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Meeting oil industry challenges: An OPEC perspective

By Mohammed Hamel
Nigerian Tribune
April 24, 2007

Speech delivered by Mr. Mohamed Hamel, Head, Energy Studies Department, on behalf of OPEC's Secretary General, HE Abdalla Salem El-Badri, at the 8th International Oil Summit, Paris, France.

Let me start by thanking the organisers for the invitation to present on behalf of OPEC’s Secretary General, HE Abdalla Salem El-Badri, to such a distinguished gathering and on such important topics. Given the history and nature of our industry, the use of the words ‘challenges’ and ‘cooperation’ for today’s session could not be more apt.

The oil industry has successfully dealt with many challenges in the past; through technology development, extended reach, innovative ways of doing business and by continuously creating and developing new opportunities. Today, in a more global and interconnected world the challenges continue, some new, others the result of past actions and behaviours, but all necessitating innovative thinking, collaboration, timely adaptation and swift action.

To the fore and perhaps the overriding challenge is that related to sustainable development. The focus is on ensuring healthy economic growth, rapid social progress and environmental protection in a mutually-supportive manner. Like in the past, energy will be essential in this respect. Our reference case projections to 2030 show global energy demand increasing by around 1.7 per cent annually. It also highlights that fossil fuels will continue to provide more than 90 per cent of the world’s total commercial energy needs, with oil remaining the leading source in the global energy mix, although its share may decrease from 39 per cent to 36 per cent.

Regarding oil, the reference case scenario displays world demand rising at an average annual rate of 1.4 per cent during this period, climbing from 84.6 mb/d in 2006 to 118 mb/d in 2030. Developing countries account for most of this rise, with consumption doubling from 29 mb/d to 58 mb/d. More than two-thirds of this growth will be in Asian developing countries. For oil, the main source of future increases will be in the transportation sector. Thus, the industry is very sensitive to any technology, policy and economic developments in this sector.

To complete the future demand outlook, what I need to underline are the uncertainties in all this. Doubts over how future oil demand plays out translate into large uncertainties over the amount that OPEC Member Countries (MCs) will eventually need to supply, signifying a heavy burden of risk. For example, to 2020, scenarios developed by the OPEC Secretariat highlight that the amount of oil required from OPEC could range by close to 9 mb/d. And this is where we come to the security of demand challenge; for the oil industry as a whole and for OPEC MCs specifically.

In monetary terms, the corresponding range for MCs is somewhere between $230 billion and $500 billion, representing a huge uncertainty for MCs upstream investment requirements, all with competing needs in such areas as health, education and infrastructure. In addition, a large amount of idle capacity would put much downward pressure on prices and be detrimental to vital export revenues. In fact, the risks have heightened recently. For example, recent policy initiatives that discriminate against oil, involving subsidies for competing fuels and higher tax rates, may see even lower demand for oil products in general, and for OPEC oil in particular.

In the EU, Member States have agreed to adopt a binding 2020 target to increase renewable fuel use by 20 per cent. And the US is promoting the use of ethanol with subsidies and has set out ambitious targets for increasing the use of alternative fuels. The most recent proposal in the US – the Alternative Fuels Standard Programme – sees alternative transport fuel hitting almost 2.3 mb/d by 2017. This is approximately 1.5 mb/d more than what has been laid out in OPEC’s reference case over the same period.

It begs the question: will producing countries need to revisit their investment plans, in the face of policies that lean towards a movement away from oil? Investments in capacity that will just lie idle do not make sense. While OPEC has offered in the past, and will continue to offer in the future, adequate levels of spare capacity for the benefit of the world at large, it cannot be expected to invest in what to all intents and purposes is a back-up security policy in case alternative fuel policy initiatives fail to materialise.

With regards to policies, it is also worth mentioning the continuing upward trend in the taxation of oil products. This has evolved over the past three decades despite the up and down nature of crude price behaviour. This throws up a challenge to the industry as a whole as most of the end-consumer price ends up in the budget of the consuming country government. It means that only a relatively small fraction is left to recover costs and provide returns to producers and those investing in the industry.

The uncertainties I have just described also impact the downstream. Our analysis reveals tightness in the refining sector in the form of inadequate refining capacity which has been putting much pressure on oil prices generally. The extent to which refining tightness will ease will depend on the evolution of what is currently a neck-and-neck race between refinery capacity growth and demand growth.

OPEC’s assessment of existing refinery projects indicates that investments, including new units and maintenance and replacement, total $455 billion, with the largest number of capacity additions and investment taking place in the Middle East. As with the upstream, however, timely investment needs to take into account policy initiatives. Uncertainties related to the levels of future products demand and non-refined supplies are currently resulting in additional risks, for a sector traditionally characterised by low margins and high volatility.

Alongside the investment issues I have highlighted, it must also be appreciated that we are presently in a period when costs are significantly inflated, in part, as a result of the low oil price environment ten years or so ago. This led to the implementation of downsizing and cost-cutting strategies in particular in the services sector. According to CERA, upstream costs have increased by 53 percent over the last two years. It leads me to the question: is this cost behaviour structural or cyclical? Whatever the answer, it is a huge challenge facing the industry and an issue that needs to be continually monitored.

The industry’s expansion is also being significantly constrained in the area of human resources. A shortage of skilled labour for drilling, engineering, procurement, construction and other services and a downturn in the number of students in energy fields are serious reasons for concern. As an industry today it often appears that we have an image problem and we are becoming less attractive as a career choice. One of the reasons is that the industry is unfortunately often painted as one in its twilight years or the cause of many of the worlds’ ills. To counteract these views, the industry needs to make concerted efforts to help facilitate education and training in energy disciplines. We need to make the industry attractive to prospective graduates – this includes making it easier for students to enrol in universities across national borders.

Let me stress at this juncture that despite the many uncertainties surrounding the future demand for its oil, in spite of the extremely high costs and the shortage of skilled labour, OPEC MCs are investing heavily in maintaining existing capacity and building new capacity, to ensure that markets are adequately supplied at all times and there is a comfortable level of spare capacity. Going forward, OPEC crude capacity expansion plans already in place are expected to result in almost 40 mb/d of crude capacity by the end of 2010, underpinned by more than 140 projects totalling more than $120 billion. In addition, many MCs are investing in the downstream, both inside and outside of their borders, thus contributing to alleviating the current downstream tightness. OPEC is doing its share and is committed to ensuring order and stability in the international oil market, with secure supply, reasonable prices and fair returns to investors.

What all this points to is the fact that the energy security challenge is one that requires a shift from talk of one-way dependence to interdependence. It is a two-way street. For example, while net oil imports in OECD countries is around 60 per cent of their total demand, oil exports in OPEC MCs account for no less than 77 per cent of total exports. The role of oil is equally important to the economic growth and prosperity of consuming-importing countries as well as to the development and social progress of producing-exporting countries. The concern of consuming countries for the secure flow of oil at reasonable price is matched by the concern of producers for predictable demand, non-discrimination against their products, access to markets, reasonable and stable prices for their exhaustible resources and adequate revenues for their socio-economic development.

I would like now to turn to another extremely important challenge for the future of the oil industry: the protection of the environment, both locally and globally. Up front, let me stress that the oil industry has a long history of successfully improving its environmental credentials, for both the production and the use of the world’s leading energy source. For example, as this slide shows, tailpipe emissions of non-CO2 substances have been enormously reduced over the past three decades.

In the global environment arena our MCs have invested billions of dollars over the past decades in flared gas recovery projects. This represents a significant contribution to the reduction – by more than half since the early 1970s – of the amount of gas that has been flared per barrel of oil produced. Globally, it is extremely important to underscore that an increase of fossil fuels use, as painted by all scenarios, can be made compatible with the objective of limiting or reducing the level of greenhouse gas (GHG) emissions.

We need to look at technological options that allow the continued use of fossil fuels in a carbon-constrained world. One promising option is carbon capture and storage (CCS), applied to large stationary sources of CO2 emissions, such as power stations and industrial sites, which together account for over half the energy-related CO2 emissions. CCS can also be used in conjunction with CO2-enhanced oil recovery. Last year, OPEC held a workshop with the EU in Riyadh on CCS, a demonstration of its commitment to this technology. It is also joining the IEA GHG R&D Programme.

In the area of CCS and similar technologies, industrialised countries, having the financial and technological capabilities, should take the lead, by promoting large-scale demonstration projects. This includes through the possible use and probable redesign of the Kyoto Protocol’s Clean Development Mechanism (CDM).

The challenges described all point to the need to develop and explore, existing and new avenues of cooperation, in the context of an increasingly interdependent world. Efforts at expanding dialogues are something our Organization has, and continues to devote much energy to. The most recent result of this was the establishment of energy dialogues between OPEC and a number of other industry stakeholders: the EU, China, Russia, a number of other non-OPEC producers and the IEA.

This year will also witness OPEC broadening its talks. In late March, there was a meeting with the Association of Southeast Asian Nations (ASEAN) in Bangkok, and early talks will be held with Japanese officials from the Ministry of Economy, Trade and Industry in Tokyo. I would also like to highlight the role of the International Energy Forum (IEF) in promoting the producer-consumer dialogue. Its Secretariat in Riyadh is also the home of the Joint Oil Data Initiative (JODI) and OPEC is extremely proud to have played a significant part in the development of JODI. The initiative has quickly evolved into an internationally-respected initiative focused on advancing the transparency, quality, timeliness and flows of energy market data.

Allow me to conclude by bringing you back to the issue I mentioned at the beginning of my speech: sustainable development. The goal in every decision we make needs to take into account its three pillars: economic growth, social development and environmental protection. With all OPEC Member Countries, developing ones, the issue of sustainable development is one close to the Organization’s heart. In fact, His Excellency Abdullah bin Hamad Al Attiyah, the Second Deputy Prime Minister and the Minister of Energy and Industry for Qatar, holds the Chair at the present 15th session of the influential United Nations Commission on Sustainable Development. What needs to be recognised is that sustainable development means different things to different people. In this world, it is abundantly clear that many social and economic disparities exist.

Today, 1.1 billion people are currently living on less than $1 a day, almost two billion have no electricity and many people rely on traditional biomass for cooking and heating in unsustainable ways. For them, energy is not just about the pumps being full, the public transport infrastructure ticking over, or the DVD player being to hand. It is about having the basic energy services to help eradicate poverty, support health care and education, provide the rudimentary conditions for economic development and enhance living standards. I am proud here to mention our sister organisation, the OPEC Fund for International Development, which is contributing its share to poverty alleviation, through developmental actions in 119 countries.

So just as oil played and continues to play a key role in fuelling the development of industrialised countries, so it will also help fuel the growth of today’s developing nations. It is thus essential that we continue to meet the challenges our industry faces.