July 26, 2016
Strategic oil projects have a considerably longer horizon and decisions taken in the oil sector are driven by what is expected with regard to the future of crude oil and its prices in 25 years. A quarter of a century is a long time, and a lot can happen over the span of 25 years. It is enough to recall what we thought of the oil market 25 years ago compared to what we know now. Back then, global economy was dominated by two superpowers: the US and the Soviet Union, and China’s GDP was ten times lower than the US GDP (in US dollars as at 2014). The world had only just started looking at climate change. The second United Nations Conference on Environment and Development (the Earth Summit), at which 170 countries adopted the United Nations Framework Convention on Climate Change, was held only in 1992, 20 years after the first Conference held in Stockholm. Crude price was under 25 dollars per barrel, and China’s demand accounted for only 3.5% of global oil consumption. There was a widely shared opinion that oil reserves would be exhausted, which should drive oil prices up in the long term.
Today, after 25 years, China is the world’s second largest economy, with GDP lower than the US GDP by less than 40%, and the country has been on a fast-growth track since joining the WTO, boosting global demand for oil and driving up oil prices to more than 140 dollars per barrel in 2008. In the US, the technology for extracting hydrocarbons directly from the source rock has been developed, and the world gained access to oil resources on a scale never before imagined. The OPEC cartel, which has controlled oil prices since 1973 (first directly, and since the end of the 1980s, when oil was first traded at a commodity exchange − indirectly), finally lost its leadership. In parallel, the increasing role of climate and environmental protection in energy sector’s strategic decisions is steadily pushing oil out from its last outpost − the transport sector (which consumes more than 65% of the global oil output). Demand for oil in the OECD countries reached its all-time high in 2007, and has been falling since. Outside the OECD, the thirst for oil is still on the rise, driven mainly by demographics and faster economic growth. However, the role of those drivers will diminish and in 15 to 20 years global demand for oil will start shrinking, as oil will be gradually replaced by alternative energy sources.
The scenarios for oil market adopted 25 years ago have proven wrong. It is very likely, if not certain, that the same will happen to today’s long-term scenarios, because there is no way to predict the unpredictable. However, if we focus our scenario analyses on the consequences of the assumptions adopted for key issues and on known adjustment mechanisms, both on the supply side and the demand side, then we are better positioned to discuss the future of oil and its prices.
In the low oil price scenario of the European Energy Agency, I referred to in my earlier post, it will not be possible to keep oil prices below 50$/b for more than 2 to 3 years; therefore, we can expect an uptrend in prices in a longer term. But how to reconcile this with the expectations that the global demand for oil will grow at a slower rate and even start shrinking in the long term trends?
This apparent contradiction is caused by the fact that to quench the thirst for oil in a long-term horizon, the production increase of crude must exceed the rise in demand several times over. This is caused by the gradual depletion of producing fields. The magnitude of the decline of output from such fields until 2040 will exceed the growth in demand for crude oil and liquid fuels. The IEA report presents a New Policies Scenario which predicts how the global energy sector could develop if politicians were determined to implement all their climate policy commitments. According to this ‘green’ scenario, demand for oil and liquid fuels (excluding biofuels) would only increase by 13 mbd (0.5 mbd annually) until 2040, which is well below current market projections. However, just to offset the diminishing output from producing conventional fields until 2040, 43 mbd of oil from new fields would be required. As new deposits are increasingly difficult and expensive to develop, the price of oil must be high enough to ensure profitability at premium cost. But what price are we talking about? In 15 to 20 years, oil prices will probably oscillate between 80 and 100 dollars per barrel (in USD as at 2014, excluding inflation).
Today we have published the ORLEN Group 2015 Integrated Report, which shows the relations and dependencies between business and non-business aspects of our operations. Our CSR activities are financed with proceeds from oil refining, the core of our business. That is why the prospects and outlooks for the global oil market, both in near and long term, have been some of the key themes discussed in our integrated reports since last year. The way we see and understand them determines our growth opportunities and readiness to deal with the numerous risks that oil market players may face. My assessment of the challenges ahead of us is presented in the Integrated Report. Interesting content and innovative form are what the report offers. I do invite you to read it.