Oil and Economic Growth A Supply-Constrained View Center on Global Energy Policy School of International and Public Affairs Steven Kopits Columbia University Managing Director 11th February 2014 Douglas-Westwood / New York 1 www.dw-1.com Our Business History and Office Locations • Established 1990 • Aberdeen, Canterbury, London, New York, Houston & Singapore Activities & Service Lines offshore • Business strategy & advisory power • Commercial due-diligence • Market research & analysis • Published market studies Large, Diversified Client Base • 1,000 projects, 70 countries • Leading global corporates onshore LNGLNG • Energy majors and their suppliers • Investment banks & PE firms • Government agencies Spanning the Energy Sectors • 10 years in offshore renewable energy downstream © Douglas-Westwood Limited 2013 renewables 2 Demand-Constrained Models Supply-Constrained Models Supply Growth Demand Growth Oil Prices Oil and Mobility The Oil Majors Oil and Economic Growth Conclusions 3 Demand versus Supply Driven Forecasting Demand-driven Forecasting GDP Oil Demand Oil Supply Growth Growth Growth • exogenous • 푓(퐺퐷푃 푔푟표푤푡ℎ) • 푓(푑푒푚푎푛푑 푔푟표푤푡ℎ) Supply-driven Forecasting Oil Demand Oil Supply GDP Growth • exogenous • 푓(푂푙 푠푢푝푝푙푦 푔푟표푤푡ℎ) • 푓(푂푙 푠푢푝푝푙푦 + 푒푓푓푐푒푛푐푦 푔푎푛푠) 4 Demand versus Supply Driven Forecasting Demand-driven Forecasting GDP Demand Supply Growth Growth Growth • exogenous • 푓(퐺퐷푃 푔푟표푤푡ℎ) • 푓(푑푒푚푎푛푑 푔푟표푤푡ℎ) • Traditional forecasting model • Many forecasters will never see anything but this during their entire career • Virtually all forecasters—investment banks, oil companies, and industry analysts, the US and foreign governments—use demand-constrained models. 5 Demand versus Supply-Driven Forecasting Traditional Oil Markets Forecasting GDP Demand Supply Growth Growth Growth 푇ℎ푒 푅푒푠푑푢푎푙 Call on OPEC • Supply growth is a function of non-OPEC supply and OPEC supply • OPEC provides the residual: “Call on OPEC” • OPEC is to stabilize prices with increased production or production cuts 6 BP / IEA Forecasting From BP’s Energy Outlook, 2013 “Global liquids consumption is projected to reach 104 Mb/d by 2030 but growth slows to 0.8% p.a. (from 1.4% p.a. in 1990-2010 and 1.9% p.a. in 1970-90).” “Demand growth comes exclusively from rapidly growing non-OECD economies. China, India and the Middle East together account for nearly all of the net global increase. OECD demand has peaked and consumption is expected to decline by 5.6 Mb/d.” BP Energy Outlook, Jan. 2013 (pp. 33, 39) • A demand-driven interpretation. 7 BP / IEA Forecasting BP Energy Outlook, Jan. 2013 (p. 41) 8 BP’s View of the Residual Call on OPEC GDP Demand Supply Call on Growth Growth Growth OPEC • BP solves oil supply growth > demand growth with rising spare capacity in OPEC. • This means purely Saudi Arabia, barring unexpected outages in other countries—on which more later. BP Energy Outlook, Jan. 2014 (p. 32) 9 Assumptions of Demand Constrained Forecasting • Oil demand is weak - GDP growth is endogenously weak, or - Social tastes or demographics have changed • OPEC is central - OPEC has enormous leverage - OPEC discipline is key to industry economics • Oil prices are balanced on a knife’s edge - Any excess supply or lack of OPEC discipline will tank oil prices—and with it, the IOCs 10 Demand-Constrained Models Supply-Constrained Models Supply Growth Demand Growth Oil Prices Oil and Mobility The Oil Majors Oil and Economic Growth Conclusions 11 Demand versus Supply Driven Forecasting Supply-Constrained Forecasting • A “binding constraint” view of economic growth • Oil supply growth is insufficient, reducing GDP growth Oil Supply Oil Demand GDP Growth Growth 훈 Growth (OPEC + non-OPEC) • Exogenous, • Inherent Demand • Efficiency Gain • Residual OPEC and non- Growth – from – Economy If efficiency OPEC considered unconstrained decreases gains + oil together supply energy supply growth • Assumes limited • Observed intensity over not sufficient, accommodation demand growth – time GDP growth from OPEC Growth actually will be limited observed in the data, less than inherent demand growth 12 Supply-Constrained Pre-Conditions Need to demonstrate…. Constrained Supply • Demand is likely higher than demonstrated • Oil supply growth is constrained • Oil is a key enabling commodity (can affect GDP) • Constrained oil supply is materially affecting economic activity • Efficiency gains are likely not enough • GDP growth is off trend Traditional Forecast (Demand-driven) • “Peak demand” largely unsupported • Oil prices sustaining in the face of supply growth in excess of forecast demand 13 Demand-Constrained Models FullSupply Cycle-Constrained Gas Economics Models Supply Growth 140 Electric Power - Gas 130 Electric Power Sector - Coal Demand Growth 120 Oil Prices 110 Oil and Mobility 100 The Oil Majors 90 Oil and Economic Growth 80 Conclusions Jul-10 Jul-06 Jul-07 Jul-08 Jul-09 Jul-11 Jul-12 Jul-13 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 E&P Capex per Barrel Source: Barclays Capital • Natural gas prices will continue to rise • Median required breakeven price is around $8 / mmbtu 14 Inherent Demand 105 Actual (EIA) - Last Three 39% Global • Oil demand historically Months of Period GDP Growth increases by 0.75 * GDP Expected Based on GDP 100 Growth @ 2.5% Eff. Gain growth (inherent demand Expected Based on GDP growth) Growth @ 1.2% Eff. Gain 95 • Implies 23%+ oil consumption mbpd growth from 2004-2013 90 • Actual oil supply growth was 85 7.5% Oil Supply Growth only 7.5% 80 • By 2008, the world economy 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 was missing a quantity equal to the output of Saudi Arabia Observed Oil Supply; and Oil Demand anticipated based on GDP growth • Today, compared to 2004 Q4, Source: EIA. IMF, Douglas-Westwood analysis we’re missing a Saudi Arabia • Demand growth = GDP growth – 1.2% annual efficiency gain and an Iraq without oil price pressure • Demand growth = GDP growth – 2.5% annual efficiency gain with oil price pressure at recent levels • That’s why oil is expensive 15 Liquids Supply Since 2005 • Total production up 5.8 mpbd 6.0 since 2005, of which 1.7 mbpd 5.1 5.0 Change Dec 2013 vs. Dec 2005 is OPEC NGL’s (non-crude) Change Dec 2013 vs. Dec 2010 4.0 OPEC liquids production • 3.0 (crude + NGL) is unchanged 3.0 since 2005 2.0 1.2 1.3 • US unconventional liquids 1.0 0.9 (shale oil and NGL) up 5.1 0.0 mbpd—literally all net crude oil mbpd -1.0 (0.7) production growth—since (1.0) 2005. -2.0 (1.8) • Canadian oil sands up 1.2 -3.0 US (incl. Canada (incl. Opec (incl. All others mbpd from 2005 Shale Oil, Oil Sands) Iraq) NGL) • Legacy, conventional system World Liquids Production Growth, 2005-2013, Oct- still peaked in 2005. Dec averages, excludes OPEC NGLs • Oil supply growth entirely Source: EIA STEO leveraged to unconventionals 16 OPEC Liquids Supply since 2005 • OPEC crude essentially 2.0 Change Dec 2013 vs. Dec 2005 1.7 unchanged in last three years, Change Dec 2013 vs. Dec 2010 1.8 mbpd less than 2005 1.2 1.0 0.7 0.5 0.6 0.3 • Most growth is NGLs, up 1.7 0.1 mbpd since 2005 0.0 mbpd (0.0) • Iran, Libya, and Nigeria -1.0 together down 2.4 mbpd since 2010 -2.0 • Saudi up nearly 700 kbpd from (2.4) 2010, close to 1979 levels -3.0 (3.0) • Iraq up only 1.2 mbpd since -4.0 2005—US adds more in a year Iraq Iran, Libya, Saudi Other OPEC now Nigeria Arabia OPEC NGLs Crude • US shale oil and NGLs would OPEC Liquids Production Growth 2005-2013 be easily the second largest Source: EIA STEO, three month averages ending December of each year producer in OPEC 17 Liquids Supply Since 2005 • Total spend since 2005 on upstream 6.0 5.1 exploration and production: 5.0 Change Dec 2013 vs. Dec 2005 $4 trillion Change Dec 2013 vs. Dec 2010 4.0 • Of which, $350 bn on US and Canadian $2,500 bn 3.0 unconventional oil and gas… 3.0 93% of supply • …and another $150 bn on LNG and GTL 2.0 1.2 1.3 • $3.5 trillion was spent maintaining the 0.9 2005 legacy oil and gas system 1.0 • About $2.5 trillion* was spent on legacy 0.0 crude oil production—94% of the mbpd -1.0 (0.7) petroleum liquids supply today. $350 bn (1.0) 7% of supply • Result: legacy oil production has fallen by -2.0 (1.8) 1 mbpd -3.0 • Peak oil for legacy system: still 2005 US (incl. Canada (incl. Opec (incl. All others Shale Oil, Oil Sands) Iraq) • For comparison: ‘98-’05, $1.5 trillion NGL) spend added +8.6 mbpd crude production World Liquids Production Growth, 2005-2013, Oct- Dec averages, excludes OPEC NGLs • Compared to ‘98-’05 period, vaporized Source: EIA STEO, Barclays, DW Analysis GDP of Germany * GDP of Germany is $3.5 trn, Italy $2.0 trn 18 Demand-Constrained Models Supply-Constrained Models Supply Growth Demand Growth Oil Prices Oil and Mobility The Oil Majors Oil and Economic Growth Conclusions 19 Motorization and Oil in Historical Context World Crude Oil Production (C+LC): 1960-2011 80 70 60 50 mbpd 40 30 20 World Crude Oil Production, million barrels per day Source: EIA • Motorization in West: 1.2 bn people, +30 mbpd supply, 12 years • Motorization in the East: 1.3 bn people, +4 mbpd crude, 8 years • Based on historical precedent, anticipated growth would be 2.7% per year, not 0.8% 20 China Key Driver of Oil Demand Growth 55 China as Japan (1960-1973) 50 45 China as Korea (1976-1996) 40 China - EIA IEO 2010 35 30 25 20 China is here.