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The Coming Oil Supply Crunch

11937_0808oilcrunch.pdf
38 pages | 630 Kb
Published: August 05, 2008
Source: A Chatham House Report
Executive summary The hypothesis and why it matters This report argues that unless there is a collapse in oil demand within the next five to ten years, there will be a serious oil 'supply crunch' – not because of below-ground resource constraints but because of inadequate investment by international oil companies (IOCs) and national oil companies (NOCs). An oil supply crunch is where excess crude producing capacity falls to low levels and is followed by a crude 'outage' leading to a price spike. If this happens then the resulting price spike will carry serious policy implications with long-lasting effects on the global energy picture. The oil market context – comparing the 1970s with today A comparison of the oil price shocks of the 1970s with the current oil market situation sets the hypothesis into context. The report considers similarities and differences between the 1970s and today. The similarities are:  Both periods are characterized by high crude oil prices.  There is a widespread view that the prices will go ever higher.  Following the oil shocks of the 1970s, the majority of developing countries did not pass on higher prices to their consumers. Today a number of countries, including the major oil exporters and India and China, are not passing on the higher prices.  Price rises were triggered by similar causes, with supply and demand playing a role.  Security of supply suddenly becomes a major issue.  A strong growth of 'resource nationalism' occurs in both periods. There are, however, important differences:  In the 1970s, the world experienced deep economic recessions. Today there has been no recession.  Today oil is much less important in the macroeconomy than in the 1970s.  The speed of the price change was much greater and the increase proportionately larger in the 1970s than today.  The nature of supply and demand is different in the two periods.  Today, environmental concerns are a key driver of energy policy; this was not the case in the 1970s.  There have been major changes in ideology affecting government policy. In particular, unlike in the 1970s, the 'Washington Consensus' discouraged government intervention. Industry investment has also been increasingly influenced by new ideas of 'value-based management' for the IOCs and 'principal-agent' analysis for the NOCs. The investment story Most conventional forecasts expect a very large increase in the production of liquid fuels. However, these forecasts simply assume this will be forthcoming. The report focuses on the willingness and ability of the IOCs and NOCs to deliver on these expectations and concludes that the expectations are likely to be disappointed. The willingness of the IOCs to invest is constrained by the adoption of 'value-based management' as a financial strategy. Thus they are returning investment funds to shareholders rather than investing in the industry. For the NOCs, willingness is driven by depletion policy. Increasingly this is motivated by a view that 'oil in the ground is worth more than money in the bank'. The IOCs' ability to invest is constrained by their inability to access low-cost reserves, by manpower shortages and by shortages in the service industries. Because of the spread of 'principal-agent' analysis which marks the NOCs as highcost and inefficient, many are starved of funds. Many producer countries are also experiencing a resurgence of resource nationalism which excludes IOCs from helping to develop capacity. In some cases, the structure of the oil sector militates against its ability to develop the country's reserves. Finally, in many cases rising domestic oil consumption is eating into the ability to export. Evidence is presented in this report to support arguments about inadequate investment. One is the failure of OPEC to meet plans for capacity expansion since 2005. Another is the poor performance of Non-OPEC. The literature on the change in investment patterns by the IOCs appears to support the a priori reasoning developed in the report that overall, investment in developing oil supply is inadequate and likely to remain so for the foreseeable future. The implications The report develops a forecast of future oil demand and supply based upon a number of assumptions. While the forecast is controversial and extremely bullish, even allowing for some increase in capacity over the next few years, a supply crunch appears likely around 2013. The implication is that it will quickly translate into a price spike although there is a question over how strategic stocks might be used to alleviate this. The problem in assessing what level the price spikemight reach is to decide from what base it might occur. This requires a view of future oil prices, which the report develops. It concludes that a spike of over $200 is possible. To avoid a crunch, energy policy needs to reduce the demand growth of liquid fuels, to increase the supply of conventional liquids or to increase the supply of unconventional liquids. Various options are considered, including helping oil-exporters manage 'resource curse', improving the investment climate for sovereign wealth funds and bringing OPEC into the IEA's emergency sharing scheme. However, the report concludes that only extreme policy measures could achieve a speedy response – and these are usually politically unpopular. Any major price spike would carry a macro-economic impact which would of itself provoke a policy reaction. The report argues that an oil price spike might break down opposition to a much greater interventionist approach by governments in their energy sectors. Thus it might do for energy policy what 9/11 did for US military and security policy. An intelligent and informed debate is needed about which energy policy interventions are desirable and which are not, and on what basis such judgments should be made.

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