Nouriel Roubini's Global EconoMonitor

RGE’s Wednesday Note – Energy Insecurity in 2010 and Beyond?

Today we look at some of the trends that might move global energy markets in 2010. Yesterday’s OPEC meeting, the first hosted by Angola, brought few surprises as countries pledged to maintain their current production cuts in the face of an uncertain global economic recovery. But as growth starts to pick up, could a combination of oil demand growth from emerging market economies and geopolitical supply vulnerabilities boost the oil price back to US$100 per barrel level–a level that could put the economic recovery in jeopardy?

Probably not. The oil market still seems over-supplied, given ample inventories, an increase in OPEC and non-OPEC production and high surplus capacity within OPEC. This supply, and a weak global economic recovery, could mute some of the pressure on the oil price. Fundamentals do not always drive prices–based on fundamentals one might expect an oil price closer to US$50-55 per barrel today–but they can be restraints. In H2 2009, the increase in the oil price was much more muted than the oil spike (and spike in base metals) in 2008. Oil prices rose rapidly in the spring of 2009, then traded in a relatively narrow band around US$75 per barrel for most of the rest of the year.

With the U.S. Federal Reserve set to remain on hold–likely into 2011 in RGE’s view–global liquidity conditions should be supportive of oil and other commodities. Any pressures on the U.S. dollar could strengthen oil. The fundamental outlook, however, could restrain this upward pressure.

The sharp fall in demand for oil in 2009 following a shallower decline in 2008 marked the first back-to-back oil and oil product demand declines in two decades. At the end of 2009, oil and product demand began to recover, but remains well below 2006 and 2007 levels. The strong pace of growth in emerging market economies, particularly in Asia, suggests EM fuel demand will be strong, only partly offsetting weak demand in OECD economies, making the global rebound in demand more muted than in 2004-07.

Despite the auto industry focused nature of the fiscal stimulus in many countries–especially China–the incentive to buy more fuel efficient cars suggests the growth in oil product demand has been and will continue to be more muted than this buying surge would indicate. Moreover with prices tied more closely to global market prices, more of a price increase would be passed on to the consumers in China. Other Asian countries have likewise poked holes in their subsidy regimes. Finally, the addition of refinery capacity in the Middle East and Asia removes one price pressure as the chance of product shortages are lower.

Demand in the U.S. improved from the very weak levels seen in late 2008 and early 2009 but remains well below the level of recent years. Inventories of oil and oil and products are well below five year average levels. Miles driven are estimated by the U.S. Department of Transportation to be at levels not seen since 2004. And with gas prices higher, we may begin to see a consumption response.

There seems little shortage of supply in the near term. As oil prices stabilized around US$70 per barrel in mid-year, output began increasing with both OPEC and non-OPEC countries increasing production. Despite an OPEC pledge to comply with past cuts and targets, a slow leak of increased production seems set to continue. As of November, aggregate compliance with the January 2009 cuts was at only 60%, down from the 80% seen in February and March 2009. The compliance with cuts varies dramatically across the GCC countries, with Saudi Arabia picking up the slack. Only a sharp drop in the oil price and demand would provoke much change. A drop in the oil price to the US$60 per barrel range would likely trigger renewed output cuts from both OPEC and non-OPEC members.

Non-OPEC output is also on the rise. Russia has boosted output, offsetting 2008 declines, and output from Canada and Brazil has also increased. These increases, at least in the near term, reinforce OPEC trends and suggest that supply will continue to outpace demand in 2010.

What about Geopolitical Supply Shocks?

There are some lurking geopolitical issues and higher security costs that could reduce oil supply on a temporary basis. Saudi Arabia is increasingly involved in Yemeni conflicts. Despite what many analysts call a proxy war with Iran, the effect on the oil supply seems limited. The resurgence of Iranian domestic opposition for the first time since the opposition was brutally suppressed in the summer of 2009 raises some uncertainties. Domestic politics and nuclear posturing suggest that foreign oil companies and expertise will be kept out of Iran for a longer period, deferring any output increase. Sanctions on Iran are tightening again.

OPEC surplus capacity (still about 4 million barrels per day) should mute some of the geopolitical pressure on the oil supply, especially when coupled with a generalized increase in production. Similarly, the increase in refineries to process GCC sour crude could reduce the impact of supply shortages on the global oil price.

Natural gas markets, which are regional, face some challenges in 2010. Last week RGE’s Jelena Vukotic highlighted the risk of a renewed gas crisis stemming from Ukraine as the cash-strapped government repeatedly struggles to pay its gas bill and refuses to pass on higher costs to domestic consumers. A year ago, Russia’s Gazprom cut off gas supplies to Ukraine when it refused to pay its bills in full, and gas to the EU was reduced sharply. Given domestic political feuding in Ukraine, the chance of a repeat has risen. While Moscow will be reluctant to be seen as meddling in Ukraine’s mid-January presidential elections, the country and its state-owned energy company Naftogaz seem to be running out of options. Funds from the IMF standby agreement are frozen following the approval of populist measures. The great recession has reduced natural gas demand in Europe, but it could be another cold winter, particularly for the countries in southeastern Europe which have few supply alternatives. Western Europe continues to have relatively ample natural gas supplies in storage.

The longer-term oil supply outlook does not look quite as good as it does today, a dynamic that elevates today’s prices. In particular, the increase in output from Iraq and Russian and African oil frontiers may be slow to come. Yet here again, Saudi Arabia may be a major source of supply. After adding new supplies in 2008, it has put further development on hold, a decision that could be reversed.

Iraq recently extended servicing contracts to a number of fields and hopes to more than double oil output to 5 million barrels per day by midway through the next decade, offsetting other declining fields. It could wind up taking longer however–and the deteriorating security situation and lack of infrastructure makes some fields much less attractive. Only Sonangol, the Angolan owned company, was willing to bid on the two fields closest to the violence in Mosul.

Shell seems about to cut some of its losses in Nigeria, reportedly preparing to sell US$5 billion in assets in the Niger Delta. As RGE’s Lee Hudson Teslik noted last month, Nigerian production remains well below its 2006 peak and the costs of providing security are making operations less attractive.

Another source of uncertainty stems from environmental policy. More energy efficiency could reduce oil demand growth. Regulatory clarity, particularly surrounding anti-climate change policies is key to future developments, not only of renewable energy technologies but also of hydrocarbons. Cleaner burning and ample natural gas could be attractive in efforts to reduce emissions. The political momentum may bring new energy efficiency policies that could reduce demand for oil over time–something OPEC members are worried about.

Further development in Canada’s oil sands is contingent not only on oil prices above US$60 per barrel but also clarity about how Canadian bitumen will be treated in the U.S. The U.S. cap and trade bill will be reconsidered by the Senate in the spring of 2010. The compromise at Copenhagen leads to little clarity on these issues, and horse trading may be as necessary for the Cap-and-Trade bill as for the health care legislation.

A strong and stable oil price could actually support efforts to diversify away from oil. A price of US$75-80 a barrel not only unlocks a lot of new oil supply over a near-term perspective–including oil sands, pre-salt Brazilian oil, as well as appetite for Iraqi oil–but also makes a number of alternatives more viable.

On a macroeconomic basis, a gradual increase in the oil price can be more easily absorbed than a spike. However, even if US$80 a barrel is a price that consumers and producers feel they can live with, such levels could still put a crimp on the global recovery as consumers spend more on fuel, particularly if rising headline inflation prompts central banks, particularly in the emerging world, to start tightening interest rates given the higher share of food and fuel in consumer baskets.

4 Responses to “RGE’s Wednesday Note – Energy Insecurity in 2010 and Beyond?”

Winston SmithDecember 23rd, 2009 at 8:47 am

TAIBBI/KUTTNER Bill Moyers JournalBILL MOYERS: If you were Barack Obama in a city that’s overrun by money, how would you try to fix it?ROBERT KUTTNER: I would go over the heads of the special interests to the people. I think there’s a lot of sullen apprehension, frustration out in the country. And I think the people are hungry for leadership. He’s not doing that sufficiently.MATT TAIBBI: It’s absolutely a political winner for the president to hit Wall Street very hard and do all the things that he’s supposed to be doing right now. You know, that all the things that FDR did. If he did those things, if he remade Wall Street in the way that it needs to be remade, he would do nothing but gain popularity. And I think that’s the strategy he should have pursued.BILL MOYERS: But what if by nature, that’s not what he wants to do? What if, by nature, he prefers to head the establishment, than to change it?ROBERT KUTTNER: Then he runs the risk of being a failed president. And I do have the audacity to hope that he’s a smart enough, principled enough guy, that some time in his second year in office, he’s going to realize that he’s at a crossroads.MATT TAIBBI: This isn’t a purely political problem. This isn’t just a question of how does Barack Obama get reelected. This is a serious problem. He has to put aside maybe his inclinations to think about what he can do to actually fix the country. And it’s, you know, desperately in need of fixing. And so, if he’s not that guy, he has to become that guyWinston sez-We need a peoples “movement” to get the money out of DC

11b40December 23rd, 2009 at 10:15 am

Either Obama gets with the refrom program, or someone else will soon. Every day reform is postponed, is a day closer to a true populist revolt in the hinterland. Already, a “throw the bums out” movement is taking hold, and the way things are going, it could catch fire. Maybe if there is real momentum in this direction, our bribed leadership will take notice….or will they stay bought?The old joke about honest politicians comes to mind. An honest politician is one who, once bought, stays bought.Independent Contractor

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