Forecasting the long-term outlook for global energy markets has always been a formidable task. The Center on Global Energy Policy sat down with Eirik Wærness, Statoil’s chief economist, ahead of the U.S. presentation of Statoil’s long-term macro and market outlook (PDF), to discuss the changes in global energy security requirements, geopolitical risks to markets, U.S. shale oil production, the impact of the developing global LNG market, and the variables which must be taken into account when looking 25 years into the future of the global energy system. The transcript has been edited for length and clarity.
Center on Global Energy Policy: Statoil’s Energy Perspectives 2014 talks about how, for many countries, energy supply issues are evolving. How are the needs of import-dependent countries changing and what are the potential impacts of those changes?
Eirik Wærness: Issues around security of supply must be seen in the context of how the energy mix is changing. For example, the European perspective is currently being informed by its status as a very large importer of oil and gas, the Ukraine-Russia crisis, changes in gas prices and coal prices, as well as the availability of coal and gas. Within Europe, policy changes also affect the perception of different fuels as countries weigh domestic concerns and the interests of their domestic industries.
Even though Europe is a very large net gas importer, concerns about whether countries have sufficient gas to fuel their energy needs has been changing somewhat as both the availability of coal has increased and as they focus on renewable energy. At the same time, they need to concentrate on jobs after the financial crisis, which has increased the focus on deploying their own coal resources. The consequence of that is, politically, the concern about CO2 emissions has faded into the background slightly. When you get acute concerns, like the Ukraine-Russia crisis, European focus on available gas obviously increases again. But overall, compared to some years ago, the long-term concern about whether Europe has sufficient gas has declined.
At the moment, concerns about North American supply security are fading as the region becomes a net exporter of energy. This can potentially change how it engages different regions and changes the competitive issues it has with other regions. On the other hand, even if North America becomes a net exporter of gas and oil products and even crude oil, it is still dependent on the market development globally for these resources. I don’t think it is very likely that North America will lose its focus on the Middle East, even though the absolute numbers in terms of energy dependence on the region are shifting.
CGEP: Long-term energy forecasting must take into account many variables, including technological developments, economic growth, and climate change policy, just to name a few. In developing the 2014 forecast, which variable did you struggle with most and which is most likely to change Statoil’s outlook over the longer term?
EW: The biggest issue is predicting how energy efficiency developments will influence the energy intensity associated with global economic development. We tried to judge whether there will be a return to the global trend of rising energy efficiency by looking at some of the efficiency standards and measures that have been developed. We expect a break with the developments of the last 10 years, when we saw relatively stable energy efficiency, and a return to rising energy efficiency.
In addition, going out to 2040, in forecasting global economic growth, you have to move from the short-term focus of the demand side of the economy to a long-term supply focus and try to estimate production potential. The potential production growth from China and India, which are two key regions when you get out to 2030 to 2040, is very difficult to forecast.
It is also difficult to gauge the importance of a number of technological issues. On the supply side, the most difficult thing to evaluate is to what extent current cost improvements in renewable energy result in a significantly larger influx into global energy systems. Such an influx would mean that the capital base of global energy production changes faster than what we have expected. But it is difficult to see how that will be done with intermittent renewable energy that has to work on a very large scale in electricity production systems.
On the demand side it is the combination of smart technologies and smart grids that contribute to the overall energy efficiency, and that is very difficult to forecast.
CGEP: Geopolitical risks are ever present in markets, and most recently they have come from turmoil in Ukraine and Iraq. Given the changes in energy supply and demand trends globally, are markets better protected against such events than in the past?
EW: These risks used to be primarily seen in oil market. But it is clear now, especially as gas markets globalize, that geopolitics and security of supply concerns affect all energy markets all the time. In the oil market it seems to be a permanent feature that we have supply shut ins and disruptions. One year it is Libya, then Libya comes back, then Libya falls out again. We have Nigeria, South Sudan, and Syria as more or less permanent features, and currently, as everybody expected Iraq oil production to grow slightly faster than what we had seen in the past, it has come back as a key uncertainty. We have sanctions against Iran that could be lifted, or not. This permanent risk premium on top of the marginal costs explains the price. We probably will increasingly see similar issues in the gas markets as they continue to globalize, although not to the same extent.
The shale revolution in the U.S. has created a supply source that is more flexible than traditional sources. By regulating production up and down, these supplies can function more or less together with the spare capacity of OPEC to dampen the effect of supply disruption or geopolitical concern. This unconventional oil production is probably better at protecting against very large reductions in price, compared to mitigating price spikes, because the flexibility in terms of stopping drilling and shutting in production is higher than the flexibility of increasing the number of rigs. Factors that would traditionally lead to a crash in prices, whether we are talking about demand changes, new sources of supply, or disagreements within OPEC, can be limited somewhat by the reaction of the shale or tight oil producers in North America because they can pull back quickly. I think, however, that U.S. shale has less of an ability to react to upward price shocks.
On the gas side, there are two factors pushing in opposite directions. Geopolitics may be playing a bigger role in global gas markets due to the combination of larger integration through pipelines, rising LNG supplies, and a greater influx of spot pricing that moves some supplies away from long term oil-linked gas contracts. This integration leads to geopolitics becoming more important as spot prices react more quickly.
On the other hand, the fact that these markets do integrate could mean that LNG eases the issues caused by geopolitical problems and that the market becomes less susceptible to isolated issues. If an issue arises like the Ukraine-Russia crisis, the extent to which it could seriously impact gas supplies to Europe will partly be reduced by the possibility of getting in more LNG.
CGEP: The advent of U.S. LNG exports and Henry Hub pricing is changing the dynamics of global gas pricing. How do you expect this to expose and change regional price differences in the longer term?
EW: Exports of LNG out of the U.S. or Western Canada will imply that Henry Hub pricing is used as a signal in global LNG markets. Producers of natural gas who supply Europe through long-term contracts will know that if the price is too high there is a potential for being competed out at the margin by new LNG coming out of North America.
You can define the North American price as the Henry Hub price plus whatever cost you have to add on, such as the cost to transport the gas to the coastline, to liquefy it, to transport it across the Atlantic, plus the re-gasification cost. That price could serve as some kind of ceiling for the price in Europe at the margin. It is not clear how big a volume of gas would be needed for that to have a price impact. There would still be a significant difference in the price of gas in Europe and in the United States because you have to add on all these factors on top of the Henry Hub price.
There would be an impact in Asia, where the willingness of the big gas buyers to enter into contracts linked to oil or spot prices significantly higher than what is implied by the Henry Hub plus price will be limited. We think therefore the likelihood of long-lasting price differentials of the kind we’ve seen between Europe and Asia over long periods is reduced.
CGEP: Statoil forecasts U.S. shale oil production to peak in 2020 at around 5 million barrels per day, and notes that the current limits on U.S. oil exports are not likely to be lifted in the near term. Would lifting this ban have an impact on the U.S. unconventional supply outlook? How would it change global oil trade flows?
EW: We don’t think that a lifting of this ban in the near term would have a large impact on the supply outlook, not if you look at it over a number of years. Our supply outlook is more or less determined by the size of the resource, the ability to produce it, and the potential to maintain the tremendous churn of rigs and infrastructure that you need to put in place to replace a huge number of wells in areas that plateau and decline quickly.
We are slightly more optimistic now than we were last year on the level at which U.S. shale oil production peaks. If the export ban is not lifted, at least if you look at it over some years, the exports will be there anyway, indirectly in the form of product exports. Of course, that increases the requirements for the refining industry and new investments might be needed in export capacity.
I think the most important impact that allowing U.S. crude exports would have is that it would give a better signal to the oil complex as to what is profitable and what is not. Having bottlenecks, gluts, and price hikes within different regions of the United States would be less of an issue. Of course a lifting of the export ban would contribute to a slightly different oil trade as there would be more crudes coming out of North America and less products and a slightly different balance of crude coming in. The links between crude grades of more or less the same quality, such as Light Louisiana Sweet, West Texas Intermediate, and Brent, would function better and you would avoid these very large price differentials that we have seen over the last couple of years.
CGEP: Statoil’s outlook calls for oil production capacity growth from Iraq of 800,000 b/d to 1 million b/d over the next four years, with total OPEC growth of 2 million b/d during that period. Given the recent turmoil in Iraq, what are the risks global oil markets could face if that capacity growth is threatened?
EW: The risk comes if this capacity growth is not delivered or if it comes later. In our forecast, we are not overly optimistic about the capacity growth from Iraq. The type of turmoil that we see now would put any type of growth estimate into danger. Global oil markets will be slightly tighter than otherwise estimated.
Part of the story here is that for the next two to four years we expect a relatively rapid increase in OPEC spare capacity, which normally indicates a slight weakening of global markets. If we have an increase in non-OPEC production and we have relatively moderate demand growth, then the call on OPEC will grow very slowly. Additionally, if Libya comes back gradually and there is some kind of creep in the capacity overall of Gulf OPEC members, you will see that spare capacity rise. But if Iraq does not come in as expected then spare capacity growth will be slower than what we have estimated. Looking at it in isolation, there is more likelihood of the price spikes that you get when geopolitical issues arise, even if the fundamental or slightly longer-term effects are small. If this is an indication of something that could spread to other parts of Iraq or other parts of the region, the impact would be larger.
Statoil Chief Economist Eirik Wærness has previously worked as Statoil's Chief Energy Market Analyst and in other roles in the company, in addition to holding different positions in government and the private sector in Norway.
Watch the video of Eirik Waerness' presentation at CGEP on Statoil's 2014 "Energy Perspectives" report