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Impact of low oil prices on investment part 2

Hydrocarbon Engineering,

Below are further highlights from a speech given by Maria van der Hoeven, Executive Director, International Energy Agency (IEA) on the impact of low oil prices on investment.

Strong Asian demand will support global LNG trade

“LNG plays a critical role in maintaining gas supply security. LNG investment is very capital intensive and routinely relies on project financing. Very often the projects are facilitated by export credits for the liquefaction equipment which is the most expensive part. Last year we saw a collapse of LNG prices due to supply demand developments as well as the pass through effect of low oil prices into long term LNG contracts. In the next couple of years this is likely to persist due to a wave of new supply coming online from Australia and the US. A more diversified, more competitive and less geographically risky supply structure could be a major benefit for consumers.

“There are concerns about the long term sustainability of supply. The Australian and US projects under construction will be absorbed by growing demand by 2020 – 2025, given the five to eight years of lead time for a major LNG project. If the current market environment leads to delays and cancellations, then future market tightness, supply security concerns and a boom and bust cycle are a real risk. Policy efforts to enhance LNG market efficiency should continue but attention needs to be paid to the capital intensity and financing needs of the LNG industry.”

Oil production to 2040

“Looking longer term on oil, there are other potential problems around the corner.”

“Tight oil production is making the US the largest oil producer in the world, and it stays that way until the late 2020s. After that, US production could start to fall back and by 2040 output is back to where it is today. Instead, it is the oilsands in Canada that take over as the main source of North American supply growth. The other major non-OPEC source of supply growth is Brazil. You can see how these suppliers do a lot to satisfy growing demand over the period to 2020. But after this, there is a large and growing gap in the market.

“This is the gap that needs to be filled by the Middle East. There is no shortage of resources to meet this challenge. But there is a real concern about a shortfall in investment. Some may argue that there is plenty of time to sort this out: extra supply from the Middle East is needed only in the early 2020s. But this would be a mistake: to produce extra barrels in early 2020s, there needs to be investment today.”

Oil and biofuel feedstock costs

“Biofuels currently provide some 4% of road transport fuel needs, and 80% of this is bioethanol, with production and use concentrated in Brazil and the US. Conventional biofuels supply is determined by production costs, which are influenced by short term feedstock dynamics, as well as investment in new plants and feedstock supply chains. In both Brazil and the US, ethanol production is broadly competitive with gasoline even at today’s oil prices, though this relationship fluctuates with the short term balance of feedstock and ethanol prices. This is because in recent years feedstock costs have fallen dramatically due to good harvests in key regions. Low oil prices also reduce fertiliser and harvesting and transport costs.

“Nevertheless, longer term supply growth in these markets will depend on continued investment in biofuel plants and feedstock supply. Such growth may be difficult in Brazil, for example, where the ethanol industry has struggled financially in the face of thin production margins, rising costs for labour and land, and competition versus regulated gasoline prices. The demand for conventional biofuels, that is, ethanol and biodiesel made from sugar, corn and oil crops, is affected by the prices of gasoline and diesel substitutes, as well as blending mandates and structural factors, such as the evolution of the vehicle fleet.

“In terms of advanced biofuels, which in the longer term are necessary to reduce the overall carbon footprint of the transport sector, there has been good progress in the last few years. A number of commercial plants have started operation, demonstrating that production at scale is feasible. The output from these first plants is not yet financially competitive with fossil based transport fuels nor conventional biofuels. However the industry is confident that if such plants could be replicated some 20 times, costs could be reduced through learning. The resulting output would be competitive with oil products at a crude oil price of approximately US$70 /bbl. Progress therefore depends on a supportive policy framework that allows the next generation of plants to be built and operated. However a prolonged period of low oil prices could reduce the policy motivation to bring forward this family of technologies, delay positive measures and lead to the abandoning of projects.”

So where does this leave us?

“It comes back to the two words with which I began this speech, energy transition.”

“The shift to a low carbon energy system is in many ways inevitable. Of course it will come much, much faster in some jurisdictions than in others. Indeed there are still low efficiency coal plants being built across Asia as we speak, and it would be unrealistic to expect these countries to simply agree to a moratorium on coal investment. But the benefits of sustainable, affordable, predictable and secure energy cannot be denied.

“But this tradition will not take place automatically. Investments are necessary today. For business there is money to be made. For government, there is energy supply to be secured. And in those places with the right policies and frameworks in place, there are rewards there for the taking. The successful low carbon energy transition depends on us taking advantage of those opportunities, and collectively enjoying the benefits.”

Edited from speech by Claira Lloyd

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