The main factor in determining oil prices next year, whether they will hold near current levels or come off what looks to be the highest ever annual average, will depend on how the economies of the world's main demand centers fare, International Energy Agency chief economist Fatih Birol said Tuesday.
"The United States is struggling. Europe is going through very tough days. China talks about 7% after spectacular growth the last couple of years. India [is forecast to be] down to 5%," he said in an interview in Singapore. "The economies are weak in the key demand centers, so there will be definite downward pressure on the prices."
But he also noted upward pressure on prices, including high recovery costs of marginal and unconventional barrels that need a higher market price to be profitable, the need of some of the Middle East countries to see an oil price of about $90/barrel in order to balance their budgets, and ongoing geopolitical turmoil in this major oil producing region.
Those are the factors that have been holding oil prices at historically high levels this year, which he said "is a pity because we need the lower prices to see a stronger economic recovery."
"It would be much better if prices were somewhat lower. This would definitely give breathing space to many countries," he said.
Still, even with slow economic growth in the demand centers and increased oil production out of the US and Iraq, Birol doesn't see any danger of a sudden fall-off in prices like that in the latter part of 2008 and early 2009, following the historic highs hit mid-2008 when crude oil futures climbed above $147/b.
"If there is no major economic troubles, such as a recession, there will be no big crash," he said. "Fundamental demand is very strong ... especially in the transportation sector there is strong growth."
The IEA said in early November that it expected Brent spot crude prices to average $111.61/b for all of 2012, before falling to an average of $103.38/b for 2013. The agency also said that spot prices for WTI crude would average $94.51/b for 2012 and $88.29/b for 2013. DOUBLE WHAMMY
In many countries, the high oil prices can be a double whammy because their natural gas prices are indexed to oil as well.
"As a result of that [oil-indexing] natural gas prices are increasing, and as a result of that electricity prices are increasing," he said.
"So in these times of this very fragile economic recovery, it is a real challenge to have such high oil prices."
In the Asia Pacific, this oil-price link can create a major disadvantage for the region's economies because over 80% of the gas trade is based on long-term oil-indexed contracts.
That has led to Asian buyers paying gas prices up to 7-8 times higher than prices in the US and up to 50% higher than prices in Europe, he said. "With increasing LNG and more LNG terminals coming into the picture, I hope to see that the natural gas prices in Asia reflect the market realities, [that is] more producers, more gas with the shale gas growth, and I hope we see more spot market pricing, which helps to reflect market realities and to a certain degree decrease the so-called Asian premium," he said.
"Otherwise the life for natural gas will be rather difficult in this region, because with the current oil prices, the natural gas prices are much more expensive for electricity generation than for coal or nuclear power," he said. As an example of the anomalies that can create in a market, Birol cited Malaysia, which imports coal for electricity generation while it sells its gas as LNG for the export earnings.
"For natural gas to be attractive ... in the Asia Pacific, the prices need to reflect the market realities, and I believe the trends are moving in that direction," he said.
EFFICIENCY, SUBSIDY REDUCTION
Long-term, energy efficiency and subsidy reduction are going to be the main ways to fight higher oil prices. "When we look at the current prices and the global economy, we have to slow down the oil demand growth," he said.
Many people in the US celebrated the IEA projection that the US is going to overtake Saudi Arabia in terms of crude oil output in 2017, reducing its oil imports substantially and moving towards self-sufficiency, Birol said.
"But they have not seen one thing: the reason for substantial reduction of oil imports is not only out of the growth in domestic oil production, but also is a result of fuel efficiency standards introduced by [President Obama] in his first term," he said.
"The success story is not only driven by North Dakota [shale oil output] but also by Detroit," he said.
So one thing that governments in consuming countries need to do is improve energy efficiency, especially in the transportation sector to lower demand growth.
The second thing that governments need to do is reduce the substantial subsidies that are provided for oil products, at more than $250 billion a year. "These oil products are so cheap that people use them in a wasteful manner," he said.
Asia and the Middle East are the two regions where this is most critical, with "many Middle East countries seeing domestic oil demand growing so substantially it may well be a problem for export in the years to come."
