BP has presented a new annual report, BP Energy Outlook 2035 (bp.com/energyoutlook), which forecasts the development of global energy until 2035. VLADIMIR DREBENTSOV, Vice President of BP Russia, Chief Economist of BP for Russia and the CIS, on the main trends in the global energy market and the place of Russian hydrocarbons.

Vice President for External Relations of the Russian division of the British Petroleum Russia (BP Russia) group of companies, BP Chief Economist for Russia and the CIS Vladimir Drebentsov during an interview
Photo: Sergey Kiselev, Kommersant / buy photo

Business Guide: What determines price trends in the global oil market today?

Vladimir Drebentsov: It’s worth starting with the events of last year and its differences from previous years. Last year we saw how the fragile balance that existed in the oil market for three years, from 2011 to 2013, was broken. It would seem that since the beginning of the so-called Arab Spring and the growth of social conflicts in a number of exporting countries (Libya, Nigeria, both Sudans, Yemen, Syria), significant volumes of oil began to fall off the market. By 2013, supplies from these countries had fallen by about 3 million barrels per day. If such a decline were not compensated for by anything, then prices would have to skyrocket. But they only hesitated slightly in a rather narrow corridor.

The drop in supply volumes was offset by increased production in the United States, where the development of tight reservoirs led to revolutionary changes in oil production. Over the past four years, US production has increased by 4.5 million barrels per day. Moreover, every year American oil production updated its own records. In 2014, the United States increased production by 1.6 million barrels per day, which radically changed the situation, knocking the market out of balance.

In this situation, many expected that OPEC leader Saudi Arabia would reduce production, thereby compensating for growth in the United States. However, this country has maintained the same level of production. There were up to 1.5 million barrels per day of “extra” oil on the market. It is worth recalling that in the spring and summer of 2012 there was approximately the same situation, when the price of oil fell by about $20 per barrel. Then Saudi Arabia unilaterally, without any decision from OPEC, reduced production from July to December by 1 million barrels per day, balancing the market.

From the point of view of oil demand, the current situation, unfortunately, is worse than production companies and exporting countries would like, for a number of reasons. Global economic growth is now accelerating in developed OECD countries and slowing in emerging markets, particularly China. From the point of view of the development of the oil market, this is not very good, since oil consumption in OECD countries has been declining over the past six years. This is a structural change that occurs due to increased energy efficiency. That is, economic growth in developed countries does not lead to a noticeable increase in oil consumption, as was the case before. Whereas China's energy-intensive economy requires a lot of oil. The new combination of factors suggests that finding a balance will be difficult.

BG: Why did the price fall so rapidly?

V.D.: The modern oil market is characterized by low price elasticity of demand. If there is a slight shortage of oil, then prices rise rapidly, but if on the contrary, the price quickly falls. Since OPEC entered the world market as an active player in the early 1970s, prices have been rising. This was the only commodity market in which the cartel was effective: prices were regulated not by ordinary economic factors, but by the actions of OPEC.

However, another consequence was the desire of consumers to replace expensive oil with other energy sources wherever possible. Therefore, the share of oil in the global energy balance has gradually declined. In the mid-70s of the 20th century, it reached almost 50% of the primary energy resources used in the world. Now it continues to decline and, according to our forecast, by 2035 it will decrease to 26–27%. Transport remains the only sector in which oil dominates. Which leads to low price elasticity of demand: if you have a shortage of oil and you have nothing to replace it with, then you are willing to pay a higher price for it. If there is an excess, no one needs it: you won’t put more gasoline in your tank. Of course, you can drive more often and over longer distances, but this cannot radically change the situation.

The simplified arithmetic of the oil market last year is as follows: global oil demand in 2014 increased by 700 thousand barrels per day, and supply by 2.2 million barrels per day. The result is the appearance of excess volumes on the market. Consumers have already filled almost all onshore storage facilities with oil. The US has reached its highest level of commercial inventories in 30 years.

To ensure market balance, it is necessary that in the current year the ratio of the increase in demand and supply compensates for the imbalance of last year. Due to low oil prices, many expect, including us, that demand growth will increase this year and consumption will increase by about 1.5 million barrels. But this means that global oil production should not increase at all, otherwise the imbalance will continue. At the same time, forecasts say something else: outside OPEC, oil production this year could increase by 800 thousand barrels per day.

BG: Can we expect oil prices to increase in the short term?

V.D.: There are no fundamental reasons for this yet: if the cartel continues to be inactive, the oil market will continue to search for equilibrium, which promises higher price volatility. The price of oil may even temporarily drop below $40 per barrel. Yes, at the beginning of 2015, prices on the market increased slightly. But this growth was based mainly on expectations. In particular, on estimates of the number of operating drilling rigs in the United States. Many believed that against the backdrop of low prices, production in the United States would begin to decline rapidly. According to Backer Huges, the number of drilling rigs used in oil production peaked in October 2014 at 1,610 rigs. By the end of March 2015, there were 815 of them left. And many decided that this already meant a drop in production. However, this has not yet happened. As of February, U.S. oil production was still 1.5 million barrels per day higher than a year earlier. That is, we can only talk about a slowdown in growth rates.

In this regard, the role of the technological factor cannot be underestimated. The American shale revolution is based on technological developments that are mind-boggling. Old drilling rigs are now being decommissioned (up to 85% of the total reduction). These are mainly rigs for traditional vertical drilling, rather than horizontal drilling, which is used in the development of shale reserves: by the end of March, the number of rigs for vertical drilling had decreased by 63% over the year, while for horizontal drilling - by 36%.

However, the main thing is that over the past three years the number of wells drilled by one rig has increased by 50%. If we evaluate the situation in the most famous shale fields, Eagle Ford and Bakken, then oil production per rig has increased by two and a half and two times, respectively (140% and 100%). That is, the number of drilling rigs is decreasing, but production is increasing. In addition, the pace of rig retirements in the US has slowed. In the first weeks of 2015, this figure was 50-90 installations per week, and in the last week of March - only 12. Moreover, in the oil market, price is the driver of cost (and not vice versa). Against the backdrop of low oil prices, service companies were faced with a reduction in demand for their services, and competition began to increase among them. Thus, in the United States, with a sharp increase in the fleet of unused drilling rigs, the cost of drilling services and, accordingly, the cost of oil production are decreasing. It should also be noted that unfinished wells have become common in the United States, that is, a well is drilled but not fracked. As a result, American companies will be able to quickly put them into operation when it becomes profitable.

Contrary to the belief that the current situation is a conspiracy against extractive countries, we believe that this is a coincidence. The game in the global oil market is too complex. In the 80s of the last century, OPEC, having dropped prices, delayed the development of Canadian oil sands for 20 years. But American shale oil is a completely different story. The main difference is that the average time to drill a horizontal well today is approximately three to four weeks. That is, even if Saudi Arabia manages to reduce production in the United States by maintaining low prices, then with a subsequent rise in prices, shale oil will return to the market within a month. It is difficult to fight shale oil in this way. The resource base allows the United States to increase oil production until mid-2020, and possibly longer, provided it can increase the oil recovery rate, which currently stands at 3-4% in shale fields.

BG: Is it possible to repeat the American shale revolution in other countries with such reserves?

V.D.: We do not expect a repeat of the shale revolution in other countries in the coming years. Only in the United States has such a successful combination developed - the availability of resources, a developed oil service industry and infrastructure, as well as subsoil ownership rights that are fundamentally different from other countries. Only in the United States is the owner of land the right holder of the resources hidden in its depths. This is not the case either in Europe or in other regions with shale reserves: the resources belong to the state. And the owner of the land, unlike the United States, fights anyone who wants to drill on his land. In America, the owner of the land becomes a co-owner of the developed reserves, that is, he has a completely different motivation. Availability of financial resources and a favorable fiscal system also contributed to the success of the shale revolution in the United States. In no other region of the world can we yet predict such explosive growth rates in production.

BG: What is the role of OPEC in the current situation?

V.D.: The cartel still plays a decisive role. Saudi Arabia's decision to reduce oil production could turn the tide. It should be noted that the country has a very difficult situation with the state budget, which has been experiencing a deficit for the second year. Last year, its balancing was possible at $98 per barrel, this year – at $104. It is very difficult for the Saudis to cut the state budget: the social costs that have increased after the Arab Spring are enormous. Until 2011, the budget was balanced at $30–40 per barrel.

Yes, Saudi Aramco can produce oil at low prices on the world market. The cost of production at most fields in the country ranges from $3 to $10 per barrel. However, this will not help the country’s budget: at prices of $60 per barrel, the resources of the State Oil Fund of Saudi Arabia may run out in two years, and in four years the country’s gold and foreign exchange reserves will be empty. It will be possible to finance the budget deficit only through external borrowing, and, as we remember from the example of Russia in 1998, they stop giving money to the country as soon as its income falls below the level necessary to service the debt. It would seem that it would be more natural for Saudi Arabia to reduce production, ensuring rising prices, than to live in a situation of low prices. However, the country chose a different strategy.

In general, oil production within OPEC has decreased markedly in recent years. In Libya alone in January of this year, the drop in production was 1.2 million barrels per day. However, according to our forecasts, by the middle of the next decade the cartel, which suffered from the American shale revolution, will be able to restore its position in the oil market and increase supply volumes.

BG: Who will be able to produce oil at current prices?

V.D.: If OPEC does nothing, sooner or later the volumes produced as part of expensive projects will leave the market. Now, in addition to a number of shale projects and oil sands development, deepwater projects are under threat. According to our estimates, such projects will provide the world market with much less oil than previously predicted. The Arctic will be one of the first to feel the burden of low prices: it is one of the most expensive regions for oil production. Production from mature fields in the North Sea is also suffering from low prices. That is, in the future, a reduction in oil production will occur in projects where the most expensive methods of its extraction are used.

It must be remembered that in the oil industry, the period between investment and the release of raw materials to the market is not measured in weeks or even months. The groundwork is now being laid for a cyclical supply contraction that may not occur for several years. Most projects simply will not have time to respond to changes in the price situation this year. The reduction in capital investment in traditional fields this year will make itself felt only in three to five years. In this regard, the behavior of companies developing oil sands in Canada is typical - one of the most expensive projects in the world. According to our estimates, oil production this year will not decrease within their framework, even if the oil price falls below $30 per barrel.

BG: What, in your opinion, are the prospects for the development of the oil and gas industry in Russia in conditions of low prices? How do sanctions affect it?

V.D.: In the Russian Federation there are Arctic fields, offshore oil, and unconventional reserves. What will the period of low prices lead to? As elsewhere in the world, companies will reduce their investment programs and refocus on the development of low-cost resources. From this point of view, attention to the Arctic and unconventional reserves may temporarily decrease, but interest in the additional development of conventional reserves will increase. Low prices on the world market have always led to increased efficiency: squeezing out larger volumes for less money. Now the oil recovery factor in Russia does not exceed 30%. Enhanced oil recovery technologies will increase this figure and ensure continued production from mature fields in the country for years to come.

Traditional oil reserves in Russia are quite sufficient to maintain production at current levels. There are no resource limitations in the near future: according to the Statistical Review of World Energy, which our company is preparing, the Russian Federation should have enough proven reserves for 22 years, and in the event of an increase in the recovery factor and the start of development of new deposits (including unconventional ones) even more long term. However, much depends on the tax policy of the Russian state.

The development of unconventional oil reserves in the Russian Federation is a task for the coming decades. Its solution largely depends on the availability of appropriate technologies to Russian oil workers. As for the production of unconventional gas in Russia, in the medium term this topic will not be relevant for the country. The Russian Federation has significant reserves of Cenomanian natural gas, which is not as expensive to develop as shale gas. They will last for the next 50 years.

As for technological sanctions, they do not directly affect gas production. They also do not apply to current oil production: projects related to the development of unconventional, Arctic and deep-sea oil were subject to sanctions. But even before the sanctions, no one expected significant volumes of production from these sources in the near future. Financial sanctions have a faster effect. But for now, Russian companies are coping with this problem.

BG: Not long ago, BP released a new forecast until 2035. What are the main trends in the development of global energy in the long term?

V.D.: According to our forecasts, the demand for liquid hydrocarbons may increase by 19 million barrels per day by 2035. It will grow mainly in non-OECD countries. But we also note a slowdown in consumption growth in China: improved efficiency in the country is leading to a slowdown in energy consumption growth, which, according to our estimates, will primarily affect the rate of coal consumption. We see structural changes in the Chinese economy: the increasing role of the service sector, light industry, that is, the least energy-intensive industries. As a result, coal demand growth will decline significantly. By the end of the forecast period, coal consumption in the country will stop increasing.

The fastest growing segment will be renewable energy sources (RES). By the end of 2035, in terms of their contribution to the global energy balance, they will overtake both nuclear and hydropower. However, renewable energy sources will provide only about 10% of the energy resources needed by humanity. Even in Europe, where alternative energy is developing at the fastest pace, fossil fuels will provide over 50% of the required energy, and in the world their share will be about 80%. Of the hydrocarbons, gas consumption will grow the fastest: by 1.9% per year over the next 20 years.

Increases in energy efficiency will become increasingly noticeable. In one of our graphs, the trajectories of global economic growth and energy consumption diverge in different directions. Unfortunately, this does not yet lead to a reduction in greenhouse gas emissions. Without a price on emissions, there is no economic incentive to change the energy mix. One of our main conclusions: if the world is serious about climate change, climate change policy must be more proactive.

BG: Eastern direction of energy supplies. How does BP assess demand dynamics in Asian markets?

V.D.: China and India will remain the fastest growing energy consumption markets. By the end of the forecast period, India will even overtake China in terms of growth in energy demand. These countries will produce significant amounts of the energy resources they need on their own. However, they will also need imported supplies of gas, coal and oil from other regions, including from Russia. We believe that the Russian Federation has good prospects for exporting energy resources to Asian countries. But Russian suppliers will have to compete fiercely for these markets.

Thus, gas supplies from Russia to China via the western route will compete with Central Asian gas. China has already signed contracts for supplies from Central Asia in the amount of about 80 billion cubic meters. m per year, and Russia plans to supply 30 billion cubic meters via the planned Altai gas pipeline. m. Will China need gas in such volumes? We believe: yes, it is needed, but only if this gas is competitive in price. The main indicator for Russian exports in this direction will be the cost of gas supplies from Central Asia. Russian gas that will travel along the eastern route will most likely compete with supplies of liquefied natural gas (LNG) from various countries. According to the West, gas exported from Russia will be competitive in the Chinese market only with certain efforts on the part of Gazprom.

BG: What are the growth prospects for the LNG market?

V.D.: Currently, low energy prices are holding back the development of this market - some projects planned for implementation have been postponed. However, we forecast the global liquefied natural gas market to double in size over the next 20 years. In the coming years, significant volumes of liquefied gas will come from the United States and Australia, which will facilitate the integration of the three largest markets: Europe, North America and Southeast Asia. For now, these are separate markets, poorly connected with each other, which can be tracked by significant differences in prices for them. Over time, prices in these markets will converge, and the difference in the cost of LNG will be determined only by transport costs.

In general, supplies of liquefied natural gas will exceed pipeline supplies. Technologies for the construction of LNG tankers, as well as the production of liquefied natural gas, are being improved, which leads to a reduction in the cost of such gas. There are promising prospects associated with the development of FLNG technologies - a floating platform for gas production and LNG production, as well as the use of liquefied natural gas as a fuel in transport.

Interviewed by Maria Kutuzova

The fragile balance of the oil market