on the edge of the precipice? implications of the us$ 40+ oil price for oil buyers and sellers...
TRANSCRIPT
On the edge of the precipice?
Implications of the US$ 40+ oil price for oil buyers and sellers
Managing risks and seizing opportunities for local companies in the oil and gas sectorRio de Janeiro, 8-9 June 2004
Lamon RuttenChief, Finance & energy,
UNCTAD
UNCTAD
NOT AN OFFICIAL UNCTAD RECORD
Overview
Have we reached a watershed?
Forecasting oil prices – worse than predicting the weather
Not managing oil price risk can spell trouble
If you can’t rely on forecasts, what can you do?
Source: cover of National Geographic, June 2004 issue
Prices since early 2003
Source: NYMEX
On the one hand, oil is getting scarcer while demand may well increase
• Proven oil reserves will last for around 40 years.
• Depleted reserves are continuously replaced by new discoveries, but the speed of new discoveries is going down – it is now one quarter of what it was in the 1960s. And instead of finding new large fields, one now finds medium and small ones. All the major areas that can contain oil have already been studied.
• The production peak for oil is expected to be in the 2010-2020 period, and for natural gas, around 2060.
• High prices and improving technology are still not allowing “mature” producers to maintain production levels – e.g., USA.
• Rapid growth in China and other Asian countries will continue sucking in large volumes of oil.
After oil production has peaked, it may well fall rapidly…
.From The Twenty First Century, The World's Endowment of Conventional Oil and its Depletion, by Colin Campbell, 1996
Pro
duct
ion
(mln
bar
rels
/day
)
Assuming 1750 gigabarrels of recoverable oil
“Non-OPEC finding and development costs dropped from $22/bbl in 1981 to $6/bbl in 2001 (2001$).” E. Baird, President & CEO, Schlumberger Ltd, “Fossile Fuels, the key to sustainable development”, World Energy, 2003, Vol. 6(1)
On the other, oil is (still) not that expensive to find, or produce
For new fields, higher exploration, development & operation costs – although in OPEC, still < $5/bbl.
From a presentation by John Crowle, Shell,
at UNCTAD’s 8th African Oil&Gas Trade
and Finance Conference, April 2004
So there is much more than 1750 gigabarrels of oil, and production may well continue increasing for a few more decades.
Source: IEA, US Department of Energy, 2000
Forward price curve, WTI, 2 June 2004
28
30
32
34
36
38
40
December of each year
US
$/ba
rrel
2004 2005 2006 2007 2008 2009 2010
The forward futures price curve on the New York Mercantile Exchange shows a heavy backwardation – but still, even for the 6-years futures contract, prices are above 29 $ a barrel.
So, have we reached a watershed? Is it « the end of cheap oil »?
Not yet. The balance of evidence suggests that prices will fall to a level below 30 US$/barrel. And this could be quite fast, as it is estimated that the current price includes a 5 to 8 US$/barrel « terror premium » which could disappear from one day to the next.
But this « fundamental analysis » applies only to longer-term equilibrium prices. In the short run, the market will remain highly volatile. Buyers remain exposed to the risk of price peaks, sellers to precipitous price drops. With hedge funds moving the market either up or down, depending on their sentiments, volatility will remain an major problem. Companies as well as governments have to be ready to survive these market movements.
It is of little use to know that « on average, the river is not too deep for crossing » before attempting to cross it. What matters is how deep it can get.
Can one base decisions on forecasts?
The herd instinct among forecasters makes sheep look like independent thinkers. Edgar R. Fiedler
He who lives by the crystal ball soon learns to eat ground glass. Edgar R. Fiedler
Delphi VIII forecast, California Energy Commission, 1995
Not managing oil price risk can spell trouble. For example, in an oil-importing country:
Oil price increases
Oil import bill increase
Pressure on the currency
Pressure on the government budget
Oil import rationing
Crowding out of other imports
Worsening of debt service capacity
Increase in energy and transport
costs
Pressure on energy-intensive industriesThe terms of trade of farmers producing export crops deteriorates
Public transport requires even larger part of the expenditure of the poor
Social and political unrest
And exporters are also exposed, e.g., And exporters are also exposed, e.g., government budgets….government budgets….
Ecuador --> budget USD 12 per barrelEcuador --> budget USD 12 per barrel
Drop in price of 40% to USD 9 per barrelDrop in price of 40% to USD 9 per barrel
Mexico --> budget USD 15.5 per barrelMexico --> budget USD 15.5 per barrel
Price drop from USD 17 to USD 9.69 per barrelPrice drop from USD 17 to USD 9.69 per barrel
Venezuela --> budget USD 15.5 per barrelVenezuela --> budget USD 15.5 per barrel
Drop in price to USD 10.60 per barrelDrop in price to USD 10.60 per barrel
Informed decision-making comes from a long tradition of guessing and then blaming others for inadequate results.
Scott Adams
19981998
The Business Times, Malaysia 4 June 2004
Oil a double-edged sword for Malaysia and Indonesia
High prices may push up earnings but will hit Malaysian export markets and boost Indonesian price subsidies
(KUALA LUMPUR) Record high oil prices are a double-edged sword for Malaysia, boosting its oil earnings but potentially also damaging the global economy and so its major export markets.
Even high oil prices can be bad for exporters, leading to Dutch disease effects, wasteful investment programmes, and other negative effects.
And if oil prices stay high for a longer period, there will be a demand-side response, which may lead to a displacement of oil by other energy sources. So even OPEC is not in favour of (too) high prices.
Widespread protests against fuel increases in Zimbabwe
By our correspondent23 June 2001
Nigeria's fuel protests gather support
By our correspondent23 March 2001
May 25, 2004 California truckers protest high fuel prices
INDONESIA: Fuel price rises spark protests - Jakarta, 3 October 2000
Protests by tens of thousands of workers and students have rocked Indonesia since the government of President Abdurrahman Wahid and Megawati Sukarnoputri, under pressure from international creditors, decreed an average 12% increase in the price of domestic fuel on October 1.
If you can’t rely on oil price forecasts, how can you improve your decision-making?
The key is to pro-actively deal with risk:
• understand the risks to which you are exposed;
• know how much risks you can afford to take;
• have a view on your optimal risk/reward equation; and then
• actively use a range of risk management tools to reach your risk/reward objectives.
Looking for a solution
If you understand risks, there is a wide array of tools available that can strengthen your capacity to deal with unfavourable oil
prices.
This goes from reviewing operational modalities to using financial market instruments.
US solution
European solution
Some of the available market instruments:
- Contracts that mitigate price risk exposure (e.g., fixed price contracts)
- Securitization (e.g., State of Rio de Janeiro, securitization of tax revenue)
- Traditional insurance solutions
- “Alternative risk management” solutions (e.g., linking loans to oil price levels)
- Derivatives contracts (futures, options, swaps).
At the end, a risky market place provides dangers, but also, opportunities. You may be standing at the edge of a precipice, but if you understand the risks and properly manage them, then you realize that you are also standing at a vantage point, giving you a priviliged view of the competitive terrain.
For further information on UNCTAD’s work on
Commodity risk management
Commodity finance
Energy