Overcoming the global weakness

Perry Fischer

January 9, 2013

During the past few years, annual change in global oil demand has been running 0.8-1%/year and the International Energy Agency (IEA) forecasts it to continue in that range in 2013 – well below the previous 20-year 1.5% average annual increase seen before the global banking crisis. The weak global economy, which likely grew by about 3.3% in 2012, accounts for much of the restrained oil-demand growth. Improvement to 3.6% is forecast in 2013, slanted toward the second half. Energy efficiency improvements account for some of the subdued global demand growth, especially in OECD countries, where demand growth continues to be negative. In these regions growth was -1.1% in 2012 and is forecast to drop 0.7% further to -0.4% in 2013, with the US leading the decline, despite improving economic conditions. Demand outside the OECD is strong, likely growing at 2.8% last year, and is forecast by the EIA to rise 2.6% this year.

ExxonMobil just released its 2013 forecast The Outlook For Energy: A View to 2040. One of the key findings is that the company agrees with the forecasts of IEA, the US and others regarding oil demand and the OECD. Basically, the developed world will see negative demand growth for many years to come, but this will be more than offset by increased demand in the developing nations, mostly due to relentless population growth. The net effect is that energy demand will increase 65% in developing nations, but because of negative OECD growth, only 35% globally over the next 30 years. The biggest increase will occur in the electricity sector. That bodes well for natural gas, which will overtake coal as the second-most-consumed fossil fuel. In the forecast, natural gas use quadruples in (primarily heavy and marine) transportation use to 4% from today’s 1%.

crystal globe

‘All liquids’ oil demand will rise to 113mmboe/d by 2040 – a 30% increase from 2010. This is just under 1% average annual growth. About 70% of that increase is in the transportation sector, entirely due to boats, planes, trains, and heavy freight. Within the light transportation sector, the number of vehicles is expected to double over 30 years but, in terms of fuel consumption, remain essentially flat due to efficiency gains. This will also be true for overall energy usage in OECD countries, as they will ‘keep energy use essentially flat, even as OECD economic output grows 80%’, says the report (Figure 1).

Even more far-reaching, the forecast says that ‘around 2030, the nations of North America will likely transition from a net importer to a net exporter of oil and oil-based products’.

According to Barclay’s Capital, since 2000, global oil production has grown 14% and gas production 34%, but industry E&P expenditures were up 387%, to an estimated $614 billion in 2012.

John Westwood, group chairman of the Douglas-Westwood research and consultancy firm, comments: ‘In short, each year we are spending more and more dollars to recover less and less oil. Much of this trend is due to the decline of conventional production, even in what we nowadays regard as “shallow water” such as the North Sea, where oil production is down 48% since its peak in 2000, and globally reservoirs are depleting three times faster than they were 20 years ago. The result is a drive to exploit unconventional reserves, both onshore and in deepwater. But such oil will be high-cost oil.’

In a general way, the ratio of energy that is produced from a well versus the amount put into a well has been decreasing over the long term. Getting 100 barrels out for every ‘barrel of energy’ put into a well was common 80 years ago, now it’s 20 barrels or less produced for each barrel input.

2012: Peaker’s Lament

Despite the underlying demand fundamentals, higher and more volatile prices, more spending for less energy return, the rise and dominance of the NOCs (national oil companies) and their associated resource nationalism, 2012 was a remarkable year for the oil and gas industry.

A few years ago the peak oil community believed that 2005 was the peak production year, and that 72 million b/d of crude was the most that the planet would ever produce (Simmons) and that 86 million b/d was the most in ‘all liquids’ terms (Pickens). IEA now forecasts that 2013 oil production will be augmented by 830,000b/d to a total of 90.4 million b/d. The future supply picture looks bright. While noteworthy in its own right, what makes that amount even more striking are the extraordinary events of the past year.

In 2012, as the IEA said in its year-end Oil Market Report, ‘rarely have so many things gone wrong in the oil patch at the same time’. Shut-ins during 2012 included Brazil, Oman, Yemen, Buzzard Field (UK offshore), an oil strike in Norway, a war-torn Libya trying to regroup, wars in Syria and Sudan, together with a dramatic increase in Japanese demand for anything that burns. These events would have rattled markets to their core in 2004-08, but last year markets were relatively stoic, calming even as the disruptions grew (although the full-year daily range for WTI was $78-108, achieved from March to June 2012). In 3Q 2012, global events cut crude supply by a hefty 1.3 million b/d, and that doesn’t include a drop of more than 1 million b/d in Iranian production with on-going sabre-rattling accompanied by an undercurrent of potential action by Israel.

graphFigure 1. No matter how you measure it, the US is doing more with less, typical of the OECD countries. Note especially the energy intensity improvement, ie energy use/US dollar GDP. Source: EIA AEO2013

Saudi Arabia stepped up production to 30-year highs, US production surged and the rest of the world more than held its own, with strong gains in Iraq, Russia and a surprisingly quick Libyan turnaround. The supply disruptions not only failed to impress markets, but OECD inventories actually increased against the normal seasonal decline in 3Q. The mediocre global economy helped the situation, as did improving energy intensity in the OECD. As this article goes to press at year end, traders are lowering their bets on crude prices. Incredibly, oversupply is a concern.

Adding to supply optimism is the fact that recovery factors still have room to grow from their present global average of ~35% to as much as 50% – easily making improved recovery the largest ‘reservoir’ on Earth. This is more easily achieved with higher prices. Statoil’s successful EOR projects, US CO2 projects (which are growing and now add more than 350,000b/d to supply), Middle East waterflood projects, improving heavy oil recovery on Alaska’s North Slope and numerous other recovery enhancement projects are adding to supply.

Longer term, the finite nature of the fossil-fuel resource will eventually play out. But a lot can happen before ‘eventually’ comes along.

Oil prices

Andrew Lebow, SVP of energy derivatives at Jeffries Bache, forecast oil prices to range $75-100 a barrel in 2013, with Iranian geopolitics responsible for $7-$10 of that. This represents a 10% lowering of his previous forecast. Lebow expects that supply will be ‘much higher’ than demand.

George Littell of the forecasting firm Groppe, Long & Littell noted that globally, one of the problems for oil demand is all of the competition from natural gas. ‘It competes by displacing residual fuel for electricity generation and, in quite a few places, it displaces distillate as well. Both the Chinese and Indians initially built their electricity-generating capacity on oil. What they’ll do now is convert to gas.’

When asked for a price forecast, Littell hinted that OPEC held a lot of the supply cards, noting that ‘Saudi Arabia is putting out 10 million b/d, which is at the top of their normal 8-10 million b/d range. There’s plenty of room for them to cut back production. There’s no reason for oil prices to go down a lot, but it’s not a smooth process. I’d expect them to range in 2013 about the same as they did in 2012.’

Global Offshore

Underscoring the importance of the sector, offshore E&P now accounts for over 30% of global production. Its vast investments now include 11,698 vessels – 13% of the global fleet, notes John Westwood.

Douglas-Westwood finds that capital expenditures in deepwater projects are forecast at $232 billion, with the US, Brazil and West Africa accounting for 72% of that. Subsea technology will garner $135 billion for hardware installed over the next five years, which means a 33% increase in subsea support-vessel days at a cost exceeding $77 billion, with deepwater operations being the biggest driver.

Floating production systems (FPS) are well established as a cost-effective method for producing oil and gas. Douglas-Westwood forecasts that between 2013-17, $91 billion will be spent on FPSs – which is double the preceding five-year period. Reasons include a larger proportion of newbuilds and conversions, a greater degree of local content (resulting in increased costs) and general offshore industry cost inflation. Douglas-Westwoodforecasts that 63% of the money spent worldwide on FPSs will be in deepwater.

FPSOs are by far the largest segment of the market, with 94 installations to be added and capex commanding 80% of all FPS expenditures 2013-17. FPS semisubmersibles account for the second-largest segment (10%), followed by tension-leg platforms (TLPs), then spars.

Latin America will have 29% of the forecast installations and 37% of the projected capex. Petrobrasoperated fields off Brazil have seen the most installations to date and this is likely to continue, albeit substantial delays are expected for Petrobras’ offshore E&P investment. Asia is the next-most active region, with 24 units to be added, while Africa should attract a forecast $18.2 billion in capex.

Mobile drilling rigs are expected to increase by 286 units during the next five years as demand for offshore drilling increases.

Remarking that any forecast could go awry, Westwood notes that the fracturing and horizontal well technologies sweeping the US could spread worldwide and impact the development of expensive environments such as arctic oil and gas.

Westwood points out other risks: ‘. . . industry costs have doubled since 2000 – skill shortages and spiralling cost inflation will continue to be an issue, as well as industry over-reaction to market cycles causing oversupply, something partially associated with vessel owners.’

Westwood’s final caveat is one of optimism: ‘The offshore business is busier than it has ever been; many offshore technology companies report record backlogs and/or orders so the industry needs to consider supply-side constraints and plan accordingly.’

For the foreseeable future, clearly, the offshore environment, led by deepwater, is the place to be for growth. OE