Lessons from the 20th century teach the oil industry how to deal with the challenge of volatility and rising demand, says Opec president Sheikh Ahmad Fahad Al-Ahmad Al-Sabah.
Oil has been the world’s dominant commercial energy source since early last century, when it took over this role from coal. In time, this highly accessible, adaptable and distributable hydrocarbon transformed the way the business world thought and acted, particularly between the two world wars, and gathered widespread industrial, commercial and domestic applications.
Oil has retained this status ever since, although, towards the end of the last century, gas began to claw into this ascendancy, as its transport and distribution capabilities improved and its profile rose among environmentalists. However, oil still accounts for around 40% of the global energy mix, compared with 25% for gas and 26% for coal.
A changing industry
Thirty years ago, in 1975, the international oil industry was experiencing a period of fundamental change. The oil-producing developing countries were asserting their sovereign rights to have a greater say in the way the industry was run, particularly with regard to the pricing of their crude on world markets and the development of their domestic petroleum sectors. A fairer balance was thus created in the market between the interests of the producers, within whose boundaries 72% of the world’s proven crude oil reserves then lay, and the multinational oil companies, who had overwhelmingly dominated the industry up to that time in the post-Second World War period.
It must be recalled here that this was happening within the framework of an international oil market that was split into “market economies” and “centrally planned economies” (CPEs – a division that vanished at the beginning of the 1990s, with the dissolution of the former Soviet Union) and that the domination to which we refer was happening in the market economies. My remarks for the period up to the early 1990s therefore relate almost exclusively to the non-CPE world, since the two oil worlds functioned almost independently of each other up to that time.
While the oil price rises that occurred during the 1970s are seen by the Organisation of the Petroleum Exporting Countries (Opec) as reflecting the rightful adjustments to the previous wrongs in the oil industry – in a directional sense, at least – they were also driven by economic and political forces in the international arena that were beyond Opec’s control. The latter was also true with the reverses of the 1980s, notably the precipitous decline and eventual collapse of oil prices in 1986. By then, it was clear that there were no real winners from market volatility and seesawing prices. Producers were losing out on several fronts. Looking at Opec member countries alone, not only did their absolute production levels plunge, from a peak of 30.8 million barrels a day (mb/d) in 1977 to a trough of less than the half of this in 1985, 14.9 mb/d, but so did their market share – from a high of 55.4% in 1973 to a low of 28.5% in 1985.
There was a double effect on petroleum revenues. The decline in revenues in absolute terms was bad enough for essentially single-product developing countries whose economic and social development was almost totally dependant on oil sales; a high of $276bn in 1980 was set against a low of just $76bn in 1986. But the fact that this was accompanied by high levels of volatility made it extremely difficult to plan and implement sound investment strategies for the future, either in domestic development or back into the industry itself. Most OPEC members found themselves laden with crippling levels of debt, and it took many years and much hard work to retrieve themselves from this situation.
Effect of volatility
In the non-CPE world economy at large, the rising oil prices of the 1970s were linked with the existing inflationary trends of that period, since oil accounted for a high proportion of the energy used in the consuming countries. But, while these countries understandably welcomed the fall in oil prices in the 1980s, the accompanying volatility and uncertainty had a deleterious effect on many of their day-to-day activities, as well as their investment planning for the future.
If we turn the clock forward to the present day, to an oil market which again, over the past 18 months, has witnessed high levels of volatility and rising prices, we see a very different situation, with regard to the effects on the world economy, which is now a truly global economy a decade and a half into the post-CPE era.
While many people recall the experiences of the 1970s, and consequently have sought to detect significant repercussions of the recent high oil prices on the world economy, they have found little or no evidence of this actually happening. In fact, in some parts of the world, notably China, India and the US, economic growth has remained robust throughout the past 18 months of volatile oil markets.
Solid growth
Indeed, recent data from the eurozone has confirmed that the third quarter of 2005 was a period of strong growth for the world economy, with the established developed areas of the US, the eurozone and Japan achieving simultaneous solid growth.
Accommodative monetary policies, low inflation rates and a healthy growth in world trade boosted manufacturing output; high levels of household wealth allowed consumers to absorb the higher energy prices; and improved levels of energy efficiency have softened the impact in industrial costs. Moreover, the forecast growth rate for the world economy in 2005 has been increased to 4.3%, and this is expected to be followed by growth of 4.1% next year.
However, there is no room for complacency, as signs of an impact on some economies are beginning to appear, especially on emerging economies with large fuel subsidies.
Why is the situation different now to what it was 30 years ago?
Let us first look at oil prices. While these have reached record levels this year, this has only been in nominal terms. In real terms, when taking into account inflation and exchange rate movements, they are still well below levels reached in the early 1980s.
Next, the world is decreasingly dependant on oil for its economic growth. Globally, oil intensity – the amount of oil required for a pre-defined unit of gross domestic product (GDP) – has declined by around 50% since 1970, due to factors such as technology, improved efficiency, government policies and changing consumer behaviour.
This means, for example, that, in the world’s largest economy, the US, (even with the present high crude prices) consumers are paying an estimated 3% of their disposable income on gasoline and oil, compared with about 4.5% a quarter of a century ago.
On top of this, the oil industry is much more cohesive and integrated than it was in the 1970s. It is now evolutionary, rather than revolutionary, so to speak. Through major advances in dialogue and cooperation right across the industry – involving all parties, Opec and non-Opec, producers and consumers, the international oil companies and so on, and supported by now-established institutions like the International Energy Forum, whose specific purpose is to foster producer-consumer dialogue – it is now much better equipped to detect and handle the challenges facing it.
This has been proved time and time again, such as successfully calming the impact on the market of the outbreak of war in Iraq in 2003 and the devastation caused by Hurricane Katrina this year. The industry has, of course, also learned from the experiences of the 1970s and 1980s, and such case studies were not available to it three decades ago.
The more mature, sophisticated and technologically advanced oil industry is also well set up to handle the challenges of the next 20 years, during which period oil demand is forecast to continue rising at an annual rate of 1.5%, according to the Opec World Energy Model (OWEM). With around four-fifths of the world’s proven crude oil reserves, Opec will have an increasing role to play in meeting this demand, and our member countries are committed and ready to carry out this task.
Steady, predictable inflows of oil revenues remain central to their economic and social development, even in those cases where they are well advanced in the process of diversifying into other lucrative areas of economic activity. In short, it is in the best interests of oil-producing developing countries everywhere to ensure stable markets, secure supply, reasonable prices and fair returns to investors.
But to be truly effective in meeting the future needs of the market requires a concerted effort from many other parties, including some which at first may seem somewhat detached from the industry, such as government policy-makers in consuming countries. The recognition that oil has a major contribution to make to the world economy for decades to come, and that it can do this in an increasingly cleaner and greener way (as is now universally expected by producers and consumers alike) should be reflected in government policies that encourage the continued exploitation and development of this vital resource, especially from areas of greatest abundance in the world.
Consistency essential
Steadfastness and consistency in policy-making here is essential, to minimise as much as possible uncertainties that can have a detrimental impact on otherwise sound investment strategies. Investment lead times can be very long in the oil industry and the capital sums up front extremely high and so every effort must be made to fine-tune investment as far as is feasible.
Opec projections show that oil will remain the world’s leading energy resource throughout the next 20 years. Even though its market share will dip slightly to 37%, it will still be well above that of gas, which will have climbed to 30% by 2025. We in Opec are confident that oil will continue to make a major contribution to the ongoing growth of the world economy, in a manner that is steady, predictable and effective. We will relentlessly pursue our longstanding efforts to ensure that this happens.
HE Sheikh Ahmad Fahad Al-Ahmad Al-Sabah is president of the Opec Conference, secretary general, minister of energy, Kuwait.
