Oil prices pushed up last week, back towards $120 per barrel. Brent crude is now 25pc more expensive than at the start of the year.
The OPEC oil exporters’ cartel, meanwhile, has just failed to agree an official boost to output. And oil markets are getting tighter, as global petroleum demand reaches levels that quite simply have never been seen before.
Prices pressures rose last week after the OPEC summit in Vienna ended with the twelve-member group in discord. Saudi Arabia had led an effort to raise production quotas. But Iran, Venezuela, Iraq and three others refused. Ali Naimi, the veteran Saudi Oil Minister, long-accustomed to getting his own way, called it “one of the worst meetings we have ever had”.
Speculation ahead of the summit suggested the cartel would raise its output quotas from the current 26.2m barrels daily, perhaps by another one of two million. In the event, a renegade group blocked the increase, a position the cartel now says it won’t review for another three months.
What was significant about Vienna wasn’t so much the differences in opinion. The likes of Venezuela and Iran have protested against production hikes many time before. The new development was that the “hawks” were so strong a camp, so galvanized, that Saudi Arabia, the cartel’s largest producer and most dominant decision-maker, couldn’t enforce its point of view.
Before examining the supply-side implications of events in Vienna, it is worth taking stock of the extent of global oil demand. For this is a subject, amidst all the intrigue, drama, conflict and high-politics that surrounds oil extraction, that generates surprisingly little attention. The reality is, though, that worldwide oil consumption is escalating far faster than is commonly understood. The numbers are actually rather shocking.
Global demand in 2011 will go above 90m barrels per day for the first time in history, according to the International Energy Agency, the Western world’s oil think-tank. That would top the previous record-high of 87.4m, set in 2010. Having fallen slightly in 2008 and 2009, crude demand surged last year and in 2011 is surging again.
This is happening even though the Western world is in the economic doldrums. For while oil demand in the OECD “industrialized nations” rose only 0.9pc last year, across the non-OECD nations it rocketed 5.5pc. The emerging markets, including the fast-industrializing giants of the East, are clearly now making the economic weather. And this has major implications on global energy markets.
China and India between them are home to a third of the world’s population. Even in 2009, when the world economy was on its knees, these emerging Asian giants grew 8.7pc and 6.6pc respectively. Last year, almost in defiance of still sluggish Western export demand, China and India expanded by almost 10pc.
As they grow, these countries are investing massively in infrastructure development – roads, buildings, machinery. This is highly energy-intensive. In conjunction with this, their vast and fast-growing populations are becoming wealthier, acquiring cars and consumer goods for the first time, while switching to protein-rich diets.
In 2010, Chinese oil use grew by an astonishing 15pc year-on-year, with the People’s Republic now burning more than 10m barrels daily. And China’s per capita oil usage still remains only at a fraction of Western levels. As incomes grow, in the decades to come, Asian crude use will not only keep rising, but could well accelerate.
New estimates by BP suggest that by 2030 the world will be consuming 40pc more energy than it does today. That’s like adding two more current-day Chinas to global energy consumption. This will happen partly due to on-going industrialization in the East, but also population growth. Almost all the rise in energy use over the coming two decades – no less than 93%, says BP – will come from emerging economies such as China, India, Indonesia, but also the nations of South America and the Middle East. So, even if America and Western Europe manage to conserve energy, and Western demand is flat, global energy demand is still on an upward mega-trend.
In 1970, the OECD countries accounted for around 70p of world energy use. Today the split between “the West and the rest” is more like 50:50. By 2030, BP expects that non-OECD countries will account for two-thirds of total energy consumption. I don’t think that’s right. The more likely date, in my view, is 2020.
We can talk about renewable energy. The emerging markets, particularly the Chinese, also won’t hesitate to burn more of their still-abundant coal. But the world economy, and particularly the West, must brace itself anyway, for previously unheard of levels of global oil consumption, driven up by the emerging markets.
Against this strong demand backdrop, turmoil in the Middle East has sparked immediate supply-side fears. OPEC has lost nearly all output from Libya, which was pumping 1.6m barrels back in January, before its descent into civil war. Given that, there was a widespread expectation in Western capitals, which now looks like wishful thinking, that Saudi would go to Vienna and, as usual, order the rest of OPEC to push up production quotas.
Yet that is to under-estimate the severity of Saudi Arabia’s acute dilemma. Many leading oil producers have been forced to spend more on social programs to placate their restless populations. Saudi’s current “break-even” oil price, at which its domestic budget balances, is now $85/barrel, according to the Washington-based Institute of International Finance, up from $68/barrel in 2010.
As recently as 2003, Saudi break-even was only $30/barrel. The IFF estimates break-even prices for Bahrain, Oman, UAE, Qatar and Kuwait, while having risen less than in Saudi, have also more than doubled over the same period. Demographic pressures mean the Saudi figure will spiral to $110 by 2015, says the IIF.
The mighty Saudi Arabia is also subject to production constraints. Riyadh’s Al-Hayat newspaper just reported that production will rise to 10m barrels daily next month, up from 9m today – despite OPEC’s Vienna tantrum. Yet Saudi also recently announced a 30pc increase in its new rig order book for 2011/2012 simply “to maintain production”.
This is part of a broader pattern among oil producers, namely an increasing reliance on smaller wells. New oil fields brought on stream over the last 3 years have averaged only around 20m barrels of reserves. Back in the 1960s and 1970s, the era of the “giant finds”, the average newly-commissioned well boasted over 520m barrels.
Industry estimates point to a global production decline rate of almost 7pc per annum among existing fields – suggesting reliance on smaller wells will intensify. Such wells, of course, require more rigs, labour, infrastructure and other inputs per barrel of oil produced. In other words, in the face of rising medium-term demand, crude is becoming more difficult and costly to extract.
The Western world used to benefit of a vital economic safety value. When our economies slowed, that would have a decisive impact on global energy demand, causing oil prices to fall back. OPEC’s raison d’etre, back in those days, when they controlled around 40pc of global production, was to stop that happening by attempting to limit supplies.
Today OPEC’s market share is much lower. Oil demand is soaring and will continue to do so whatever the Western world does. The main economic influence on global oil prices is no longer “OPEC-induced supply constraint” but “rampant demand”. OPEC can still drive a headline, and matters at the margins. But when it comes to the long-term trends, the Vienna summit meant nothing.
Liam Halligan is chief economist at Prosperity Capital Management
This article first appeared in The Sunday Telegraph: