The Prospects for Crude Oil Trade East and West of Suez.

Below are extracts from a presentation to the 15th Annual APS Conference, held in Tehran on Feb. 16-18, by Antony Scanlan, the British Institute of Energy Economics.

The major watershed (in the 20th century) was the Second World War; and the ensuing so-called "cold war" for four decades thereafter highlighted the strategic - rather than the purely economic - aspects of world oil... Everybody concerned became accustomed to the need to 'overcome' problems at Suez, or elsewhere in the balancing supply of world oil, and apart from the major exception of Japan this meant maintaining supplies to markets 'West of Suez' - the Atlantic Basin rather than the Indian...There were three events in 1985 apparently unconnected which completely altered the situation.

Firstly, and absolutely crucially, the emergence of Mikhail Gorbachev as the supreme leader of the Soviet Union signalled the end of the cold war, and indeed of the Warsaw Pact, of Comecon and eventually of the Soviet Union. The new nations of the CIS were rapidly accepted into the United Nations, and the opening up of national economies all over Eastern Europe as well as in Russia heralded what we now know as "globalisation". This has been paralleled in Asia by the emergence of China as a major world economic trading partner, one which has just joined the World Trade Organisation. Secondly, world oil prices, which had been at record levels since 1973, fell sharply in 1985, since when they have remained at levels which in real terms (i.e. adjusted for inflation) are broadly similar to pre-1973 levels. Thirdly, totally unnoticed at the time, 1985 was the year in which oil movements from the Middle East to markets East of Suez equalled those West of Suez, and ever since have continued to grow. Now they exceed westward volumes by about 50%.

The following table...shows the development of Middle East exports to main regional markets, grouped into East of Suez and West of Suez at five year intervals since 1970, the year in which USA import quota restrictions actually collapsed, (although this was not rationalised legally until April 1973).

         Exports of Middle East Oil East and West of Suez (m b/d

                 Westwards                         Eastwards
Year    Africa Europe USA  OWH   Total    A/NZ China Japan Asia   Total
1970    0.4    6.2    0.2  0.4    7.2     0.3  -     3.5   1.7     5.5
1975    0.5    9.6    2.5  2.1   14.7     0.2  -     4.2   2.7     7.1
1980    0.4    7.5    1.6  1.9   11.4     0.2  -     3.6   2.3     6.1
1985    0.4    3.2    0.4  0.7    4.7     0.1  0.1   2.7   1.8     4.7
1990    0.5    4.1    2.0  0.2    6.8     0.2  0.1   3.4   3.7     7.4
1995    0.7    3.9    1.6  0.7    6.9     0.2  0.2   4.2   5.1     9.7
2000    0.7    3.9    2.5  0.6    7.7     0.2  0.8   4.2   6.1    11.3

OWH = Other Western Hemisphere. A/NZ  = Australia/New Zealand (Australasia)

The second table shows the total Middle East export in these years with total world exports of oil, including product exports between main regions. Products made up 22% of total oil movements in 2000 but only 11% of Middle East exports.

                           TABLE TWO                          mbd

   Year    World Consumption      World Movements            Middle-East
Exports
    1970        46.5                 25.5                         12.7
    1975        55.7                 36.0                         21.8
    1980        61.5                 32.0                         17.5
    1985        58.5                 25.5                          9.4
    1990        65.5                 32.7                         14.2
    1995        68.2                 36.8                         16.6
    2000        74.0                 42.7                         19.0

The statistics in this paper, unless otherwise stated, all come from one source for consistency - the annual editions of the BP Statistical Review of World Energy. The only adaptation is that due to different regional groupings over time - e.g. the late appearance of China as a separate entity in the pages of the Review, or the break-out of the former "Eastern Europe" from the Soviet Bloc and renamed "Central Europe" (which I have added in the tables to Western Europe and just called it Europe) - some reallocation of statistics from earlier editions to modern regional groupings has been made. ...

The statistics for the year 2000 enable us for the first time to compare the developments before and after 1985 over two fifteen year periods and then to look forward to the horizon year of this conference which is also another fifteen year timespan from 2000 (latest actual data) to the beginning of 2015...

The next table lists the progress in consumption of total energy over these three 15-year periods - this time starting in 1955, so that the fifteen years before high oil prices can be compared with the fifteen years after high oil prices.

WESTWARD MOVEMENTS: Referring to Table One it is apparent that the prospects for the major development of Middle East trade westwards clearly depend upon the traditional markets of USA and Europe.

USA: With less than 5% of world population, the USA uses one quarter of total world consumption... From 1958 to 1973, except for the west coast (Petroleum Administration District 5 or PAD 5) the USA ring-fenced its own production from free market import competition but this protection policy failed by 1970 to meet demand. Since 1973 a free market has prevailed, joined eventually by a free gas market where the problem was the opposite, to get rid of low prices and bureaucratic restrictions on consumption outlets. This policy has had a good effect on gas supplies as well as usage but, despite the major discoveries in Alaska, oil output continues to decline in the main continental USA, or "lower 48" states...

             USA OIL SUPPLY & DEMAND BALANCE IN 2000 (m b/d)

     CONSUMPTION                           20.0
         Alaskan crude                 1.0
         Federal offshore deep water   1.5
         NGLs                          2.0
         Processing gain*              1.0
         Lower 48 states crude oil     3.5
         Imports                      11.0
     TOTAL SUPPLY                          20.0

*Processing gain results from volumetric expansion during refining of crude
oils into lighter gravity products and also net energy gain from the firing of
oil refining processing units by natural gas.

Federal offshore deep water production is almost all in the Gulf of Mexico.

Footnote:Texas alone produced the same volume of crude oil in the sixties that it now takes the whole of Continental USA (Lower 48 States) to produce.

The majority of imports are on the Atlantic and Gulf coasts. This places USA squarely in the "West of Suez" movement for Middle East exports, with a very minor role indeed for eastward movement across the Pacific to PAD 5.

The Pacific coast zone, PAD 5, has always remained part of the global free market, except that when Alaskan production commenced in the seventies it was (then) forbidden to export it. However mainly for reasons of unacceptable sulphur content it was largely shipped via a Panama pipeline to eastern USA to be blended. Statistically, PAD 5, which includes Alaska, is oil deficit and is also energy deficit. Alaskan oil output is one mbd below its peak and just about equates with PAD 5 oil demand excluding California. California, traditionally one of the three leading "Lower 48" producers, consumes about 1m b/d more than it produces and has done for over a decade (it also produces only 20% of its gas consumption which results in another deficit of similar size). However, other western hemisphere producers including Canada make up the supply deficit so there is no recourse to trans-Pacific imports of any magnitude. East of the Rocky Mountains, the remaining four PADs all consume more oil than they produce. This is perhaps especially surprising for PAD 3, inasmuch as Texas is the epitome of "big oil". Texas still produces 1.25m b/d but consumes 3.25m b/d although the 2m b/d deficit is partly offset by NGL production and natural gas exports equivalent to 1m b/d. However, it is also a net importer of 50 million tons of coal annually, has only 2 out of the 65 nuclear power stations in the USA and has virtually no hydropower potential. Texas in this century is an energy importer.

Louisiana, the third of the leading three producing states in the Lower 48, is also deficit on oil, consuming 0.5m b/d more than it produced in 2000, but this is more than compensated by NGLs and by a massive net export of natural gas, equivalent to 2m b/d of oil. But although Louisiana compensates for the Texas deficit, PAD 3, the heartland of USA oil, while still a major gas exporter, consumed 50% more oil than it produced in 2000.

PAD 4, the mid-Northwest, while geographically huge, is a...minor producer and consumer with a small population. Effectively, the 80% of the US population living on the Atlantic seaboard (PAD 1, consumption 6m b/d) and around the Great Lakes/Midwest (PAD 2, consumption 5m b/d) who in total consumed 11m b/d of oil last year, statistically speaking had to import all of this quantity internationally.

This is some of the background against which the new President is calling for more indigenous energy production. Surprisingly, but not for the first time, little is heard about the need to do better on the demand side of the energy balance. With a current average per capita use of energy of 10 barrels of oil (equivalent) in the rest of the world, including about 20 barrels per capita in other developed economies such as Canada - the USA average of about 60 barrels per capita does suggest that to concentrate solely on the supply side of the balance is to ignore half the field of play and to overlook a potential benefit to the fiscal and trade balances of the nation as a source of tax revenue to curb excess consumption and a reduction of foreign outflow of dollars. A Texan President in particular might be expected to notice that, in the State of which he was recently the Governor, the current consumption of energy, equivalent to 100 barrels of oil per person, might have something to do with the new image of Texas as an energy importer. ...

Only one quarter of USA oil imports come from the Middle East. Over half come from the rest of the Western Hemisphere, and a further 30% from Europe and Africa, where the naturally low sulphur content of the crude and lighter gravity are preferred.

Moreover, the energy balance of the USA is well spread between primary fuels and the majority of it, 60%, is non-oil and except for a large import of gas from Canada this 60% is nearly all indigenous. 98% of electricity is generated from non-oil sources, so the current problems in Californian power shortages are irrelevant to the oil import debate.

In this total energy context US dependence upon energy imports is limited to about one quarter of total energy demand and imports of oil from the Middle East constitute only about 5% of total energy consumption. This is the other, equally factual perspective on the largest national energy economy in the world. However the volume of imports is the highest ever and it is reasonable to ask whether or not it is going to produce a disturbance in world markets similar to 1970/73.

In modern circumstances it is less likely. With realistically priced and unrestricted global markets for all fossil fuels and better information it is much harder to build up unnatural pressures such as those which caused the import eruption of 1970-1973. On the other hand, the sheer economic pressures on the current administration to meet projected demand in this largest of markets could easily raise or lower the demand for world oil - (balanced as usual on the Middle East trade, whether imported directly or not to the USA itself)- in volumes measured in millions of barrels per day by 2015. I expect the effects to be rather more modest and almost certainly indirect, but we could be looking at a doubling of USA - Middle East crude trading by the horizon year.

EUROPE: The advent of North Sea oil and gas in the seventies transformed the net import situation. Although now in its third decade, new technology has repeatedly proved forecasts of early decline to be premature. Furthermore, the impact of offshore technology on natural gas development has been outstanding - who would have predicted the Europe-wide network of pipelines from the Norwegian North Sea, from Algeria and from Russia as being more than fiction when offshore gas production commenced in the late sixties?

European electricity and industry, which before North Sea development was switching from coal into imported oil is now moving as rapidly as possible into gas, together with a large part of the domestic heating market. As in the USA, the European primary energy is well balanced with 60% of it being non-oil based. Oil is increasingly reserved only for transportation and has to compete with gas even in petrochemical feedstock. The modernisation of the refining sector along trends similar to those in North America continues to intensify.

In 1970 the European Common Market consisted of the six founding members of the Treaty of Rome in 1957. Now the EU consists of 15 nations with a population of 390m and with another 12 applicant states negotiating membership. It is expected that all these will be fully integrated in the EU before our horizon year of 2014. They are mainly former Comecon nations, who will add another 110m consumers making the EU a market of 500m people. Morocco and Tunisia have achieved "Associate" economic status and so has Turkey. Turkey is making strong overtures for full membership. This is more difficult to predict than mere economic convergence or "compatibility" which can be measured by stages, since it involves human rights issues which are at the core of the reasons for setting up the EU after the two world wars. However, as and when full negotiations with Turkey do commence, it is possible that by 2014 the I.R. of Iran could have on its western border a direct land frontier with the expanded European Union and its "single market" of about 600m consumers - double the population then forecast for the USA and with a GNP perhaps three times that of USA. The energy pipeline projects now developing into Turkey will receive a major boost if this scenario comes to fruition, but it will also facilitate general crude oil trade with Europe.

Depending on the prospects for maintaining the North Sea as a major producer including of course Norway, which perhaps because of her great hydrocarbon reserves and small population of 4m is one of the few European countries not in the EU - the growth in energy consumption is expected to continue to focus on improving the rationalisation and transparency of internal networks across European gas and electricity markets and with only a minor increase in oil consumption by 2014.

Even the EIA in Washington, which tends to forecast high levels of energy demand, only expects an increase in European oil consumption of about 1.5m b/d by 2015, plus 0.5m b/d in Turkey.

A significant part of this increase would be met by supplies from North African and Russian oil export increases. Perhaps a reasonable expectation for an increase in Middle East exports to the new Europe by 2015 would be 1m b/d above current levels. Long term economic growth rates in Europe and USA are "mature" i.e. averaging about 2% to 3% annually, and population growth, expected to rise slightly in the USA, has ceased in Europe (except Turkey).

"Western" prospects for expanding Middle East crude oil trade therefore centre on a possible 2-3m b/d to the USA and Caribbean, and this 1m b/d to Europe. Smaller prospects of growth in oil markets in South America and sub-Saharan Africa are likely to be met by oil production development within those regions, especially offshore in West Africa and Brazil and along the north coast of South America. Latin America will remain a net oil exporter and in the most populous area between Buenos Aires and Sao Paolo a major impetus has been given to international natural gas development as an alternative fuel.

EASTWARD MOVEMENTS: East of Suez development has different characteristics. Here the "mature" economy, apart from Australasia, is Japan. Japan's record of energy efficiency among the major consumers is outstanding, and in recent years it is locating much of its industrial effort outside its own shores. The primary energy profile is only 50% based on oil, with 33% based on coal or gas: however all these have to be imported. This total dependence on imports for all fossil fuels is the motivating factor behind the high level of efficiency in the use of energy. Although the past few years have seen the economy stagnant or on the verge of recession this has not caused a fall in total energy consumption, although oil demand in 2000 was at the same level as in 1992. Little major movement is anticipated in internal (in contrast to "offshore") oil demand and for the offshore demand growth we have...to look at other national economies. Several of these are also in Asian markets - for instance in Malaysia.

Perhaps the two unifying or common characteristics of Asian markets are the large size and rapid growth of the population and the absence of a major indigenous source of oil or gas. Recently economic problems have caused a slowdown in parts of the region but the underlying growth trend will resurface as these problems pass with time. There is concern that with a concurrent slowdown in all the major economic regions of the world - the USA, Japan, and mainland Europe, a recession may develop which will prevent a return to growth in the Asian markets which had such spectacular growth in the past decade. If so, I would expect a slowdown in energy growth below trend for 3 or perhaps 3 years, and then, from 2005 or thereabouts, the underlying trend will resume - although perhaps at a more modest rate in economies such as Taiwan and South Korea as they reach more mature levels...

The second half of the twentieth century showed that one, or even two, periods of global slowdown in a period of over a decade is containable within normal economic growth cycles...Growth prospects in an increasingly open and global free market world economy has shown that growth no longer depends so heavily upon the developed OECD economies. Asia/Pacific economies, even the more mature, are more population-driven than markets in Europe. In Europe, with a static or falling population, economies are comfortable with growth rates around 3% p.a.

In contrast, Asian economies, in order to achieve an equivalent 3% net economic growth above population growth must aim at target levels of economic growth of 6% p.a. or more. So although we may not see a return to double-digit annual growth rates, nevertheless, except in periods of downturn or recession, Asian market growth will be stronger than in Europe. This is not only in South and East Asia, but also in the Middle East - e.g. Saudi Arabia has a population growth of 4% p.a.

Until very recently there has been a tendency to focus upon the Asian "Tiger Economies" in the Asean group, and upon Taiwan and South Korea, and it is indeed on these and Japan that the debate over the economic slowdown has been focused. But it is now clear that the two giant population economies, China and India have emerged, with different characteristics, into two of the largest six national economies in the world after the USA. India has recently joined China as a nation with over one billion people and recorded the largest increase in total energy consumption in Asia over the past decade.

A useful perspective on the giant population economies came from a recent discussion on BBC. One speaker questioned whether India, with so many poor people, could really occupy such a high place in the world economic league. The answer was that only the top 10% enjoyed the full range of modern economic benefits - but that "only the top 10%" is larger than the entire population of Germany. The population drive of the remaining 90% to close the gap underlines the scale of the potential demand. Similar forces exist in China.

But although well endowed with solid fuels, neither India nor China have the necessary indigenous potential for oil and gas to meet this demand. China actually produces more oil than the UK North Sea, but has twenty times more people to supply, and all the offshore west coast Indian oil successes have been unable to meet the increases in demand, so imports continue to rise.

The situation is similar in the rest of Asia. While there have been some success stories of oil development in Vietnam and Malaysia, and output has also increased in Australia, the only OPEC member in the region, Indonesia, has actually experienced a decline in oil output over the past decade as well as a 60% rise in internal consumption.

In summary, between 1985 and 2000, the markets eastwards stretching from Pakistan to Japan and Australasia have achieved an oil production increase of 2m b/d rising from about 6m b/d in 1985 to 8m b/d in 2000. During the same period oil demand has doubled from 10m b/d to 20m b/d, thereby creating an increased demand for imports of 8m b/d for which there have been no large scale regional supply sources outside of those in the Middle East.

Will this continue?

United Nations studies of population growth continue to show that the strongest growth in the world is in Asia. By 2015 the population of India is expected to increase from 1 bn to 1.2 bn and of China from 1.25 bn to 1.4 bn, which combined will be an increase larger than the total population of the USA... The population in Indonesia is expected to reach 250m and that of Pakistan is expected to exceed 200m, so that these two Asian nations will occupy fourth and fifth places in the world population table.

Four of the top five most heavily populated countries will thus be in Asia. In addition, Japan and the Asean group will comprise 600m people which alone will equal the new 27 nation European Union plus Turkey. Asia by the end of 2014 will have over half of a total world population expected to exceed 7 bn compared with 6 bn at the beginning of 2000.

The population drive therefore remains the key to future potential demand for oil and energy, always providing that the economy is able to grow structurally.