Credit Suisse Energy Petroleum: Ratcheting up but still range bound (update 1)

There are critical uncertainties surrounding 2011 on both supply and demand. On the supply side, will non-OPEC continue to surprise to the upside? We believe so. On the demand side, will energy efficiency reduce the normal relationship between GDP and industrial production growth and oil demand? Or will the apparent acceleration in demand in 2010 continue through 2011? We believe not.

We do not share the growing sentiment that oil prices are on an inevitable upward and sustainable journey to over $100 a barrel any time soon. There are what at present appear to be low-probability scenarios for 2012 and beyond where a significant breakout above $100 is plausible. But for the time being euphoria about significantly higher prices is reminiscent of the late 1980s and early 1990s, when analysts of the Cold War were doing everything they could to convince themselves and the outside world that the Cold War wasn’t over. So it is with peak oil enthusiasts today.

2011 is not 2008 all over again
Supply cushions are robust
It’s important to remember why oil prices rose in two waves from 2003-2008. The first wave started with the initial anti-Chavez strikes in Venezuela, which brought Venezuelan production down from over 3-million b/d in late 2002 to 575-k b/d in early 2003 and that country’s production has never again recovered. Venezuela had plans to increase output to 5.2-mb/d by 2008. Shortly after that Nigerian output, which had reached 2.3-m b/d at times, succumbed to episodic unrest and disruption, losing on a near-permanent basis over 700-k b/d. Over 2009, Nigerian output averaged 1.7-m b/d. Nigeria had plans to reach 4-m b/d by 2008. Over the same time period, Iraq, whose output had been restored to 2.8-mb/d by 2002, lost output with the ousting of Saddam Hussein in early 2003 and still has not returned to its pre-2003 level. Iraq had plans to boost production to 4.5-m b/d by 2008. In short, the three countries, with combined production of about 8-m b/d in 2002, were producing 4.7-m b/d by spring 2003, a loss of 3.3-mb/d. In 2008, when they had a planned combined capacity of 12.7-m b/d, their combined production was 7.4-m b/d, 600-k b/d less than in 2002 and 5-m b/d less than their once credible plans for the same year. The failure of OPEC production to grow in the last decade and the actual loss of production capacity was responsible for price hikes. Today OPEC has plenty of spare capacity.

High sustained global demand growth starting in 2004 met declining supplies and those countries with spare capacity started producing more oil, so the global supply cushion became frail. But high prices also led to a startling increases in upstream capital expenditures both in OPEC and non-OPEC countries, and it is the sustained high expenditures that is having a stronger-than-expected impact on global inventories and production capacity.

Non-OPEC supplies continue to surprise to the upside. Some organizations, including the Energy Information Administration, believe that they will finally fall short in 2011, declining by 280-k b/d in 2011 after increasing by 1.06 this year versus 2009. The International Energy Agency sees non-OPEC rising by 600-k b/d this year versus last. Both watchdog agencies have had to revise up their initial non-OPEC supply outlooks for
the past two years. In 2009, for example, the IEA’s first forecast for 2010 non-OPEC supply was 400-k b/d. It has been revised up by 700-k b/d since. We do not believe recent non-OPEC supply pessimism is warranted. Indeed, we believe the market and the analytical community are vastly underestimating the supply response to higher prices and higher capital expenditures since 2003 and are misunderstanding the required lead times that are involved. We project that if all things go well on new projects, non- OPEC could add at least as much as 670-k b/d of crude oil in 2011. In addition, another 200-k b/d of biofuels are expected as well as further gains from refining. We thus project an increase of 900-k b/d in our balances, a bit less than we actually think will be brought in. There are few doubts, for example, that Ghana’s Jubilee Field will be
producing next year; the questions about Africa are rather how quickly the field will see production growth and what will be the declines elsewhere in the continent. What is so extraordinary about the growth in non-OPEC is its dispersion globally and the fact that, outside of Brazil and Russia, the increments are small but can add up.

Meanwhile, we expect both OPEC capacity and OPEC production to grow in 2011, with a good deal of potential for the upside. We estimate that OPEC currently has about 5.7-m b/d of spare production capacity – a higher number than many others have projected. Our estimate of Saudi capacity is based on how much petroleum the kingdom should be able to supply within 90-120 days of a decision to do so. Our estimate of Kuwaiti and Emirates capacity is based on input from what we consider to be reliable sources. We think that current OPEC production of just over 29-m b/d will likely rise in 2011, whether or not the producer group makes a decision to raise production targets. In our balance we project OPEC to add 240-k b/d of crude oil
production – a wildly conservative number, in our view, based on what is possible and plausible. By end of 2011 we believe it is likely that Iraqi production alone will be 300-k b/d higher than at present and that Angola will have built new capacity enabling the country to return to production levels in the 1,850-1,900-k b/d range. While Iran and Venezuelan output is likely to fall by a combined 200-k b/d, we believe this will be made up by others with spare capacity as needed; but on the whole, we believe the market will remain
well balanced. OPEC production should also include 140-k b/d of new gas-to-liquids from Qatar.