The Inflation Cycle of 2002 to 2015 - Uhlmann Price Securities

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Industrial Portfolio Strategy The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -46- Legg Mason Wood Walker, Inc. • European share of new oil supply growth falls from 24% in 1981 to 2001 to 1% in the 2001 to 2015 period. This is caused by maturing North Sea fields, which were major non-OPEC producers after 1981. • FSU and Eastern European demand collapsed after 1981, subtracting 41% from the change in world oil supply, but rebounding post-Communist demand in those countries adds 15% to 2001–15 estimated growth. Although we expect FSU oil production in 2015 of 14.4 million barrels per day to eclipse the prior production peak of 12.7 million barrels per day in 1987, the rebound in FSU demand to 8.3 million barrels per day we forecast in 2015 is still below the 9.1 million barrels per day consumed in the peak year of 1982, 33 years earlier, for perspective. • African oil production, 66% of which comes from three OPEC members, Nigeria, Algeria, and Libya, could be joined by newly discovered oilfields in offshore Angola, which is not an OPEC member. Development of these fields should add about 2 million barrels per day by 2015, representing about onethird of Africa’s incremental growth in production over that time per EIA estimates. Whereas OPEC’s ability to periodically constrict supply was the “oil weapon” of the 1970s, we believe that the key to OPEC’s strength in the coming years will be its rising market position filling incremental world demand for oil. In our view, this shift in market power from the western oil-consuming nations to the generally eastern and southern oil-producing ones will probably have widespread economic and political ramifications that lead to still more developing country modernization. In Exhibit 36, we show the percent of world oil production held by oil export-based countries recovering from 57% in 2001 to 66% in 2015, and even though this is a sharp rebound, it is still below the 1976 peak of 70%. In Exhibit 37, we Exhibit 35 – World Oil Supply And Demand History and Our Projection to 2015 World 2001 / 1981 2015 / 2001 World 2001 / 1981 2015 / 2001 Oil Demand Demand As Demand As Oil Supply Supply As Supply As (million bbl/day) % of Total % of Total (million bbl/day) % of Total % of Total Incremental Incremental Incremental Incremental 1981 2001 2015 Demand Demand 1981 2001 2015 Production Production Net importers: USA/Canada 17.8 21.7 27.4 26% 16% 12.4 11.9 13.3 -3% 4% W. Europe 12.3 13.8 15.5 10% 5% 2.9 6.7 6.9 24% 1% E. Europe 2.3 1.4 2.0 -6% 2% 0.5 0.2 0.3 -1% 0% Japan 4.8 5.4 6.6 4% 3% 0.0 0.1 0.1 0% 0% China 1.8 4.9 10.0 21% 14% 2.0 3.3 3.1 8% -1% India 0.7 2.0 4.1 9% 6% 0.3 0.7 0.7 3% 0% Other East Asia 2.5 7.4 11.7 33% 12% 2.2 3.2 3.3 6% 0% Australasia 0.8 1.1 1.8 2% 2% 0.5 0.8 0.8 2% 0% Net exporters: Middle East 2.5 5.2 8.6 18% 9% 16.5 22.3 38.8 37% 47% Africa 1.6 2.4 4.5 6% 6% 4.9 8.2 14.4 21% 18% Latin America 4.9 6.8 11.3 13% 13% 6.4 10.3 15.6 24% 15% Former Soviet U. 8.9 3.7 8.3 -35% 13% 12.2 8.8 14.4 -21% 16% World 60.9 75.8 111.8 100% 100% 60.7 76.6 111.7 100% 100% Source: 1981: BP Statistical Review of World Energy 2001; 2001: EIA Monthly Energy Review, March 2002; 2015: EIA’s International Energy Outlook 2002 reference case forecast, except high economic growth forecast was used to estimate demand in China, Japan, Middle East, FSU, and Australasia. EIA IEO 2002 reference case supply forecast was used. Because demand forecast exceed reference case supply forecast, incremental supply increases were added to each region, with the regional shares based on 2001-2015 reference case supply growth as a percentage of the world total.
Industrial Portfolio Strategy The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -47- Legg Mason Wood Walker, Inc. Exhibit 36 – Oil export-based economies as share of world oil production, 1965-2015E Exhibit 37 – Non-OPEC Reserve-To- Production Ratio, 1952 to 2015E Percent of World Oil Production Held By Oil-Export-Based Countries 70% 65% 60% 55% LM Estimate Non-OPEC Reserve/Production 24 22 20 18 16 14 12 10 Major new non-OPEC discoveries 1968- 1975 in North Sea, Alaska, Siberia, but rate of new discoveries has declined. Forecast assumes non-OPEC reserve additions continue at 1986-2001 rate. LM Estimate 50% 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013 8 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 Source: BP Statistical Review of World Energy June 2001, 1965- 2000. 2001 data: EIA. 2002-2015: Legg Mason projection based on EIA, international Energy Outlook 2002, March 2002. “Oil export-based economies” include OPEC, FSU, and non-OPEC Africa and Middle East. Source: Production: Source: UN 1952-1964; BP 1965-2000. EIA 2001. Reserves: 1952-2002: OGJ Energy Statistics Sourcebook, Oil & Gas Journal. Legg Mason projection show the reserve-to-production ratio of non-OPEC producers falling from 13.3 in 2001 to 8.2 in 2015, far below the 1975 peak of 22.3. Although higher oil prices, if they occur, would prompt increased exploration and reserve additions, the cost of those wells may rise as an offsetting factor. For example, successful experiences in Brazil, Argentina, and Angola demonstrate that deepwater drilling at water depths that test the limits of available exploration technologies can result in new discoveries, but at great expense. To summarize, we believe that the world appears to be in a transition phase from generally slack to generally tight oil supply, thanks to Asian oil demand and recovering FSU and satellite usage in excess of rising production, with no North Sea-sized non-OPEC price spoiling discoveries expected. Exhibit 38 summarizes the global import/export balance of petroleum from 1965 through our 2015 estimate, with net oil exporters shown on the top half of the graph and net importers shown on the bottom half. From 2001 to 2015, we project that 62% of the incremental growth in net imports by region will be in Asia/ Pacific ex-Japan. On the supply side, 69% of the growth in net exports is seen coming from the Middle East, followed by 21% from Africa and the rest from FSU and Latin America. The major story is the increasing reliance of Asia on Middle East oil on a scale that reorients economic and security alliances. Exhibit 38 also contains our oil price forecast, in both real (2000$) and nominal terms. We project that U.S. crude oil prices, expressed in real 2000 dollars, will rise from $22.40 in 2001 to $26.11 in 2015 (with sharply higher inflation that accrues to oil producers), and that the U.S. average nominal crude price will rise from $23.01 in 2001 to $62.81 in 2015, in line with our estimate of growth for the PPI for All Commodities index, shown in Exhibit 31.
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