OPEC: Todays m arket dilem m a and tom orrow s econom ic challenge - PDF document

3 rd OPEC Sum m it Ministerial Sym posium Day - Session I V The Role of OPEC in Providing Petroleum and Prom oting Stability Riyadh, 1 5 Novem ber 2 0 0 7 OPEC: Today’s m arket dilem m a and tom orrow ’s econom ic challenge By Ali Aissaoui, Head of Econom ics & Research Arab Petroleum I nvestm ents Corporation ( API CORP) Handout – Com m ents and feedback to: aaissaoui@apicorp-arabia.com About the author Ali Aissaoui is Head of Economics & Research at the Arab Petroleum Investments Corporation (APICORP). He is formerly an advisor to the Algerian government on energy policy issues and member/ chairman of the OPEC Board of Governors. Prior to joining APICORP, Ali Aissaoui was Senior Research Fellow at the Oxford Institute for Energy Studies. At APICORP he set up and head a research unit in charge of scanning the Corporation’s environment, framing its business strategy and assessing and monitoring country risks and petroleum industry risks. Ali Aissaoui is a member of several professional associations including the Oxford Energy Policy Club and the Paris Energy, Oil and Gas Club. He is the author and co-author of three books as well as numerous commentaries, op-ed and analyses articles on energy markets and the political economy of the major petroleum-exporting countries of the Middle East and North Africa. 3 rd OPEC Sum m it Ali Aissaoui Slide 2 1

Outline of presentation • Responding to a rapidly changing m arketplace • Shaping LT price expectations and a com m on investm ent policy • I nform ing public policy on econom ic diversification • Possible sub-them es for the panel discussion 3 rd OPEC Sum m it Ali Aissaoui Slide 3 1 . Responding to a rapidly changing m arketplace 3 rd OPEC Sum m it Ali Aissaoui Slide 4 2

Oil prices on the upsw ing: OPEC’s capacity to m aintain stability questioned 1 0 0 APICORP Research using EIA- DOE w eekly dat abase $/ bl)) 8 0 Focus on t he e (US cu rren t 6 0 u pw ard cycle pot pric 4 0 WTI S 2 0 0 Ja n- 8 6 Ma y- 9 0 Se p- 9 4 Ja n- 9 9 Ma y- 0 3 Se p- 0 7 3 rd OPEC Sum m it Ali Aissaoui Slide 5 Multifaceted Reasons for High Oil Prices Factors influencing OPEC's W hat has determ ined recent balancing act trends? Stronger than anticipated Global oil dem and dem and in China, OPEC area, Fundamentals dynamics and I ndia Failure to invest ( or denied Non- OPEC supply and refining opportunities?) despite strong capacity m arket signals Proactive approach to OPEC production capacity investm ent resulting in tightness of spare capacity I nventory levels and Disconnect betw een levels of m ovem ents inventories and spot prices Hedging pressures and Very long contango shifting speculative activities unexpectedly to backw ardation fundame Geopolitical developm ents in Heightened tensions and Non ntals key oil-producing areas uncertainties in the Middle East Stances and consequences of US Sharp depreciation of the US m onetary and fiscal policies dollar against other currencies APICORP Research 3 rd OPEC Sum m it Ali Aissaoui Slide 6 3

Has speculation contributed to high com m odity prices? • I n assessing the direction of causality betw een m ovem ents in spot and futures prices and changes in speculative position, the I MF staff found ( I MF’s W EO - Sept 2 0 0 6 – Chap 5 - Box 5 .1 ) – No causal influence on prices by speculative activity ( as m easured by net long noncom m ercial positions on the NYMEX) – Little support for the hypothesis that speculation affects either LT price levels or ST price sw ings • Have the I MF staff m em bers overlooked som ething? 3 rd OPEC Sum m it Ali Aissaoui Slide 7 W hat has m ost changed that has m ade difficult OPEC’s policy stance and actions? 90 APICORP Research using EIA-DOE w eekly database 80 W TI spot prices ( US$/ bl) ) 70 Data for 2 0 0 3 -2 0 0 7 60 50 Data for 40 1 9 8 6 -2 0 0 2 30 20 10 0 250 300 350 400 US inventories excluding SPR ( million barrels) 3 rd OPEC Sum m it Ali Aissaoui Slide 8 4

High levels of inventories are associated w ith contango and low levels w ith backw ardation 4 1 0 0 Va ria tion in US crude oil stocks ( e x cluding SPR) 8 0 ( 4- week minus 52- w eek moving averages) 3 illion barrels) 6 0 $/ bl) 2 4 0 WTI futures basis (US 1 tocks (m 2 0 0 0 S Variation in US - 2 0 - 1 - 4 0 W TI future s ba sis - 2 ( First t o second mont h spread) - 6 0 - 3 - 8 0 API CORP Research using EI A-DOE w eekly dat abase - 4 - 1 0 0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 3 rd OPEC Sum m it Ali Aissaoui Slide 9 A m ore com prehensive interpretation Co st o f st o r a g e • le v e ls o f I n t e r e st r a t e • in v e n t o r ie s Co n v e n ie n ce y ie ld • H e d g in g d e m a n d Co n t a n g o f r o m r isk - a v e r se t o m a r k e t p S p a r t icip a n t s B a ck w a r d a t io n h c r a e R isk p r e m iu m s se t t le d s e R b e t w e e n h e d g e r s a n d P R f u t u r e s O C in v e st o r s/ sp e cu la t o r s I P A 3 rd OPEC Sum m it Ali Aissaoui Slide 1 0 5

Com m odity investm ents on the rise • Recent theoretical and em pirical researches have dem onstrated the superior perform ance of com m odity futures investm ents in term s of: – historical risk-return profile – inflation-hedging properties – portfolio diversification benefits • Com m odity investm ents have rapidly developed as an attractive alternative to traditional asset classes. 3 rd OPEC Sum m it Ali Aissaoui Slide 1 1 Low levels of inventories induce higher com m odity investm ent returns Equally High Low Reference period from I nventory December 1990 to Weighted Inventory December 2006 Index Portfolio Portfolio Annualized Returns 8.98% 4.62% 13.34% 10.80% Volatility 8.93% 11.27% 0.86 Sharpe Ratio 0.55 0.05 Source: Gorton et al. (July 2007) 3 rd OPEC Sum m it Ali Aissaoui Slide 1 2 6

Com m odity investors focus their strategies on backw ardated contracts, m ostly petroleum products 4 0 Source: Morgan St anley - June 2007 Pet roleum cont act s highlight ed by APICORP Research Brent Total annualized returns (%) 3 0 Gas oil Gasoline 2 0 Nickel W TI Copp Lead Heat ing oil Soy beans 1 0 Live catt le Cott on Gold Fe e de r cattle Silver Zinc Le an hogs Corn Wheat Alum inum 0 Sugar Coffee Kansas w heat Cocoa - 1 0 Natural gas - 2 0 - 25 - 2 0 - 1 5 - 10 - 5 0 5 10 Ave rage annual ba ckw arda tion ( % ) 3 rd OPEC Sum m it Ali Aissaoui Slide 1 3 OPEC’s tough balancing act and policy Dilem m a… • I n discouraging inventories build up backw ardation facilitates OPEC stabilizing role, but attracts m ore speculation • OPEC’s policy dilem m a is how to encourage backw ardation w ithout letting speculators com prom ise its efforts • No easy solution as long as OPEC’s sole policy instrum ent is lim ited to quantitative adjustm ents to output 3 rd OPEC Sum m it Ali Aissaoui Slide 1 4 7

2 . Shaping LT price expectations and a com m on investm ent policy 3 rd OPEC Sum m it Ali Aissaoui Slide 1 5 Traditional fram ew ork for investm ent assum es • Exogenous price A ssume an D etermine expectations oil price path global oil demand (exogenous) • Uncoordinated investm ents to A ssess N on-O P E C supply m eet the “residual” A ssume dem and for D educt demand O P E C will invest for O P E C oil OPEC to meet the demand 3 rd OPEC Sum m it Ali Aissaoui Slide 1 6 8

Extension of the traditional fram ew ork • To allow for the Assume this Determine (endogenous) determ ination of an global oil demand oil price path endogenous price Sustainable using the perm anent Determine “permanent non-OPEC supply income” and incom e hypothesis resulting price path • Assum ing Demand for OPEC oil coordinated fiscal Policy coordination on and investm ent royalty, tax and I nvestment? policies 3 rd OPEC Sum m it Ali Aissaoui Slide 1 7 Perm anent incom e hypothesis • Translation of Milton Friedm an’s “perm anent incom e hypothesis” assum ing governm ents are forw ard looking • Accordingly, governm ents’ spending decisions are determ ined by longer-term incom e expectations • A perm anent incom e is calculated as the net present value ( NPV) of petroleum ( oil and gas) tax revenue stream s consistent w ith a production profile and a depletion horizon 3 rd OPEC Sum m it Ali Aissaoui Slide 1 8 9

Basic set of assum ptions • Proven reserves 2006 APICORP Research only ( far-distant Proven R/ P future URR reserves ratio Data include all 12 OPEC MCs discounted) Gtoe years • All productions Oil proven reserves 122 72 valued at Gas proven reserves 81 172 international prices Total proven reserves 203 93 • Oil and gas prices LT-correlated 2006 2030 • Governm ents’ take Gas/ Oil price ratio (% ) 75 75 decreasing w ith Government's take (% ) 70 60 costs 3 rd OPEC Sum m it Ali Aissaoui Slide 1 9 The “residual” dem and for OPEC • W orld oil dem and, non-OPEC supply and the dem and for OPEC oil as assum ed by the OPEC Secretariat in its reference scenario ( W orld Oil Outlook 2 0 0 7 ) • Dem and for OPEC w ould develop to som e 5 0 Mb/ d of crude oil and 1 0 Mb/ d of condensate in 2 0 3 0 ( total equivalent of 3 ,0 0 0 Mt) • W hen including natural gas, total OPEC petroleum output w ould reach som e 4 ,0 0 0 Mt at that horizon . 3 rd OPEC Sum m it Ali Aissaoui Slide 2 0 10