Monday, April 7, 2014

Rising Oil Demand in Asia Will Offset Headwinds

In an exclusive interview to the Website of the Emirates Center for Strategic Studies and Research, Dr. Herman T. Franssen (Executive Director of the Energy Intelligence Group, US), said
Dr. Herman T. Franssen
that despite prospects of a rise in US oil production, expanding use of shale oil technology and slowdown in OECD demand, the Middle East oil sector will continue to thrive amidst rising petroleum demand in emerging economies in decades to come. Following is the text of the interview:

Q: What are the important new trends that you believe will shape the future of the energy sector?

A: Well, there are a number of trends. One trend is that the market will continue to increase as majority of people in the world consume very little energy and very little oil, which means that consumption can only rise, as it cannot fall further. It is only in the OECD countries, where you see the beginning of a decline in consumption of oil because of efficiency gains and capital turnover. But almost everywhere else the demand for oil will continue to go up because the middle class is growing in emerging economies, particularly in Asia. And as it has happened with the growth of middle-class everywhere else in the world, you would find in these countries more electrification, as people would opt for having more than one house. The second thing people need after they reach that target is transportation, and it is in human nature that even if you have public transportation people like to have their own vehicle. Thus, if you assume that even 1% of the 1.2 billion people in China and the 1.1 billion people in India were to move every year from the lower class to the middle-class there is going to be a huge and steady increase in demand.

Recently, the Chinese car market became bigger than the American car market. We see this trend continuing, so the demand will continue to grow fast in Asia. Unfortunately, countries in Asia are generally poor in oil and gas resources compared to the size of their populations. So they would have to come to this part of the world, the Middle East, to meet their energy needs. They can also go to some extent to other parts of the world, like Africa, but they would continue to depend heavily on exports from the Middle East to meet their oil requirements. It is important to note here that 55% of the oil import of China comes from the Middle East and in the case of Japan the same tops 80%. This will continue unless these countries find massive accumulations of oil and gas in their own territories, which I doubt.

Q: What are the most recent technological breakthroughs in the oil and gas sector and how promising are they?
A: What has happened in the American market, and this has really happened in the past 10 years, is that small companies have been very innovative in finding technology to tap the secret of developing shale gas. It is gas found in fairly solid form embedded in shale and these companies use a technology for generating enormous water pressure, which with the use of certain chemicals mixed with water, break open molecules from which this gas escapes to the surface. This was impossible to achieve in the past because the technology was not developed, which in part was because the price of natural gas was too low to incentivize innovation. But now the secret has been cracked and the technology has been improving rapidly, and consequently the economics of it has also been improving. In fact, these companies have started producing so much shale gas that it has brought down the price of natural gas. The price now stands at about $4 per million BTU, which is equivalent to $25 per barrel oil. This is very cheap compared to what you pay for in Asia or in Europe. Therefore, the industry is now concentrating more on shale oil, which is found in the same basic formation and uses the same technology, but it focuses more on the liquid part and not on the gas part. Industries are focusing more on producing the liquids, because the gas will anyway be produced as a free byproduct, but if the liquids could be sold for say $100 per barrel, they become more attractive than $25 per barrel gas. This has wide-ranging implications because such shales exist everywhere. In the Middle East, there are massive shales and China also has huge shale deposits. In fact, they are all over the world. But the key lies in finding out which of these shales are good for development. Are they located close to markets, if not an entire infrastructure has to be built to source them to the markets. In addition, you need the right infrastructure and qualified people who know how to use this technology. America has always had large numbers of small companies that develop oil because the US law says that any resource found under the ground are your resources, unlike other countries in the world where most resources found under the ground become government property.

Q: Apart from these technological developments, the US also has large oil reserves that remain untapped. As you mentioned in your lecture at the conference, the US could increase its oil production, but would this not inundate world markets with too much oil?
A: Yes, the US has deep water oil and gas resources in the Gulf of Mexico and the Alaskan offshore resources and now you have the non-conventional resources. If they are developed together, they can significantly increase the production both of liquids and gas in the United States. However, this abundance of oil will only be for the US. The shale oil technology will not make any massive difference for the world unless the rest of the world is also going to develop these resources. Nobody expects major shale gas developments outside of North America in this decade. We may see the beginning of it, for example we see it in Poland, in China but not in the near term.

Q: What is the short to medium term outlook for the price of oil in your view?
A: Right now, all OPEC countries need a minimum price of oil of around $80 per barrel, if it goes below that it will start eating up the budget. If next year, the world were to be in a recession—in a worst-case scenario—and the demand does not only go up but decline and you still have from investments made in the past more non-OPEC oil coming onstream, Libya producing more oil—assuming things stabilize there—and more oil is produced in Iraq, then of course OPEC would have to cut production. In the speculative market the perception is that next year the price may cool down somewhat, not substantially, but somewhat. But this in turn would hurt renewables, as they gain from high prices of oil.

Q: Non-OPEC oil producing countries are said to be becoming more influential in the market. Is it true?
A: I would say they were more influential in the past than they are today. At some point after the two oil shocks of the 1970s, prices rose to about $35 per barrel in 1980, which at current prices would be around $100 per barrel. At that time, oil was the principal fuel for almost everything. It also happened to coincide with the dramatic development of nuclear power. So people speeded up their move toward nuclear. So in power stations oil was very quickly replaced. In industries, wherever possible, oil was replaced with coal or natural gas. For this reason, the share of oil fell from 52% to about 40% in the mid-80s fairly quickly. But once you have reached there it is very difficult to get it down further because the more you reduce that share the more you begin to start eating into the transportation sector. In the OECD countries, 70 percent of the oil is used in the transportation sector and it is very difficult to further improve efficiencies, for example, in Europe and Japan, because they have already done that.

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