BP: ‘We should see volatility increase’


Tight global fossil fuel markets, increased nationalisation of oil reserves and massive economic growth in developing countries like China and India are creating new realities in global energy markets, which will remain volatile for some time to come, according to BP’s chief economist Christof Rühl, who spoke to EURACTIV in an interview.

Christof Rühl is chief economist at oil giant BP. 

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Energy markets are changing rapidly and we are in a situation of high demand and high oil prices. How would you position this year’s statistical review in this context? Is it very different from previous reviews?

This review is different in two ways. First, it works out the long-term drivers that have pushed up oil prices and energy prices over the last two years. Since 2003, oil prices have increased 300%, traded coal by 200% and natural gas by 100%. These are enormous magnitudes.

At the same time, the report distinguishes between short-term volatility and long-term developments. If you look at the last few months, you have seen oil prices come down as quickly as they have gone up in reaction to these short-term market disturbances.

We should expect this to continue. The basic story of this report is that prices will be stronger for longer, because they are driven by new players in economic growth and by really drastic changes in the composition of economic growth, with more participation from so-called emerging or developing economies that have much higher energy needs because of industrialisation.

And at the same time, there are constraints on the supply side – either because access is restricted like in oil markets or because trading isn’t fully developed like in coal markets. As long as there is no global economic recession and growth remains relatively strong, this mixture will be the background.

But energy markets in general, and oil markets in particular, are strange. Like any complex system they need a degree of redundancy. But the oil market, for example, has only two million barrels of spare capacity at the moment and operates at almost full capacity. So every little interruption causes these violent reactions, and we should see volatility increase in the short term, because the market is dominated by a cartel and because the cartel has the only free spare capacity, we should also expect this to be possibly downwards. 

Saudi Arabia, for example, in response to the economic situation has increased production, and oil prices are coming under severe pressure. More oil on the market together with a crash in demand means we will also see prolonged periods of low oil prices.

Do you expect a downturn in demand?

We saw this already in 2007 and 2008, and independent of the financial crisis, when oil demand fell in the OECD. It only increased in two groups of countries: the oil-exporting countries and the fast-growing emerging market economies, mostly in Asia.

The consumer in OECD countries was the first to get squeezed out, and this was before the financial crisis. On top of this we now expect some impact of slower economic growth.

Last year the IEA pointed out that, for the first time in history, the link between higher oil prices and decreased demand had been broken, meaning demand no longer responds to a sharp increase in prices. But what you have just said seems to contradict that?

Yes, absolutely. If it is true that someone said this then he is wrong. We have clearly seen evidence of demand destruction. At the moment we are in a situation where we produce almost a million barrels per day more than a year ago, and where demand is almost a million barrels per day less than a year ago. It’s most visible in the US, where August demand slowed by 830 thousand barrels per day due to lower demand in transportation. 

If the IEA said this they are wrong by their own statistics, as they have been busy for months now downgrading their demand figures, and to catch up with other analysts. There is also a tendency for consumer organisations to describe demand as higher than it really is. 

But demand forecasts are coming down everywhere, and we should expect oil demand growth in 2008 to be no more than 500,000 barrels per day, maybe less, which is much lower than historical standards. And next year who knows, it depends on economic developments.

But you still expect volatility to continue and you don’t expect a long-term downward trend in prices?

This will be a function of global economic growth, and will depend on developing countries. Again: global demand overall increased last year. It fell in OECD countries but increased in non-OECD countries more than it decreased in OECD countries.

So it will depend on the global economic outlook and on countries such as India, China and so on.

If growth trends continue as they have been – meaning declining demand in OECD countries and higher demand in developing countries – then what kind of oil prices should we expect as ‘normal’?

Nobody can tell you where it would settle. I could tell you between $60 and $140 per barrel and you could narrow it down by $20 on both sides, but we really don’t know.

If economic growth trends continue as you describe, then it will not fall back to where it was five or six years ago. But also as a supply response slowly comes online, one could expect spikes if there are interruptions in the system, but no permanent shift higher than we have been.

Somewhere around $100 would be as good a guess as any, and probably somewhere a little bit lower than $100.

How much has speculation played into oil price fluctuations?

It’s very important to understand that according to everyone who looks at this market: speculation is not driving prices. 

Financial investors are no fools. They observe the same kind of market fundamentals and interactions as we do, and then they invest. They jump on the train but they don’t determine the direction of the train.

Last year when oil prices went up so much, it was in the wake of OPEC cuts, and undiminished large demand in a period of record economic growth in developing countries. Financial speculation was a consequence of that tight situation but it was not a cause of it.

But investors always have the capacity to accelerate or decelerate price movements. This is what happens now. Last year they accelerated it by investing en masse. Oil markets are no different from other markets – as soon as investors have a one way bet, existing movements can be accelerated. 

Now, after the market realised that OPEC is producing more and demand is falling off, and prices accordingly go down, this will probably be accelerated by investors. 

In our view, attempts to limit investment possibilities for certain groups of investors – for example by restricting pension funds from investing in commodities markets – are misguided and can produce market distortions in markets that are already distorted. There is no rationale for this from the economic point of view.

Are you comfortable with the transparency of reporting about oil reserves in countries like Saudi Arabia and Russia?

There is a principal difference between how private companies and governments look at reserves. 

For private companies, reserves are very important because they determine to a large extent the value of the shares, and thereby the value of the company that has access to the reserves.

For governments that is not the case. Governments do not necessarily go to the trouble of updating their reserves figures, meaning hiring people and calculating and updating these figures every year. 

But sometimes you see jumps in reserves due to influences which are different from the pure economics of energy production, for example the famous jump in OPEC reserves in the 1980s, in response to OPEC quotas becoming dependant on reserve size. 

We don’t think there has been an overestimate of reserves. The bias is actually the other way around. We generally believe that what is published by these governments and in the Statistical Review in terms of proven reserves is really there, and the bias would be rather to not publish the excess reserves that are there. 

If global reserves, which are largely under the control of governments, were properly updated then we would have seen a jump in reserves. Because proved reserves are defined in terms of the amount of oil that you can get out of the ground with current technologies and at current prices. So if prices have increased as they have in the last few years, then reserve numbers should have increased in tandem – and they didn’t because most countries were slow to adapt to new reporting.

There is a popular concern about ‘peak oil’ and the availability of oil. But what you are saying is that, overall, there is no shortage but rather a constraint in the market, due partially to higher growth from India and China?

There is no resource constraint at the moment for oil. There is enough oil if you’re willing to accept the costs – including the environmental costs for sources like tar sands.

There is an access problem. Which means that on the back of these high prices it becomes more and more difficult for oil companies to go and do what they do best, which is to, in response to high oil prices, maximise production.

One has to recognise that that is a potential problem, because the reaction to high oil prices is different between companies and governments. 

Oil companies will try to maximise output to maximise profits when oil prices are high, and they will do so in competition with each other even to their own long-term detriment, meaning even if they create excess capacity and economic cycles. 

A government is different in that it will try to maximise the long-term revenues from its rent. You will hardly ever see governments engage in price competition with each other. And they will try to keep all the rent in their countries, meaning limiting access to foreign companies, and all of this slows down the investment rates.

We now live in a world where a cartel no longer controls 40% of production, the cartel makes movements and the rest of the world reacts. Now there is another 40% to 50% controlled by governments in one form or another, and that slows down the supply response. 

But that is an above ground problem, a political problem, which means that we cannot invest in many countries. Latin America and Mexico are examples. Russia is another example. 

But isn’t the result the same in terms of economic impact, whether it is peak oil or severely restricted access?

No, the result is not the same. Because this situation will react to prices and other fuels becoming available, and it will react to low prices and to these barriers coming down again.

Physical peak oil, which I have no reason to accept as a valid statement either on theoretical, scientific or ideological grounds, would be insensitive to prices. In fact the whole hypothesis of peak oil – which is that there is a certain amount of oil in the ground, consumed at a certain rate, and then it’s finished – does not react to anything.

Whereas we believe that whatever can be turned into oil strongly depends on technology and technology depends on prices as well.

Therefore there will never be a moment when the world runs out of oil because there will always be a price at which the last drop of oil can clear the market. And you can turn anything into oil into if you are willing to pay the financial and environmental price.

It is more likely that demand will peak, which is what we are seeing in Japan and in Europe. 

And then of course there is another constraint. The human capacity of digging hydrocarbons out of the ground and burning them and turning them into energy seems to be much larger than the atmospheric capacity to absorb the resulting CO2.

That is likely to be more of a natural limit than all these peak oil theories combined. Peak oil has been predicted for 150 years. It has never happened, and it will stay this way.

How do you see the impact of a new and resurgent Russia on world energy markets?

Russia has a problem in that its economy depends to a large extent on the export of commodities in the broad sense and in hydrocarbons in particular. And this export market is still not diversified to the extent that the government would wish.

Now what this means is that in times of rising prices, Russia’s economic and political weight increases asymmetrically faster than in sterile times and in times of falling prices. The vulnerability of Russia’s economic system becomes more exposed, and we see some signs of this right now in these very turbulent markets.

I’ve been working in Russia and it’s a very thin line to walk between what many analysts call the oil curse or the energy curse, and turning these resources in the ground into gainful employment above ground. And Russia of course is not the only country with this problem.

Countries that had a sophisticated institutional infrastructure in place before they discovered oil – such as Canada, the UK, the US and Australia – do best in terms of capturing the windfall profits that come from resource extraction. And countries that found these resources when they were still in the process of developing legal and institutional infrastructures or, in the case of Russia, when they were undergoing tremendous transformations from feudalism to socialism and then to capitalism found that much more difficult.

The IEA is calling for 50% renewables by 2050 and the EU has set its own ambitious targets. What do you make of these?

Many of these appeals and targets appear unrealistic to me. 

In all renewables we have very fast growth, we have continued government support, but they start of course from a very low base. Renewables are still not important enough to play a role in the global energy balance but they do play an increasingly important role locally. 

The global production of ethanol last year was equivalent to only 0.7% of global oil production. Now 0.7% is not enough to relieve these tense markets or to sway them one way or another, but if you look at the main producing countries – Brazil and the US – then it is enough to make a difference in gasoline markets and in refining.

If you look at power generation from wind, solar and geothermal, it is somewhere between 1% and 1.5% of global power generation. Again, it’s not enough to make a major difference for carbon emissions, but it is enough to make a difference locally – Portugal, Spain, Denmark and Germany – these all have more than 10% of their national electricity produced from renewables, and in the OECD as a whole I think it’s more than 10%.

So, we are in this world where they are growing fast and still need support because most renewables are not competitive at market prices and that is the big problem we still need to solve. So there is still research to be done and there needs to be a technological step change to really maintain existing growth rates without government support. 

Some of them are competitive – wind at certain locations – but most are not. That is the difficult task ahead for the industry, to push for research and development to accomplish this kind of technological step change. And that is very hard to do and very unpredictable and therefore I’d be careful with prognoses and targets.

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