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    Energy price could bust the boom

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    Demand from emerging nations could lead to worldwide shortages, writes economics correspondent David Uren
    | July 16, 2007

    RISING energy prices could yet be the pin to pri*ck the global economic boom.

    The International Energy Agency warns that soaring demand from emerging nations could crash into the ceiling of non-OPEC oil supplies over the next three years.

    The result could be energy prices spiralling high enough to choke economic growth.

    The IEA expects tightness in oil and gas markets to be mutually reinforcing. When short of gas, industry turns to fuel oil.

    "Ultimately, this may lead to upward pressure on fuel oil and gas prices until electricity or industrial demand growth abates," the agency says.

    Industrial production may, at an extreme, respond to high prices, but the IEA is less confident about the elasticity of the demand for energy for transport.

    OECD oil demand growth plunged in 2005 and 2006 following the jump in prices. However, the IEA says, the weaker demand had more to do with unseasonably warm weather in the northern hemisphere than prices.

    Detailed analysis of the link between retail prices and transport fuel usage shows there was little response to the price spike. The IEA's view on the outlook for energy markets has changed sharply since its February forecast. There has been no single event that has been a catalyst.

    Rather, the agency, which represents the industrialised energy importing nations, is marking its forecasts to the market reality.

    World demand is growing faster than expected and supplies are responding more slowly. It has upgraded its forecast demand for 2010 by 600,000 barrels a day and reduced its forecast supply by 1.7 million barrels a day.

    Available capacity, particularly from OPEC, will be sufficient to keep the world adequately supplied until 2009. But beyond 2010, the IEA says, refining shortages and continued growth in emerging nations will slice spare capacity to "uncomfortably low levels". The IEA expects demand from emerging nations, mainly China and Middle East states, to grow more than three times as fast as the OECD. By 2012 they will be taking 46 per cent of the world's oil.

    The IEA has not revised its view of this demand growth, but has lifted the base estimate for the amount they are consuming now, as a result of new information.

    It says the difficulty in getting accurate information about oil consumption in China, India and the former states of the Soviet Union means its forecast could still be an underestimate.

    It notes that China, along with a number of emerging nations, is approaching per-capita income of $US3000 ($3450) a year.

    "At this point, a middle class usually emerges, eager to purchase cars, fly in aeroplanes, install airconditioners and, more generally, use energy-consuming appliances."

    The IEA assumes that the world will keep growing at its current breakneck pace of 4.5 per cent. Even if growth were to slow to 3.2 per cent a year, it would only postpone by a year the time when demand was growing faster than world energy capacity.

    The most startling conclusion in the IEA report is that non-OPEC crude oil production will not rise above the 40 million barrels a day reached in 2003 until beyond its forecast horizon of 2012.

    The IEA says: "The concept of peak oil production and its timing are emotive subjects that raise intense debate." With an eye for semantics, the IEA comments that non-OPEC crude production has "reached an effective plateau, rather than a peak".

    The 2 million barrel a day increase in non-OPEC supply will come from biofuel, gas-to-liquid plants and Canada's tar sand deposits.

    Hydrocarbon resources are finite, but the IEA argues that issues of access to reserves, investment regimes and availability of refining capacity are greater barriers to medium-term growth.

    Here, the news is not good. The 900,000 barrel a day downward revision to non-OPEC supply over the next three years follows a 1.1 million barrel a day downward revision in February, both mainly blamed on project delays and cancellations.

    "Project timings across the non-OPEC forecast continue to slip on problems accessing raw materials, equipment and labour," it says.

    Project delays also affect OPEC production, as output has been marked down by 800,000 barrels a day.

    The biggest growth in production is expected to come from Saudi Arabia, where production capacity is expected to rise from 10.7 million barrels a day to 12.6 million barrels a day over the next six years.

    There has been debate in the past week about the IEA's confidence in Saudi production.

    Comments on the widely followed oil industry blog, The Oil Drum, have noted that Saudi production has been falling over the past two years from 9.5 million barrels to a current level of 8.6 million barrels a day, and questions are raised as to whether Saudi's reserves are depleting more rapidly than expected. The IEA says questions about the strength of Saudi and other OPEC investment belong more to the period after 2012 than the current expansion phase.

    Others argue that the Saudi Government is impressed that the world did not enter a recession with the 2005 price spike and is deliberately withholding oil to maximise its revenue from the current economic boom.

    The IEA sees an emergence of resource nationalism as a growing threat.

    "A host government's aspirations for increased rents and control can perpetuate high prices in the short and medium term. These can lead to distorted flows of upstream investment capital, particularly if returns are used to directly fund social programs, which become embedded in national spending.

    "As access to reserves in producer countries becomes ever more restricted, it is little wonder that consumers focus on supply diversity, both geographically and by fuel form. This can create a vicious circle for investment as producer concerns over demand security and the need for capacity expansion then arise."
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