International Energy Agency: Oil Supply/Demand Trends For 2007-2012

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Includes: OIH, OIL, USO, XLE
by: Hard Assets Investor

The Medium-Term Oil Market Report [MTOMR] by the International Energy Agency was just released. The IEA is about as "non-kook" as you can get, being a stuffy starched-white-shirt group of 150 researchers funded by the OECD – 30 countries representing mostly what you'd think of as the developed capitalist world: North America, the EU, Japan and Korea.

In the report, they take a hard look at where the oil market is headed between now and 2012. This is an important timeframe often missed in discussions of energy: plenty of folks will tell you what's going to happen next month, and even more will sing you songs of fear and greed that start, oh, in 2020. But five years is an extremely useful time frame for investors to follow.

The top line of the report doesn't ring with surprises for anyone who's been paying attention: demand is staying strong, supply is staying tight. But the MTOMR has the data to back up all the news and punditry, and is simply required reading if you plan on investing in oil, gas, biofuel or related industries. And if you like data, you'll be in number heaven.

Let's take a look into the IEA’s crystal ball and see what's ahead in the coming years.

Strong Demand

The IEA forcasts global demand to expand by an average of 2.2% (or 1.9 million bpd) per year and reach 95.8 mb/d by 2012. Unsurprisingly, demand growth is expected to come from Asia and the Middle East, as well as other non-OECD countries. The result of this growth will put non-OECD countries oil consumption “close to the point at which it will surpass total oil consumption in the OECD.” While per capita consumption will still be lower than that of the OECD countries, the non-OECD countries will be using 46% of global oil by 2012 (up from today's 42%)

The why is fairly obvious -- the economies of these countries are, by and large, based on heavy industry and processing of raw materials, both of which are energy intensive. On top of that, average incomes in these countries will continue to rise to the point where consumers start buying cars and other modern conveniences that tax the power grid: refrigerators, dishwashers, washers and dryers, etc.. Appliances often represent real quality of life improvements, but they are energy drains.

But Asia, the Middle East and other non-OECD countries are not the only areas that are predicted to see demand rise. The IEA thinks that demand will continue to grow in the OECD as well, mostly due to North America's thirst for transportation fuel … a thirst that looks “to grow twice as fast as in Europe or the Pacific (1.3% per year on average versus 0.7% and 0.6% in the latter two regions).” In North America, the US carries the bulk of the demand in terms of overall volume, but Mexico is looking to have the fastest growing demand (up an average of 1.9% per year).

Outside the US, we could learn some lessons. Demand inside Japan is projected to fall by 0.1% per year. While not a big number, it is the only country with a contraction in demand. They're frankly just getting it right. The promotion of fuel efficient passenger cars ("mini vehicles") is having a noticeable impact – something not seen for the US in the near future, no matter how many Priuses you see at Whole Foods. Additionally, power generation in Japan is switching from oil to natural gas, and if Japan's nuclear facilities can keep clear of operational problems and the natural gas continues to flow, the predicted demand for crude should decline. If problems arise with either, that 0.1% yearly decrease will vanish.

Of course, all of these demand forecasts depend on myriad factors, primarily how the world economy behaves, and the report goes deep into the various risks, both on the downside (think inflationary pressures, continued high oil prices, a pronounced slowdown of the US economy) and the upside (China mostly). It's a better toolbox for understanding supply over the next few years than we've seen elsewhere.

Supply - The Other Side Of The Equation

OPEC

During 2007-2012, OPEC crude supply is expected to grow by 4.0 mb/d of installed capacity. Seventy percent of that increase will come from Saudi Arabia (+1.8 mb/d), the UAE, and Angola (+0/5 mb/d each). It's important to point out that this forecast is lower than OPEC's own numbers. The IEA has included a haircut because of security and investment risks in Iraq, Venezuela and the Niger Delta. Given the continued news flow, we think this is a prudent prediction.

Non-OPEC

Total non-OPEC supply is forecast to go up by an average of 1% annually, which is slower than the previous 1.4% average from 2000 to 2007. This runs counter to some of the hype surrounding investment in production, and indeed, the growth for 2007-2009 looks to be stronger than the years that will follow. In 2011, the forecast has been revised down by 0.8mb/d in part because of project slippage, but also to try and account for a “tendency for unscheduled field outages” -- econ-nerd speak for "stuff happens more often than you'd like to think." Of course, supply growth is not uniform across the globe. Here's the chart that matters:


Source: IEA MTOMR July 2007

The report goes into the reasons for each country's growth or decline and gives predictions for specific rates, but the factors that influence the supply side can be generalized to “above-ground” and “below-ground” factors.

Below-ground is "how much oil is there, really?" While the MTOMR does note that there will be a “leveling off of non-OPEC conventional crude supply,” it states that this “is inconclusive as evidence for an imminent oil supply peak.” But is does calculate net oilfield decline rates to “average 3.6% annually for non-OPEC and 3.2% per year for OPEC crude.” And it warns that “aggregate levels mask much sharper declines in a 15-20% per annum range for mature producing areas and for many recent deepwater developments.” All in all, the industry is going to need to “generate 3.0 mb/d of new supply each year just to offset decline.” The reason all of that is in quotes is because this is extremely political (read our piece on Peak Oil). The conflict over the peak oil hypothesis isn't getting any quieter, but the peakies have more ammunition in this report than the non-peakies.

Despite this acknowledgment of in-ground problems, IEA believes that the “above-ground” factors are more important risks. Supply pressures due to drilling and service capacity constraints, construction projects slippage (delays and cost over runs) as well as geopolitical pressures in sensitive areas – those continue to be the real bugaboos.

Refineries

The report is upbeat on the midterm outlook for refineries. New investments are planned (mainly in Asia and the Middle East) which will account for 9.1 mb/d of the predicted 10.6 mb/d rise in crude distillation capacity. The rest of the rise comes from improvements to existing facilities in North America, Europe and the Pacific – what the report terms “capacity creep.” In addition, the new refineries will be positioned to deal with the forecast increase in refining complexity – making cleaner and cleaner products from worse and worse feedstocks. All of this sets up a little easing in the gasoline market, possibly as early as 2008. We'll believe it when we see it.

Biofuels

The MTOMR then turns its attention to biofuels. Of course, biofuels are expected to grow by leaps and bounds, and all the hype can't be completely wrong. But – and this one is interesting – it's still going to meet only the tiniest part of demand in the medium term.

The numbers? Biofuel will grow to 1.75 mb/d by 2012 (up from 863 kb/d in 2006). That's a double, with ethanol accounting for about 78%. And, no surprise here, ethanol will be seen mainly in OECD countries and will only feed about 6% of demand by 2012, despite the doubling in volume. One interesting thing to note (at the bottom of page 14) is that the report states that “volumetric demand” would be lower (by 225 kb/d) by the end of 2012 if biofuels were not used because of their lower energy content. Hmmm, could biofuel use be supporting higher fuel consumption in the mid term?

Then there are the crop influences to consider. With all of the interest and support for biofuels, feedstocks have become more expensive. Higher corn prices did lead to record corn plantings, but even with this increase in supply, prices are still 50% higher than in 2005. High corn prices combined with lower ethanol prices mean the margins could fall out of refining, which means that future refining projects don't get built. Meanwhile, other crops have felt the land pinch due to the increased corn plantings. All this, combined with the vagaries of softs (weather, rot, blight, locusts, rains of frogs) and the report simply says “projecting biofuel viability is difficult.”

To Sum Up

Information is always an investor’s greatest ally. Even if you're not planning on investing in oil stocks, oil futures or anything related, data this good doesn't come along every day. The world energy market drives the economies of the developed word. You owe it to yourself to absorb this kind of information when it pops up for free.

Don't take our word for it. Check it out. You'll be glad you did.

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