Crude oil, as one of the world’s most
important energy sources, has a bright future. Crude oil can look
forward to incrementally increasing world demand as well as increasing world
production in the next decade.
Both current and expected levels of
economic growth and activity can influence oil demand and prices. Commercial
and personal transportation activities, manufacturing processes consuming oil
as fuel or using it as feedstock, and oil used for power generation tie the
price of oil to economic activity. Oil prices tend to rise when economic
activity and in turn oil demand is growing strongly. Yet, it is also true that economic
growth and activity has more room to grow in developing countries as vehicle ownership
per capita is already high in OECD countries and OECD countries have much
larger tertiary and quaternary sectors that are less energy-intensive. Thus,
oil consumption in OECD countries has declined in the past decade. However 50%
of oil demand still comes from these OECD countries. Energy policies in OECD
countries, such as higher fuel taxes and tax incentives to encourage clean
energy, will slow their oil demand. Increased research into gas-to-liquid and
even coal-to-gas products as well as increased natural gas reserves should
supplant some oil demand in OECD countries. In the next decade, developing
country oil demand will grow to around 60%, largely driven by China, India and
Saudi Arabia. These countries have greater economic growth to look forward to,
which will feed into greater oil demand. As incomes rise in developing
countries, more people will have aspirations to vehicle ownership and
contribute to higher oil demand. Many developing countries, such as Indonesia,
control or subsidize end-use prices of oil products, which reduces the demand response
to prices and strengthens the importance of economic growth as a driver of global
oil prices. In addition, developing countries are experiencing rapid population
growth translating into more people requiring more oil consumption. Although
developing countries will boast a larger middle class by 2020, a major
proportion of their economies will still be manufacturing, which is more
energy-intensive than service industries. Therefore, developing countries will
largely drive oil demand in the next decade.
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| Future pyramids of oil? |
On the oil production side, there is
also the potential for increases to stave off the threat of a peak oil
scenario, which is a period where the maximum rate of global oil extraction is
reached and after which the rate of production will terminally decline. This
doomsday scenario has been pushed back several decades due to technological
innovations. Major international oil companies, such as Shell, BP, Exxon Mobil,
Statoil and Gazprom are spending billions on exploring the Arctic – estimated to
hold around 13% of the world’s unfound oil reserves. This is equivalent to
around 400 billion barrels of oil, roughly nine times the total oil produced in
the North Sea to date. The innovations of combining horizontal drilling with
hydraulic fracturing has also opened up tight oil reserves in the USA – oil production
in The Bakken shale formation has increased from 150,000 barrels per day in
2008 to 700,000 barrels per day in 2012. In fact, it is estimated that the USA
will surpass Saudi Arabia as the world leader in oil production by 2022. Brazil
is projected to become a top 10 producer globally, particularly due to
unconventional sources such as the Tupi subsalt reservoirs. Innovation has
unlocked bitumen from Canadian tar sands by transforming it into synthetic
crude oil. Additionally, there are over 200 deepwater wells worldwide currently
that supply 8% of the world’s oil and this figure is expected to double by
2021. These technological developments should increase oil production from
countries outside OPEC from 60% of world oil production currently to 70% by
2023. However, this increase in production from non-OPEC members is unlikely to
affect OPEC’s influence on international oil prices in the next decade as they
will still export a majority of the world’s oil. Consequently, OPEC spare
capacity will still provide an indicator of the world oil market’s ability to
respond to potential supply shocks. As a result, if OPEC spare capacity reaches
low levels in the next decade expect oil prices to rise due to incorporating a
risk premium. Markets will also still be influenced by geopolitical events
within OPEC countries, which is a significant risk in the coming decade with
unresolved issues with a nuclear Iran and the recommissioning of oil production
in Iraq as well as the potential for popular revolutions among OPEC members. Furthermore,
the increase of extreme weather as a response to global warming will play a
significant role in oil supply in the coming decade. Hurricanes and tsunamis
can shut down oil production and refineries and severely cold winters can
stretch the capability of markets to supply products. Nations such as China,
Japan and the USA are also expected to add aggressively to their national
strategic oil reserves. Therefore, whilst oil supply will increase in the next
decade there are potential disruptions to supply that can not be foreseen.
It is estimated that one in twelve of
the largest oil tankers are being used for storage, rather than transportation,
of oil. This estimation reveals the important role inventories play in
balancing oil demand and supply. When production exceeds consumption, crude oil
can be stored for future use. Inventory building tends to correlate with
increases in future oil prices relative to current prices (and vice versa). As
inventories satisfy either current or future demand, their level is sensitive
to the relationship between the current oil price and oil futures prices. A change
in market expectations towards either stronger future oil demand or lower
future oil production, futures contract prices will likely increase, which
encourages inventory building to satisfy the prospect of a tightening future
balance. When futures prices rise relative to the current spot price, incentives
to store oil and wait to sell at the higher expected price strengthen.
Conversely, a loss of current production or unexpected increase in current oil
consumption tends to increase spot oil prices relative to future prices and
encourage inventory drawdowns to meet current demand. Alternatively, an
increase in inventory levels can indicate that current production is greater
than current consumption at the prevailing spot price, which will push spot oil
prices down to rebalance supply and demand. Increased sophistication of
inventory building will likely mean that inventory levels have a greater impact
on oil prices in the next decade.
The past decade, particularly in the
ongoing financial crisis, crude oil has conformed to the risk-on risk-off
pattern seen in many financial assets. Crude oil tends to move in the same
direction with stocks. In periods of rising risks, stocks and crude oil prices
tend to decrease. Conversely, in periods of lessening risk or recovery, stocks
and oil prices tend to increase. Oil prices have also been observed to have an
inverse relationship with investment-grade bonds - as investors become more
worried about future returns in higher risk assets such as crude oil they tend
to increase allocations to investment-grade bonds in their portfolio. Thirdly,
oil prices have an inverse relationship with the exchange value of the USD. Oil
benchmarks are traditionally priced in USD, and therefore a depreciation of the
USD decreases the effective oil price outside the USA. This decreased cost of
oil acts as an incentive for consumers to purchase oil, which adds upward
pressure on oil prices. In addition, investment in crude oil is also more
attractive to US-based investors as a hedge against inflation, as a
depreciation of the USD tends to increase inflation expectations. Therefore, greater
interest from a variety of financial market players in crude oil will continue
in the next decade and therefore these are important trends to take note of.
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