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Energy volatility - The place of oil
The economic recession could amplify short-term volatility in the oil and gas sector by causing a slow-down in investments and thereby sowing the seeds for the next supply crunch. In addition, we are entering an era of long-term volatility that our industry has never had to face before in its century-old existence. It is directly related to different perceptions over what will be and should be oil’s place in the world in the next 50 to 100 years. In this speech, Malcolm Brinded discusses short-term and longterm volatility, and ways to reduce it, comprising: predictable tax regimes, clarity on climate policies, and enduring, value-driven partnerships between national oil companies and international oil companies.
Energy volatility - The place of oil
The shock to the real economy arising from malfunction and poor practice in the financial system is deep. This recession will likely become the worst since 1929. And it will slow down investments by the oil and gas industry in new projects, amplifying the already cyclical nature of our industry.
But in addition to this short-term volatility, I believe we are entering an era of long-term volatility that our industry has never had to face before in its century-old existence. It is directly related to different perceptions over what will be, and should be, oil’s place in the world in the next 50 to 100 years.
We can all recognise the damage to global and regional growth that such oil price volatility brings. This morning I’ll say a few words about both short-term and long-term volatility, and provide elements of a possible response.
Economic crisis impact
Today, global oil demand is roughly 3% lower than last year. The oil price is back to where we were in 2004, but industry costs have more than doubled since then.
At the same time, many producing fields are in decline. And we know that when the economy recovers, so will energy demand.
All this means that new investment is both necessary and difficult. According to Barclays’ Capital, investments are likely to fall by 12% in 2009. And I think this could be too optimistic.
A supply crunch by mid-next decade seems inevitable and is likely to be severe. This would result in new price spikes, putting another drag on economic recovery. Then the ‘boom-to-bust’ story could begin all over again.
Energy needs vs Climate issues
Apart from the short-term economic cycle, it’s important to look at the longer-term challenges our industry faces. This uncertainty relates to both the total resource available and the lack of clarity on climate policies.
I can imagine two very different outlooks, each of which would pull our industry in opposite directions.
In the first outlook, growing oil resource scarcity is the overarching theme. The decline of easy oil and the inexorable demand growth in developing nations are the dominant factors in the market, with prices going up dramatically in the coming 10 years and beyond. The wealthier major resource holders will continue with depletion policies to make sure that production can be sustained over decades and wealth shared with future generations, when real terms oil prices are even higher.
In the second outlook, the realisation that there may be a shrinking market window for oil begins to dominate the price late in the next decade. Climate change issues become ever more important – with CO2 policies increasingly geared towards displacing oil in transport with a focus on electric mobility in combination with renewable energy, nuclear, clean coal technology and natural gas. As a consequence, the remaining window for substantial oil production growth is curtailed. With the oil price looking set for the long term downward trajectory, producing nations start to race to fill the remaining market opportunities, so the price decline would accelerate.
These are, of course, two extreme outlooks. But for the next 10-20 years, the prevailing view on which outlook will eventually turn out to be true will likely oscillate, and cause particular volatility in the market, pulling our industry in different directions.
To reduce both short-term and long-term volatility, I see room for positive action by governments and companies in three areas: tax regimes, climate policies and NOC-IOC partnerships.
First, more stable tax regimes by both producer and consumer nations would help. Governments all too often suddenly increase taxes when the oil price goes up and then keep them there after the price has gone down. This slows down investment. (This is not a plea for lower taxes; although it’s always welcomed.) Well-designed tax structures can and should be stable through the economic cycle, since they already redistribute surplus rent when prices are high.
The real problem is sudden, unexpected changes. And my concern about unexpected tax hikes is increasing. Governments all over the world are becoming increasingly indebted as a result of the recession, and many are very tempted to increase taxes. But there’s a link between tax volatility and energy sector volatility, and more predictable tax regimes would reduce both.
The second area of importance concerns climate policies. It’s all too easy for politicians in oil-importing nations to be seduced by the prospect of a fast displacement of oil in the transport sector, despite not fully understanding the true cost of a rush to electrification.
To combat this we need to show how we can reduce the CO2-intensity of liquid transportation fuels on a wells-to-wheels basis.
I believe we can preserve and make room for oil in transport through a combination of lighter-weight vehicles, more efficient engines, and, in the longer term, by adding CCS to liquid hydrocarbon fuel production. Blending with biofuels will also be important.
If we can make progress in these areas, liquid fuels will be able to compete with vehicle electrification on environmental grounds for many decades, not to mention the major cost and convenience advantages.
And if you as producer nations agree to have an interest in sustaining the era of hydrocarbons in transport, you should actively support CO2 Cap and Trade mechanisms, CO2 Capture and Storage and sustainable biofuels.
A third way to foster greater stability is through value-driven partnerships between National Oil Companies (NOCs) and International Oil Companies (IOCs).
The goal of such partnerships is that more economic value is generated over the long term for both parties, while sharing risks and rewards fairly, including when the going gets tough.
There is no doubt in my mind that many NOCs possess outstanding skills, technologies and capabilities.
But as long as hydrocarbons are needed to meet the world’s energy needs, we will need to extract them effectively, efficiently, and responsibly, using the skills and capabilities of all industry players.
Value-driven partnerships between NOCs and IOCs can help us to do that. As His Excellency Minister Al Attiya (Qatar) said in his opening, working together, we can use the complimentary capabilities of both to achieve higher production and recovery rates, for a longer period of time.
Let me give you a few examples of enduring, value-driven-partnerships that Shell is involved in. In Qatar, I’m proud to have the opportunity to use our technology to build Pearl GTL, a world-class project that will supply customers across the globe with remarkably high-quality liquid products. Pearl will diversify Qatar’s market for natural gas from LNG and bring benefits for generations to come.
Upstream in Oman, in Brunei, in Malaysia we have been working together for 50 to 100 years to provide value to the nation with a focus on developing national talent and maximizing recovery through technology like in the Harweel field.
In Russia, the going certainly got tough over Sakhalin II, but we found a mutually acceptable solution, moved forward and completed this immense and complex project – embracing Gazprom as a key, valued partner for the long term. Now it’s on stream, producing oil and Liquefied Natural Gas (LNG) on its way to customers.
In the downstream, Saudi-Aramco and Shell jointly run thousands of petrol stations in the United States and are currently expanding the Motiva refinery in Port Arthur in the US. And we are both shareholders in Showa Shell in Japan.
Enduring, value-driven-partnership also means delivering value to the nation by building local supply chains.
Let me give just one striking example, from Oman. In 1977, a small Omani construction company with less than 30 people, won its first contract from Petroleum Development Oman, worth just 2 thousand dollars. Galfar is now one of the largest engineering and construction companies in the Middle East, employing 25,000 people, a majority of whom are Omani citizens, and its wide-ranging work for PDO includes the huge Harweel Enhanced Oil Recovery project.
So enduring value-driven-partnerships contribute to sustainable growth, and create stability in ‘good times and in bad’.
In summary, short-term cyclicality in our industry looks set to increase.
More predictable tax regimes would help increase confidence in our industry to make the huge capital investments needed to supply the world’s growing energy needs.
In the longer term, we face uncertainty about the place of oil in the world’s energy mix.
Early clarity on climate polices would help to reduce that uncertainty.
And long-term value-driven partnership between NOCs and IOCs are crucial to sustain investments through the cycle and recover the world’s hydrocarbon resources effectively and efficiently, sharing risks and rewards over many decades.