Friday, August 2, 2013

Oil production booms, demand drops, prices stay high: Why?

Tim Bradner
Alaska Journal of Commerce

University of North Dakota student Maxwell Johnson, an intern for Hess Corp. stands in front of an oil rig July 10 near Tioga, N.D. Production from the Bakkan oil play in North Dakota jumped 50 percent last year and contributed to the largest single-year increase ever in oil production for the U.S.. Despite the increase in supply and slack demand, prices remain high, however.

The world is awash in oil and the U.S. recorded its biggest increase in oil production last year. Oil demand is down, mainly due to high prices and the weak economy, but also due to huge gains in energy efficiency.

Yet oil prices remain high. Why?

That’s a conundrum energy economists are struggling with, says BP’s chief U.S. economist Mark Finley. If supply is up and demand is down, price ordinarily would fall. It isn’t happening, though.

“It’s a key question we’re facing, and we don’t really know the answer,” Finley said.

One possible answer might be that there is demand on world markets that isn’t being tracked, he said, possibly from governments quietly buying up oil to build strategic stockpiles.

“The U.S. isn’t the only nation with a strategic oil stockpile. China is also building a stockpile, and we now know that Saudi Arabia is building a supply storage, so that it has inventory for strategic advantages,” Finley said.

This could be one explanation for why oil prices remain high.

Finley spoke in Anchorage July 29 to a group of business and community leaders at a luncheon sponsored by the Alaska Oil and Gas Association.

Finley’s comments were drawn from data in BP’s annual Statistical Review, the 62nd edition of the report. BP’s data for 2012 is the latest available as of May, 2013, and the company’s report is typically the first analysis of energy trends published for a year, and is ahead of other reports, such as those produced by the U.S. Department of Energy’s Energy Information Administration.

Overall, the world’s energy market showed weak growth across all regions and all types of fuel.

“Energy consumption grew by 1.8 percent, which is low by recent standards,” Finley said.

The 10-year average is 2.6 percent. Energy consumption in OECD (Organization of Economic Cooperation and Development) countries, or developed nations, fell by 1.2 percent, led by a decline in the U.S. of 2.8 percent.

Among OEDC countries oil consumption dropped 1.3 percent, or 530,000 barrels per day, the sixth decrease in the past seven years. Among non-OECD nations, oil consumption grew by 3.3 percent, or 1.4 million barrels per day.

Non-OECD nations, mostly the developing nations, saw a 4.2 percent growth, but that was below the 10-year average of 6.3 percent growth.

Oil development continues at high levels, however.

“For every barrel of oil consumed reserves grew by two barrels, mainly because of technology improvements, such as in shale oil production,” he said. The world now has a 53-year supply of proven oil reserves and a 56-year supply of gas reserves.

The U.S. enjoyed a booming increase in oil and gas production, led mainly by the technology revolutions in shale production, but oil demand was down in the U.S. mainly due to a sluggish economic recovery and continued high prices.

An interesting aspect of the U.S. shale revolution is that the technology gains continue to improve in shale, somewhat confounding experts who had predicted a plateau effect.

“North Dakota saw its production increase 50 percent (mostly shale oil) but the number of rigs were up only 10 percent. Why is that? It is because the rigs were more productive, and drilling more wells. They were more efficient,” Finley said.

Global energy efficiency gains were also at record levels. Worldwide, the “energy intensity” of economic growth dropped by 1 percent mainly due to efficiency gains, Finley said.

In Asia, still the driving force in world energy markets, oil demand in China fell due to slowing growth, but coal use continued to increase. In Japan, cutbacks in that nation’s nuclear industry led to increased use of oil and particularly gas for power generation, in the form of imported liquefied natural gas, or LNG.

That had a chain-reaction effect on LNG markets, and indirectly on U.S. coal markets, Finley said.

“European LNG purchases fell 25 percent as Europeans were outbid by Japanese importers. To fill that need for fuel for power generation, Europe imported more coal, mostly from the U.S.,” he said.

The U.S. had coal available because cheaper natural gas was available, due to shale production. U.S. gas prices fell by one-third percent in 2012, making gas more attractive for power generation. This illustrates the linkages across regions and types of fuels that connect the world’s energy business today.

Oil remains the dominant fuel of in the world but it is gradually losing market share to other fuels, mainly gas and coal.

“The decline in oil use tracks perfectly with price,” Finley said. “The use of oil (in the mix of energy) is the lowest it has ever been.”

However, in the long term oil demand will be driven by growth of demand for transportation fuels, which is linked to larger numbers of automobiles being purchased, mainly in Asia.

“Twenty years ago China accounted for only 2 percent of new sales in the world. Now it accounts for 20 percent,” Finley said.

Asia overall accounted for 16 percent of new care sales two decades ago and now accounts for almost 80 percent.

A key message Finley conveyed to listeners is that most of the big innovations in energy like shale oil and gas, production from deep offshore fields and the Arctic, and including the biggest gain in energy efficiency in decades, have mostly been in North America.

That’s no accident. “It has happened because we have a political and economic structure that allows markets to respond. We don’t (have the government) pick winners and losers,” in industry, he said.

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