Executive Summary
Fossil fuels are the predominant source of energy for industrial and transportation consumption. It is however expected that in a few more decades, fossil fuels will have lesser role to play than non-conventional oil and gas sources and renewable energy sources. This paper presents an overview of some of the socioeconomic factors that are driving the global oil industry and their implications for the UK industry. Four key influences are studied to understand the implications for the industry in terms of economic and environmental factors.
The steady influence of OPEC is a significant factor in the pricing of crude oil. Global prices in future are expected to be influenced by how OPEC does their pricing in relation to non-OPEC producers and alternate fuel producers. For the UK competitive pricing could mean lower costs and investments for alternate fuel research. Non-OECD countries are primed to become the largest consumers of oil and gas in the next two decades. The economic trends in those countries will directly impact the economy of countries like the UK where energy demands will reduce and options for export will open up. However, non-OECD countries will also move towards alternate fuel sources which means that the UK and other mature markets need to look for avenues for research and development of non-fossil and renewable energy while also developing and implementing climate change policies that will enhance productivity and innovation and keep the market competitive.
It is recommended that the oil and gas industry look for avenues for diversification beyond fossil fuels. Indigenous production of conventional fuels and alternate fuels is essential to be able to meet local current demand and future global demand. The industry should work with governments to develop policies that ensure competitiveness while protecting the environment and ensuring that the industry can continue to contribute positively to the general economy.
Introduction
Oil and gas are the primary types of fossil fuels that are currently in use for human and industrial consumption . Over the centuries the technology for extraction and refining oil has been continuously modernized in order to keep pace with the demand. The industry is generally vulnerable to demand changes, pricing changes, political and legislative changes and may also be facing the scenario where natural fossil fuels are no longer available. By the 21st century, alternative fuels have made an appearance and are gaining ground. While demand for oil and gas products is expected to grow, the industry itself is faced with slower growth and lower return on investments. This paper examines the impact of select socioeconomic factors on the oil and gas industry. These factors include the growing influence of OPEC, the climate change policy, the economic growth of the non-OECD countries, and development of alternate fuels.
In the UK by the middle of the 19th century shale oil production had become common. During the First World War, Lower Carboniferous oil shales were producing 3 million tons of shale oil annually . The Kimmeridge Bay oilfield was founded in 1959 and remains the oldest continuously producing well site in the country. In 1973, the Wytch Farm in Dorset was founded and is the largest oil field in Western Europe. UK’s oil industry received significant acceleration during the World Wars when domestic production became imperative. The 1979 Iranian crisis further boosted domestic production. Over the last four decades, the North Sea has become a leading source of oil and gas for the country . By 2014, UK was importing hydrocarbons to meet the demand and had spent over £25 billion in exploration, capital investments and operating costs.
Impact of oil and gas
Economic
Increasing demand for oil leads to significant economic uncertainty owing to the oil price volatility . In the short term it means that even small changes in demand and supply have high impact on prices. This was witnessed in late 2014 when oil prices went from $110 per barrel to $48 per barrel due to the over-supply in the market . In the long term, the volatility can actually reduce the price inelasticity as witnessed in the mid 1980s . Expenditure on crude oil imports have increased significantly since 2006 in OECD countries even though consumption has declined. In 2011, crude oil import represented 86% of UK’s trade deficit whereas in 2003 it was only 22%. Oil price increases since 2003 have meant that countries are spending more to meet their demand, although the demand itself is unchanging. Increased dependence on crude oil imports presents the risk of unsustainable expenditure in the event of a political event like exiting the Eurozone (proposed for Greece in 2015 and in speculation for UK in 2016). Although the industry performed well in the early 21st century, the contribution of Oil and Gas extraction was just 1.1% to the UK economy . Tax contributions from the industry were around £2.5 billion while rate of return steadily declined from 2011 onwards in spite of growing capital investments. The industry also employs more than 400,000 people. Growing costs will force companies to make their processes more efficient which may ultimately result in job losses in the industry.
Environmental
The environmental impact of the oil and gas industry is also significant. Air pollution from particulate matter occurs during refining process and when used in industry and transportation . During exploration and extraction from offshore units, marine life behavior is affected . Fishermen who depend on marine life for livelihood may lose their catch if fish and other animals are driven away from their natural zones. Even with measures in place to reduce the amount of oil and other materials leaking into the sea during the production process, small amounts get deposited every day. As production increases, the deposits also increase. As rigs and refineries age, the deposit sizes also increase from the increasing inefficiency of systems. This impacts the chemical balance of the ocean waters which again affect the food chain. Oil spills from capsized oil tankers is another major source of marine life pollution. The next part of the paper will look at the implications of these factors by studying four key influences.
The future of oil and gas
OPEC influence
The Organization of Petroleum Exporting Countries or OPEC was established in 1960 in Baghdad with the aim of unifying petroleum policies for member countries and for ensuring steady income to producing countries . The 12 members comprise of countries from South America, the Middle East and Africa. OPEC aims for the stability of market and prices. An example of this was the quota system that member countries followed during periods of high surplus. This ensured that prices were competitive and prevented a collapse . One strategy is maintenance of adequate crude oil reserves to meet sudden demand . Another is creating security of demand by studying energy consumption in countries and ensuring a predictable supply chain. OPEC regulates over a third of the world’s oil production; it has significant influence in short term and medium pricing . Competition (or a lack thereof) between OPEC countries sets the crude prices in the short term. The investments of the OPEC countries will set the medium term prices. In the long term OPEC pricing will influence the global pricing because oil companies are now facing rising competition from alternative fuel sources. OPEC’s pricing in relation to non-OPEC oil companies and its pricing in relation to alternate fuel companies will determine global prices. For the UK, competitive pricing could mean lower expenditure on crude imports which means that the money saved can be directed into research and development of alternative fuel sources for domestic consumption. OPEC countries will also realize that an increased dependence on oil exports is harmful for their respective economies and look for methods to diversify. If the direction of diversification is into alternative fuels, then for countries like the UK it will mean that they need to invest more in that area if they are to remain competitive and not just consumers.
Non-OECD Countries
Non-OECD countries accounted for 47% of the global consumption in 2010 . This demand is expected to grow over the years. It is projected that in non-OECD countries the energy demand will be 68% higher than current demand by 2030 and account for 93% of the global demand. In contrast OECD energy consumption is projected to be only 6% higher compared to current consumption. It is also predicted that fossil fuels will not see as much growth as non-fossil fuels and renewable fuels although gas will see more growth than oil. One of the reasons for decline in growth for oil is the saturation of mature markets in terms of transportation. Vehicle sales are expected to slow down by 2035 in developed markets like the US, UK and Japan . This will mean that in the UK, the domestic supply may outstrip demand leaving the option for exports. Alternately, depending on both the domestic and international market trend, the UK may decide to invest more into renewable energy sources with the aim for creating export options in fuels. Vehicle sales are expected to triple in non-OECD countries leading to increase in demand for liquid fuels. Although this appears to be in favor of oil consumption and for a time oil will continue to dominate transportation fuel (88% of vehicle fuel is expected to come from oil in 2030), it is expected that eventually non-OECD countries will review their consumption patterns and come up with policies that are aimed at fuel efficiency . The industrial sector will also see a trend towards alternate fuels over oil which further reduces the oil demand over the next several decades. It is projected that OPEC will still have a large market share in meeting the increasing demand in non-OECD sectors like Asia – specifically China and India – but for the UK there could be an opportunity to tap the market by keeping prices competitive and ensuring adequate reserves.
Climate Change Policy
Research has shown that while countries are committed to addressing climate control issues, oil companies have demonstrated varying strategies in addressing the issue . Shell supports the Kyoto Protocol while Exxon Mobil opposes it. The Kyoto Protocol is an international agreement between governments linked to the United Nations Framework Convention on Climate Change. Under the agreement member nations have to set emission reduction targets that are binding . Some companies chose to wait and watch while others like BP Amoco are proactively adopting measures to achieve emission reduction targets . In 2008, the UK adopted the Climate Change Act according to which the country is committed to reducing emission of greenhouse gases by 80% by 2050 . It is expected that the energy savings will be to the tune of £8.5 billion annually on fossil fuel imports and household incomes will be up by £565 on average. The employment and GDP is also expected to perform better. Oil and gas extraction and refineries are not expected to be adversely affected by policies adopted for climate change . However, it is possible that poorly designed policies or incorrectly implemented ones can have an adverse impact on international business competitiveness especially if similar policies are not adopted by all trading countries. There is also a possibility that innovation may be affected. While there may be innovation in order to comply with environmental regulations, the innovation on core products may be compromised . For the UK oil and gas retail industry, adoption of climate change policies can have impact in different scenarios: Costs would be higher if the import prices increase due to increase in cost of production for the seller. If the government increases taxation or import duties it would mean increased cost to the consumer and lower profits for the industry.
Access to new fuels
Natural gas is viewed as a bridge between oil and ‘green’ energy sources as the world moves to a low carbon model . It is set to become the preferred fuel for power generation and there is also a possibility for large scale adoption by the transportation sector. Liquefied Natural Gas and Liquefied Petroleum Gas are viewed as alternatives for long distance shipping while Compressed Natural Gas is a viable option for commercial transportation like trucks and buses. A global market for natural gas is possible as long as government regulations are in favor of exports and a global distribution pipeline network can be achieved. Non-conventional oil like shale and tight are also gaining ground . This will mean that more investments will need to be made to develop these reserves. In the UK, primary shale reserves are found in Scotland and Wales . The oil and gas industry needs to work with the government to develop alternative reserves that can strengthen not just the country’s position as a consumer but also as a supplier of alternative fuels.
Conclusion
The Oil and Gas industry is one of the foundations of the industrial world, fueling businesses globally. However, in the future, the dominance of conventional oil and gas extraction and manufacture may decline as more countries move towards ‘greener’ options. Globally there is a shift in demand from OECD countries to non-OECD countries. For the UK, where demand is expected to eventually slow down in the next 15-20 year time period, it opens up the opportunities for becoming a player in the export market while developing strong environment friendly policies and presents the avenues for spearheading research into alternative fuels.
Recommendations
Diversification of oil extraction facilities beyond oil and gas becomes imperative as the demand for energy grows. This is a long-term opportunity for companies involved in offshore and onshore extraction and refining. In the UK today oil is predominantly used for transportation (97%) and gas for power generation almost half of which demand is met by imports. The requirement for indigenous production is paramount – it will provide both economic stability and supply security in addition to adding more jobs to the domestic market. Implementation of any policy with respect to climate change and environment needs to be carefully considered and structurally sound. Policy should ensure adequate competitiveness for the industry and not increase the cost burden on the consumer. Research and development into alternate fuels has to be made priority. Within this century, alternate fuels may overtake or at least equal oil and gas in consumption. If the economic contribution of the oil and gas industry to the general economy is to remain unaffected, the industry and the government need to work towards developing commercially viable alternatives.
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