influence both government and industry responses in the years to come.
OPEC policies will remain as the key driver. Mexico and Venezuela will capture the major part of the growth in the US import market. Refiners will continue to invest in heavy crude processing capability.
Opportunities may also arise for Mexico and Venezuela to diversify heavy crude supply to eastern customers. Sales from Mexico to Japan and Venezuela to India are current examples.
In the US, the refining industry will need to continually invest to produce cleaner products that consumers demand. This may force the closure of small refineries, but will stimulate larger refineries to be more efficient and increase output.
Mexico and Brazil are investing in refining capacity to reduce import dependence in a hemisphere with reduced surplus refining capacity. But product-exporting countries like Venezuela will see increasing competition from Middle East product exports.
Refining will therefore remain a business that is highly competitive and demand high performance levels as well as sound investment strategies.
I am very pleased to have been invited to contribute to this ‘international oil markets perspectives’ panel at a very interesting point in the development of global oil markets, after a period of exceptional change and volatility.
This applies equally to markets here in the Western Hemisphere where new governments are beginning to frame their views on energy policy in a critically important region.
The Oil Market has seen many twists and turns over the past four years. Prices rose to US$25 per barrel, fell to US$10 per barrel then climbed back to US$35 per barrel.
Apart from the Gulf War period, the early 1990’s appears dull by comparison, although I can’t say it felt that way at the time.
High oil demand in the cold first quarter of 1996 caused global stocks to fall. Key OPEC countries decided not to increase production and let prices rise.
Many upstream companies were convinced that higher oil prices were here to stay. Non OPEC expenditure increased to record levels but drilling rigs could not keep up with demand. Upstream service companies planned for high growth.
Then OPEC’s inability to manage the return of Iraqi exports back into the market from 1997 was compounded by the Asian economic crisis in 1998.
Global supply greatly exceeded demand and so stocks rose inexorably and prices crashed. Many forecasters then predicted single digit oil prices were inevitable for the future. Even The Economist in a brave forecast said we were en route to a $5 world!
History has shown that companies and organizations often need a crisis to activate major change. The price collapse through 1998 and 1999 was a crisis OPEC maybe needed to have.
OPEC recovered a common purpose and, with the important help of Mexico, have become extremely effective in increasing and holding oil prices.
The forward oil prices varied in a narrow band through the early to mid 1990’s before falling during the low price period.
Now forward prices are well above US$20 per barrel and many forecasters are again predicting forward oil prices will remain high for the foreseeable future.
However most major upstream companies remain cautious and are screening projects at prices well below US$20 per barrel. We in Shell are also doubtful that prices at these levels are sustainable, given the marginal cost of new non-OPEC production which we assess at $15-17 per bbl.
Assuming oil prices return towards historical ranges, investments for non-OPEC production will be screened at equivalent Brent prices of around $15 - 17 in line with this marginal cost assessment.
We envisage that non OPEC oil supply will grow at an average of 600 to 700 kb/d per year over the decade to 2010. The majority of this growth will occur in the Atlantic Basin.
In the Asia/Pacific region production growth will be small. More than half of this growth will be in NGL’s.
On the demand side we expect that world oil consumption will rise from 76 mb/d to 92 mb/d over the decade, broadly split equally between the Western and Eastern markets.
If upstream companies were to become convinced that investment opportunities should be judged against price forecasts of over $20/bbl, we could envisage that non-OPEC investment opportunities over the decade could exceed 1 mb/d per year, again with the majority of the supply growth in the Atlantic basin.
This means that the Middle East’s share of the Western market will at best remain broadly flat in volume terms but decline to a less than 10 percent share of this market. By contrast, the Middle East will supply the vast majority of demand growth to the Pacific basin, increasing from 40 percent to near 70 percent of the supply.
Western hemisphere governments will draw comfort from the increased diversity of supply and the decline in dependence on long haul Middle East cruds.
Eastern governments on the other hand will be increasingly concerned with their dependence on Middle East supply. They will need to consider investing in local or regional emergency oil stocks as well as looking for ways to diversify supply that may have to include long haul supply from the west.
Mexico has had a long term supply arrangement with Japan. Recently, Venezuela has supplied crude to India. These flows are small by global standards at the moment, but may grow.
Looking back I think that competition to supply the strategically and politically important US crude import market was a key reason for the tensions within OPEC that culminated in the differing views of Saudi Arabia and Venezuela.
If the trend through the mid 1990’s had continued, Saudi Arabia would have become a marginal supplier to the US and one of the key linkages between those countries would have been broken.
Production cuts agreed through 1998 and recent declines in the rate of growth in upstream investments, particularly in Venezuela, have slowed Latin American imports to the US.
But this will change as future production growth in Mexico and Venezuela will predominantly supply the US market where refineries have been willing to invest in deep conversion technology to handle the heavy crude exports from these two countries.
Shell’s partnership with Pemex in Deer Park is an example of this.
Saudi Arabia has targeted growth in the US market. Production cuts in 1999/early 2000 were concentrated on Eastern and European markets and not the US. Supply to the US has steadily increased.
It is unlikely that Saudi Arabia can maintain this recent trend in US imports for the reasons I outlined earlier - that is the strong growth in non OPEC supply, coupled with the fact that output growth from Venezuela and Nigeria will also mainly supply Western markets.
At the end of this decade, Saudi Arabia’s crude exports will be heavily weighted towards eastern markets.
How Middle East producers respond to a declining importance in Western markets will be a key factor in the development of the oil market prices over the decade.
The Middle East’s status as the major crude importer to the US has been important to Middle East producers in the past and will only be conceded with reluctance.
During the 1990’s the Downstream market evolved in a way that few would have predicted. In the mature US and Western European markets, spare refining capacity at the start of the decade was a comfort to governments as it provided supply security and lead to low supply costs, at least from the refining part of the value chain.
The Eastern markets also had spare capacity in 1990. However at that time refinery reliability in many parts of the region was less than it is today. Sustainable capacity tended to be less than demand and the region was supported by product imports from the west, mainly via the Suez canal.
By the end of 2000, the US and European refining systems are closely balanced to demand. Leuna refinery in Germany was the only Greenfield refinery built during the decade. Brownfield expansions and capacity creep were partly offset by some 40, mainly small, refinery closures.
Against this background, the planned refining investments in Mexico and Brazil to reduce product import dependence appear to be well timed. However, I do not expect to see any marked increase in refining margins from historical levels because of growing product flows from the East which may target Latin American markets, particularly Brazil.
Refinery additions outpaced demand growth in the East. Over 9 million barrels per day of refining capacity was added over the decade compared to 8 million barrels per day of demand growth.
More than half was achieved through Brownfield expansions and capacity creep in existing refineries, but also many Greenfield refineries were built.
In the past new refineries were relatively simple with future plans for the addition of conversion units. Now, many of the Greenfield refineries are built as supersets with deep conversion facilities and full chemicals integration. The Reliance refinery in India is a prime example.
In addition, refinery reliability in the region has generally reached world best practice. Hence most of the world’s spare refining capacity is now in the East, a statement that few would have predicted five years ago.
Most of the investments in the East have been in growing markets that historically were supplied from the Middle East and Singapore export refining centers. Over the past few years these export centers have responded differently to market developments.
In the Middle East, investments in condensate splitters and deeper conversion facilities in existing refineries has expanded light product output in spite of the generally poor recent margin environment.
Singapore on the other hand has responded by decreasing refinery intake as their traditional markets shrunk.
Both of these refining centers will have to rethink their future roles in refined product markets. Singapore will need to develop more structural and tied markets to supply.
More chemicals integration is likely. While there will continue to be a market for Middle East fuel oil and naphtha exports to the East, gasoline, kerosene and diesel exports are likely to increasingly flow westwards.
This flow will be driven by demand pull as well as supply push. Recent upstream profits will provide Middle East countries with funds to invest in product quality driven refinery modifications to supply premium products to these markets.
This trend is already evident in product movement data through the Suez canal and by relative product price differentials between Western and Eastern markets.
The East provided major support to western gasoline requirements last summer and I suspect when fourth quarter data is available, distillate flow northbound through the Suez canal will have increased markedly.
It is also noteworthy that Eastern fuel oil balances are tightening. Few would have predicted that ships would find it cheaper to bunker in Rotterdam than the Middle East, yet this has frequently been the case over the recent past.
This Eastern fuel oil strength may provide support for more heavy Latin American crude to flow to the East.
It is not unrealistic to imagine that light product flows from East to West could double or triple from current levels and become a major structural feature of the future market.
The product market would become more global in contrast to the crude market where I mentioned earlier that the Atlantic basin will become more and more self sufficient.
Let me summaries with a few broad conclusions - first on the crude oil market. This market has continually surprised us in the past and I expect we will continue to experience many twists and turns over the next decade.
Some we may expect but others will certainly come as a surprise. My sense however is that changing regional relationships, both in the crude and products markets, will be a driver for many of these changes and influence both government and industry responses in the years to come.
Against this background what are the likely features of oil markets in this region in the years ahead and the impacts on the leading players. In the crude oil market, OPEC policies will remain as the key driver.
Mexico and Venezuela will capture the major part of the growth in the US import market. Refiners will continue to invest in heavy crude processing capability.
Opportunities may also arise for Mexico and Venezuela to diversify heavy crude supply to eastern customers. Sales from Mexico to Japan and Venezuela to India are current examples.
Turning to refined products market. In the US, the refining industry will need to continually invest to produce cleaner products that consumers demand.
This may force the closure of small refineries, but will stimulate larger refineries to be more efficient and increase output.
Mexico and Brazil are investing in refining capacity to reduce import dependence in a hemisphere with reduced surplus refining capacity. But product exporting countries like Venezuela will see increasing competition from Middle East product exports.
Refining will therefore remain a business which is highly competitive and demand high performance levels as well as sound investment strategies.
Thank you again for inviting me to participate in the Conference and I look forward to the panel discussion.
By Paul Skinner, Group Managing Director & Chief Executive, Oil Products, Royal Dutch/Shell Group at the Hemispheric Energy Conference, Mexico City, Mexico
Source: SHELL.COM
© 2001 Mena Report (www.menareport.com)
