In the coming decade crude oil supply from the Middle East will meet most of the new demand in the fast growing economies of the Asia Pacific region. The quantities of Middle East oil going into Western markets will stabilize - and market share may decline.
Present refining over-capacity in the Middle East and Asian Pacific regions is likely to continue for some time as major historical import markets like India achieve self-sufficiency.
This has already reversed the historical flow of light products from West to East. The emergence of eBusiness platforms - online markets in particular - is likely to have a significant impact on how oil is traded within the next decade.
There will also be a need to review the marker used as a basis for pricing Middle East cruds into Asia Pacific. Cost efficiencies will improve as oil market players take advantage of the new technologies to re-structure and build closer links with customers.
They will be moving from producing and supplying hydrocarbons towards providing energy solutions in markets which have become increasingly global.
I am very pleased and honored to have been invited to make a contribution to this year's Middle East Petroleum and Gas Conference.
This meeting comes at an interesting time in the development of oil markets and provides an opportunity for reflection on two years of quite remarkable change and price volatility.
In my remarks today I shall focus on recent developments in both crude oil and refined products markets in the Middle East and Asia, and highlight what I see as some of the more important structural changes, which have impacted the position of market participants in this very important region.
In addition I shall comment on two areas that are also making a significant contribution to the shaping of future oil markets. These are the exciting developments in e-business, and the increasingly global nature of oil market participants.
Crude Oil Markets
The crude oil market has shown extreme price volatility over the past three years. Apart from the price spike during the Gulf War, the early to mid 1990’s price environment looks tame by comparison, although it didn’t feel that way at the time.
OPEC’s actions, and its reactions to market changes, were the key drivers of price movements over the previous decade and this will continue over the next decade.
The price collapse in 1998 was the result of conflicts within OPEC, which resulted in an inability to effectively respond to the twin challenges of the return of Iraqi exports and the downturn in demand caused by the Asian economic crisis.
OPEC has successfully managed a stunning reversal over the past two years and most industry forecasters envisage the organization being able to manage prices at higher levels in the future.
The forward price curve shows this. After varying in a narrow band throughout the early to mid 1990’s, the market lost confidence in OPEC’s ability to be effective.
Forward prices fell to below $15/bbl and many forecasters speculated that future oil prices would remain below $10/bbl.
Now for the first time there is an emerging belief that prices could remain well above $20/bbl for some time. For the first time 3 years out futures prices are now above $20/bbl.
Most major upstream companies remain cautious and are continuing to base investment decisions on price environment well below $20/bbl.
We in Shell are also doubtful that steady oil prices above $20/bbl are sustainable over long periods.
Assuming oil prices return towards historical ranges, investments for non-OPEC production will be screened conservatively at equivalent Brent prices in the mid-teens.
We envisage that non-OPEC oil supply will grow at an average of 600 to 700 kb/d per year over the decade to 2010.
The majority of this growth will occur in the Atlantic Basin. In the Asia/Pacific region production growth will be small. More than half of this growth will be NGLs.
On the demand side we expect that world oil consumption will rise from 76 mb/d to 92 mb/d over the decade, broadly split equally between the Western and Eastern markets.
If upstream companies were to become convinced that investment opportunities should be judged against price forecasts of over $20/bbl, we could envisage that non-OPEC investment opportunities over the decade could exceed 1 mb/d per year, again with the majority of the supply growth in the Atlantic basin.
This means that the Middle East’s share of the Western market is likely to remain broadly flat, at least in volume terms, but decline to less than 10 percent share of this market.
By contrast, the Middle East will supply the vast majority of demand growth to the Pacific basin, increasing from 40 percent to near 70 percent of total supply.
How Middle East producers respond to a declining share of Western markets will be a really key factor in the development of the oil market prices over the decade.
The Middle East’s status as the major crude importer to the US has been important and I expect will be conceded reluctantly.
What is clear is that the Pacific basin will become increasingly more important to Middle East producers and Pacific markets will become increasingly reciprocally dependent.
Most new refining capacity is being designed for Middle East crude processing. But future likely increases in domestic refining capacity in countries producing sweet Far East export grades - such as Vietnam and Papua New Guinea will reduce their exports.
Hence increasing quantities of West Africa cruds will flow East for quality reasons, as well as being driven by the desire to increase diversity of supply.
Increasingly Far East countries will become concerned with supply security. India, ASEAN countries and China have all recently announced intentions to develop emergency/strategic crude oil stocks.
Middle East exporters often regard such stocks with suspicion as importing countries are frequently tempted to use them to moderate prices. However, in our view, it is unrealistic to assume strategic stocks are not required.
Open and co-operative dialogue between Middle East exporters and Eastern importers would ensure such facilities are developed as efficiently and co-operatively as possible.
In addition to strategic storage, the pricing basis and markers for Far East cruds continue to be of concern. Term supply contracts dominate the market and limited spot crude trading inhibits price discovery.
The steady decline in Dubai production has concerned the market for some time. It has survived as the marker grade in the East for much longer than most commentators would have expected – I admit to ringing a warning bell at the APPEC meeting in 1992.
But sooner rather than later, another crude grade will be required to fill the marker crude role.
The major Middle East crude exporters are reluctant to allow their crude to be traded and used as a marker grade. They prefer to maintain tight control of their customer portfolio and generally do not concede tradability.
Nevertheless, we think it is inevitable that a high volume Eastern destination crude will need to perform the marker role, and dialogue between producers and buyers should be initiated to achieve this.
The downstream market in the region is also undergoing major changes. In 1999, the Middle East exported over 2.1 mb/d of products - the main trade flows being naphtha to Japan & South Korea, fuel oil to Pakistan & Singapore, and middle distillates to the Indian Sub Continent
Product exports to the West were 250 Kb/d, which was typical of historic patterns.
The Middle East refineries represent by far the largest export refining center in the world. Singapore is the other large export refiner in the region.
Both those refining systems have historically supplied the many fragmented import markets spread across Asia and the Indian Sub Continent.
ME refining export capacity continues to rise. New refineries, condensate splitters, new conversion plants in existing refineries continue to increase export capacity.
In spite of the very weak refining margins during 1999, Middle East refineries increased processing rates and continued the trend of rising levels of exports.
Our assessment is that many Middle East refineries did not cover variable costs on their marginal output. It would have been more economic to export crude rather than operate the refineries to export products.
By contrast the Singapore refining system has steadily reduced its throughputs in response to weak margins and a steady decline in import markets requiring their products as local refineries have been developed.
Singapore distillate exports have reduced while fuel oil imports have increased to supply the large bunker market and to provide feedstock’s to maintain intake in conversion plants.
India was one of the major importers of products from the Middle East and Singapore. This is unlikely to be the case ever again.
Like many governments, India perceives that refining self-sufficiency is in the national interest and is prepared to provide high tariffs on product imports to support domestic refining investment.
India has exchanged product import dependence from the Middle East for crude import dependence from the Middle East. The level of increase in supply security is limited unless substantial emergency crude stocks for use in a supply crisis are developed.
India is the latest and largest country to change from a net product importing country to an exporting country. It will likely not be the last.
In spite of high growth rates in oil demand in the Far East, refining capacity increases in the Middle East/Asia Pacific refining system have substantially exceeded the growth in demand.
Excluding China, just over 7 mb/d of refining capacity was added to the region’s refining system during the 1990’s and nearly 4 million barrels per day is already planned during the first half of the coming decade.
This currently exceeds the aggregate demand for refining capacity in these countries by nearly 3 million barrels per day.
By contrast, China has completed or announced capacity additions of 2.1 million barrels per day from 1990 to 2005 compared to demand growth of 3.7 million barrels per day over the same period - a shortfall of 1.6 million barrels per day. Hence exporters hope that China will remain a large and growing product import market to target.
At the same time, China is implementing substantial restructuring in its oil industry. The IPO’s of PetroChina, Sinopec and CNOOC - coupled with China’s desire to become a member of the World Trade Organization - will accelerate restructuring and we will certainly see efficiency and productivity improvements.
Nevertheless, China will perceive the same refined product security issues over the next 5 years that India perceived over the second half of the 1990’s. My sense is that China will not become a major product importer - in the worst case, it may overbuild and become a net product exporter.
The impact of the current capacity surplus can be seen in trade flow statistics and relative product pricing between Eastern and Western markets. There has been a marked shift in product flows through the Suez Canal. Before 1998, fuel oil flowed from East to West and white products flowed from West to East.
This pattern has now reversed, and we expect increasing quantities of light products to flow from the East to West. The steady investment in conversion plants in existing refineries, and the construction of “super refineries” like the Reliance unit in India, has resulted in a relatively tight fuel oil market in the East.
The impact on product pricing is clear. Singapore light product prices are now structurally below Rotterdam prices. We expect that Eastern crude prices will remain at a premium to Western crude prices and Eastern refining margins to remain under pressure.
Middle east refineries will turn increasingly to Western product importers and probably invest to meet US and European quality specifications.
As Shell has substantial refining investments in the region, and in Singapore in particular, we have had to rethink our refining strategies for the future. Refinery restructuring has already been announced in Japan.
We will only invest in refineries that we are confident have a robust future and accept a lower level of sales cover from our own refining system.
We think that Singapore refineries will need to rely less on commodity export product, develop specific long-term markets for its products and shift increasingly towards chemicals integration.
But Shell will remain a major refiner in the Eastern market. Supply security is important and we wish to expand our oil product sales and services in the region. We will ensure that our refining assets are consistent with that goal and as profitable as they can be in a competitive market.
I would now like to turn to some broader developments that are likely to have a significant impact on our industry in the coming years.
Paul Skinner, Group Managing Director & Chief Executive, Oil Products, Royal Dutch/Shell Group at the Middle East Petroleum and Gas conference, Dubai
© 2001 Mena Report (www.menareport.com)