The Key Energy Sources

The diagram below depicts the world’s marketed energy by type.

Crude oil consumption continues to rise, though its share in the world marketed energy sources is on the decline. In 2000, global crude oil consumption accounted for 39 percent of world marketed energy source at 155.9 quadrillion British Thermal Unit (Btu). By 2010, the share of crude oil in world marketed energy source is likely to fall to 36 percent or 185 quadrillion Btu.

The period depicted above shows that the overall demand for energy has grown at a CAGR of 2%. Nuclear energy has been the fastest growing segment growing at 4.6% CAGR (starting from a much smaller base), while crude oil has been the slowest growing segment growing at 1.2% CAGR(albeit from a very high base). Natural Gas and coal have grown at 2.7% CAGR and 2.1% CAGR respectively. Consequently, the share of crude oil in the energy basket has dropped from 46.6% to 36.4% over the 30-year period. It is interesting to note that the share of coal has remained virtually unchanged in the energy basket, over 30 years.

The trends suggest that while the share of crude oil will continue to decline, it will remain the most important energy source for the next few decades at least.

The following charts, based on the past data of over 30 years illustrate the trend further.

Source: OECD Factbook

The energy mix has changed significantly between 1971 and 2003. Nuclear energy, which experienced an annual average growth of 10% since 1971, increased its share of production from 0.5% to 6.4%. Renewable energy also experienced a high growth rate over the 32 years, but its share was very low in 1971, making this growth less meaningful. The share of natural gas in total production increased from 16.0% in 1971 to 21.0% in 2003, and the share of oil has fallen from 44.9% to 35.3%. The share of coal production remained at around 25%.

Historical Price Behavior of oil

In the recent times, crude oil prices have hit the highest level not seen during the past 20-25 years. This is for several reasons. International factors such as Gulf war II, US-Iran tensions, Organization of Petroleum Exporting Countries (OPEC) micro-managing supply etc, have contributed significantly to the crude oil price hitting $75 a barrel mark in 2006. Since then prices have retreated but still hover above 30- year average level.

Crude oil prices behave like any other commodity with wide price swings in times of shortage or oversupply. The crude oil price cycle may extend over several years responding to changes in demand as well as OPEC and non-OPEC supply. However, crude prices also respond violently to political shocks owing to the concentration of supplies in politically sensitive regions.

The diagram below depicts the price behavior over the last 45 years. The chart is in terms of 2006 USD to factor out inflation.

Prices ranged between $2.50 and $3.00 from 1948 to the end of the 1960s. When viewed in 2006 dollars, crude oil prices fluctuated between $15 - $17 during the period, and fell below $10 levels by the end of the sixties. The 20% nominal price increase just kept up with inflation.

From 1968 to 1970 prices were stable at about $3.00 per barrel, and in real terms the price of crude oil declined from above $15 to below $12 per barrel.

OPEC was formed in 1960, which was to influence the oil industry significantly. By the end of 1971 11 members had joined the group. All this was happening while the member countries were experiencing a steady decline in the purchasing power of a barrel of oil.

The Yom Kippur War started with an attack on Israel by Syria and Egypt on October 5, 1973, and this led to the first oil shock. In 1972 the price of crude oil was about $3.00 per barrel and by the end of 1974 the price of oil had jumped to over $12.00. Several Arab nations imposed an embargo on the countries supporting Israel. Arab nations curtailed production by 5 million barrels per day (MMBPD). Only about 1 MMBPD could be made up by increased production in other countries. The net loss of 4 MMBPD extended through March of 1974 and represented 7 percent of the non Soviet Bloc production. Prices increased 400 percent in six months.

From 1974 to 1978 world crude oil prices were relatively flat ranging from $12.21 per barrel to $13.55 per barrel, in nominal terms.

In 1979 and 1980, the Iranian revolution resulted in the loss of 2 to 2.5 million barrels of oil per day. Subsequently, Iraq invaded Iran in September, 1980 and by November the combined production of both countries was only a million barrels per day which was 6.5 million barrels per day less than a year before. Worldwide crude oil production was 10 percent lower than in 1979.

The combination of the Iranian revolution and the War resulted in crude oil prices more than doubling from $14 in 1978 to $35 per barrel in 1981. Even today, Iran's production is only two-thirds of the level reached in pre revolution Iran.

From 1980 to 1986 non-OPEC production increased 10 million barrels per day, this helped prices stabilize. The price cycle then turned up on the back of a strong US economy and the great boom in the Asia Pacific region. From 1990 to 1997 world oil consumption increased 6.2 million barrels per day. Asian consumption accounted for virtually all that gain.

The price increases came to an end with the economic crisis in Asia. In 1998 Asian Pacific oil consumption declined for the first time since 1982. The combination of lower consumption and higher OPEC production sent prices into a downward spiral.

Russian production had declined significantly since the Soviet era. It started its recovery in about 2000. Since 2000 Russian production increases dominated non-OPEC production growth and has been responsible for most of the non-OPEC increases. This could have moderated the price rise, but 9/11 was the next major event which was to have a big impact on oil prices.

In 2002, problems in Venezuela led to a strike at PDVSA causing Venezuelan production to plummet. In the wake of the strike Venezuela was never able to restore capacity to its previous level and is still about 900,000 barrels per day below its peak capacity of 3.5 million barrels per day.

In 2003, just as some Venezuelan production was beginning to return, military action commenced in Iraq. Asian recovery was complete by this time and demand for crude oil was growing at a rapid pace. The loss of production capacity in Iraq and Venezuela combined with growing international demand led to the present boom in prices. During the last 5 years, India has joined the Asian party and its rapid economic growth is beginning to impact global demand significantly.

Oil Price Spurt in last Five Years

The following political events have influenced oil prices since 2000:

• September 11attack on the World Trade Center, USA.
• Gulf War II begins and ends in early 2003
• Insurgency in Iraq takes a toll on Iraqi oil production (2003 to 2006)
• Iranian Nuclear debate that started in 2005 with no end in sight.

Notable economic reasons, which prompted the price rise in last five years, are:

• Russia’s entry into the world oil market in a big way from 2000 onwards
• Hurricane season of year 2004 in the US.
• Hurricane Katrina and Rita in the year 2005.
• Rising demand, which the controlled supply could not meet.

All the above factors have played their role in pulling up the price to $75 a barrel. Some events have impacted more significantly than the others, but the net impact has been that the world’s consumers are paying a huge price for their oil consumption.

Development of alternative fuel sources is a factor that can impact oil price. Many alternative fuels are profitable if the crude oil sustains above $50/barrel

Crude Oil - Balance of power

Production and Consumption centers of crude oil

The United States and The EU account for 43% of the world demand. Russia and Saudi Arabia account for 23% of the production.

Data source: CIA website

The consumption is heavily skewed towards developed countries. The USA, Japan, The EU, Korea, China and India are heavily dependent on imports since the demand far outstrips the domestic production. Saudi Arabia, Russia, Iran, Mexico and Venezuela are the leading producers with a very significant part of their produce being available for exports. Asia is also the region which is experiencing the fastest growth on the back of rapid economic development of several countries including two large economies India and China.

Key players in International Trade of crude

Apart from Russia, most of the leading exporters are OPEC nations. The US, The EU, Japan, China, Korea and India are the leading importers

Data source: CIA website

The EU figures in the above list, because it consists of several countries trading amongst themselves. Norway is the most significant exporting nation in Western Europe. Most of the leading exporters are part of OPEC. China, India and Korea have emerged as significant importers and their import requirements are growing fast.

Proven Reserves of Crude oil

Seven OPEC nations control 62% of the world’s proven resources

Figures in Billion barrels

Data source: CIA website

62% of the world’s proven reserves are controlled by Saudi Arabia, Iran, Iraq, UAE, Kuwait, Venezuela and Libya. Saudi Arabia alone controls 20%, and Iran and Iraq account for 18.5% together, while UAE and Kuwait account for another 15% together.

Vegetarianism counts

As income rises, food consumption habits shift dramatically towards meat eating. In India, for the last 10 years consumption of meat, egg and milk are rising fast. In case of poultry meat in particular, there has been a sustained growth of 15% pa or more. What does it do to agriculture and agriculture commodities? The demand for commodities rises even faster. This is because meat eating is inherently more inefficient. We are no longer in the era of poaching meat from nature. The animals we eat have to be fed and for that we need to dedicate farmland to it.

Poultry meat for example is essentially processed soy and corn. The chick is fed on a diet consisting mainly of the above two ingredients. The feed pays for the growth and metabolism of the animal, and for the feathers and bones, which you cannot eat. You do not add any new protein or carbohydrates, whatever you get out of the animal is basically from the corn and soy that is fed to them.

Lets look at conversion factors:

• About 8 kg of grain gets you 1 kg of beef
• About 6 kg of grain gets you 1 kg of lamb meat
• About 2 kg of grain gets you 1 kg of poultry meat

The above comparisons are on live weight basis. In case of chicken for example 25% will be lost to feathers and another 25% to bones. Additionally the final meat product will have at least 30% moisture (the initial grain will also have about 15% moisture). So, on a dry basis, you end up with a conversion rate of 1:5 for chicken, ie., you pay 5 times more (in terms of feed) to get a certain amount of nutrition. You can arrive at this figure intuitively by simply comparing the market prices of meat products and the basic commodity (adjusted for nutritional value). The conversion rate is more adverse for red meat products.

What happens when large populations of China and India start consuming more and more meat. China for example was a producer of about 6 million tons of soybean about 20 years ago and it was exporting some. Today, it grows 16 million tons and imports another 16-17 million tons. Vast lands in Brazil grow soy to feed China, some of which are former forests.

Fortunately, the large proportion of vegetarians in India has tempered the growth in consumption of meat somewhat. However, the trend for the next 15-20 years is quite clear. Pressure of this magnitude on farmlands on a global scale will ultimately lead to rising prices of most agricultural commodities.

At a micro level, vegetarianism makes sound economic sense. But then we are slaves to the cravings of the taste buds.