BP Chief Economist Christof Rühl sat down with Columbia University’s Center on Global Energy Policy ahead of the release of BP’s annual Statistical Review of World Energy in the United States to discuss the rise of U.S. oil production and the subsequent surge in domestic demand last year, European dependence on Russian natural gas, the outlook for oil price stability, and growth in global coal consumption. The transcript has been edited for length and clarity.
Center on Global Energy Policy: The BP Statistical Review of World Energy showed that the U.S. led global oil consumption growth in 2013. What accounted for this growth and what is the outlook for it continuing at this pace?
Christof Rühl: It was driven by industrial consumption growth, which accounts for 80 percent of the increase. U.S. oil consumption went up by 400,000 barrels per day last year, compared with an annual average decline of 110,000 barrels per day over the last ten years, and for the first time in 15 years outpaced Chinese consumption growth. Most of that growth was driven by the availability of discounted domestic light oil and liquefied petroleum gas (LPG), as well as by low-priced natural gas liquids (NGLs).
People in the public discussion still look at natural gas to drive some kind of industrial renaissance in the U.S., but we don’t see that in the data yet. There was nothing exceptional about industrial demand growth for gas. We do see it in oil, however.
That’s the smaller picture, but it fits into a bigger pattern we discovered in the data. Globally we found a rapid pick up of energy consumption growth in the OECD last year, despite slowing and lackluster economic growth; and we saw a pronounced slowdown in energy consumption growth in the non-OECD, despite decent economic growth.
This boils down to North America being responsible for the acceleration in OECD energy consumption, despite slower GDP growth and Asia being responsible for the slowdown in non-OECD energy consumption, despite the steady GDP growth it has seen. If one drills down one level further, one discovers the consumption decline is caused by China and the consumption growth by the United States. In China, the decline is mostly driven by coal, where the growth rate fell to less than half the 10-year average but is visible in oil as well -- and despite official GDP numbers indicating there was no change in economic growth.
I have no trouble understanding how, in the case of the United States, cheap domestic resources, such as the available discounted crude, would translate into an increase in industrial sector energy consumption first, and then into an increase in economic growth. I find it a lot harder to understand why the massive restructuring currently under way in China should lead to such a marked slowdown in energy consumption growth, but at steady GDP levels. In other words, this leaves doubts about the combination of Chinese energy and economic data.
CGEP: The Review showed U.S. oil production including natural gas liquids topped 10 million barrels per day in 2013, making it the third largest oil producer in the world behind Saudi Arabia and Russia. How important has this U.S. growth been to markets and what does the outlook for further growth look like related to the prospect of a lifting of the current limitations on oil exports?
CR: Crude export restrictions introduce an inefficiency into the American market but provide little by way of export limitation at the moment; currently we just see crude being converted into products and exported.
U.S. oil production rose by 1.1 million b/d in 2013, the second year in a row it grew by more than 1 million b/d, and the second year in a row of record U.S. production growth. To be precise, we had only nine instances in the entire history of global oil markets with higher annual production growth, and each of these cases was in Saudi Arabia. But six out of the nine were based on existing spare capacity, production that the Saudis had previously cut and could then ratchet back up again. In terms of organic growth, based on genuine capacity expansion, this then turns last year’s increase in U.S. oil production into the fourth biggest annual increase in history – any time, any place. And so far this year, it’s even higher. In our longer-term outlook we anticipate tight oil growth slowing eventually but still driving U.S. production higher until about the early 2020s.
I think that gradually the U.S. oil export limits will be lifted because they so clearly create inefficiencies. You have bottlenecks in infrastructure and therefore discounts for domestic crude and refineries turning that discounted crude into products and then exporting it. That means that the American consumer actually doesn’t benefit from these discounts because the products are still traded globally, and so the price at the pump is still the global price. You have someone benefitting in the system, but not the final consumer.
I believe that argument, together with all the benefits from free trade and staying globally integrated, will win the day. But if you look at global oil markets, the concern about US exports is actually dwarfed by much larger implications of the tendency toward energy self-sufficiency in North America. It implies a large re-orientation of trade, and this has already started: All Middle Eastern oil exports will switch from North America to Asia. But Asian growth will also require oil from other places such as Africa and the former-Soviet Union. Such a re-orientation of global trade patterns is fraught with much bigger risks – and in comparison, the U.S. situation becomes a little less important. It clearly is an inefficiency, but a local one.
CGEP: Europe’s reliance on Russian natural gas has been in the headlines recently due to the Ukraine crisis. Overall, European dependence on natural gas declined in 2013 to the lowest level since 1999, according to the BP annual data. What is driving this reduction in European natural gas consumption, and what is the realistic expectation for lowering dependence on Russian gas?
CR: The European Union is ultimately a shrinking market. Production seems to be in terminal decline. Consumption is down due to lower demand for electricity. Last year, natural gas lost out in the competition with coal for power generation again. More to the point, natural gas in Europe faces competition with other fuels such as subsidized renewables in power generation, to which it loses more market share than to coal. That will be the long-term situation.
Russia made big inroads in Europe last year. Recall that Russia in 2012, when European spot prices were considerably below oil-indexed prices, had lost 12 percent of the European Union’s gas market to Norway because Norway decided to adjust its deliveries to spot prices whereas Gazprom insisted on oil-index pricing. In 2013, spot prices rose and almost closed the gap with oil-indexed prices again, but Gazprom also offered discounts and rebates. European Union imports from Russia increased by almost 20 percent.
There are two elements here – why Russia could increase its exports so much and why Europe needed this gas. On the first, the recapturing of Russia’s market share comes against a background of falling power demand and high availability of hydroelectricity in Russia, reducing the call for natural gas in power generation. More importantly, independent producers in Russia – that is, producers other than Gazprom which continues to hold the export monopoly – now account for 28 percent of Russia’s production but supply 39 percent of Russia’s gas consumption. By taking over domestic market share from Gazprom because they can offer gas more cheaply, they make resources available for Gazprom to direct toward export markets.
That meant Europe did not to have to compete as much for expensive LNG imports. This became important last year as Europe has faced big gas supply disruptions from North Africa – specifically Algeria and Libya – as well as from Nigeria. There is slack in the global growth of LNG for the next few years, and Europe did not need to enter into the competition for expensive LNG because the composition of its imports shifted away from Africa toward Russia. Overall Europe was a big beneficiary of Russian export policy. Europe and Russia are mutually dependent, and it is hard to see how that will change in the short term.
CGEP: Oil prices have been relatively stable in recent years. How long can this last? What are the risks from Iraq?
CR: We have not only seen three years of high prices -- the highest three years in nominal and real terms ever – but we have also seen three years of very stable prices The last three-years was the three year period with the least price volatility since 1970. That comes against a background of an increase in U.S. production of historic proportions and an equally historic increase in supply disruptions starting in 2011 with the civil war in Libya. Since then, cumulative supply disruptions account for about 3 million b/d, the largest volume since the coincidence of the collapse of the Soviet Union and the Iraqi occupation of Kuwait.
By shear coincidence, and I cannot emphasize that often enough, the supply disruptions have been offset almost barrel for barrel by the increase in tight oil production in the United States. The result is fairly stable prices. Oil prices would look rather different today if we only had seen the supply disruptions: You would have seen oil prices driven higher, and there would have been talk of a release of oil from strategic reserves and talk about damage to the global economy. If we had only seen the actual tight oil production increase in the U.S. you would have seen prices under pressure and talk of OPEC cuts. That’s why in oil markets today we have this eerily calm situation, waiting to see which side gets the upper hand.
On Iraq, so far production has not been reduced because the fields in the south and north have not been damaged. Iraq produces around 3.1 or 3.2 million b/d of oil and it would be hard to replace this given that existing spare capacity is somewhere around 2.6 million b/d, mostly in Saudi Arabia. That would tip the balance that I previously described toward the side of more disruptions. But it is just speculation right now and you can see in the oil price that people are fairly cautious and not expecting the worst.
CGEP: Coal was the fastest growing fossil fuel in 2013. What drove that increase and how long do you anticipate this trend to continue?
CR: What drove it primarily was that coal won out against gas in power production in the United States for the first time since 2008. Natural gas prices had hit a historic low in 2012 and then increased about 35 percent for the year in 2013. That was not enough to accelerate natural gas production because the price differential between oil and gas was so large that it remained more lucrative to chase liquids by diverting drilling rigs from shale gas to tight oil production. It was enough, however, for gas to lose out in consumption, at the point where it faces direct competition against other fuels, i.e. against coal in power generation. In US power generation, natural gas actually lost market share of 3 percent, which was the biggest decline since 1974.
In the long term and globally, the massive slowdown in coal consumption we saw in China is probably a harbinger of things to come. The Chinese economy will become less coal dependent and growth rates for coal are likely to slow down over the next decades. Either the Chinese succeed in rebalancing their economy away from heavy industrial production toward more services and domestic consumption, which would slow down coal demand growth, or they fail, and that would also negatively impact coal consumption by adversely affecting economic growth in China.
Christof Rühl is Group Chief Economist and Vice President of BP plc. Prior to joining BP, he was at the World Bank (1998-2005) where he served as the Bank’s Chief Economist in Russia and in Brazil. Before that, Christof worked in the Office of the Chief Economist at the EBRD in London and was an Economics Professor at UCLA.
Watch the video of Christof Rühl's presentation at CGEP on the 2014 BP Statistical Review of Energy