World oil production rebounded by 2.2% in 2010 to reach 82.095 million barrels per day (B/D), up from 80.278 million B/D in 2009, but virtually unchanged from 2008 levels. World oil consumption, though, increased by 3.1% to hit 87.382 million B/D.
Due to the inclusion of non-oil additives in the consumption figures (especially ethanol) and some unavoidable differences in definitions, consumption always runs higher than production, so don’t read the differences in levels as meaning that world oil inventories fell by over 5 million barrels per day. The differences in the level of change are, however, worth looking at.
Changes Over Longer Term
Since 2000, world production has risen by 9.6% and world consumption has risen by 14.1%. Oil giant BP (BP) has just released its statistical review of world energy for 2011 (which has 2010 data). Whatever you might think of BP as a company after the Gulf of Mexico disaster, their statistical review is one of the most authoritative sources of data on the world energy markets.
That has been a big part of the reason that oil prices have soared in recent years. The average price of oil was up by 28.3% in 2010 over 2009, rising from $61.92 to $79.45. Since 2000, the price of oil has soared 161.6%.
One would expect that such a sharp increase in prices would lead to lower consumption and higher production. That is what the textbooks say is supposed to happen in response to a large and persistent rise in the price of a commodity. The persistent part is important, since it is tough to bring on new production right away — the lead times in the energy business can be extremely long, and people tend to be locked in to their energy consumption in the short term.
For example, if the price of gasoline goes up, in the short-term you might drive a little bit less, but you will still be driving the same old gas guzzler. If it goes up and stays up, or continues to rise, the next car you get will probably be much more fuel efficient, but that transition takes time.
A decade should be a long enough time to see those sorts of changes take place. An increase of 9.6% over the course of a decade is not much of a positive supply response to a 161.6% price increase. Instead of the negative-consumption response that the simple textbook diagram would suggest, consumption has actually increased faster than production. Clearly it looks like oil has not read the intro to economics textbooks. What is going on?
Low-Hanging Fruit Already Picked
Well, it turns out that the economics textbooks are not the only ones that apply; the geology textbooks are at least as important — if not more so. The simple fact is that the world is running out of cheap, easily accessible oil. That is why oil companies have been going to the ends of the earth to find more of it. It is the reason why they have to drill in more than a mile of water or locate in more and more politically unstable parts of the world.
Oil is, after all, a non-renewable resource. Once you have drained the oil from a nice, safe, easily accessible place like West Texas, it is gone, and gone for good. Oil consumption and production fell in 2009 relative to 2008 in response to the worldwide economic downturn, and the increases in 2010 are due to the economic rebound around the world.
Consumption growth, both short term and longer term, is being driven by the emerging economies, especially China and India. While not as big in absolute terms, in percentage terms the increase in consumption among the oil producing countries is just as big.
As oil becomes harder and harder to find and develop it also requires more work from the Oil Service firms. This puts a nice long-term tailwind at the back of companies like Halliburton (HAL) and Baker Hughes (BHI). With more and more oil production moving into deeper and deeper waters, the drilling firms that specialize in deepwater such as Transocean (RIG) and Diamond Offshore (DO) are very well positioned.
This is highly significant, since ultimately for the U.S. what matters is not just world oil production, but how much of that production is a available for export. Any country, regardless of how democratic or despotic its leadership, is going to first prioritize the energy needs of its own people before the energy needs of the rest of the world. That is particularly true if they are not being forced economically to export every spare drop.
Most of the oil-exporting nations of the world are either poor or middle income. In such countries, the link between increases in incomes and increases in oil use are very strong. People are going to want to move up the transportation scale from bicycles to motor bikes to cars as they start to get a little bit more money. In those countries, new auto sales generally represent an addition to the overall auto fleet of that country.
Emerging Markets
In the developed world, new auto sales are generally replacements for older vehicles. Thus, if the new cars are more fuel efficient than the ones they are replacing, new car sales can reduce overall demand in places like the U.S. In places like China, new auto sales mean overall oil use is increasing. Last year, new auto sales in China far exceeded sales in the U.S.
As the price of oil rises, these countries prosper. Thus paradoxically, in those countries the demand curve is just plain weird. Higher prices result in more, not less, consumption.
China and India are also getting more wealthy, but not because of higher oil prices. In 2010 relative to 2009, Chinese oil consumption soared by 10.4%. This was not simply a rebound from lower consumption in 2009 as was the case in many other countries, relative to 2008 consumption was up 14.1%.
Since 2000, Chinese oil consumption is up an astounding 90.0%. China is now the world’s second largest oil consumer, burning 10.6% of all the oil burned in the world in 2010. That is up from 6.2% of total consumption in 2000. India’s oil consumption growth was a bit more subdued in 2010, rising 2.9%, but it is up 8.2% over two years and up 42.0% over the decade.
In absolute terms, of the 10.777 million B/D increase in world consumption since 2000, 4.291 million (39.8%) was due to China, and 1.058 million B/D (9.8%) was due to India. In other words, almost half of all the increase in consumption over the decade was due to just these two emerging giants.
Consumption by Exporters
The amount of oil consumed by the major oil-exporting countries is generally smaller in absolute terms, but not insignificant. In 2010, Saudi Arabia consumed a total of 2.812 million B/D, up 7.1% from 2009, and up 17.8% over the last two years. Since 2000, Saudi consumption is up 78.2% — far more than India, and almost as fast as in China. As a share of total consumption it is up to 3.1%. In 2000, the Saudi’s only consumed 2.1% of the World total.
The story with Russia, which is actually a bigger oil producer than Saudi Arabia, is not quite as dramatic over the last decade, up “just” 18.6%. Its consumption fell fairly dramatically in 2009 in response to the worldwide economic downturn, and has had a sharp rebound in 2010, with consumption up 9.2%, but that puts its consumption 5.4% above 2008 levels.
China is also a major oil producer, although like the U.S. its oil production is far less than it consumes making them a major oil importer. They produced 4.071 million B/D in 2010, up 7.1% from 2009 and 16.9% higher than in 2000. China is the world’s fifth largest producer — after Russia, Saudi Arabia, the U.S. and Iran.
The U.S. & Other Developed Regions
The U.S. remains a very profligate user of oil, but we, along with the rest of the developed world have been relatively restrained in the growth of our consumption. As the economy rebounded a bit in 2010, so did oil consumption, rising 2.0% on the year to 19.148 million barrels a day. That, however, is still 1.8% less than we were burning in 2008 and is actually down 2.8% from what we were using in 2000.
Europe did not see any rebound in consumption in 2010, with consumption down 1.1% for the year and off 5.9% from 2008 levels. In part that is because the economic recovery in Europe as a whole has been even weaker and more anemic than it has been here. In part it is also because of policies in Europe designed to lower oil consumption and encourage alternative energy. Since 2000, European oil consumption is down 4.8%.
Japan saw a 1.5% rebound in consumption in 2010 from 2009, but it is still down 8.0% from 2008 levels and is down 19.5% since 2000.
The U.S consumes 21.1% of the world’s oil, down from 25.7% in 2000. Europe consumes 16.4%, down from 19.0% in 2000. Japan consumes 5.0% of the oil, down from 7.2% in 2000. The share of the world’s oil consumed by the three largest developed economies has thus dropped from 51.4% in 2000 to “just” 42.5%. A drop of 9.4 points in just a decade is a very dramatic shift.
U.S. Production Trends
There were some interesting trends on the production side as well. Despite the Deepwater Horizon disaster that shut down new drilling in the deepwater Gulf of Mexico for much of the year, U.S. production actually rose for the second year in a row, up 3.2% from 2009, and a very impressive 11.6% from 2008. That is a big turnaround as overall U.S. production has been on a declining trend for decades now.
Relative to 2000, production is still down 2.8%. Between 2000 and 2008, U.S production fell 12.9%. The recent performance certainly seems to contradict assertions that the Obama Administration is deliberately trying to hold down U.S. oil production. Another way of looking at it is that oil companies have responded recently to the price signals over the last decade, and that those long-tailed projects are finally coming on line.
Much of the increased U.S. production has also come from new technological abilities to tap oil trapped in shale formations, most notably in North Dakota. This is roughly similar to the technological progress that has opened up fast new supplies of natural gas from shale formations especially in Texas and in Pennsylvania. The shale projects have substantially shorter lead times than do ultra deepwater drilling projects.
How long can the U.S. keep increasing production? Not that long, unfortunately. First, you have to realize that the U.S. is already a very major producer of oil. The third largest in the world in fact, trailing only Russia and Saudi Arabia. We were responsible for 8.7% of world production in 2010. That is as much as the combined production of Venezuela, Norway, the U.K. and Qatar. However, we have only 2.2% of the world’s total reserves.
In the short term, the increase in U.S. production is very welcome, as it helps to hold down our oil import bill. Even when you have 8.7% of the world’s production, if you consume 21.1% of the total, you are going to have to import a lot.
Worldwide Production Trends
Production in the North Sea is in terminal and rapid decline. Norway’s production fell by 9.4% in 2010 relative to 2009, and is down 13.1% from 2008 levels. Since 2000, Norwegian production has plunged by 36.1%.
In the U.K. production was 7.7% lower than in 2009 and 12.3% lower than in 2008 and is off 49.8% since 2000. The North Sea is especially important in that it is production that comes from a politically stable part of the world.
Mexico is not quite as politically stable as Norway, but at least it has the virtue of being close to home. It too has been facing long-term production challenges, although the decline slowed significantly in 2010, dropping just 0.8%, but it is still 6.6% below 2008 levels and down 14,3% from 2000.
Canada on the other hand, thanks to growing production from the Alberta oil sands, has been able to raise its output by 4.3% in 2010 over 2009, and is up 22.6% over the last decade. It has lots and lots of reserves of oil in oil sands, but it is very expensive and environmentally damaging to produce. Oil from the oil sands are becoming the marginal barrel of oil for the world, and that means that the cost of production for that oil should form the floor for world oil prices.
Will the Trends Reverse?
The key question is will any of these trends stop and reverse themselves? I think it is highly unlikely that China and India will dramatically slow the rate at which they are increasing the amount of oil they use. The world’s supply response of only a 7.2% increase over the course of a decade in the face of a near tripling in of oil prices is extremely weak (and oil prices surged in 2000, relative to 1999, oil prices are up more than fourfold to the 2010 average, and are about one fifth of recent current levels of around $100 per barrel.
The constraints on increasing oil production are not economic, they are geologic (and often have a bit of the political to them as well, as many key oil-producing areas of the world are very prone to political upheaval). It would be silly to expect that we will see a prolonged surge in worldwide oil production.
Yes, new areas such as the Brazilian offshore will come on-line, but they will need to offset not just the growing demand from countries like China and India, but the declining production from mature areas such as the North Sea and Alaska’s North Slope. That means that oil should remain in a secular bull market, unless the overall world economy falls apart again.
Paradoxically, that will probably lead to increased consumption by the oil-exporting countries. If those countries have declining production due to depleting fields, that means that the amount they have available for export could fall dramatically.
Those firms that hold large reserves of domestic (or other politically stable) oil should be very handsomely rewarded over time. The independent producers such as Devon Energy (DVN) and Apache (APA) should be very good long-term investments. More adventuresome investors might also want to consider smaller firms with large reserves and growing production relative to their size. One of my favorites of these is ATP Oil and Gas (ATPG).
If oil demand is going to continue to grow rapidly in the developing world and among the oil exporting countries, world oil production will struggle to keep up — and then there will be a bidding war for the last available barrel. The developed countries will have to reduce their share of (relatively flat) world production.
If we don’t have strategies to either intelligently reduce our consumption through greater efficiency, or find ways to shift to other forms of energy, the lack of energy is going to be a huge headwind to developed world economic growth. This is a secular, not cyclical, challenge faced by the U.S., Europe and Japan. Over the last decade, these three economies have made great strides in lowering their share of total consumption, but it is a trend that will have to continue for the next decade and beyond.
APACHE CORP (APA): Free Stock Analysis Report
ATP OIL & GAS (ATPG): Free Stock Analysis Report
BAKER-HUGHES (BHI): Free Stock Analysis Report
BP PLC (BP): Free Stock Analysis Report
DEVON ENERGY (DVN): Free Stock Analysis Report
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