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Lloyds List: Shipping feels the energy crunch

Martyn Wingrove, Lloyds List
Published: Jul 17, 2007

THE world is finally beginning to open its eyes to the fact that oil supply shortages are looming as global oil production is pushed to peak levels.

The recent announcement by the well-respected International Energy Agency that the world is facing an oil crisis early in the next decade is a milestone for those that have predicted falling levels of oil production.

When the IEA cautions of a supply crunch in the opening two paragraphs of its medium-term oil market report, the world takes notice. But it is unlikely to react quick enough.

In its latest report, the IEA forecasts annual growth in global oil demand of 2.2% per year, from around 86m barrels per day this year to a huge 95.8m bpd in 2012.

This means the oil industry will have to invest heavily in finding and developing new resources to keep pace with demand driven by surging populations and economic growth in Asia.

The IEA’s supply shortage conclusions are a sign that the oil industry is ready to formally adopt the peak oil theory.

Analysts at Barclays Capital call the IEA’s change in tone a brave and welcome move.

‘We would now claim that the supply crunch view is moving into the mainstream,’ say Barclays’ Paul Horsnell and Kevin Norrish in their weekly report.

The IEA, which advises 26 governments, predicts rising demand will lead to even greater dependence on Middle East oil, as there are not enough projects in the pipeline outside this region.

The IEA believes production levels in countries outside the Organisation of Petroleum Exporting Countries will increase, but at a rate slower than demand will rise, putting more pressure on the oil cartel to increase exports.

This will be good news for Opec, which controls the flow of crude through the Straits of Hormuz to North American, European and Asian markets.

But it will also mean that any spare production capacity will be needed to meet market demand, leaving no slack in an already nervous market that is getting too comfortable with high prices.

The IEA’s message can be seen as a warning to Opec nations, especially Saudi Arabia, not to hold back on their investment plans in order to extract profits from high oil prices.

It is also starting to sound like a cry of desperation from oil consumers.

The Paris-based IEA says Opec’s production capacity will need to rise from around 34m bpd this year to 38.5m bpd by 2012, but its spare capacity of 3m bpd now could shrink to almost nothing by 2012.

Tight supply levels means oil prices could climb even higher than the $75 a barrel seen this month, and if Opec cannot turn on any more taps there are doubts as to where the rest of the oil required will come from.

‘A stronger demand outlook, together with project slippage and geopolitical problems has led to a downward revision of Opec spare capacity by 2m bpd in 2009,’ the IEA says in its report.

‘Despite an increase in biofuels production and a bunching of supply projects over the next few years, Opec spare capacity is expected to remain relatively constrained before 2009.

‘Slowing upstream capacity growth and accelerating demand once more will pull spare capacity to uncomfortable levels,’ the report says.

The world will likely be lumbered with high oil prices for the medium-term, and will have to adjust to this in the long run, unless demand can be constrained.

The IEA forecasts of 2.2% demand growth is rather bullish, as the historic long-term average is 1.9%, but it is based on continuing economic expansion in China, India and the rest of Asia.

The Tiger economies are following the lead of their larger neighbours, but this could all change if Asia’s economies are driven into recession by high energy prices.

The growth forecast relies on bullish forecasts for global GDP increases of 4.5% per annum. A recession during the next five years could put back the peak oil date by a few years.

But taking the IEA forecast at face value, there are simply not enough new oil projects to raise global production levels at a pace that meet rising demand, leaving the world’s consuming markets relying further on the Middle East.

A quick analysis of the world’s oil reserves, production and export positions shows that once non-Opec production has peaked, then it is up to the oil cartel, and particularly Saudi Arabia, to find the extra barrels.

Most peak oil supporters do not think this is viable.

Geology is not the only reason for a forecast supply shortage. The IEA also blames delays in projects and tight oilfield markets.

‘Upstream construction, drilling and service capacity will remain stretched, leaving forecasts prone to slippage due to cost overruns and project delays,’ the IEA says.

‘Total non-Opec liquids supply growth to 2012 is pegged at 2.6m bpd, partly reflecting slippage and a contingency factor for unscheduled field outages. The above-ground risks are still seen as greater than those posed by resource depletion.’

The IEA forecasts non-Opec supply growth at around 1% per annum, below half the extra barrels needed to meet surging demand.

This leaves Opec with the potential for increasing market share if it wants to. Some of the factors that could rescue the world from a supply crunch come from outside the conventional oil industry, and include the use of biofuels, increased output from exploitation of Canadian oil sands and the recovery of more natural gas liquids.

It remains uncertain what affect these energy sources will have, although IEA predicts biofuel use will double in five years, and most forecasts see Canadian oil sands production doubling.

Some optimists hope there will be enough oil resources in the Arctic to bring relief to the tight supply situation, but any reserves in Antarctica are completely out of bounds under international agreements.

Companies such as Shell are investing heavily in exploring the Beaufort Sea. Italy’s Eni has found oil in the Barents Sea, and the Russians claim to have plenty of reserves in their territorial waters.

But it could take 10 years before any of this crude hits the market, too late to stop the crunch.

So consumers cannot necessarily rely on the oil industry to meet their demands in the medium and long-term, and in the next five years we should all be prepared to pay higher prices for our energy.

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