Petrol prices will continue to keep on rising

Posted on: 10 June 2010 by Mark O'haire

While the Budget will raise fuel prices only a little, the long-term outlook is for ever-higher pump prices. Find out why.

The likely hike in VAT on petrol in the emergency Budget will put a few pence on a litre here in the UK this month, but for motorists this is merely a small step on an inexorable rise in fuel costs that will last for many years. It's really a matter of supply and demand.

While Western demand is subdued because of the recession, surging Asian economies are gulping down oil like there is no tomorrow.

While alternative energy sources for vehicles are on the horizon, it's unlikely we'll see anything big enough to dent fuel demand within the next 10 years.

Supply, meanwhile, is restrained by delays in boosting Iraqi output and an ever-increasing dependence on remote, expensive or deep-water sources.

BP's difficulties in stemming the leak at its Deepwater Horizon rig in the Gulf of Mexico have graphically illustrated the lengths we have to go to for new oil.

Like harvesting apples from a large tree, most low-hanging fruit is long gone and we have to climb ever higher and more energetically to maintain our rate of harvest.

Matching demand is tough

It doesn't help that demand keeps rising, either. China, which takes 10% of the world's oil, has shown an astonishing thirst, with fuel demand up 16% in the first quarter of 2010, following a similar rise in the previous quarter, according to energy traders Platts.

“No country of this size has seen energy demand grow this fast before,” Jonathan Sinton, China programme manager at the International Energy Agency (IEA), told the New York Times.

With China absorbing almost every extra barrel the world can produce, there isn't much spare for anyone else.

Scooter first, car later

The power of Asian economic transformation was brought home to me on a recent trip to Vietnam.

When I last visited Hanoi in 2000, everyone had a bicycle. By December 2009, everyone had a scooter. And I mean everyone. There are six million scooters and motorcycles in the city - that's one per person.

In fact there were so many parked on the pavement, pedestrians often had to walk in the road. Perhaps in a decade, most of them will have a car.

Economic transformation isn't yet so pronounced in India, Pakistan, Indonesia and the Philippines, but they all have much bigger populations than Vietnam's 84 million. China, of course, leads the way.

China is expected to produce 17 million cars in 2010, as many as Japan, the US and Britain combined. Most will be bought by Chinese customers.

Subsidies galore

How can they afford to run them? Quite simply, fuel is massively subsidised. A study by the International Energy Agency shows that $550 billion a year (£380 billion) is spent each year by governments around the globe to keep fuel affordable, the bulk of it in China, India, Russia and the Middle East.

Sometimes this leads to bizarre waste. On a trip to Libya a few years ago, I saw that many unused buses were left to idle right through the night.

When I asked a driver why, he answered that it helped to prolong engine life. When fuel costs just a few pence a litre, as it did in Libya, this kind of behaviour seems rational.

The IEA estimates that, if subsidies were removed, global consumption would be reined in by the equivalent of the consumption of Japan, Australia, New Zealand and South Korea.

Not only would higher prices stop demand, but alternative energy schemes would be worth pursuing.

The public backlash

Subsidy cuts aren't going to happen, at least not quickly. In the last decade cuts in petrol subsidies have caused riots and many deaths in places as far apart as India, Indonesia, Yemen and Venezuela. Affordable fuel is seen as much of a birthright in the developing world as it is in the US.

In time, Asian demand growth will slacken off, as it has in the west, but that time is a long way away.

The average Chinese person uses only 9% of the fuel that the average American does, and the average Indian uses 5%. Even if it rises to no more than 30% of per capita US usage, it will still mean a trebling of China's oil consumption and a six-fold rise for India.

Boosting supply

So what can be done to boost supply? Despite our seemingly insatiable demand, there are still enormous reserves yet to be exploited around the world: in the Arctic, in Siberia and in deep water around North America, Africa and Brazil.

The world is not, in an absolute sense, short of oil, at least for the next few decades. However, it is the difficulty and cost of extraction that is the issue.

The cost of getting a single barrel from a Middle Eastern nation used to be as low as 50 cents (35p).

Siberian oil, after paying Russian taxes, may cost a foreign exploration firm $100 (£70). Tar sands oil, after tricky refining, costs $40-50 (£28-35). As old oil fields decline and new ones come on stream, the mix of costs is moving inexorably higher.

BP accident ratchets costs higher

The BP spill has turned that cost lever another notch. A six-month moratorium on offshore exploration around the US, ordered by President Obama in the wake of the spill, will actually cause a longer hiatus because drilling equipment will be moved elsewhere in the interim.

Also, increased environmental compliance costs and delays brought on by the accident will affect all operators, squeezing some of the less deep-pocketed out altogether.

"The future potential (for oil supply) is offshore in deeper water and in the Arctic, so if offshore investment is going to be slowed down, that is a concern," IEA director Nobuo Tanaka told a conference.

The costs do not stop at US shores. British Energy Secretary Chris Huhne this week promised to double the number of rig inspections in the North Sea and further tighten rules.

Canada, which used to subsidise development of its huge tar sands deposit at Lake Athabasca, Alberta, no longer does so due to rising oil prices.

Athabasca "most destructive project on planet Earth"

As the market price of oil climbs further, Canada is likely to demand higher environmental standards for the Athabasca area (about the size of England), which Greenpeace describes as "the most destructive project on planet Earth" because of the pollution and heavy carbon cost involved.

Those hoping to avoid higher oil prices have one great hope: Iraq.

Iraq has the world's third largest oil reserves, 115 billion barrels, which is enough to supply total global demand for three and a half years.

The growth of Iraq's oil production and exports will play a "decisive role in shaping global oil markets," IEA Chief Economist Fatih Birol told a recent conference.

Iraq: the great cheap oil hope

But Iraq is a mess. Still devastated by the US-led invasion of 2003 and the subsequent insurgency in which more than 100,000 may have died, its infrastructure is antiquated and damaged.

Not only the oil fields themselves, but electricity supply, water and roads are still in an atrocious condition.

Though £500 million of contracts were awarded to energy giants - including BP - in March, the Byzantine process of forming a national coalition after elections that month is still ongoing.

And until that has been finalised, and the government's approach to oil contracts agreed by the previous government is clear, full-scale investment will not happen.

Iraq had hoped to boost oil supply capacity by 10 million barrels a day by 2017. Oil experts reckon three to four million barrels is just about possible, but would be a feat matched only by Saudi Arabia in the 1970s.

Despite hopes for a quick rebound in oil output after the 2003 invasion, it took six years for Iraq to get back to 2.5 million barrels per day, the level it was producing in 2001.

Ambitious timetable

Iraq's new expansion timetable "...would dwarf the most rapid build-ups that we have recently seen in places such as Russia and Saudi Arabia," says Bhushan Bahree of energy consultancy firm IHS CERA.

"The political, security, operational and infrastructure challenges in the country, along with a likely shortage of skilled personnel, are likely to hamper progress towards such an unprecedented achievement," he said in a recent report.

There is no doubt that the tightness of the oil market is worrying. As the IEA's Fatah Birol says: "One day we will run out of oil; it is not today or tomorrow, but one day we will run out of oil and we will have to leave oil before oil leaves us, and we have to prepare ourselves for that day."

That day may be a while coming, but the oil price run-up that precedes it already looks to be underway.

By Nick Lough

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