The April 12 IEA Full Oil Market Report is in agreement with Mr. Simmons as far as the demand end is concerned, predicting 4Q05 demand of 86.1 Mb/d, despite a recent slowdown of the rate at which China's demand is increasing. Despite OECD crude oil stocks (this refers to crude oil that is being stored by the major industrialized countries) being higher in 2005 than they were in 2003 and 2004, Brent crude oil futures are in contango all the way out to the December 2005 delivery date, indicating an expectation of a tighter oil market at that time. In 2004 at this time, Brent futures to December 2004 were in backwardation, which was consistent with an expectation that prices would ease. Commodities investors seem to anticipate that demand for the light sweet Brent crude will at least challenge supply in 4Q04, although not to the extent predicted by Mr. Simmons.
The April 2005 IEA OMR included some explanatory commentary on the contango for future crude delivery contracts.
While a crude price above $55 and a contango structure may have appeared a paradox a year ago, the current limited spare production capacity, lag between investment and output and the subsequent need to hold stocks makes such a structure seem more logical. This is not simply a case of building crude or product stocks during “off season” demand, but also looking to have sufficient reserves to meet periods of above trend annual demand growth.....
Current high prices are not just the sum of current supply and demand, but are also a reflection of expectations of future needs. When we reach that future, there should, under current demand projections, be additional supplies from stocks available.
In other words, even the IEA expects that stocks will have to be drawn down in the future to meet not only normal seasonal fluctuations in demand, but to handle normal secular demand growth.
Earlier this year, Saudi Arabia abandoned its long time policy of closely watching the level of OECD stocks and reducing production when high stock levels threatened to erode support from the desired OPEC market price band. The Saudis no longer seem concerned that excess stocks will soften the oil market price, and in fact seem to be encouraging a buildup of stocks to head off a potential supply crunch in the fourth quarter. This is consistent with both Mr. Simmons' outlook and that of the IEA.
Assuming that the IEA's 86.1 Mb/d demand prediction will hold, to what extent will global production in 4Q05 be inadequate to satisfy that demand? In March 2005, global production totaled 84.24 Mb/d, with 50.40 Mb/d coming from non-OPEC sources and 33.84 from OPEC. The IEA Report estimated that OPEC had an additional sustainable production capacity in March of 1.86-2.36 Mb/d, which would be reduced to 1.03-1.53 Mb/d if troubled producers Iraq, Venezuela, Nigeria and Indonesia are excluded. Using the latter figure, OPEC's maximum sustainable production capacity as of March 2005 was estimated at 35.37 Mb/d. The IEA expects non-OPEC production by 4Q05 to rebound to 51.88 MB/d as issues in the Gulf of Mexico and elsewhere are resolved, and new projects such as the ACG megastructure project in Azerbaijan, which started production in mid-February and is expected to average 410 kb/d in 2005, contribute to non-OPEC production. Assuming that OPEC's sustainable production in 4Q05 remains what it was in March 2005, global oil production in 4Q05 could total 87.25 Mb/d, which is more than enough to satisfy the IEA's projected demand of 86.1 Mb/d, or even Mr. Simmon's high demand figure of 87 Mb/d.
Moreover, the ODAC Megaprojects 2004 analysis projected that about 3.4 Mb/d of new production capacity will be coming online in 2005. The non-OPEC component of these new projects was incorporated into the 51.88 Mb/d IEA 4Q05 figure. The OPEC projects slated for completion in 2005 included Nigeria's Bonga South (RD Shell; 250 kb/d) and Erha (ExxonMobil; 150 kb/d) oilfields, Venezuela's Corocoro Phase I offshore field (ConocoPhillips; 50 kb/d), Abu Dhabi's NEAD project (Adnoc; 110 kb/d), and Kuwait's GC-15 project. According to the EIA, the Erha field is presently not expected to come online until 2006 to 2007. Corocoro development was held up somewhat by a dispute between ConocoPhillips and the Venezuelan government, but that has been settled. It is unclear whether production will in fact commence in 2005. According to OPEC, the NEAD project will begin producing in 2005. OPEC estimates that a total of about 1.6 Mb/d of net capacity will be added in 2005. If this is correct, world supply capacity by the end of 2005 could be 88.85 Mb/d, which is much more than is necessary to meet projected demand.
Why then have the futures markets and even the Saudis been acting as if there will be a supply crunch later this year? I think the answer lies partially in fears of political stability in Iraq, Nigeria and Venezuela, a fear of open conflict between the United States and Iran and perhaps most of all the fact that much of the marginal production capacity increases in recent years have come from heavy oil or sour oil instead of the much preferred light sweet crude. While Peak Oil may be a few years off yet, production of light sweet crude may be in the process of peaking right now. A recent specification change by China of the amount of sulfur that is permitted in permitted in gasoline has also increased increased demand for light sweet crude. According to a recent OPEC report:
These developments are likely to result in Asian refiners increasingly seeking more lighter crude from West Africa, drawing sweet barrels away from the Atlantic basin and thus further pressuring light sweet benchmarks WTI and Brent, the report said.
In contrast, the prospect for heavy sour grades looks less promising and may even weaken if the high sulfur fuel oil market remains at the steep discounts seen last year. With the decline in global fuel oil consumption by at least 1.5% per year, this situation will likely persist in 2005, adding further pressure on heavy sour grades, the report said.
It appears that absent unforseen geopolitical developments and/or an unanticipated sharp rise in demand, global oil supply at the end of 2005 should be adequate to meet demand. The supply demand balance for preferred light sweet crude, however, will be much tighter than it is for the overall market, and this situation is expected to worsen in the future.
