The Outlook for the World Oil Market

Ann Curran, Director, Corporate Relations, AIC Limited and Past President, The Empire Club of Canada; Husayn Dharshi, Grade 12 Student, Marc Garneau Collegiate Institute; Robin Korthals, Chairman, Ontario Teachers' Pension Plan Board; William Thorsell, Director and CEO, Royal Ontario Museum; Shawn Cooper, Managing Partner, Russell Reynolds Associates; Richard Waugh, President and CEO, Scotiabank; His Excellency David Reddaway, British High Commissioner to Canada; Tony van Straubenzee, President, Rockhaven Consulting and Past President, The Empire Club of Canada; Father Marc-Andre Campbell, St. John Vianney Parish, Barrie; Donald K. Johnson, Retired Vice-Chairman, BMO Nesbitt Burns; Michael Norris, Deputy Chairman, RBC Capital Markets; and Jim Estey, President and CEO, UBS Securities Canada Inc.

Introduction by Bart Mindszenthy

Ladies and gentlemen, I learned about three things last night in preparing for today's luncheon and Lord Browne.

First, I learned a whole lot about the history of oil. Probably more than I ever wanted to know, but nevertheless, all of it interesting.

I learned how the oil industry actually began some 5,000 years ago in the Middle East, where oil seeping through the ground was used to waterproof boats and baskets, in paints, lighting, and even for medication.

I learned about how Marco Polo observed the collection of oil from seeps in the city of Baku on the shores of the Caspian Sea in 1264. About how oil wells up to 35 metres deep were hand-dug in Baku by 1594. And about how seep oil was used in street lamps in the Polish town of Krosno by the 1500s.

I learned how oil sands were mined in Alsace, France by 1735, and how the first modern oil well was drilled near Baku in 1848.

I learned a Canadian geologist in 1849 discovered how to derive kerosene from oil, and how that discovery, in fact, saved the whales, whose oil was until then in such stunning demand.

And how the first oil well in North America was drilled right here in Ontario in 1858.

I learned how relatively stable the world oil market was for some time, and how new technology allowed the industry to become much more effective, and reach much farther--into the North Sea and up to Alaska.

The second thing I learned is that BP is one very big organization. It spans the globe, operating in more than 70 countries with more than 100,000 employees. BP spends more on salaries and R&D and goods and services than what many nations can register as their GDPs.

BP today is one of Britain's largest companies, and one of the world's largest oil and petrochemical groups.

It also has a senior management team that is driven by strong values and a commitment to sound corporate governance and social responsibility.

So here is an organization that is just one year older than the Empire Club, but definitely larger.

The third thing I learned is that our speaker today is a man with simply awesome credentials on all fronts.

A Cambridge graduate in physics, he went on to earn an MS in business at Stanford. Lord Browne joined BP in 1966 as a university apprentice and obviously passed muster.

Since the mid-1980s, he has assumed successively more senior positions.

In 1991, Lord Browne joined the Board of BP as a managing director, and was appointed group chief executive in 1995.

After the merger of BP and Amoco, he was named group chief executive of BP Amoco in 1998.

Knighted in the 1998 Queen's birthday honours, he was made a life peer in 2001. And Lord Browne has earned a long list of distinctive awards and recognitions, while also serving on a number of corporate, cultural and charitable boards in England and the United States.

Ladies and gentlemen, please join me in welcoming to the podium of the Empire Club of Canada, the Rt. Hon. The Lord Browne of Maddingley.

Lord Browne

President Mindszenthy, ladies and gentlemen, it is a great pleasure to be back in Canada, which is a country that is very important to us in BP and to the whole of the world energy market. We very much appreciate the links that we have here. We already invest some C$8 billion here, and I hope we soon will be able to invest a little more.

You asked me to talk about the outlook for the world oil market. I think it is appropriate to start with the immediate events which are shaping people's thinking about the market, and raising new concerns about the question of energy security. The price of Brent on the international market has fluctuated over the last 12 months from around $25/barrel a year ago to over $45 for a period in the autumn to just below $40 today.

To understand the reasons for those shifts, you have to look back at the events of the last five years. What's changed and what are the consequences of those changes?

Back at the end of the 1990s, we all were accustomed to an oil price, which averaged a reasonably stable $18/barrel, with only very occasional excursions into the low $20s, and one brief fall at the end of the 1990s to $10. That was the picture for a decade, from the end of the first Gulf War onwards.

Throughout the 1990s, technological advances had opened the range of what was possible. Advances in seismic technology reduced the risks and costs of exploration. Advances in deep water technology opened up new areas for exploration and development. Advances in reservoir management technology pushed up recovery factors.

And political change also had opened new doors. International companies were able to invest in areas previously closed to them--including Russia, Central Asia, the Caspian, and China.

So there had been a series of developments, which had created a situation in which costs were falling, and in which prices were moderate and seemed liable to decline rather than increase.

The factor which changed the outcome was the decision in April 2000 by the OPEC member-states to use their market power to set a price framework for oil at around $25/barrel--varying up or down from that level by no more than $3/barrel. That was a major step, and OPEC's successful management of their production set prices at those levels throughout the period, from 2000 to the end of 2003.

The next fundamental change came on the demand side. The growth in demand for oil in 2003 and 2004 has been so strong that for the first time in 30 years, the rate of oil demand growth worldwide almost matches the growth of GDP. That is the context in which the rise in prices we've seen over the last 12 months has developed.

That rise is driven by demand, particularly the dramatic growth in demand in China, which has increased its imports of oil by 400 per cent in just four years, and is reinforced by concern about supply security.

For most of the last two decades, the market has operated with around three million barrels per day of spare capacity. This year, that spare capacity has fallen to around one million barrels per day--an amount less than is produced in a number of areas where continuity of supply has been threatened by disruptions--including Iraq, Nigeria and Venezuela. There has been no shortage, but there has been a fear that a shortage would develop.

Fortunately, the market operates in a very effective way. Partly in response to this increased price, and in response to the confidence inspired by OPEC's effective management of the market, the private sector part of the industry began to increase its spending on exploration and production. The top-30 quoted companies have increased their investment in exploration and production by more than 15 per cent a year during the last five years. They now invest almost $100 billion a year between them.

That already is producing increased supplies. A whole series of major new fields are coming on stream over the next three years--in the Caspian, in Angola, and in the deep water of the Gulf of Mexico.

Those new developments should help to restore stability to the market. So will the growth in OPEC capacity. If, as can be reasonably expected, the growth in demand resumes its normal growth path of around 1.5 per cent per annum, surplus capacity should build over the next three years back to a more comfortable level of around three million barrels per day. In the absence of any further major disruption, prices might then revert to a level set by the decisions of the OPEC member-states on production.

Given the revenue needs of many of those states, which have large, youthful populations and which have not yet succeeded in diversifying their economic development away from oil, it seems realistic to expect that with the insecurity premium removed, prices might stand at around $30/barrel.

That is a reasonable level which will reward investment by the private sector and generate sufficient revenue for the producing states, but which will not do major damage to the global economy or to those who depend on oil imports.

Such an outcome, however, is not the end of the story. None of the developments I've described should be taken to mean that the issue of energy security has been resolved.

There are two substantive issues, each of which poses challenges for energy security over the medium and longer term.

The first is about supply and demand.

The demand for energy continues to grow, with the growth underpinned by the increase in population numbers and by the gradual spread of prosperity.

The world's population grows by almost 10,000 an hour--almost a quarter of a million every day. In 10 years' time the world will have an additional one billion citizens--making 7.3 billion in total. All those people need food, housing and all the other basic products and services which require energy.

More and more of the world's population can afford the energy they want to buy. The spread of prosperity, especially in China, India, and parts of Latin America, adds to effective demand on a daily basis. The result is that there are tens of millions of new consumers of commercial energy every year.

The current projection from the International Energy Agency is that global demand for all forms of commercial energy will rise from the current level of around 190 millions of barrels per day of oil equivalent to some 240 millions of barrels per day of oil equivalent by 2015. A rise of almost 30 per cent.

That forecast is made on quite cautious assumptions about economic growth rates. The numbers could turn out to be significantly higher.

How can that demand be met? Some place their faith in renewable and alternative forms of energy supply. Power from the wind and the waves. Power from solar panels. We believe those are important sources of future supply. We in BP are investing in research and development work in photovoltaics--the technology which supports solar power--and in various other forms of alternative energy supply.

One day, one or more of those new sources will provide a significant proportion of global energy demand. But the evidence is that day is still a long time off. Today, all the renewable and alternative forms of energy supply provide just 2.5 per cent of world demand, the bulk of which currently comes from biomass.

Research continues in many other countries around the world. But in every case, we still are at the stage of research and experimentation. We believe renewables will provide material supplies of energy in the long term. But the long term could be 20 or 30 or more years away. The estimate from the International Energy Agency is that in 2015 they will provide only 3.3 per cent of total demand.

What sources then will meet the demand?

Some people believe that the key lies in the potential of nuclear power. That certainly is possible. But it seems a remote possibility on the timescale of a decade. Nuclear currently supplies 7 per cent of world energy demand. The first generation of nuclear stations are reaching the end of their natural lives. Last year, only two new nuclear stations were commissioned and public doubts both about safety and about the uncertain long-term costs continue to constrain new investment. In the U.S., no new stations have been commissioned for over two decades, while in Europe the forecasts suggest that on current trends nuclear capacity will decline rather than increase over the next 10 years.

And that leaves hydrocarbons--coal, oil and gas--to meet the balance.

The mix will vary from one country to another. China, for instance, will no doubt continue to use large volumes of coal, but in terms of convenience, oil and gas seem set to remain the fuels of choice.

In reality, energy security is about the supply of oil and gas to meet demand which could grow, again taking the IEA figures, to around 93 millions of barrels per day of oil and 64 millions of barrels per day of natural gas by 2015. That would represent a 20-per-cent increase in oil demand from today's level and a 45-per-cent increase in the consumption of gas.

Can the oil and gas industry meet that demand? In physical terms the answer is clearly yes. The resources are there. The world holds some 1,000 billion barrels of oil, which have been found but not yet produced, and some 5,500 trillion cubic feet of natural gas--also found but not yet produced. At current consumption rates, that is 40 years of oil supply and 60 years of gas.

In addition, the US Geological Service estimates that some 800 billion barrels of oil and 4,500 trillion cubic feet of natural gas are yet to be found. And that does not include the very substantial heavy oil resources here in Canada and in Venezuela, which also are beginning to appear to have real potential as a source of future supply.

In terms of physical resources, then, energy security is within reach. There is no fundamental physical reason why there should be a shortage in the next 10 years, or indeed for many decades beyond that.

The challenge for energy security is that supply is not co-located with demand.

The fundamental fact is that now, and for the foreseeable future, four regions will account for the bulk of trade on the import side of the equation--the U.S., Europe, Japan and China. Even assuming that all four develop their own indigenous resources to the limit of what is economically rational, and diversify their energy supply sources where practicable, they still will need substantial and growing volumes of imported oil and gas.

Over a 10-year period, the trade in oil, in particular, will grow as a proportion of total demand, because production from the mature provinces in the developed world is plateauing and beginning to decline.

Oil trade is likely to rise as a proportion of consumption, from 50 per cent today to almost 70 per cent by 2015. Gas trade will also rise over the same period.

As I have discussed, there is no shortage of resources.

But the export side of the trade equation displays an even more powerful concentration of activity. By 2015, three areas will account for almost 80 per cent of all the oil traded in the world each day. The three are Russia, West Africa and the Gulf States of the Middle East. By 2015, on the IEA estimates, Saudi Arabia alone will be required to export some 15 to 16 million barrels of oil every day to balance the world market--and that assumes that both Iran and Iraq are by then producing and exporting at something close to their full capacity. That is a manageable situation, of course, but it does emphasise the need for the development of a wide variety of sources of supply, and of the infrastructure necessary to bring those supplies to market.

Canada is very important in that process. The energy produced and traded from this country--potentially including heavy oil--is a crucial element in the overall picture, and so is the infrastructure, which can take those resources to the markets where they are needed in North America and internationally.

That is one element of concern about energy security. The other concern is the environmental challenge associated with the growth in hydrocarbon consumption. In part, that is about the level of pollution caused, particularly in the cities as hydrocarbons are burnt. In part, and potentially more seriously, it is about the impact of increasing emissions of greenhouse gases on the earth's atmosphere--the issue of climate change or global warming.

The detailed science of climate change is still provisional. There are many things we don't know. But science is always provisional and in business we are used to working in circumstances where we don't know all the facts for certain.

That means we have to make judgments in conditions of uncertainty, weighing all the risks. On the basis of the available evidence about climate change, the clear judgment must be that there is a powerful case for precautionary action.

It would be too great a risk to stand by, do nothing and to wait so long that when the impact on the climate really does begin to be felt, the action, which has to be taken will be so fundamental as to cause serious damage to the world's economy.

There is a very strong case for precautionary action designed to limit any increase in the world's temperature to around 2 degrees Celsius. That translates into a stabilisation of greenhouse gases in the atmosphere at around 500 to 550 parts per million. That is the best current estimate of the level of safety and, of course, as knowledge advances that estimate could be adjusted and refined.

Can that stabilisation be achieved?

The answer is yes. It would mean putting ourselves on a trajectory to the point where in 2050, 50 per cent of global needs for energy would be met by conventional fossil fuels and the other 50 per cent would come from fuels with lower carbon emissions--in some cases with zero emissions. Each of those two halves would be about the size of today's energy industry.

I believe that is achievable.

A great deal of work and experimentation has been undertaken over the last few years--by governments, by academics and by the business world. We may not have a full international agreement, but we have a great deal more knowledge and experience than we did seven years ago.

People have demonstrated that emissions can be reduced--and at a very low cost--simply by reducing waste and inefficiencies. We did that in BP, and we found that we actually made money in the process.

Cutting out waste is a first step, but beyond that people have also begun to demonstrate that there are practical ways of managing the problem.

Some of the possible steps involve advances in efficiency such as raising the mileage per gallon of vehicles from 30 to 60 or eliminating waste, for instance, by ending the process of flaring the natural gas, which is produced in association with oil.

Some of the steps involve changing the product mix--using, for instance, natural gas to fuel power stations rather than coal, or looking further ahead, taking action to encourage the growth of solar power or some other form of energy supply which does not generate carbon emissions. There also is the possibility of developing coal gasification technology.

And some of the steps involve the development of new techniques, which are just emerging, to capture and store the carbon so that it never reaches the atmosphere. We in BP are developing a project in Algeria, which takes carbon out of gas, which is bound for Europe and re-injecting it into storage. That is a large-scale test of what is possible. If it works, it will reduce emissions by the same amount as would be achieved if we took 200,000 cars off the road.

Of course, there are many uncertainties. The decisions that require changes in life style may be unacceptable. The technology of carbon sequestration may be unattainable. There are uncertainties, but they are not all on the negative side. Technology is moving very quickly and will almost certainly offer new opportunities over the next half century--possibilities we can't even envisage at the moment.

What we need above all is an agreed target--set for the long term and supported by a trading system, which allocates resources effectively and efficiently. The European Trading System is an important step in that direction, and could set a global standard, which leads the way forward.

So there are two major challenges for the world oil market, which will remain, even if prices subside from their current levels.

What conclusions can we draw?

First, that the world needs a secure supply of oil to provide heat, light and mobility--and that it needs an effective market mechanism to ensure that the supply is available when and where it is required.

Second, that there need be no shortage of oil and there need be no damage done to the world's natural environment. We can work our way through all the challenges.

The third point is that this is a common problem. Energy security in one country is impossible. So is environmental security. There is one market and one global climate.

That means that we all have to accept the reality of the challenges and the fact that their solution will require the combined actions of all those involved in the industry--governments and companies, public sector and private alike. We can't live in denial.

That need for a collective co-operative response is true with respect to energy security and with respect to the environmental issues. The private sector can do a great deal, but it can't operate effectively unless there is an effective framework which enables infrastructure and investment to proceed, and which incentivises innovation and the development and application of new technology.

I've spent more than 35 years in the oil industry now, including some very happy years here in Canada, and I've seen the market move through many different phases.

The market will never be placid and calm. No one who wants a quiet life should ever work in the oil industry. But it is a fascinating and very exciting place to be.

And I've always found from my experience that the market is a very dynamic phenomenon. It produces answers, often-unexpected answers, precisely because it stimulates innovation and creativity.

And that experience gives me the greatest confidence that however great the challenges answers will be found, and that the oil market, and the industry as a whole, will be as important to the economy of this century as it was in the last.

Thank you very much.

The appreciation of the meeting was expressed by Tony van Straubenzee, President, Rockhaven Consulting and Past President, The Empire Club of Canada.