2003's constant surprises may not be finished

Matthew R. Simmons, Chairman and CEO, Simmons & Company International, Houston

The year 2003 was marked by a string of oil surprises. It is beginning to look as if "normal" is an oxymoron when used with the oil market. Perhaps 2004 will be the year when more answers than surprises occur.

Oil prices were the first surprise. For the fourth year in a row, West Texas Intermediate crude prices spent most of the year above $30/bbl, far higher than most "oil experts" had forecast, Fig. 1. The only time that oil prices took a sharp drop below this level was when the Iraq War broke out, spurred by the mistaken view that war in Iraq would soon be followed by a glut of Iraqi oil.

Fig. 1. West Texas Intermediate spent most of 2003 at its highest price level in years.

Surprise number two was the growth in oil demand, despite weak economic conditions around most of the globe. For a decade or more, oil observers have fretted about how weak global oil demand would be. This thesis turned out to be wrong.

Demand growth sources. Global oil demand grew 1.4 million bpd in 2003, or 50% higher than the 15-year average growth of 900,000 bpd. Over the last 15 years, global oil demand increased every single year, growing 13.5 million bpd over the period, despite decreased demand from the Former Soviet Union (5.3 million bpd). Had FSU demand grown as fast as the OECD's rate, global oil demand would now be somewhere between 85 million and 90 million bpd!

Fueling this growth was China, but demand was also strong in the Middle East, parts of Latin America and throughout most of the rest of Asia. Only a few years ago, conventional energy wisdom assumed that it would be almost impossible for Asian oil demand to see any robust growth until Japan's economic miracle returned. Today, Japan's economy is still weak; its oil demand has barely grown over the past decade. Nonetheless, this did not stop demand growth in the rest of Asia.

Perhaps the biggest surprise regarding oil demand was the growth that happened in the US. For two decades, most forecasts assumed that growth in US oil demand was slowing each year and would soon stop. In the early 1990s, a widely circulated National Petroleum Report on the future of the US refinery industry envisioned in its base case that US motor gasoline demand would stay flat at 7.2 million bpd for 1996 through 2010. It projected little growth for other oil products.

This gloomy view of US oil usage turned out to be wrong. By 2003, US oil demand was setting new records almost every month. Leading the way was the backbone of US oil usage, motor gasoline, where total demand came close to averaging 9 million bpd for the entire year. Peak summer usage exceeded 9.4 million bopd. There was virtually no evidence, either, that surprisingly high oil prices had any impact on any aspect of US oil demand.

The world still seems to have an insatiable appetite for oil. Almost five billion people have very limited use of cars and other energy-consuming luxuries, but their access to global media is creating pent-up demand that could expand this usage.

In the 60 years since World War II ended, the only time there was any meaningful downturn in oil demand, outside the one-time collapse in FSU oil demand, was when usage of oil in any great quantities to generate electricity stopped from 1979 to 1983. This one-time change was triggered more by the advent of nuclear power coming on-stream than the explosion oil prices.

There were a few one-time reasons fueling the strong, global oil demand in 2003. Japan's nuclear plant shutdown, when some cracks appeared, created as much as 100,000 bopd to 200,000 bopd of extra oil demand. The extremely high natural gas prices in the US caused about the same level of added oil usage, due to

fuel switching. But these impacts were tiny compared to overall growth in global oil demand.

Oil supplies. The third 2003 surprise was what happened to oil supplies. A widely anticipated surge never happened. As far as any good data now show, oil supplies barely grew in most regions, except the one area where demand also failed to grow, the FSU. Despite exceptionally high oil prices for the fourth consecutive year, no serious surge in oil supplies resulted.

There was a genuine glut of published oil supply forecasts that continually predicted that massive amounts of new oil were about to appear. The common theory was that these new volumes would bring oil inventories back into balance or even build storage until it was too full, but the surge never came. The only part of the world with any sizeable supply gain was the FSU. Elsewhere, output increases were modest, keeping inventories tight all year.

Supply did grow in some areas. Mexico added another 200,000 bopd offshore, as all the benefits of the $10.5-billion, Cantarell tertiary nitrogen injection program bore their fullest fruit. Now Cantarell's output seems likely to begin a steady decline. Canada enjoyed growth in its production of synthetic crude and bitumen, which offset supply declines from conventional crude supplies. Equatorial Guinea added close to 100,000 bopd, and Exxon's major oil project in Chad finally came onstream. Algeria added some new productive capacity, and Brazil still hopes its oil production will grow by 100,000 bpd, although the last few months of 2003 saw unexpected production declines.

Positive production surprises, however, were few and far between. Meanwhile, significant output declines were reported in countries like Oman - where its giant Yimal oil field is now in serious decline - and Colombia, whose oil production peaked at almost 800,000 bpd in 2000 but now struggles to stay above 500,000 bpd. Egypt also came close to hitting a record 1 million bopd as recently as 1995, but now the country struggles to stay above 700,000 bopd. A country reporting oil supply growth is becoming the exception to the rule as declining output from almost all older fields is offsetting most new oil projects.

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