Crude oil prices continue to fluctuate. The West Texas Intermediate (WTI) spot price increased from US$69.48/bbl on December 14 to US$83.12 on January 6 and then fell to US$72.85 on January 29. EIA expects the crude oil market to strengthen again this spring with WTI rising to an average of about US$81/bbl over the second half of this year and US$84/bbl in 2011. The crude oil price forecast is unchanged from last month’s Outlook. EIA’s forecast assumes that US real GDP grows by 2.3 per cent in 2010 and by 2.5 per cent in 2011, while world oil-consumption-weighted real GDP grows by 2.7 per cent and 3.6 per cent in 2010 and 2011, respectively.

EIA forecasts that the annual average regular-grade retail gasoline price will increase from US$2.35/gal in 2009 to US$2.84 in 2010 and US$2.97 in 2011 because of the rising average crude oil price forecast. Pump prices may exceed US$3/gal at times during the approaching spring and summer. Projected annual average retail diesel fuel prices are US$2.95 and US$3.16/gal, respectively, in 2010 and 2011.

EIA expects this year’s annual average natural gas Henry Hub spot price to be US$5.37/MMBtu, a US$1.42/MMBtu increase over the 2009 average of US$3.95. EIA projects continuing price increases in 2011, averaging US$5.86/MMBtu for the year. EIA envisages working gas inventories to end the first quarter at about 1,644/bnft³ compared with 1,734/bnft³ in the previous Outlook, because of colder-than-normal weather in early January.

The annual average residential electricity price changes only slightly over the forecast period, falling from US¢11.6/KWh in 2009 to 11.5 cents in 2010, and then rising to US¢11.7/KWh in 2011. These projections are unchanged from the previous Outlook.

Projected CO₂ emissions from fossil fuels, which declined by 6.3 per cent in 2009, will increase by 1.5 per cent and 1.3 per cent in 2010 and 2011, respectively, as economic recovery contributes to higher energy consumption.

Global crude oil and liquid fuels

Crude oil and liquid fuels overview
The world oil market should gradually tighten in 2010 and 2011 as the global economic recovery continues and world oil demand begins to grow again. Continuation of the production targets set by the Organization of the Petroleum Exporting Countries (OPEC), as well as lower overall growth in non-OPEC supply over the 2010-11 forecast period, would also contribute to a firming of crude oil prices to above US$80/bbl this summer. However, the combination of high commercial inventories among members of the Organization for Economic Cooperation and Development (OECD) and ample OPEC surplus production capacity should help dampen the likelihood of any large upward swings in prices.

Global crude oil and liquid fuels consumption
EIA has revised upward slightly its projections for global liquid fuels consumption growth in this Outlook as the Asian-led recovery continues. China’s apparent liquid fuels consumption in December increased by 0.9mbpd (bbl/d), or 12 per cent, above year-earlier levels a its economic stimulus package continued to help push up both oil usage and economic growth. While Japan is expected to continue its long-term decline in consumption, signs of an economic turnaround in that country lead EIA to be less pessimistic about the Japanese decline in liquid fuels consumption for 2010-11. EIA’s revised outlook is for global liquid fuels consumption to grow by 1.2mbpd in 2010 and 1.6mbpd in 2011 after showing annual declines in 2008 and 2009. Non-OECD countries are expected to account for the majority of this growth in both 2010 and 2011.

Non-OPEC supply
Non-OPEC supply increased by 560,000bpd in 2009, the largest annual increase since 2004. However, EIA does not expect this level of supply growth to continue during the forecast period. Non-OPEC supply is projected to increase by 430,000bpd in 2010. The largest source of growth in 2010 is the United States, followed by Brazil and Azerbaijan. Offsetting this growth, production is forecast to decline in Mexico, the United Kingdom and Norway. Non-OPEC supply is expected to fall by 120,000bpd in 2011, as declining production in mature areas overwhelms any new production growth.

OPEC supply
OPEC cut its crude oil production by 2.2mbpd in 2009, one reason why WTI crude oil prices stabilised between US$70-80/bbl since the middle of last year. This range is consistent with the “fair price” range for crude oil proposed by King Abdullah of Saudi Arabia at the beginning of 2009. Oil prices hovered in this range despite sustained high levels of oil inventories and rising spare production capacity, which rose, in part, because of cuts in OPEC production. OPEC surplus crude oil production capacity currently stands at about 5mbpd and could grow to 6mbpd by the end of the forecast period. However, most of this surplus capacity is concentrated in Saudi Arabia, which is not likely to use it as long as the oil market is stable and its price target range is being met. In contrast, OPEC surplus crude oil production capacity averaged 2.8mbpd during the 1999-2009 period.

EIA expects annual OPEC crude oil production will increase by an average of 0.4mbpd in 2010 and again in 2011 as global oil demand recovers. In addition, EIA expects OPEC non-crude petroleum liquids, which are not subject to OPEC production targets, to grow by 0.6 to 0.7mbpd each year through 2011, for a total of up to 2.2mbpd of increased OPEC liquids production over the next two years. OPEC is scheduled to meet in Vienna on March 17, 2010, to reassess market conditions.

OECD petroleum inventories
EIA estimates OECD commercial oil inventories were 2.69bnbbl at the end of 2009, equivalent to about 58 days of forward cover, and about 90mbbl more than the five-year average for the corresponding time of year. Projected OECD oil inventories remain at the upper end of the historical range over the forecast period.

Crude oil prices
WTI crude oil spot prices averaged US$78.33/bbl in January 2010, almost US$4/bbl higher than the prior month’s average and matching the US$78-per-barrel forecast in last month’s Outlook. The WTI spot price peaked at US$83.12 on January 6 and then fell to US$72.85 on January 29 as the weather turned warm and concerns about the strength of world economic recovery increased. EIA forecasts that WTI spot prices will remain near current levels over the next few months, averaging US$76/bbl in February and March, before rising to about US$82/bbl in the late spring and to US$85 by late next year.

Expected WTI price volatility was fairly steady over the month. April 2010 implied volatility (based on options prices) averaged 35 per cent per annum during January, and, over the five days ending February 4, 2010, it was slightly over 34 per cent. April 2010 WTI futures averaged US$75/bbl over that same five-day window, yielding a lower and upper limit for the 95-per cent confidence interval of US$60 and US$94/bbl, respectively.

One year ago, April-delivered WTI into Cushing, Oklahoma, was priced at US$45/bbl, and implied volatility, at 74 per cent, was more than twice the rate now trading in the options markets. Thus, the 95-per cent confidence interval for April 2009 WTI futures had lower and upper limits of US$28 and US$72/bbl at that time, respectively.

US crude oil and liquid fuels

US liquid fuels consumption
US liquid fuels consumption declined by 820,000bpd (4.2 per cent) to 18.7mbpd in 2009, the second consecutive annual decline. Motor gasoline was the only major petroleum product whose annual consumption did not decline, having remained relatively unchanged. Distillate fuel consumption declined by 330,000bpd (8.4 per cent), in 2009, led by a sharp economy-related decline in transportation usage. Jet fuel usage fell by 130,000bpd (8.6 per cent).

Despite the cold weather that gripped much of the country in late December 2009 and early January 2010, total US liquid fuels consumption in those two months still fell below the levels seen in the same months a year earlier. Nevertheless, EIA projects that total petroleum products consumption will rise by 180,000bpd in 2010 because of the economic recovery that began in late 2009. All major products contribute to that increase. The projected continuing economic recovery in 2011 boosts total petroleum products consumption by 210,000bpd. Motor gasoline consumption increases by 70,000bpd and distillate consumption rises by 100,000bpd in 2011. Throughout the forecast, continued increases in aircraft efficiencies result in flat jet-fuel consumption despite growth in air activity.

US liquid fuels supply and imports
Domestic crude oil production averaged 5.32mbpd in 2009, up 370,000bpd from 2008. Projected growth in domestic output is slower in 2010, increasing by about 190,000bpd, and then falls slightly in 2011 by 30,000bpd. Ethanol production continues to grow to meet the volume requirements of the Renewable Fuel Standard. Projected ethanol production, which averaged 700,000bpd in 2009, increases to an average of 800,000bpd in 2010 and 850,000bpd in 2011. EIA forecasts that liquid fuel net imports (including both crude oil and refined products) will fall by 150,000bpd in 2010 and then rise by 160,000bpd in 2011, after having fallen by 1.42mbpd during 2009.

US petroleum product prices
Monthly average regular-grade gasoline prices averaged US$2.35/gal in 2009, increasing from US$1.79/gal in January 2009 to US$2.61/gal in December. EIA expects these prices will average US$2.84/gal in 2010 and US$2.97/gal in 2011. Gasoline retail prices have followed crude oil prices over the last few months with the troughs and peaks in gasoline prices following those of crude oil by about one week. Average regular-grade pump prices may top US$3/gal at times during the upcoming spring and summer and will easily pass that benchmark in high-cost regions, such as the West Coast. Due to forecast growth in motor gasoline consumption, the difference between the average gasoline retail price and the average cost of crude oil increases slightly in both 2010 and 2011.

On-highway diesel fuel retail prices, which averaged US$2.46/gal in 2009, average US$2.95/gal in 2010 and US$3.16 in 2011 in this forecast. As with motor gasoline, the expected recovery in the consumption of diesel fuel in the US, as well as growth in distillate fuel usage outside the country, strengthens refining margins for distillate throughout the forecast period.

Natural gas

US natural gas consumption
EIA expects total natural gas consumption to increase 0.4 per cent to 62.5/bnft³ per day (Bcf/d) in 2010 and another 0.4 per cent in 2011. Very cold weather during the first half of January, particularly in the Southeast, contributed to an 8.4-per cent jump in the monthly estimate for electric-power-sector natural gas consumption from the previous forecast. The latest estimate for electric-power-sector consumption in January would be a new record for the month. Although natural gas consumption in the electric power sector has been strong so far this year, an increase in coal-fired generation capacity and higher natural gas prices through the remainder of the year should reduce the share of natural-gas-fired generation in the baseload power mix in 2010. This is despite lower-than-normal snowpack in the Northwest, which we expect to reduce hydroelectric generation in that region in 2010 to about eight per cent below last year’s level and boost natural gas consumption. The projected 1.3 per cent decline in electric-power-sector natural gas use is offset by growth in the residential, commercial and industrial sectors in the 2010 forecast. The outlook for growth in total natural gas consumption in 2011 comes from increases in the industrial sector as a result of improved economic conditions.

US natural gas production and imports
Total marketed natural gas production declines 2.6 per cent to 58.7/bnft³/d in 2010 and increases by 1.3 per cent in 2011 in this forecast. Working natural gas rigs hit a low of 665 in mid-July 2009, and EIA anticipates that the impact of lower drilling activity last year will contribute to the production decline in 2010. While the number of working natural gas rigs is currently about 25 per cent below the year-ago level, the number has increased during the last month by about 100 rigs to a total of 861 rigs at the end of January. Current 2010 futures market prices between US$5.50 and US$6.70/MMBtu appear to provide the necessary economic incentive to expand drilling programmes even further. As a result, EIA expects monthly natural gas production to begin to slowly increase later this year and continue on an upward trend through the end of 2011.

Projected US pipeline imports decline by 8.3 per cent (0.7/bnft³pd) to 8.1/bnft³pd in 2010 due to the sustained impact of lower Canadian drilling activity and production, as well as increasing demand from oil sands projects in western Canada. A portion of the decline in pipeline imports this year is expected to be offset by imports of liquefied natural gas (LNG), which were double year-ago levels in January as temperatures plummeted and prices jumped. The outlook for higher US LNG imports in 2010 is largely due to recent global LNG supply additions in Russia, Yemen, Qatar, and Indonesia. EIA expects net imports of natural gas to decline in 2011 as flows from Canada remain limited and global demand for LNG strengthens.

US natural gas inventories

On January 29, 2010, working natural gas in storage was 2,406/bnft³, 150/bnft³ above the previous five-year average (2005–09) and 199/bnft³ above the level during the corresponding week last year. Colder-than-normal temperatures in the first half of January led to the largest consecutive-week withdrawal on record as a total of 511/bnft³ was pulled from storage during the weeks ending January 8 and 15. The withdrawals over these two weeks were a combined 317/bnft³ above the average withdrawal for the corresponding weeks over the previous five years. However, weather turned considerably warmer during the second half of January, and working gas stocks over the last two weeks fell by 201/bnft³, compared with the previous five-year average withdrawal of 357/bnft³. Despite the large inventory draws in December and early January, EIA expects working gas inventories to finish the first quarter of 2010 at about 1,644/bnft³, or seven per cent higher than the previous five-year average.

US natural gas prices

The Henry Hub spot price averaged US$5.83/MMBtu in January 2009, US$0.49/MMBtu higher than the average spot price in December and US$0.36/MMBtu higher than the forecast for January in last month’s Outlook. The Henry Hub spot price peaked at US$7.51/MMBtu on January 7, as colder-than-normal weather tightened its grip on much of the country. When temperatures eased the price fell to about US$5.30/MMBtu by the end of the month. While the early cold spell contributed to a substantial withdrawal from working natural gas inventories, prices are projected to reflect an end-of-winter storage level that is still above the five-year average. The relatively high inventory level combined with the increased supply potential from domestic resources should keep prices from rising dramatically this year. However, in addition to anomalous weather, unforeseen consumption increases in the electric power and industrial sectors could elevate prices above the current forecast. The Henry Hub spot price forecast averages US$5.37/MMBtu in 2010 and US$5.86/MMBtu in 2011.

Both March and April implied volatilities based on natural gas futures market options contracts started the month in the 55-to-60 per cent range and finished the month slightly below 50 per cent. Implied volatility for April natural gas options averaged 46 per cent per annum for the five days ending February 4, 2010. With the average April delivery price at US$5.35/MMBtu for the five days ending February 4, the lower and upper limits of the 95 per cent confidence interval were US$3.80 and US$7.50/MMBtu, respectively.

Natural gas delivered to the Henry Hub during April 2009 was trading at US$4.60/MMBtu at this time last year. Options market participants were pricing the April 2009 implied volatility at 60 per cent, producing a lower and upper limit for the 95-per cent confidence interval of US$3 and US$7/MMBtu, respectively.

Electricity

US electricity consumption
January heating degree-days in the South Census Region, where about 60 per cent of households use electricity as their primary space heating fuel, were 13 per cent higher than in January 2009. Consequently, residential electricity sales in the South region also increased by about 12 per cent to an average of 2250GWhpd. Temperatures across the United States this summer are expected to be about 2.5 per cent cooler than last summer, limiting overall growth in electricity sales. Projected total US consumption of electricity grows by 1.9 per cent in 2010 and by 1.7 per cent in 2011.

US electricity generation
The large increase in South Atlantic electricity consumption during January was likely supplied in large part by natural gas generation. In addition, low snowpack levels in the Pacific Northwest are likely to reduce hydropower generation and boost natural gas consumption as noted previously. However, offsetting these increases, the projected higher price of natural gas compared with last year reduces its attractiveness as a baseload fuel. The projected 1.6 per cent decline in natural gas consumption for electricity generation in 2010 is lower than the 3.0 per cent decline in last month’s Outlook.

US electricity retail prices
The estimated November 2009 US residential electricity price was US¢11.2/KWh, 2.4 per cent lower than November 2008. EIA projects US residential electricity prices will fall by 1.0 per cent in 2010, followed by an increase of 1.9 per cent in 2011 resulting primarily from higher natural gas generation fuel costs.

Coal

US coal consumption
Estimated coal consumption by the electric power sector fell by more than 10 per cent in 2009, a slightly larger decline than estimated in last month’s Outlook. The most recent consumption estimate for November 2009 is nearly eight per cent lower than was expected in last month’s Outlook. Anticipated increases in electricity demand and higher natural gas prices, both of which are higher than in the previous Outlook, will contribute to modest growth in coal-fired generation in 2010 and 2011. Forecast coal consumption in the electric power sector increases by almost four per cent in 2010, though staying under 1bnst. EIA projects coal consumption in the electric power sector will increase by 1.6 per cent in 2011, but remain below the 1bnst level for the third consecutive year. Consumption of coal at coke plants rises over the forecast period as economic conditions improve, increasing by nearly 6mst (38 per cent) in 2010, followed by a small increase (less than one per cent) in 2011. A higher forecast for raw steel production is the primary reason for higher coke plant consumption than in the previous Outlook.

US coal supply
EIA estimates that 2009 coal production fell by nearly eight per cent in response to lower US coal consumption, fewer exports, and higher coal inventories. Production declines by an additional four per cent in 2010 in this forecast despite increases in domestic consumption and exports. The balance between production and consumption is satisfied through significant reductions in both producer and end-user inventories. EIA projects a 5.4-per cent increase in coal production in 2011 to meet continued growth in coal consumption and exports.

US coal prices
EIA estimates that the 2009 delivered electric-power-sector coal price increased by seven per cent in 2009 despite decreases in spot coal prices, lower prices for other fossil fuels, and declines in coal-fired electricity generation. This higher cost of delivered coal is due to the significant portion of longer-term power‐sector coal contracts that were initiated during a period of high prices for all fuels. The projected electric-power-sector delivered coal price falls by almost eight per cent to average US$2.04/MMBtu in 2010 and declines by an additional 1.6 per cent in 2011.

US carbon dioxide emissions
CO₂ emissions from fossil fuels fell by an estimated 6.3 per cent in 2009. Emissions from coal led the drop in 2009 CO₂ emissions, falling by nearly 11 per cent. Declines in energy consumption in the industrial sector (a result of the weak economy) and changes in electricity generation sources are the primary reasons for the decline in CO₂ emissions. Looking forward, projected improvements in the economy contribute to an expected 1.5-per cent increase in CO₂ emissions in 2010. Increased use of coal in the electric-power sector, and continued economic growth, combined with the expansion of travel-related petroleum consumption, lead to a 1.3-per cent increase in CO₂ emissions in 2011. However, even with increases in 2010 and 2011, projected CO₂ emissions in 2011 are lower than annual emissions from 1999 through 2008.

For more details, consider visiting:

http://www.eia.doe.gov/emeu/steo/pub/contents.html

The consulting firm also envisages an uptick in M&A activity across the energy and power sectors, with particular room for consolidation in the mining and independent oil company subsectors. It’s worth noting that there are two main factors at work. First, regardless of your views as to whether we will see a “W” shaped recovery, the fact remains that we are currently far off the peak in the current cycle and therefore now is a good time to go shopping for other firms. The second factor is that the panic induced by the financial crisis re-enforced the mantra that “Cash is king”. As a result, many companies have freed up significant amounts of cash and may well be looking to invest. A real limitation for those on the prowl is expected to be the lack of suitable targets, so those companies that unexpectedly flounder may be quickly pounced on.

As far as the power sector is concerned, Deloitte expects the M&A environment to become more favourable, given governments’ and regulators’ growing awareness of the scale of investment required and the resulting need for capital.

Interestingly, Deloitte expects that the smart grid sector could become the fastest growing of the new wave of energy technologies in 2010 due to large-scale investment from utilities and stimulus packages. However, the consultancy highlights that several factors might cap growth below the sector’s full potential, such as the lack of unified standards, the need for complex software and the fact that consumers are unlikely to see the benefits for some years to come.
As far as carbon is concerned, Deloitte doesn’t see the issue of coal-fired generation being resolved this year and it is easy to see why. While carbon capture and sequestration technologies are expected to continue advancing at a rapid pace, they will still be some years off from full-scale deployment. In addition, the lack of progress made at Copenhagen and the loss of a vital senator for the US Democrats in Massachusetts, makes it clear that 2010 will not see a quantum leap towards an effective US and by extension, a global carbon trading market.

While coal might be a slow burner in 2010, the same will not be said for solar and wind. With initiatives like Masdar City boldly pushing forward and oil-rich countries in the Middle East starting to realise the untapped potential of the sun, a great deal of progress could well be made over the course of this year.

Perhaps one of the most intriguing of Deloitte’s predictions, the idea of a shift towards sector wide regulation of carbon emissions, is more of a manifesto. The consultancy makes a convincing case, arguing that these could result a more balanced approach and provide the long-term signals needed for sustained and large-scale investment. However, while this does seem laudable, it is hard to envisage how such schemes would not be bogged down by politicking and arguments resulting from conflicting national interests. Any carbon emission scheme designed and put forward by major emitting industries would also have a credibility issue in the eyes of the public, making it difficult for politicians to support.

Light at the end of the tunnel?

Looking beyond 2010 and towards the coming decade, there are several key developments that will have a dramatic impact on the energy and power sector. The rise of the electric car, coupled with the growing appetite for the latest technological wizardry from consumers, will both change the way the power sector operates while dramatically boosting demand, typically outside of peak hours.

At the same time, the need to manage the issue of intermittency will continue to grow, thanks to greater use of renewables, but the major transmission projects needed to address the issue cheaply may lag behind, creating headaches for power utilities and making the need for flexible consumers and load-shedding more acute.

From a more global perspective, a truly seismic shift will occur once the focus of China’s manufacturing base begins to shift towards addressing domestic demand as opposed to its current focus on imports. This could have major implications for the economies of the US and Europe, with obvious knock-on effects for power demand. China’s appetite for US public debt is another issue and the mutually beneficial relationship between the two countries may well sour if this grows thin, particularly if the US attempts to reduce its debt by devaluation. A related issue is the growing realisation as exemplified by the recent Google fiasco that although China is getting wealthier, it isn’t softening in its attitudes to the west. This could be argued to be the result of the rapacious attitude the West adopted towards China in the early half of the 20th century, which has created a nation with a reflexive resentment to what it sees as “colonialist meddling”.

Other economic issues to be aware of is that given the sheer pace of industrialisation and development in Asia, coupled with the growing costs of oil exploration and upstream production, we may find ourselves in a vicious cycle in which rising energy prices trigger recession, followed by a collapse in the price of oil, which in turn reduce the volume of investment in the energy sector, which then sets the scene for a subsequent boom/bust cycle. Renewables, possibly in conjunction with nuclear power are an obvious solution, but changing the entire world’s energy sector before this comes to pass will require a monumental level of investment.

In terms of the upstream sector, all eyes will be on Iraq, particularly as to whether it can boost its production to the much-trumpeted 10mbpd. If this comes to pass, then in an absence of carbon-restraints, we might be looking at another decade or two of essentially business as normal. If not, then China’s strategy of locking up supplies in Africa and Latin America will become increasingly the object of scrutiny, as will the state of OPEC oil reserves. In addition, Brazil’s oil largesse will begin to make itself known towards the end of the decade and the question as to who will supply Europe with energy will become increasingly urgent, given the decline of the North Sea and the issues conspiring to limit investment in Russia.

As for the burning issue of climate change, it is fair to say that progress will be made, but it will be at a pace greatly lagging that dictated by the science. While it is hard to envisage major impacts that can be directly attributed to global warming making their presence felt so early, the mounting risks from hurricanes and powerful storms may well make infrastructure hardening a key issue. Over in the EU, carbon trading will either begin to bite in a big way or fade into irreverence. With much clamour from businesses for a stable long-term carbon price, it would be wise to bet on the former. Meanwhile in the US, even if a cap-and-trade system is introduced next year, it will be several more years before it tightens to the point where it starts significantly impacting day-to-day plant operations. Investment decisions are another matter and the tide already seems to be turning against coal. 2009 saw a large number of potential projects being canned as a result of litigation and fierce opposition from local residents and environmental groups and this coupled with the threat of cap-and-trade is going to prove a major headache for both coal-users and also the coal mining industry, which may have to redirect significant volumes abroad. Fortunately, Asia’s appetite for the black stuff is very likely to continue, as exemplified by the news today that Vietnam is expected to become a net coal importer in 2013.

In general with any forecasting exercise, its worth bearing in mind that people vastly overestimate the rate of technological progress, but at the same time, predicting the important innovations that will define the next decade is nigh-high impossible. Perhaps a lesson can be learned from of all places, martial arts. As my Sifu taught me, one does not fix one’s gaze onto one particular part of an opponent for to do so means potentially missing the bigger picture. So then, as we head into a new decade, with all the various possibilities in mind, we should still keep a wary eye out for the unexpected.

The full report from Deloitte can be accessed here

What are your predictions for 2010 and beyond? Feel free to comment on this topic below.

Brent crude oil futures: US$73.01/bbl, down 0.9 per cent, as of GMT 09:45, January 26
WTI crude oil futures: US$74.45, down 1.0 per cent, as of GMT 09:45, January 26
German power: €49.56/MWh, up 1.00 per cent
Coal: €96.50/t, down 0.26 per cent
Natural Gas: GB 36.95p/therm, up 5.57 per cent
EUAs for December 10 delivery: €13.45/t, up 2.44 per cent
CERs for December 10 delivery: €11.80/t, up 2.25 per cent

Latest Buzz
After closing up 72 cents at US$75.26/bbl, front month NYMEX crude now appears to be retreating, primarily as traders appear to be holding off until the results of the US Federal Open Market Committee (FOMC) meeting are announced on Wednesday and which will forecast US economic growth, employment and inflation, as well as determining the appropriate level of credit availability.

Interestingly, Goldman Sachs latest weekly commodities report has made the point that China and by extension, Asia, is increasingly driving the oil markets with a 1.6mbpd rise in crude imports, almost perfectly off-setting a 1.5mbpd decline in US demand. The report states that:

” Furthermore, recent data on crude loadings suggest that close to 14 mn barrels of West African crude is being redirected from the West to the East. The surging Chinese demand for oil suggests that the drivers of not only consumption growth, but also world oil demand and prices, are shifting from the West to the East.”

Morgan Stanley has announced that it now expects NYMEX crude to rise to US$95/bbl by the end of 2010. According to Hussein Allidina, a commodity analyst at the USA’s second largest security firm, crude oil in 2011 will average US$100/bbl.

“We expect that fundamentals will continue to improve,” said Allidina. “Our increased 2011 price forecast reflects an improved GDP outlook that will require a higher price to ration demand to meet inadequate supply.”

Morgan Stanley expects global oil demand to rise by 1.7mbpd and global GDP by 4 per cent over the course of 2010, while it predicts spare capacity will drop to 5.7mbpd from the current 6.5mbpd.

Meanwhile, carbon prices appear to be firming, on the back of stronger natural gas and German power prices. However, a recent report by Bank of America Merrill Lynch has warned that the lack of action resulting from the Copenhagen Summit, coupled with lingering doubts over the ability of US and Australian governments to pass cap and trade legislation this year and low demand in the European market, are weighing heavily on the outlook for carbon trading.

However, at the same time, it is forecasting a 5.6 per cent rise in the value of EUAs over the course of 2010, as the economy moves out of recession, but emission levels will still be lowered than they were before the global financial crisis. As a result, the bank is now warning that EUAs will be in surplus by around 166Mt over the second phase of the ETS, which is set to finish in 2012. Merill also has stated that it does not “foresee significant price upside over the next three to six months.” A knock-on effect of both predictions would be depressed demand for UN-based CERs.

IFandP: Given the drain on the public finances of many countries resulting from economic stimulus packages and bank-bail outs, would it be fair to say that governments in the OECD will be sidelined in terms of investment, compared to the role of private utilities?

Dr Fatih Birol: In the near-term, many governments have actually stepped up their direct investment in some types of energy infrastructure and have increased incentives for private investment, especially in clean-energy technologies. But, clearly, in the longer-term, the need to reduce budget deficits can limit the scope for public investment. So, yes, a growing portion of times in the run-up to Copenhagen, many countries’ announcements are encouraging. Although more is needed to be on track with the 450ppm scenario in our World Energy Outlook 2009, current pledges, if implemented, are more in line with a 550ppm scenario (leading to a 3°C increase in global temperature)”. The IEA believes there is room for optimism given the growing political will globally. For example, the US EPA has recently identified carbon dioxide and five other greenhouse gases as dangers to public health and welfare.

IFandP: Given the clear need for rapid action called for by the WEO 2009, how do you think the rate of progress could be accelerated at both the national and international level? It seems clear that while democracy and a consultative approach are laudable, they may be ill-suited to the speed of response required to prevent runaway climate change. Given that the developed world is not going to adopt China’s political system, what can be done to create the consensus needed to get the job done?

Dr Fatih Birol: The energy path to stabilise climate is clear, but only vigorous action will put our economies on that path to green growth. Major technological and financial breakthroughs are needed. Right, timely and clear incentives need to be given to investors (and consumers). A strong political signal is needed now to drive the necessary changes. Stimulus packages can be prolonged well beyond economic crisis, which can provide additional clear signals of strong political will. Some of the current proposals include strong voluntary efforts as well as fund-raising addressed to developing countries in order to fight against climate change.

IFandP: Following on from this, should international organisations be working to reduce the influence of interest groups and lobbyists who might see the reference scenario as being in their interest?

Dr Fatih Birol: The role of the IEA is to advise our member governments on how to achieve their stated policy objectives and to facilitate policy cooperation among member and non-member countries alike. All our governments agree that we need to move away from the Reference Scenario and, through the World Energy Outlook and other activities, are showing them how they might go about achieving that.

IFandP: What response would you like to see from North American and European power utilities going forward?

Dr Fatih Birol: In the 450ppm scenario of the World Energy Outlook 2009, North American and European power utilities are implementing the cap and trade system with a CO₂ price reaching US$50/t by 2020 and US$110/t in 2030.

In the US, a substantial amount of coal-fired generation is replaced by gas-fired generation, as well as by increased renewables and nuclear generation. By 2025, with CO₂ prices going beyond US$50/t, about 30GW of nuclear plant additions will have been built, replacing substantial numbers of coal plants and non-hydro renewable sources will have increased almost five-fold over the 2010 levels. By 2030, electricity generation from renewables will account for 26 per cent of the total, nuclear for 25 per cent, gas without CCS for 24 per cent, CCS plants for 15 per cent (almost 90 per cent of which is coal-based) and coal without CCS only 10 per cent.

In the European Union, where the CO₂ price already in place gradually converges to the level for OECD+ countries as a whole by 2020, the adoption of lower carbon emitting technologies is accelerated relative to other countries and regions. Renewable sources account for most of the increase in electricity demand and contribute to displacing generation from coal-fired plants, which are mothballed or retired. Wind alone will account for 20 per cent of electricity generation by 2030, nuclear will see by 2030 an increase of around 20 per cent over 2007 levels. Generation from CCS plants is to account for six per cent of the total generation in 2030.

IFandP: Is it fair to say that as we start relying on more and more difficult to reach oil, the lead-time for projects will increase, making the industry as a whole more vulnerable to the oil price volatility seen over the past two years?

Dr Fatih Birol: The lead time for greenfield projects has been growing steadily in recent years as the focus shifts to more difficult terrain and to larger projects. That trend is likely to continue, though it may be offset by some degree by technological advances which may speed up the time it takes to bring new discoveries into production. Any further increase in average lead times would indeed make the market more vulnerable to price volatility.

The “BP Statistical Review” was presented by the company’s chief economist, Christof Ruehl. He began by highlighting that the Review states that the world is not running out of oil and gas, before turning to the subject of high energy prices. According to the report, since January 2003, oil, coal and traded gas prices have increased by 300, 200 and 100 per cent, respectively. Prices rose fastest in 2007, after accelerating in 2005. Mr Ruehl said that there are some similarities between the 1970s price cycle and today. For example, the 10-year period leading up to 1973 had the highest economic growth ever recorded, while the same period leading up to 2007 recorded the second-highest growth.

However, he pointed out the pattern of energy demand growth is quite different. In the 1970s “energy and the economy moved in lockstep”, while now, non-OECD countries are growing fast but are not yet responsible for the majority of the contribution to world growth. According to the Review, the non-OECD is far more energy-intensive than the developed world, requiring 4.4boe to produce US$1000 of GDP, compared to 1.3boe for OECD countries. Mr Ruehl noted that in the case of non-OECD countries, much of the growth is coming from the move towards urbanisation, which is creating increasing demand for electricity and coal, in a manner which is relatively unresponsive to prices.

Oil

Looking at each of the different fossil fuels in turn, Mr Ruehl started with oil. Crude demand rose by 1.1 per cent in 2007, but fell by 0.9 per cent in OECD countries, the biggest decline seen since 1983. The same year started with US gasoline costing US$2.30/gal at the pumps, but ended up at over US$3/gal.

He indicated that non-OECD demand growth was led by Asia at 0.6mbpd, with China and India accounting for a half and a third of the total, respectively. However, the consumption of oil exporting nations rose higher than those of net importers, climbing three per cent (0.51mbpd) and for the first time contributing more than the rest of the world, to demand growth.

The Review states that “if there was one defining moment in oil markets in 2007, it was the re-emergence of OPEC in successfully managing its production.” Mr Ruehl explained that by the summer of 2007, OECD oil inventories were at record levels, but then fell back dramatically during the time of the year when they normally build. This was because OPEC had reduced production twice, most significantly in February 2007, with Saudi Arabia, UAE, Kuwait and Venezuela cutting back by 0.9mpbd. This, he suggested was an important factor behind the rise in the price of crude on the international market.

The situation was exaggerated by a decline in OECD output, with only Russia and Azerbaijan reporting increases. Worryingly, Russia has reported a decline in production since January, mostly due to an “unattractive tax system and lack of investment in new fields”, but greater output from Azerbaijan effectively cancelled this out. Overall, oil production in 2007 was 81.5mbpd, down 0.13mbpd from 2006.

Moving downstream, the report indicates that global refining capacity is being added at about twice the rate of earlier this decade and that refiners experienced another record year in terms of margins in 2007.

Mr Ruehl then discussed the matter of speculation, commenting that one barrier to proper analysis was the fact that the available data is incomplete. Interestingly, he reported that total open interest on NYMEX crude has roughly tripled over the past five years, but after looking at all of the traded energy communities, there didn’t seem to be an obvious correlation between the amount of financial investment and the price of said commodities.

The report concluded its focus on oil by claiming that the cause of the rise in prices was a combination of a muted supply response in the face of strong demand triggered by high-income growth (rising faster than fuel prices, especially in Asia), natural declines in OECD provinces, an increase in state control and barriers to private investment.

Natural gas

According to the report, natural gas and coal consumption rose by 3.1 and 4.5 per cent, respectively, in 2007. The US was responsible for the largest increase in both demand and production (up 40 23bnm³ and 23bnm³). The second greatest contributor to both demand and supply growth was in the Asia Pacific, with demand and output up 27bnm³ and 18bnm³, respectively. With the exception of Norway, European production declined, partially due to depletion in the North Sea.

As far as international trade was concerned, LNG grew by 7.3 per cent, boosting its total share of gas trade and production to 29 per cent and eight per cent, respectively. At the same time, 2007 saw a number of pipeline supply disruptions, such as Iran cutting exports to Turkey, due to a lack of supplies from Turkmenistan.

China’s coal consumption accounted for 40 per cent of growth
in world energy demand in 2007.

Coal

China’s demand for coal in 2007 (up 7.9 per cent) was so great that it constituted 40 per cent of the growth in the world’s entire primary energy demand. However, demand growth in the country was slower than in previous years. It substantially lagged behind the country’s growth in power generation (15.6 per cent), which in conjunction with coal price liberalisation and the constraints on electricity prices helped to create the widespread blackout seen at the beginning of the year. Elsewhere, the US grew strongly in coal demand, but this was countered by a decline in the EU, the former Soviet Union and the Middle East.

The international coal trade accounted for only 15 per cent of consumption, but the Review indicates that this is on the increase. Four countries have been responsible for 95 per cent of the increase in coal production over the past 10 years: Indonesia, Australia, India and China, with domestic demand driving the latter two, while the former are export-orientated. In fact, 88 per cent of the growth in production since 1997 was used for export.

Like the oil market, the coal sector was, and is still, subject to supply constraints such as congested transport facilities and mine closures in Indonesia, Australia and South Africa, caused in part by bad weather conditions.

The review estimated using energy consumption and standard conversion rates, that the world’s CO₂ emissions grew by 2.8 per cent in 2007, with a warm winter in the EU making it the only region to report a decline (1.2 per cent). Hydropower production increased by 1.5 per cent, while the output from nuclear installation fell by two per cent. The year saw four new reactors come online, with construction commencing on another seven. Renewables accounted for 1-1.5 per cent of energy production, while ethanol represented 0.7 per cent (volumetrically) of total oil consumption.

General outlook

Mr Ruehl’s presentation of the report indicated that, at current production rates, the world has 42, 60 and 133 years of oil, gas and coal remaining, respectively. Global oil reserves fell by 0.1 per cent to stand at 1.24tnbbl, but this was attributed to reporting lags. Natural gas reserves rose 0.6 per cent to 177.4tnm³. The Review also indicated that OPEC members hold 76 per cent of world oil reserves, with another 10 per cent held by former Soviet Union countries.

These numbers are, although not being presented as such, rather disturbing. Forty-two years may seem a long time in human terms, but is still less than two generations away. Viewed in the context of human history it is the blink of an eye, especially when one considers that this bounty has taken millions of years to form.

IFandP asked why the Review takes OPEC reserve figures at face value, when they jumped significantly in the 1980s due to a move to reserve-based production quotas. Mr Ruehl replied by saying that yes, these things happen, but he didn’t believe it was an over-estimation and that BP had to base the Review on official information, otherwise it becomes a question of which set of numbers you prefer to believe.

When asked to discuss the possible ways in which governments might act to reduce speculation in the energy markets, Mr Ruehl commented that deliberately attempting to exclude one type of investor was “somewhat absurd and would be circumvented anyway.” He added that singling out one commodity would be detrimental and that volatility is the price we pay for efficient markets.

IEA five-year oil forecast

This was presented by Lawrence Eagles from the IEA. The key findings were that oil supply and demand have both been revised down sharply. The report indicates that 2.5mpbd of new projects in Saudia Arabia could be brought online relatively quickly and that significant investment in refining is needed as the tight diesel market has been one of the major causes of the rapid increase in the price of crude. This is because refineries cannot increase the percentage of diesel in their refined output at short notice, but they can increase overall utilisation. This does produce more diesel but it also ups the output of other oil products and boosts crude consumption. Therefore, a lack of upgrading capacity is a clear factor in the increase in oil consumption.

As to whether economic forces such as speculators are driving the market, Mr Eagles said that if this were the case then it would result in imbalances, resulting in stockbuild. As this is not occurring, a combination of high demand and/or low supply is more likely. He mentioned that the weakening dollar is having an impact, given that oil is sold in US dollars, and that when the currency in which it is traded depreciates in value, the price of oil increases. Mr Eagles pointed out that the price of oil is still at records in all currencies, so it would be wrong to blame the dollar for most of the surge in oil prices. He also argued that question marks remain over the spare capacity available to the market, primarily in terms of how quickly it could be released and how easily it can be refined.

The IEA sees a two-tier economy developing, with real demand for crude declining over the next five years in the OECD, but consumption likely to increase in the developing countries, with a limited response to higher oil prices and increased demand for energy intensive products. The report predicts that the bulk of future demand growth will be in Asia, China, India, the Middle East, Latin America and small parts of Africa.

It also predicts a move away from heating and fuel oil and towards increased use for transport and petrochemicals. The former will be particularly important, representing 48 per cent of the additional demand for middle distillates. The IEA anticipates that OECD/non-OECD demand will reach parity in 2015, and that thereafter, non-OECD countries will start to use the majority of produced oil.

Supply forecast

On the supply side, the IEA sees non-OECD supply growing poorly, with biofuels accounting for 50 per cent of the growth seen over the next five years. OPEC’s role in boosting supply is uncertain, with a response expected in 2009-2010.
Adding to concern, the IEA has increased its estimate for the global net decline rate to 5.2 per cent per annum. This means that the oil industry will need to bring online an additional 3.5mbpd of new capacity each year, merely to maintain production at its current rate, for the 2008-2013 period. The report indicates that OPEC is facing a mature field rate of decline in excess of 10 per cent annually, with some fields falling much faster. Another issue is that, on average, the industry is seeing 10-12 months of slippage, accompanied by “quite astronomical” cost overruns.

Overall non-OECD supply is expected to increase by 1.2mbpd between 2008 and 2013, but a dip is expected for 2010-12, with Mexico and the UK predicted to see the largest decline. In addition, the report claims that non-OPEC crude output has been declining since 2004. Some relief is expected from Russia, from projects in the Caspian and Kashgan, but not until the next decade.

As far as OPEC is concerned, the IEA believes that some of the projects in the pipeline could cause Saudi Arabia’s capacity to break above 12.5mbpd. However, according to Mr Eagles, the agency believes that 11.5mbpd is more realistic (after 2013) and that the significant boost to capacity is not going to materialise by 2011, with 2010 being the year in which a decision would have to be made.
Iraq, Nigeria and Venezuela are extremely uncertain going forward, therefore the IEA has been conservative in its estimates. It predicts that Iraqi oil production will be around 3mbpd over the next five-year period. The report also assumes that oil subsidies in the Middle East will still be in place, but start being removed elsewhere. Mr Eagles suggested that many countries have badly targeted subsidies that should be replaced with more specific measures to protect the poor.

It also expects OPEC gas liquids production to reach 7.2mbpd by 2013 and that this will be a huge part of supply growth going forward. Biofuel production in volumetric terms amounted to 1.35mbpd globally in 2008 and this is expected to increase to 1.395mbpd by 2013. The IEA has taken a cautious approach in this projection, given the questions surrounding the availability of feedstock and the current backlash triggered by higher food prices. The agency sees the total potential for biofuel supply at 3.5mbpd.

Returning to refining, the IEA expects increased investment in upgrading capacity in the OECD, while a large number of new refineries are likely to be built close to areas of growing demand (Asia and the Middle East). Still, these are likely to suffer the same level of slippage and cost inflation as upstream projects and could slip further if refining margins come under more pressure.

The IEA expects that even with the above investment, meeting demand for middle distillates will be difficult, while the supply situation for gasoline is likely to improve due to anticipated increases in fuel efficiency and the use of biofuels. In contrast, the fuel oil market is expected to tighten, given the increasing amount of upgrading predicted to take place and increasing demand for power generation.
IFandP questioned Mr Eagles as to whether the large coal to liquids projects hinted at in China and India are likely to materialise. He replied by saying that the IEA sees some coal to liquids coming on-stream, but there are other calls on resources as well as environmental concerns.

In its summary of how the IEA sees the market going forward, Mr Eagles said that spare capacity is likely to increase in 2008-09, but the market will tighten in 2010-13, due to a recovery in demand.

It was interesting to note that both BP and the IEA are united in their belief that the extraordinary increase in the price of crude is not the result of speculators. One can’t help but wonder if their comments will serve to make it harder for US democrats, who are seeking to limit the role of hedge funds in energy commodity trading.

If the IEA’s predictions are right, then it is possible that the price of crude and oil products could continue to fall in the short-term. Although this would be good for the world’s economy, it might well dampen interest in the technologies needed for when the market tightens much more, such as energy efficiency measures and renewables. The fact that CO₂ emissions are still increasing is also cause for concern and brings into question the effectiveness and sincerity of recent efforts.

Finally, if BP and the IEA are correct, then not only has OPEC been primarily responsible for the move to above US$100/bbl oil, its influence over the oil market will only increase in the years to come. In particular, the investment decision to be made by Saudi Arabia in 2010, alluded to by Mr Eagles, and the level of future Iraqi oil production (which Fadhil Chalabi, director of the Centre for Global Energy Studies, believes could produce up to 10mbpd), will, to a large extent, determine the outlook for the oil industry when we leave the first decade of the 21st century behind us.

For more information consider visiting the following websites:
http://www.bp.com/productlanding.do?categoryId=6929&contentId=7044622

http://omr.public.iea.org/