It may come as no surprise to learn that high and rising energy prices defined the worldwide energy scene in 2007. But a review of the inexorable increase in the price of crude oil and other fuels reveals the extent to which the world is entering uncharted territory in terms of the prices people are paying to meet their energy needs.
By 2007 oil prices had increased every year for six years and that trend is continuing into 2008, Mark Finley, BP general manager, global energy markets, told a packed audience in Anchorage’s Captain Cook Hotel on June 19. That’s the longest continuous price increase since at least 1861, the time of the Pennsylvania oil boom, the earliest year for which BP has data, Finley said.
And, either on an inflation adjusted basis or after making adjustments for the efficiency of energy usage, oil has now reached its highest ever price level, he said.
Finley was presenting an overview of BP’s Statistical Review of World Energy, the company’s annual analysis of a massive array of data that describe worldwide energy production and consumption.
So what can that data tell us about the recent energy price hikes?
1970s price hikeIn looking for the drivers behind recent energy trends it’s worth comparing the steep climb in energy prices to a similar price spike during the 1970s — energy price graphs across the two periods look quite similar, Finley suggested.
“Can we look at the 1970s and see if there are similarities between that and now that we can learn from?” Finley asked.
Both the current period and the 1970s showed exceptionally high worldwide economic growth for driving energy demand, he said. But a careful examination of the data shows that the current situation is not just a rerun of what happened three decades ago.
In that earlier era energy consumption increased in lockstep with the economic growth; in the current situation, by contrast, consumption has slowed relative to an expanding world economy, Finley said.
“Globally last year energy consumption rose by 2.4 percent,” Finley said. “That is slightly above average but not nearly as strong as you would expect.”
And one of the most striking aspects of the recent situation has been the contrast between energy use in the developed economies of the Organization for Economic Cooperation and Development and in the non-OECD countries, Finley said.
The OECD countries have responded to escalating prices in a somewhat predictable manner by curtailing energy usage — these countries have shown no growth in energy consumption for about two years, he said.
Developing countriesBut during that same period developing countries outside the OECD significantly increased their contribution to energy usage.
“In the last five years they’ve contributed 40 percent of the economic growth,” Finley said. “… These same emerging economies have contributed 90 percent of all the growth in the world’s energy consumption in last five years.”
Finley said that this relatively fast non-OECD consumption growth probably resulted from factors such as a shift of heavy industry into the developing world, the use of cheap energy sources such as coal and government subsidies for energy use in many developing countries.
The picture for oil consumption is particularly striking. In the face of rising prices, oil consumption accelerated in the developing world while consumption fell in the OECD countries. The net effect was modest growth in overall oil consumption.
“Globally oil consumption last year grew by about 1 million barrels per day — that’s below average, but only slightly below average,” Finley said.
One factor in this phenomenon was an increase in oil consumption in oil exporting countries, where economies were especially booming. But developing countries that import oil also increased their oil use — energy subsidies appear to have been a significant factor in non-OECD consumption growth.
“All of the growth in global oil consumption last year occurred in countries that subsidize oil,” Finley said. However, countries are starting to cut back on those subsidies, he added.
OPEC cutsOn the supply side of the supply and demand equation, OPEC cut oil production in 2007 in response to a sharp drop in oil prices in late 2006, early 2007, Finley said. The resulting sharp fall in inventories was followed by a dramatic increase in oil prices.
Available data suggest that the 2007 OPEC production cut amounted to about 350,000 barrels per day, with net worldwide production falling by about 130,000 bpd. But because of missing data from Iraq and Angola, and because natural gas liquids data are not included in the reported OPEC figures, the actual OPEC production drop probably came closer to 900,000 bpd, Finley said.
In countries like the United States and Canada oil production is rising, as increasing prices encourage new investment in oil development.
“Last year U.S. oil production … increased slightly and it was the first increase since 1991,” Finley.
Production continued to grow in the countries of the former Soviet Union. However, there are signs that Russian production is faltering.
“Since 2000 the growth in Russian oil production has met all of the growth in the combined consumption of China and India,” Finley said. “… In recent months we’ve seen the first year-on-year decline in Russian oil production this decade.”
Finley attributed the Russian production decline to “a high tax regime and a regime that is increasingly difficult for investment.”
Gasoline pricesFinley said that the primary driver behind rising gasoline prices has been the rising price of crude oil. He discounted the theory that high gasoline prices have resulted from a lack of oil refining capacity. In actual fact, worldwide refining capacity has grown, mainly in the Asia-Pacific region and the Middle East, and refining margins have tightened, he said.
“If the world was awash in oil and the bottleneck was at the refinery gate, that would tend to support refining margins,” Finley said. “… For two years in a row the growth in refining capacity has actually outpaced the growth in oil consumption. … It’s important to recognize that refining is very substantially a global market.”
The one exception to that pattern in the refining business has been the especially robust demand for mid-distillate fuels such as diesel and jet fuel. These fuels have seen the fastest growth of any form of oil consumption for seven out of the past nine years, Finley said.
Finley also questioned the concept that market speculation is driving fuel prices higher. Worldwide there is a lack of data on the role that speculation plays in oil and natural gas trading. However, data from U.S. markets indicates a lack of correlation between, for example, fuel oil prices and the volume of trading activity that might be linked to speculation, Finley said. That lack of correlation points to pricing that is not driven by speculation, he said.
“We tend more toward the view that most of the increase in prices that we can see is driven by (market) fundamentals and by changing expectation for the future,” Finley said.
And the oil market is constrained in several ways that would drive those fundamentals, Finley said. In addition to the OPEC production cuts in 2007, oil resource owners around the world are making access to new oil sources difficult. Production is declining in many mature oil basins. There have also been constraints in the oil industry’s ability to ramp up investments quickly at a time of cost inflation and mounting project delays. And at the same time government subsidies have distorted the market dynamics.
So, how do other energy markets compare with oil?
Natural gasOne notable factor in 2007 was the fact that natural gas was relatively cheap compared with other fuels. As a consequence natural gas usage accelerated, with gas use for power generation growing by 10 percent.
“Gas consumption globally last year grew by 3.1 percent,” Finley said.
Chinese demand has become a big factor in natural gas consumption, with both Chinese gas production and Chinese gas consumption seeing the second highest increase of any country in the world in 2007.
The largest contribution to the increase in global gas supply in 2007 came in the United States, with the relatively high prices of recent years encouraging expanded production.
But, curiously, factors such as a relatively mild winter in Europe led to a decline in Russian natural gas production in 2007.
Natural gas typically competes with other forms of fuel, but the nature of that competition varies from one part of the world to another, Finley said. In the United Kingdom, for example, gas competes with coal for power generation and there is scope for gas to increase its market share in the energy mix. In the United States, on the other hand, gas competes with oil and gas appears to have won out for power generation — there is no further scope for oil to replace natural gas as primary energy source.
Finley also commented on the importance of LNG in connecting worldwide natural gas markets — although LNG represents a minority of the total gas market, LNG can be readily shipped around the world.
“Liquefied natural gas plays a role in connecting what had previously been disconnected regional gas markets around the world,” Finley said.
In fact, there is a disparity between the locations of LNG production regions and LNG consumption regions. The most diversified LNG suppliers are located in the Atlantic region while the biggest and most diversified consumers are in the Pacific region, Finley said.
CoalCoal remains a major world source of energy but differs from oil and gas in that coal production tends to occur close to where the fuel is consumed.
“The two biggest consumers in the world of coal are the two biggest producers — China with a 40 percent market share, the United States with a 20 percent share,” Finley said. The six biggest coal producers worldwide account for 80 percent of both the production and consumption, he said. The result is that only 15 percent of the world’s coal is traded internationally.
And although coal prices in international trade have increased sharply, coal for local consumption has tended to remain relatively cheap — that cheap local coal accounts for a rapid rise in worldwide coal consumption. In fact, coal was the fastest growing fuel in 2007, with China accounting for 40 percent of that growth (China accounted for half of the worldwide growth in total energy consumption in 2007).
Over the past 10 years electrical power generation has tended to grow worldwide a little faster than economic growth.
“In 2007 we had a very strong year for power generation — it grew by 4.8 percent globally,” Finley said. That’s twice the rate of growth of overall energy consumption, he said. But power generation followed the general worldwide energy pattern, with a slowdown in the OECD countries and rapid acceleration elsewhere.
Hydropower and nuclear power, each at about 6 percent of total worldwide energy, have remained fairly static over recent years. Nuclear power output declined by 2 percent in 2007, largely as a result of a major earthquake in Japan and government action in Germany.
Coupled with the growth in overall power generation, the decline in combined nuclear and hydro outputs suggests that power generation formed the main driver for fossil fuel consumption growth in 2007, Finley said.
RenewablesFinley characterized the electricity generation from renewable sources such as wind power, solar energy and geothermal energy as expanding rapidly from a very small base. Renewables represent about 1 percent to 1.5 percent of total world electricity generation. But the distribution of renewable energy generation across the world is very uneven, with countries such as Germany making especially high use of renewable sources.
Globally, ethanol production reached 900,000 bpd in 2007, Finley said. On an energy equivalent basis that represents 0.7 percent of the world’s oil consumption. In the United States, rapid growth in ethanol use pushed consumption of that fuel to a level representing about 5 percent of gasoline usage.
Overall, with fossil fuels, especially coal, dominating the world energy scene, carbon emissions grew faster than energy use in 2007. However, carbon emissions fell in Europe, probably because of the warm winter.
“(Worldwide) we don’t really see the evidence in the data that we’re making progress on constraining the growth of carbon emissions,” Finley said.
So what does all of this mean in terms of the world use of crude oil?
Rising oil reservesWorldwide, proven oil reserves continue to increase, with sufficient reserves to maintain current production levels for a little more than 41 years, Finley said. There are more than 60 years of reserves of natural gas and more than 130 years of reserves for coal. And oil reserves are being replaced — in 2007, for example, the Canadian government reclassified the portion of reserves in oil sands that are under active development.
“The world is not running out (of oil),” Finley said. “Reserves go up and not down over time.”
So why is there an oil supply crunch that is driving prices up?
“The challenges that the world faces on global basis for expanding supply are not below the ground,” Finley said. “… We believe that the world has the resource base to support much higher levels of production.”
The keys to increasing supplies lie above the ground, in loosening market constraints that limit access to new resources, he said.