28 Industry Structure, Supply-Demand and Stake Holders

Chapter-3

INDUSTRY STRUCTURE,
SUPPLY-DEMAND AND
STAKE HOLDERS
Introduction
The minerals and oils industry may usefully be defined to embrace exploration for, and
extraction and primary processing of, minerals, including processing up to the first pouring
of the refined metals (Minerals Council of Australia, 2004). In a definition that includes all
the activities, the industry then includes:
„ exploration-locating an oil/gas field, ore body, deposit delineation, and prospect
evaluation;
„ extraction-removing it from the source, by a variety of methods (e.g. drilling,
underground, underwater, open cut, alluvial);
„ processing-refined metals as bars and ingots, refinement of crude and gas as first
oil or gas derivatives.
Though very well connected, this definition of excludes the activities of the processed
products and fabricated metal products, etc. dowstream. The book chapters will revolve
around the centrality of supply and demands of the minerals, metals oil and natural gas as
raw materials and their production factors. Needless to say, however, that larger such
companies frequently have vertically integrated operations across the industry value chain,
with smaller companies often restricted to just parts of the chain.
Wide Research Group 29

Structure
The minerals industry is often considered, misleadingly, as a low-tech and, by inference,
a low-innovation industry. This is because the conventional indicator used to decide
whether an industry is high, medium or low tech in the innovation literature is R&D
intensity, that is industry expenditure on R&D expressed as a proportion of industry
turnover. By this measure the industry falls in the low-tech category: the research
intensities for the Basic Metals and Other Metallic Mineral Products industries in 1997
were 0.7% and 0.9%, respectively (OECD, 1999), well below those of other industries
such as pharmaceuticals and information processing.
Often targeted at the costs of research and investment, neglecting the search for
exploration as research investment, this approach can lead to misdiagnosis and a failure to
appreciate the role of technology and innovation in the industry. The simple research-
intensity approach fails to consider non-R&D expenditures, for example, on design
activities, engineering development and experimentation, or exploration of markets for new
products (Smith, 2004). In addition, it understates or ignores mineral exploration activities,
which involve extensive use of high-tech equipment and often innovative approaches: in
2006 exploration expenditures for commercial non-ferrous metals were estimated at
US$7.5 billion (Metals Economics Group, 2006). Moreover, simple R&D measures ignore
the R&D which is embodied in capital goods and intermediate inputs, that is the
contribution of new technology from other industries to the mineral industry. One way this
may be captured is to use an alternative indicator, namely the ratio of acquired R&D
intensity (R&D embodied in capital and intermediate goods) to simple R&D intensity. The
Basic Metals and Other Metallic Mineral Products sectors rank highest of all industry
sectors by this measure, with ratios of 2.85 and 2.89 (OECD, 1999; Smith, 2004).
It is also easy to overlook the innovativeness of mature industries where technologies
and market conditions change relatively slowly (von Tunzelmann and Acha, 2004). For
Pavitt (1984), who recognised that innovation processes vary according to industry, the
minerals industry is best understood as a scale-intensive industry engaged in innovation,
with its own characteristics. In any case, every industry offers scope for innovation,
whether new or mature. As Porter (1999) notes “all industries today are high tech, all
industries use information technology, new materials, new kinds of technology to
dramatically improve the way they do things. There are no low-technology industries; there
are only low-technology companies: companies that have not yet woken up to the potential
of technology to transform what they do”.

Explaining the Current Boom

The current boom in commodity markets, seen from the end of 1990s, is different. Like
its predecessors, it arose from a demand shock, prompted this time by a combination of
30 Industry Structure, Supply-Demand and Stake Holders

unprecedented macroeconomic expansion and high intensities of commodity use in a

number of emerging nations, notably China. In addition there is a growing feeling that good
resources are the things of the past. Another important reason is the return of demand in
the Europe and America for major maintenance of infrastructure. These resulted in the
boom’s distinguishing feature, its durability: the prices of many mineral materials began
their rise already in 2003. In part, the boom owes its longevity to continued strong economic
growth: real world GDP expanded by more than 4% each year over the 2004-2007 period,
the first 4-year period of such growth since the early 1970s (International Monetary Fund,
2008).
High commodity prices and profits over the past one and half decade have not
stimulated the capacity additions needed to allow supply to catch up with demand at prices
more in line with production costs. Clearly, in the absence of a broad economic slowdown,
commodity booms might well continue for more than one or two years, as expansions to
existing installations typically take at least that much time, while 5 years or so are needed to
build new greenfield capacity ([Tilton, 2006a] and [Tilton, 2006b]; Radetzki, 2008).
However, as the boom enters its 6th year with little sign of abating, many who initially
assumed the needed capacity would soon be forthcoming are looking for other
explanations.
The major alternative view now emerging among analysts and others is that the present
boom reflects the start of a super cycle-the third or fourth such cycle the world has
experienced over the past 150 years (Heap, 2005; Cuddington and Jerrett, 2008). For the
next 20-30 years or so, according to this view, rapidly growing demand in China and other
developing countries will keep commodity prices high, allowing producers to earn
excessive profits. As history shows, however, rapidly growing demand does not
necessarily produce high and rising commodity prices. For example, the aluminum industry,
whose global output rose 40-fold in the 30-year period (1939-1969), experienced at the
same time persistently falling real prices (Schmitz, 1979).
This suggests that a super cycle can only be caused by an unanticipated shift from one
path of demand growth to a higher one, such as undoubtedly occurred in the early years of
the present century. The super cycle thesis also requires some explanation as to why a
sector of the economy can earn high profits for a decade or more without attracting the
investment and capacity needed to reduce prices and profits.
For this, three possible explanations are suggested: first, it now takes much longer to
construct new capacity. Lead times for purchasing new trucks, drills, shovels, tires, mills,
and other equipment in the present boom are twice or more those of 5 years ago, while the
shortage of mining engineers and other technical people cannot be eliminated quickly. All
this is true, suggesting that it will take longer than 5 years, as many have previously thought,
to build the needed new capacity. Yet to assume the delays will stretch out over two or
Wide Research Group 31

three decades seems excessive. Moreover, if the bottlenecks in equipment and trained
people are responsible for the delays, the suppliers of these critical inputs are most likely to
reap the bulk of any excess profits associated with commodity production, thereby creating
incentives to expand capacity in the input industries.
Second, investors as a group may fail to understand the changing world in which they
operate and so persistently underestimate needed capacity. As a result, supply continually
lags behind the growth in demand. However, this explanation, too, requires a rather strong
assumption: namely, that investors fail to adjust their expectations and behavior over a
couple of decades despite constant evidence of past errors. It brings to mind similar
arguments made less than 10 years ago that for various reasons the mineral sector
suffered from an inherent tendency to over invest, keeping returns persistently below
levels available in other sectors (Crowson, 2001).
Third, the costs of finding and developing new oil & mineral deposits are rising,
requiring in turn ever higher prices to justify investment in new capacity. This increases the
value of existing capacity, enhancing the worth of mining firms and the returns to their
owners. While it is true that the costs of finding and developing new capacity have
increased substantially since the start of the boom, it seems unlikely that this trend will
continue over several decades. In fact, a major portion of the recent cost increases is due
to rising input prices, which, as noted above, may well be cyclical, and could reverse once
the industries that produce these inputs expand their own production facilities.

Supply and Demand for Oil

Over the last 2 years global oil production growth has slowed down considerably, in
particular in 2007 when global production increased by a modest 0.2%, or 200 kbls/d (IEA
OMR, 2008a). The slow growth in 2007 was caused by rapidly declining production in the
North Sea and in Mexico’s largest field, the super-giant Cantarell field, deferral of several
new projects that were scheduled to come online during the year and numerous
unscheduled field outages. Furthermore, half a million barrels of production capacity
remained shut-in in Nigeria and in early 2008 production data indicated that Russia’s oil
production growth had stalled. In combination with increasing global demand OPEC’s
surplus production capacity was further eroded, from around 4 mmbls/d in February 2007
to less than 3 mmbls/d in May 2008.38 These factors together with an expected peak in
non-OPEC conventional oil production in the next decade, a worsening of the situation in
Nigeria and Sudan, increasing state control over oil resources in Russia and Venezuela and
President Chavez (Venezuela) increasingly hostile attitude towards USA, the situation in
Iraq and the nuclear issue with Iran, who also struggles to maintain oil production levels,
have all contributed to the perception that future supply will not meet demand. This have, in
32 Industry Structure, Supply-Demand and Stake Holders

turn, led to soaring oil prices and since January 2005, oil prices have more than tripled
passing US$140/bl in June 2008. In spite of a tightening market OPEC has consistently
refused any immediate raise in production levels claiming that the market was in balance
and that instead a weak US dollar and market speculations should be blamed for the high oil
price. Late June 2008 Saudi Arabia called for a meeting between oil producers and
consumers along with representatives from the oil industry, IEA, the International Energy
Forum (IEF), OPEC, Goldman Sachs and Morgan Stanley. However, apart from renewed
assurances from Saudi Arabia that they are raising sustainable production capacity by
around 2 mmbls/d to 12.5 mmbls/d by the end of next year (SUSRIS, 2008), the meeting
provided few assurances on any immediate improvements in the supply situation.
Although the resource base appears sufficient to cover demand for the next two
decades (see Fig. 1 and Fig. 2), it is a completely different matter to get the oil up from the
ground and transported to markets in a timely manner in order to meet increasing global
demand. The current supply situation with declining growth in oil production during a period
with strong demand and sustained high oil prices is partly the result of many years of
underinvestment in the upstream oil sector. Moreover, under prevailing market conditions
and policies there are few signs that this situation will improve, in particular considering the
fact that oil increasingly will have to be sourced from countries in the Middle East, Russia
and Venezuela (Kjärstad and Johnsson ,2008). The underinvestment problem within the oil
sector is well known and has been extensively analysed and discussed in for instance
Mabro (2006) and IEA (International Energy Agency), 2003 and IEA (International
Energy Agency), 2005b.
On the other hand, over time the high oil prices should materialise into increased efforts
in exploration and production, development of marginal fields and enhanced oil recovery
projects as well as increased interest in the production of synthetic fuels. However, these
efforts are constrained by limited access to resource rich areas, lack of skilled personnel,
equipment and rigs throughout the industry. The high oil prices should also affect demand
but due to various reasons the effects so far appear to be limited.

Factors Constraining Investments in Oil Exploration and

Production
As mentioned above, several factors have constrained investments into exploration and
production of oil in the past and these factors are to a large extent responsible for the
current (2008) situation with tight supply and record high oil prices. Brent crude oil may
average $75 a barrel in 2010 and trade “largely” within a band of $60 to $85 a barrel, Credit
Suisse Group AG reported . “Drops below or above this range are likely to be short lived,”
said Edward Morse, an analyst for Credit Suisse. “What has been most striking about
prices since 2008 has been the narrowing of the trading range within which prices have
fluctuated and the reduction in volatility under the mush too predictable supply conditions.”
Wide Research Group 33

It is therefore vital to analyse whether the investment climate will improve over time
allowing for sufficient and timely investments into exploration and production of oil.
Most of the oil fields that entered into production between 2000 and 2008 were
discovered a decade earlier, i.e. between 1990 and 2000. In the late 1970s and early 1980s,
OPEC’s production declined dramatically caused by rising non-OPEC production and
declining global demand. Consequently, OPEC ended up with having a huge surplus
capacity in the mid-1980s and had therefore little interest in raising production capacity
further. Also, in the mid-1980s the oil price dropped ending up around US$20/bl for almost
one and a half decade leaving little interest among oil companies to raise investments
(Mabro, 2006; BP, 2008). According to IEA (2006), IMF (2008a) and Mabro (2006),
investments into oil and gas exploration and development have risen since the beginning of
the current decade, and will continue to rise till 2010. However, much of this increase is due
to cost inflation and a shift to more complex and costly projects in locations where no
infrastructure exists (IEA, 2006). Furthermore, it is costly to maintain a spare production
capacity and few producers, apart from possibly Saudi Arabia, are willing to invest the
large amounts required to hold idle capacity.
Access to existing reserves and resources as well as to exploration acreage will be vital
to ensure sufficient production in the future. National oil companies (NOC)’s control an
increasing share of global resources while international oil companies (IOC)’s face
deteriorating fiscal terms and difficulties in accessing reserves. According to Mabro
(2006), IOC’s have full access to around 14% of total global oil and gas reserves and some
equity access to 11% of the reserves held by NOC’s, while 17% of global reserves are held
by Russian companies and the remaining 58% by NOC’s without any access for IOC’s.
More recently, nationalisation of energy resources in Russia together with increasingly
tougher fiscal terms may have led to declining investments in the upstream sector partly
being responsible for the stalled production growth observed in Russia in 2007 and 2008
(see for instance Milov, 2008). It remains to be seen whether the recent nationalisation of
Venezuela’s resources will enhance oil production but most analysts are sceptical. Also,
promising exploration acreage has been closed for many years in Alaska and offshore
USA’s east and west coast as well as in the Gulf of Mexico and off northern Norway,
including the promising blocks Nordland 6 and 7 and Troms 2.43 There are few signs that
this situation will improve in the near term as demonstrated by the recent nationalisation of
resources in Russia and Venezuela, the repeated failures of opening potentially promising
exploration acreage in the US, the transfer of ownership of the Kashagan field to a larger
share for Kazakhstan’s NOC as well as the failure to implement project Kuwait.
There are many other factors explaining the low investments in the past in the upstream
oil sector like the budgetary constraints often faced by NOC’s and various geopolitical
34 Industry Structure, Supply-Demand and Stake Holders

factors affecting investments in countries like Iran, Iraq, Nigeria and Sudan. The capital
expenditure budget of the NOC is often determined by some governmental authority which
may cause inefficiencies and yield sub-optimal rates of investment (Mabro, 2006; Energy
Policy Research Foundation Inc, EPRINC, 2008). In Venezuela, the national oil company
PdVSA, funds various social programs as well as infrastructure projects directly from its
budget (EIA CAB) and according to IEA OMR (2008a), modest energy sector reforms
proposed by President Calderon in Mexico and widely seen as necessary to reverse
production decline, now appear stalled. Furthermore, civil strife and attacks on oil
infrastructure in Nigeria has more or less permanently shut-off some 500 kbls/d of
production capacity since December 2006 and attacks on oil infrastructure has also
recently increased in Sudan. At the same time, oil production in Iran has been hampered by
the investment climate and poor financial terms offered to IOC’s as well as economic
sanctions imposed by the US. More recently, the nuclear issue with Iran appears to have
further raised the fears for future production problems. On the other hand, production has
increased in Iraq consistently since 2005 passing 2 mmbls/d in 2007 and approaching 2.5
mmbls/d through the first 5 months of 2008 (IEA OMR, 2008a).
IOC’s are often accused of spending too much of their revenues to favour generous
shareholder dividends and expensive buy-back programs instead of increasing spending on
exploration and production. Critics have also been raised against IOC’s for applying too
conservative estimates for future oil prices when deciding upon development projects
(Mabro, 2006; IEA, 2003). As mentioned above, limited access to reserves and
increasingly tougher fiscal terms in countries where they already operate are also
constraining investments and probably leading to projects not being developed since each
dollar will be directed towards projects yielding the highest net returns.
Most of the factors mentioned above are likely to continue to hamper oil production in
the foreseeable future and it is therefore also perfectly possible that global oil production
may peak or plateau in a relatively near future, not as a consequence of limited resources
but because too many factors over long time constrain investments into E&P. It should,
however, be emphasised that most of the issues outlined above are under prevailing market
conditions and policies, which, over time, may be subject to considerable change.

Supply Side and Responses

As mentioned above, global oil production increased by a modest 200 kbls/d in 2007 in
spite of some 85 large-scale projects coming online during the year adding around 4.5
mmbls/d gross production capacity when producing at plateau. However, as explained
below there are several reasons for the modest net increment in global production. Several
project start-ups were delayed to 2008 of which the most significant were South Pars in
Iran, phases 6-8, Khursaniya in Saudi Arabia and Thunder Horse in USA. Together, these
projects alone will add more than 1 mmbls/d in gross production capacity when producing
on plateau.
Wide Research Group 35

Looking at future production, Fig.1 shows estimated gross production capacity additions
for conventional and unconventional oil by region between 2008 and 2012 based on plateau
production rates and start-up year. It can be assumed that most large-scale projects
coming on line between now and up to 2012 have already been announced, while more
projects probably will be added in 2012. Fig.1 includes projects in Iraq that will add around
0.8 mmbls/d in gross capacity up to 2013 although these have recently been removed from
OPEC’s (2007) project list. Kashagan phase 1, initially scheduled to come online in 2005
but delayed several times and now scheduled to come online in 2013, and project Kuwait,
together adding almost 1 mmbls/d in gross capacity additions, have not been included.
Production from the recently discovered Tupi field in sub-salt layers off Brazil has been
assumed to add 100 kbls/d to production capacity in 2010.

Fig.1. Regional capacity additions by start-up year and expected plateau production level 2008-2012, sources:
Company reports, OPEC (2007), various issues of O&GJ and Petroleum Review.

In total, some 28 mmbls/d of gross production capacity will be added between 2008 and
2012. However, few projects produce for the entire year in the start-up year and many
fields use several months to build up to plateau level indicating that actual gross capacity
addition for any year is lower than the combined plateau level shown in Fig.1. On the other
hand, this applies of course to any year (although to varying extent) meaning that some
fields that came online in for instance 2006 and 2007 were still building up to plateau level
in 2008 adding to capacity in that particular year. Also, a number of projects have been
36 Industry Structure, Supply-Demand and Stake Holders

announced without disclosing production figures and there are numerous marginal
additions worldwide almost on a continuous basis of which it is impossible to keep a track.
CERA (2006) quantifies the latter by adding 10% of known capacity additions as capacity
additions from small fields and field upgrades. However, it seems unlikely that all
announced projects should go on line according to schedule, in particular considering the
fact that more than 8 mmbls/d of the incremental capacity up to 2013 will occur in Iran,
Iraq, Russia and Venezuela. Therefore, total gross capacity additions between 2008 and
2013 are not likely to significantly exceed 30 mmbls/d.
Assuming a global average decline rate in existing fields of between 5% and 8%
(CERA (Cambridge Energy Research Associates), 2006 and CERA (Cambridge Energy
Research Associates), 2008a, IEA, 2006; IEA OMR, 2008a) indicates that between 19 and
29 mmbls/d of production will have to be replaced by 2013 just to replace current
production. Adding demand as forecasted by IEA (2006) indicates that between 27 and 37
mmbls/d will have to be added between 2008 and 2013. In other words, the global decline
rate cannot be allowed to exceed more than marginally the 5% average annual decline as
envisaged by CERA (Cambridge Energy Research Associates), 2006 and CERA
(Cambridge Energy Research Associates), 2008a if supply and demand is to be in balance,
provided of course that demand evolves as outlined in IEA (International Energy Agency),
2006 and IEA (International Energy Agency), 2007, EIA (US Energy Information Agency,
2006 and EIA (US Energy Information Agency, 2007a and ExxonMobil (2007a).
Regarding the sensitivity in applying decline rates see also IEA (2007)47. Fig. 7 also shows
that the supply situation will ease somewhat in 2009 and possibly even in 2010 since
relatively large capacity additions are expected during the second half of 2008 and in 2009.
In addition, it should be added that we do not know the state of many of the world's 20
super-giant oil fields, which in 2004 accounted for almost a quarter of global oil production.
Fourteen of these fields have been on line for four decades or more and at least three of the
super-giant fields are currently in decline; Dacqing in China, Prudhoe Bay in Alaska and
Cantarell in Mexico with the latter approaching annual decline rates of 25% (IEA OMR,
2008a; IHS, 2007f). Furthermore, and as mentioned above, several of the super-giant fields
in Iran and Iraq are suffering from poor maintenance and use of outdated production
technology. More frequent occurrences of unscheduled field outages in increasingly more
mature production areas like the North Sea and Gulf of Mexico may also reduce expected
future production. In fact, in July 2007, IEA OMR (2007) introduced a reliability adjustment
factor in their oil production forecasts for certain countries to account for unscheduled
outages.49 Finally, lack of skilled people, material, equipment and rigs will continue to
hamper development as well as drive up costs. According to for instance CERA (2008b),
costs associated with developing new oil and gas upstream facilities have doubled since
2005. Goldman Sachs (2008) claims that the oil price required to return cost of capital for
the marginal barrel has increased from around US$50 in 2004 to US$80 in 2007, while the
corresponding oil price for the average barrel has increased from around US$19 to US$44
Wide Research Group 37

over the same period. This means of course that an increasing share of capital expenditure
goes to discover and produce the incremental barrel.
Rising concerns for energy security, high oil prices and, in the case of biofuels, climate
change, have led to renewed interest for production of synthetic fuels, in particular in
countries with large (stranded) gas reserves or coal resources. Synthetic fuels (synfuels)
can be produced from any raw material containing carbon and hydrogen, i.e. natural gas,
coal and biomass and the various concepts are usually denoted gas-to-liquids (GTL), coal-
to-liquids (CTL) and biomass-to-liquids (BTL). According to IEA (2006) reference
scenario GTL and CTL will only have a modest impact on total liquids supply reaching
around 3 mmbls/d in 2030 and thus accounting for less than 3% of total supply while
biofuels is projected to cover 4% of global road-transport demand at the end of the
projection period. Key drivers for expansion of synfuels will continue to be the oil price,
concerns for energy security but also increasingly stricter environmental regulations in the
transport sector throughout the world. More recently, escalating construction costs have
led to that several planned synfuels projects have been moved forward into the next
decade or been shelved entirely.
GTL has two major advantages; (i) it diversifies the portfolio for development of
stranded gas (GTL and LNG) and (ii) the synthesis gas is converted into very clean
conventional oil products, mostly diesel. The drawback is a highly energy-intensive
conversion process consuming around 45% of the feedstock gas (e.g. IEA, 2004). As of
March 2007 there are only three GTL plants in operation worldwide with a combined
capacity of 95 kbls/d. Another two plants with a combined capacity of 174 kbls/d are under
construction, while 16 plants with a total capacity of 1.1 mmbls/d are under various stages
of planning. Qatar will soon become the dominating global supplier with 34 kbls/d in
operation, 140 kbls/d under construction and 455 kbls/d under planning. In February 2007,
the American company Syntroleum Corporation (2007) signed a Memorandum of
Understanding (MoU) with the Chinese oil company Sinopec to jointly develop a 17 kbls/d
GTL plant in China. Syntroleum is also considering construction of a 50 kbls/d GTL plant in
Papua New Guinea. IEA (2006) estimates a global capacity of 300 kbls/d in 2015 rising to
2.3 mmbls/d in 2030, while Sasol Chevron (2006) believes GTL could provide some 4% of
global diesel consumption in 2015, i.e. around 750 kbls/d. A qualified guess would be that
IEA's intermediate projections for 2015 are too low given that at least 270 kbls/d will be on
line already in 2010 but it appears at the same time that GTL is unlikely to have anything but
modest impact on long-term liquids supply.
The increasing global competition for oil and gas resources, concerns for security of
supply and soaring oil prices have raised the interest for CTL in countries with large coal
resources such as Australia, China, India and the US. However, CTL plants are cost and
energy intensive, emit seven to ten times more CO2 than a conventional refinery and
consume and often pollute large quantities of water. IEA (2006) gives capital costs for an
38 Industry Structure, Supply-Demand and Stake Holders

80 kbls/d unit to around US$5 billions, while the capital cost for an equivalent GTL unit is
less than US$2 billions. According to IEA (2006), at current (2006) coal prices, CTL has a
break even price well over US$50/bl, while according to Sun (2008), the break even price
for China's first CTL project, currently under construction, is between US$35 and 40/bl.
IEA (2006) projects global CTL capacity to increase modestly from the current 160 to 750
kbls/d in 2030. There is currently only one CTL plant in operation worldwide, the Sasol
plant in South Africa with a capacity of 160 kbls/d. Sasol is also planning a new plant in
South Africa, the Mafutha project, with a capacity of 80 kbls/d. One CTL plant with a first
stage capacity of around 20 kbls/d (1 million tons of liquids per year) is under construction
by the Shenhua group in the Shaanxi province in China while another six are under
development. Apparently, the Shenhua plant is being prepared for CCS, either for injection
of CO2 into a nearby aquifer or for enhanced oil recovery (Sun, 2008). China is targeting
between 0.6 and 1.0 mmbls/d of liquids from CTL by 2020, which will utilise between 240
and 400 Mt of coal annually (IEA CCC, 2007; CIAB, 2006). In the US, the air force is
currently testing synthetic fuels on their aircrafts aiming to certify the entire fleet of almost
6000 aircrafts for use of synthetic fuels by 2011 and to purchase 50% of its aviation fuel
requirements from domestic synfuel sources by 2016 (Futurecoalfuels, 2008; Rentech,
2008; Air Force Link, 2008). In Australia, the Monash Energy Clean Coal Project is under
development by Anglo Coal and Shell. The Monash plant will use around 25Mtpa of lignite
to generate 60 kbls/d of liquids with commissioning expected shortly after 2015 (Monash
Energy, 2008). Numerous other plants are under development or have been proposed,
mainly in China, India and the US. One plant is planned in Europe, a 3 kbls/d pilot plant in
Germany. Although it appears that IEA's projections again may be too low, in particular
considering persistent high oil prices above US$100/bl, CTL is not expected to make
anything but marginal contributions to global liquids supply by 2015.
Global biofuel production has increased by 70% over the last 2 years reaching
1.1mmbls/d in 2007, accounting for 1.3% of global liquids supply. The prospects for
biofuels have improved tremendously over the last 2 years driven foremost by concerns for
energy security and climate change and the high oil prices in combination with decreasing
production costs. The USA, Brazil and Europe account for the bulk of global biofuel
production. While ethanol is the dominating biofuel product in Brazil and the USA, biodiesel
is the main product within Europe accounting for more than 80% of total biofuel
production. In January 2008, the EU Commission proposed that sustainable biomass
consumption should account for at least 10% of overall petrol and diesel consumption in
2020, but in July 2008 the European Parliament's Environment Committee rejected the
Commission's proposal (Platts, 2008). Also, based on current trends EU-15 will only reach
slightly more than half the target set in the biomass action plan for 2010 (Eurobserver,
2006). US DOE biofuel initiative aims to replace 30% of current gasoline consumption with
biofuels by 2030. The Energy Policy Act passed during the summer of 2005 aims to boost
biofuel output to 22.5 Mt in 2012 by imposing mandatory measures. In 2007, ethanol
production in the US increased by 30% reaching 545 kbls/d accounting for more than 7%
Wide Research Group 39

of total liquids production and according to IEA OMR (2008a) production will reach 660
kbls/d in 2008. China, India and other Asian countries like Malaysia and Indonesia have
also started to realise the potential of biofuel both with respect to energy security and
climate change. India has for instance targeted production of 6 million tons biodiesel by
2010 increasing to 30 million tons in 2020 and 60 million tons in 2030 (Automotive Research
Association of India, ARAI, 2007). However, the growing demand has also led to an
upward pressure on food prices and to increased deforestation and deterioration of
wetlands and peat soils, which has actually increased CO2 emissions (IEA, 2008). IEA
OMR (2008b) recently downgraded their expectations on medium-term growth projecting
total global production to reach around 2 mmbls/d in 2015, accounting for 2% of total liquids
supply. On the other hand, second-generation biofuels54 may have the potential to
significantly reduce demand for oil in the long term. As mentioned above, IEA (2008)
investigates how CO2 emissions in 2050 can be brought back to current levels (ACT
scenarios) or be reduced by 50% (BLUE scenarios) through inclusion of, among other
things, a sizeable contribution from biofuels. In the ACT Map scenario biofuels
consumption reaches 570 Mtoe in 2050 accounting for 17% of total transport fuel demand,
while in the BLUE Map scenario consumption reaches 693 Mtoe in 2050 accounting for
26% of total transport fuel demand (IEA, 2008). However, IEA (2008) also states that it
remains unclear what level of biofuels production that can be achieved globally on a
sustainable basis by 2050 referring in particular to food security, land competition and
potential impact on water resources.

Demand
Economic growth, increasing population, urbanisation and infrastructure development
will drive growth in demand for oil in countries like China and India. In China, GDP growth
has averaged nearly 10% annually between 1980 and 2005 and escalated to almost 11% in
2006 and the first half of 2007. In India, GDP grew by almost 6% annually in the 1980s and
1990s and has increased further in recent years from more than 8% in 2004 to almost 10%
in 2006 (IEA, 2007). Car sales are booming in the so-called BRIC countries (Brazil,
Russia, India, China), increasing in 2007 by almost 60% in Russia, 30% in Brazil and more
than 20% in China, while in India, production of the Tata Nano car with an expected selling
price of US$2500 is expected to allow millions of people to buy their own car (CIBC,
2008). In the Middle East, oil demand grew by 3.0% p.a. between 2000 and 2007, while
corresponding growth averaged 2.7% in Africa and Asia-Pacific, raising global demand by
6.3 mmbls/d. In total, these three regions accounted for more than 70% of total worldwide
increase in oil demand between 2000 and 2007. Table 1 shows key indicators in 2005 for oil
demand for the BRIC countries compared with the same indicators for EU-27, Japan and
USA. The data have been taken from European Commission (EC, 2008), IEA (2007),
United Nations Population Division (UNPD, 2008), Organisation for Economic Co-
operation and Development (OECD, 2008) and IMF (2008b).
40 Industry Structure, Supply-Demand and Stake Holders

Table 1. Key indicators 2005 global oil demand

Unit EU-27 Japan USA China India Russia Brazil

Population millions 490 128 297 1313 1134 144 187

Urban % of total 80 66 81 40 29 73 84
population

GDP in PPP billion US $ 13,054 3870 12,376 5333 2341 1698 1585
terms

GDP/Capita in US $ 26,652 30,290 41,674 4091 2126 11,861 8606

PPP terms

TPEC Mtoe 1815 527 2340 1717 537 647 210

TPEC/Capita toe 3.7 4.2 7.9 1.3 0.5 4.5 1.1

POCa Mtoe 671 249 952 327 129 133 85

POC/Capitaa toe 1.4 1.9 3.2 0.2 0.1 0.9 0.5

No of vehiclesb millions 230 69 232 34 11 35 27

No of cars/1000 cars/1000 466 540 776 26 13 245 145

peopleb people

POC: primary oil consumption.

Sources: EC (2008); IEA (2007); UNPD (2008); OECD (2008); IMF (2008b).
a
POC and POC/Capita refers to 2005 apart from Brazil (2004).
b
Refers to passenger cars for all countries apart from India (LDVs) including all 2-axis, 4-tyre vehicles in USA
and minicars in Japan, year 2006 for EU-27 and Russia, 2005 other countries.

Projections of future demand by IEA (International Energy Agency), 2006 and IEA
(International Energy Agency), 2007, EIA (US Energy Information Agency, 2006 and EIA
(US Energy Information Agency, 2007a, see footnotes 8 and 9) and ExxonMobil (2007a),
all foresee global oil demand to reach between 116 and 118 mmbls/d by 2030, indicating an
average annual growth of around 1.3% relative to real demand in 2007. As expected, the
growth is driven foremost by the transport sector in developing countries in Asia, Middle
East and Africa but also in countries like Brazil and Russia, while growth within OECD is
expected to be modest, at around 0.5% per annum up to 2030.
Sustained high oil prices together with concerns for security of supply and the
environment may, however, have the potential to significantly alter the relatively robust
Wide Research Group 41

expectations on future demand as outlined above. Already, the high prices seem to have
affected demand within the OECD, most notably in the US, and IEA OMR (International
Energy Agency), 2008a and IEA OMR (International Energy Agency), 2008b has on
several occasions recently written down their expectations on short-term demand growth.
Nevertheless, growth in demand is expected to rise again from 2010 in combination with
increasingly stronger growth in global GDP (IEA OMR, 2008b). The most recent report by
EIA (2008) has also revised down their long-term growth forecasts although the impact on
cumulative demand between 2006 and 2030 is relatively modest (see footnote 9). Although
inflation adjusted oil prices have passed previous record levels noted in 1980 there are
several factors implying that the global economy is less vulnerable to high oil prices than in
the past which in turn suggest that the high prices may only have modest impact on
demand. First of all, the so-called oil burden, or global oil expenditures as share of global
GDP, is lower today than it was in 1980. According to IEA OMR (2008a), the oil burden
stood at 4.2% in 2007 versus 7.3% in 1980. In practice therefore, income gains have more
than offset price increases. Secondly, global oil intensity has halved since the 1970s, most
markedly within OECD countries, while at the same time many non-OECD countries have
reached the stage, in terms of GDP per capita where oil demand typically accelerates (IEA
OMR, 2008a). Also, the depreciation of the US dollar against many currencies, taxes in
Europe and fuel subsidies in Asia, Latin America and the Middle East and lack of any real
substitute to oil in the transport sector are contributing to maintain strong demand. For
instance, according to IEA OMR (2008a), only a very large price adjustment to subsidised
retail oil prices in China would have the potential to effectively curb demand in Asia and
could in fact also have the opposite effect by improving supply.
As outlined in Section 2, concerns for climate change has the potential to significantly
alter future demand for oil, in particular considering the fact that global CO2 emissions
should be reduced by between 50% and 85% between 2000 and 2050 to limit the global
temperature increase to 2.0-2.4°C (IPCC, 2007). A positive side-effect of reducing oil
consumption is the potentially significant improvement in national energy security and the
combined effect of concerns for climate change and energy security could have the
potential to significantly influence future demand for oil. According to IEA (2008) global
demand for oil (not liquids) could reach 135 mmbls/d in 2050 under a baseline scenario
based on energy and climate policies implemented to date. However, efforts to reduce
global CO2 emissions back to 2005 level by 2050 could reduce demand by 30%, while a
50% reduction in CO2 emissions could reduce demand by 55%, in both cases relative to the
baseline scenario. The latter scenario, denominated BLUE Map, envisages global oil
demand (not liquids) to reach 61 mmbls/d in 2050, almost 30% below current consumption
levels. The BLUE Map scenario is based on, among other things, that:
„ Electric vehicles (EVs) and fuel cell vehicles (FCVs) reach 20% and 40% of light-
duty vehicle (LDV) sales, respectively in 2050.
42 Industry Structure, Supply-Demand and Stake Holders

„ Beginning in 2015, plug-in hybrid electric vehicles (PHEVs) reach a 60% share in
travel on electricity by 2050.
„ Gasoline and diesel hybrids have a 70% market share in LDVs by 2030 dropping to
35% in 2050 (i.e. replaced by EVs, FCVs and PHEVs).
„ 70% reduction in new LDV fuel efficiency (fuel/km) by 2050 from FCVs and EVs.
„ FCVs and EVs each account for 25% of total stock of trucks.
„ Between 35% and 50% fuel efficiency improvements in buses, rail, air and water
transport.
„ Second-generation biofuels accounting for almost 20% (693 Mtoe) of total global
liquids supply in 2050.

According to IEA (2008) the BLUE Map scenario will require urgent implementation
of unprecedented and far-reaching new policies in the energy sector. Moreover,
increased Research, Development and Deployment (RD&D) over the next 15 years into
energy storage systems, fuel cell systems and advanced biofuels systems appears critical
to bringing down longer-term costs of CO2 reductions in the transport sector where
marginal CO2 emission reduction costs could reach as high as US$500/ton (IEA, 2008).

Minerals and the Economy: A Case of Organised Mining

As a result of the iron ore boom, output from nonexpanding export-oriented industries
and import-competing industries is forecast to fall slightly due to an appreciation in the real
exchange rate, whereby the nominal exchange rate appreciates relative to costs. As
explained by the Gregory thesis theory, the additional demand generated (particularly in the
construction phase of new projects) pushes up the aggregate level of prices in the local
economy and the surge in iron ore exports also puts upward pressures on the exchange
rate. As a result, the competitiveness of the state’s nonexpanding exports industries (e.g.,
agriculture) and import-competing industries (e.g., transport equipment) deteriorates,
leading to the contraction of output in these industries.

Investment-related Industries
All investment-related industries are projected to benefit from the development of new
iron ore projects, particularly during the construction phase. As a key input to business
investment, the construction industry is expected to benefit the most in percentage terms.
For example, the modeling results indicate that production of the construction sector would
be 3.6 percentage points higher in 2004-05 compared with the base case level. Other
industries that supply construction materials are also expected to benefit from the iron ore
boom.
Wide Research Group 43

Energy Industries
Demand for energy is expected to rise due to the resources boom. As a result, all
energy industries are forecast to grow faster than in the base case. In cumulative
percentage deviation terms, for example, the output of the electricity industry will be about
2.5 percentage points higher in 2008-09, when new projects become fully operational
compared to the base case level.

Domestic Industries
Higher employment resulting from the resources boom will increase the consumption
capacity in Western Australia. In addition, the influx of interstate migrants associated with
large investment activities in the state will stimulate the demand for financial, education and
health services. As a result, Western Australia’s domestically focused industries such as
retail trade, and hotel and other services are forecast to expand relative to the levels in the
base case.

Impacts on Western Australian Industries’ Employment

Fig. 2 presents the effects on employment for selected Western Australian industries.
These results are reported as the average number of jobs created in each industry over the
simulation period to 2024-25.

Scenario 1
4.0

3.0
Thousand Persons

2.0

1.0

0.0

-1.0
Trade
IronOre

TransOther

ElecOther

FoodOther

ManufOther

AgOther
Cement

ElecGoal

ElecOil

Oil
Coal

FoodAnimal

IronSteel

AgAnimal
Construction
ServicesOath

OtherMining

MetalPrd
ElecSupply
WaterSupply

GasSupply

PetrolRefin

ElecHydro
OwnerDwellin
NmtlMinPrd

Forestry
PlasticRbrPrd

PaperProd
Drink

Commun
WoodProd

Fishing

OtherEqp
TranspEqp
GovServices

RailTrans
HotelsCafes
FinServices
BusServices
RoadTrans

WaterTrans

AirTrans
ElecGas

Gas

ChemProds

Fig. 2 (Contd)
44 Industry Structure, Supply-Demand and Stake Holders

Scenario 2
0.8

0.6
Thousand Persons

0.4

0.2

0.0

-0.2
Trade

IronOre

Cement

ElecGoal

ElecOil

Coal
Oil

FoodAnimal

IronSteel

AgAnimal
Construction
ServicesOath

OtherMining

MetalPrd
ElecSupply

WaterSupply
GasSupply

NmtlMinPrd

PetrolRefin

ElecHydro
OwnerDwellin

Forestry
PlasticRbrPrd

PaperProd
Drink

WoodProd
OtherEqp

Fishing

Commun
TranspEqp
TransOther

ElecOther

FoodOther

ManufOther

AgOther
GovServices

RailTrans
HotelsCafes
FinServices
BusServices
RoadTrans

WaterTrans

AirTrans
ElecGas

Gas

ChemProds
Fig. 2. Western Australian sectoral employment effects (average annual deviations from the base case).

As can be seen from the upper panel of Fig. 2, in Scenario 1, apart from the iron ore
industry, most service industries and industries that are closely related to investment are
projected to experience increases in employment due to the surge in iron ore exports and
new iron ore projects. The top five industries whose employment expands significantly are
government services (3290 additional jobs), wholesale and retail trade (2740), iron ore
(1740), construction (1360) and other services (920). The largest increase in employment
in the government services sector is mainly due to the labor-intensive nature of services
such as education, health and community services. By contrast, nonexpanding export-
oriented industries and import-competing industries such as agriculture, transport
equipment and other manufacturing are forecast to experience a contraction in
employment.
The sectoral employment effects in Scenario 2 exhibit a similar pattern to that for
Scenario 1. The top five industries are the same, except that the wholesale and retail trade
sector is now the most expanded industry in terms of the number of jobs created.

Does the Government Budget Balance Matter?

In resources led economy like Australia the government budget apportionment and
balance are dependent on the supply side economics, currency fluctuations and non-
mineral export-import deficit. Budget balance tries to satisfy different stakeholders. One of
the assumptions underlying the above modeling results is that government budget balances
at both the federal and state levels are fixed at their base case levels; that is, the resources
Wide Research Group 45

boom is assumed to be budget neutral. To examine how changes in the Western Australian
government budget balances affect the modeling results, this budget balance restriction is
released for Western Australia in Scenario 3.
Table 2 contains a comparison between Scenario 1 and Scenario 3. As can be seen
from the table, without fixing the government budget balance, the potential economic
benefits resulting from the resources boom would be reduced. The only exception is
exports, which are higher. Compared with Scenario 1, in which government budget
balances are fixed, GSP gains from the iron ore boom would be 1.7% lower, investment
gains 1.3% lower, private consumption gains 2.3% lower, import gains 0.62% lower and
employment gains 15.7% lower if government budget balances are not fixed. The reason
for this is straightforward: with unfixed budget balance, government can build up a large
surplus derived from the resources boom. As these surpluses are not converted to
consumption/investment either through tax cuts, transfers or other channels, stimulus in the
economy is reduced. Consequently, the economy-wide impact of the resources boom will
be smaller. Lower investment and consumption is likely to reduce local absorption, which in
turn results in a rise in exports.

Table 2. Impact of budget balance changes ($ million in 2002-03 prices and discounted)

Budget balance
Changes (%)
Fixed (Scenario 1) Not fixed (Scenario 3)
Average annual deviations

GSP* 1732 1703 -1.7

Investment 360 356 -1.3
Private consumption 890 870 -2.3
Exports 1235 1307 5.8
Imports 294 292 -0.6
Employment 10,040 8467 -15.7

Total cumulative deviations

GSP* 36,372 35,757 -1.7
Investment 7564 7469 -1.3
Private consumption 18,696 18,263 -2.3
Exports 25,945 27,442 5.8
Imports 6175 6136 -0.6

Note: Unit for employment is persons. *Gross Service Products

46 Industry Structure, Supply-Demand and Stake Holders

Technological Innovation
Technological innovation contributes at each stage of the value-adding chain within the
minerals industry, namely oil exploration, extraction, and processing, as well as to broader
environment issues related to the industry.
Oil, gas & mineral exploration has become more difficult over the years and requires
increasingly sophisticated technology. Most of the easily discovered outcropping surface
deposits have been found and techniques are now needed that are tailored to different
geological terrains and that can look under deep cover. Australia, for example, is a deeply
weathered continent with the bedrock often covered by a heavy layer of weathered
inhomogeneous rubble, or regolith. Increasingly exploration depends on highly sensitive
equipment and novel techniques drawing on disciplines such as geophysics and
geochemistry.
The extraction process depends on the mining equipment and techniques employed
including, for example, drilling, blasting, cutting, excavating, loading and hauling, as well as
mining logistics, equipment monitoring and diagnostics. Efficiency enhancement in each of
these benefits from technological innovation, as do remote control and automation
techniques, which remove people from mine sites and improve safety.
In mineral/metal processing, the technology imperative is to improve the efficiency and
reliability of processes employed to recover metals from the ore. Given the high throughput
involved, incremental improvements can make a big difference-for example, in conveyor
belt technology, or comminution/grinding, or furnace design and performance
(computational fluid dynamic modelling). Processes also need to be optimised to respond to
the “signature” of individual mineral deposits. Incremental improvement is characteristic of
scale-intensive industries: “given the potential economic advantages of increased scale
combined with the complexity of … production systems the risks of failure associated with
radical but untested changes are potentially very costly. Process and product technologies
therefore develop incrementally on the basis of earlier operating experience and
improvements in components, machinery and subsystems” (Tidd et al., 2001, p. 113).
Non-incremental mineral and metal process improvements, on the other hand, require
newly designed plants and operations, which are expensive and of high risk. Significant
practical and financial risks are involved in scaling-up processes from laboratory to pilot
plant size and then to full-size plants, and in “ruggedising” large-scale processes to be
efficient and reliable. The risks are evident in the number of projects abandoned before
commercial operation. In Australia, the examples include the A$2 billion, hot briquetted iron
project in the Pilbara, Western Australia and the Australian Magnesium Corporation
smelter in Gladstone, Queensland. Moreover, these “step-change” projects often take a
long time to enter commercial operation. For example, HiSmelt, a novel one-stage process
to produce molten pig iron commissioned by RioTinto in Western Australia in 2005, has
Wide Research Group 47

been under development since the 1980s. In a review of HiSmelt and other direct-smelting
techniques, Dry and colleagues note “the path from initial ‘concept euphoria’ to real world
commercial performance is long and difficult, far more so than one might logically expect”.
They draw three lessons: “(i) the time-scale for developing this type of technology is more
like 20 years than 3-5 years; (ii) for successful development there is no way of avoiding a
large expensive pilot plant phase; and (iii) if the underlying motivation is not strategic and
strong enough to counterbalance the risk and costs of the exercise, don’t do it” (Dry et al.,
2002).
Finally, the environment is also a focus for technological innovation. Environmental
concerns arise, for example, in relation to mine or plant operations or the rehabilitation of
damaged areas. Mine-site management and process changes to reduce waste, dust, noise,
water and air pollution, or damage to flora and fauna are also the focus of research and
innovation. More recently concern about greenhouse gas emissions has driven technology
development in the coal industry.

Summary
The observations given above indicate that in case of oil although there are substantial
capacity additions to global production in the short term (2008-2010), in the medium-term
long lead times in project development, lack of skilled personnel and equipment, frequent
field outages, declining production from operating fields, limited access to large resources
in the Middle East, Russia and Venezuela and the fact that new oil increasingly will have to
be found and produced in more difficult environment will continue to constrain global
production. Prevailing market conditions and policies indicate that limited access to
resources and deteriorating fiscal terms for IOC’s together with budgetary constraints for
large NOC’s and continued geopolitical tensions will limit oil production growth also in the
long term. Additionally, few oil companies/nations, apart from possibly Saudi Arabia, are
likely to be willing to maintain surplus production capacity and we do not know the
condition of many of the world’s 20 super-giant oil fields accounting for almost a quarter of
global oil production. As a consequence it is a distinct possibility that global oil production
may peak or plateau in a relatively near future, not as a consequence of limited resources
but because too many factors over long time constrain investments into E&P.
Unconventional oil production is currently expanding rapidly in Canada, but worldwide
production is not expected to significantly exceed projections by the IEA, indicating a
relatively modest contribution from unconventional oil up to 2030. Synthetic fuels are not
believed to attain more than a marginal role in the short term but still offer significant
production potential in the long term. Fundamentals clearly indicate continued rapid
expansion in worldwide demand for oil, driven foremost by the transport sector in Asia,
Africa, Middle East, Brazil and Russia. Given the above analysis it is difficult to project
anything but continued tight oil supply, also in the long term but it must be underlined that
this assumption is under prevailing market conditions and policies.
48 Industry Structure, Supply-Demand and Stake Holders

A global concerted effort to mitigate climate change may, alone or together with
concerns for energy security, have the potential in the long term to profoundly reduce
supply for oil and minerals. Concerns for energy security are already leading to steps being
taken to curb growth in demand in China, USA and Europe and, as shown by IEA (2008),
if the world seriously wants to reduce CO2 emissions in order to meet IPCC emission
reduction targets, drastic measures will have to be taken to reduce consumption of fossil
fuels including oil. How these will play out in the market is to be seen.