Cheaper petrol a false hope

Cheap petrol for Christmas is now a rallying cry, but after so many wrong calls by the energy agencies, it may be unwise to get our hopes too high. Certainly Saudi Aramco officials of late '” and Saudi Arabia's King Abdullah himself '” have been saying there is plenty of Arab crude available, and even difficulty in finding buyers, but this is hard to reconcile with the prices we’ve been experiencing.

All through 2003, 2004 and 2005, analysts and oil forecasters such as Cambridge Energy Research Associates (CERA) were saying the price would soon kill off demand and the oil price would retreat to its natural level of $US25–30 a barrel. When this didn’t happen the natural price became $US35, then $US40–45.

Daniel Yergin of CERA (co-author of the best-selling The Commanding Heights) has rejoined the fray and now says that while oil demand has not been crunched, supply is about to rise rapidly. Local forecasters, such as CommSec's chief economist Craig James (see attachment) and others, take their cue from these projections and suggest a pump price of $1.15 a litre is coming, not only as supply arrives, but as global tensions ease.

But are global tensions easing? The Lebanon is still in shock, Iraq is almost beyond repair, Iran is daring the US to attack, Russia is applying a price squeeze to yet another client state (this time Bosnia), oil companies were kicked out of Bolivia in June (Repsol) and from the sub-Saharan nation of Chad (TOTAL) this month, in Venezuela the Chavez administration has increased tariffs on foreign oil companies, Nigerian oil production is still down 20%, the situation is bleak at best. Throw in North Korea playing a nasty game of nuclear blackmail and it may get worse.

This week Independent Strategy, a UK-based asset consultant, even dragged in comparisons with the Great War (1914–18) to make the point that sometimes chaos does occur. Back in Sarajevo in 1914, the assassination of Grand Duke Ferdinand made headlines, but few thought that only five weeks later guns would be booming across Flanders. All we need is an attack on Iran or another Hurricane Katrina for oil to heading more towards $US100 than $US50 a barrel.

But geo-politics aside, demand and production are more or less in set trajectories. Chris Skrebowski, visiting editor of Petroleum Review, told audiences in Melbourne and Sydney last week that the even using the lowest realistic demand projections and highest likely output from new offshore Nigerian, Gulf and Angolan fields, production and demand data split apart after 2010. After 2010 supply is a long way short of demand: the peak oil scenario.

Even near-term data is not encouraging. True, US demand is not rising as rapidly as it did last year, but a 0.6% increase took the June 2006 figure to the highest US oil consumption on record. Nor is China’s demand bolting as in 2004, but after easing to 3% growth for the first half of 2005, demand is now up 8.6% as a very hot summer, rapidly rising car production (46% for the first quarter) and rising incomes fail to dent demand. If the US and China '” two countries representing 33% of world oil consumption '” keep lifting demand, supply will need to speed up.

Supply is certainly in uptrend, but supply is a net figure: rising flows from newer fields less the amount no longer being produced from older fields. This is why the Saudi claims of abundant oil are hard to fathom. Its older fields are falling by 4–5% and its new oil seems to be largely heavy crude, the type only specialised refineries can handle. Abundance also doesn’t square with “Operation Maintain” '” a $15 billion effort to prolong the life of Ghawar, the largest Saudi field, and renovation of old, previously mothballed fields such as Manifa, Khurais and Khurisaniyah.

Industry insiders are loath to suggest that Saudi Aramco is raising false hopes, but it does seem unlikely that Khurisaniyah, which reached 200,000 barrels a day in 1980, can be lifted and held at 500,000 barrels a day for a prolonged period.

Similar issues can be seen in Mexico and Brazil. Old fields are being renovated and although new offshore discoveries '” some very large '” are expected to come into production in the next two to three years, start-times are likely to slip. Rigs, seismic services and drilling ships are in high demand and Saudi Aramco can outbid most. So those using CERA data need to be cautious. It tends to put the most optimistic case for starts, capacity and costs rather than factoring in the usual 10–20% slippage in time, plus the now endemic 20–30% blow-out in costs.

So we can’t say humbug to cheap Christmas oil, but it may be smart to cross a few fingers and toes.

Richard Campbell is a director of the soon-to-be-launched Global Energy Transition Fund.