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Opec pins hopes on China's cars and shale's failure

The producers' group has released its latest oil outlook. And, as Derek Brower reports, the cartel has based some of its predictions on the unknown

Can you predict what kind of engine will power the average Chinese vehicle in 2035? No, nor can most people.

Opec, though, must have a good idea. Its latest annual World Oil Outlook  plots a rosy future for oil demand over the next 22 years, as population growth, urbanisation and the rise of developing economies lift consumption from 88.9 million barrels a day (b/d) last year to 108.5m b/d in 2035 (see table below).

But the most startling source of the growth will, apparently, come from Chinese drivers. By 2035, Opec thinks there will be 442m cars on China's roads, far greater even than the number in OECD America (344m). It's enough to make any purveyor of oil - and especially the Opec exporters that increasingly see their future in Asia - glow with joy.

The outlook's latest forecast of China's fleet is more bullish than earlier ones, because new factors - like the low density of vehicles on the country's roads (less than half the number per kilometre in the US) and the rapid expansion of its road network (which grew by 130,000 km per year between 2005 and 2010) - have been added to the model. Anyway, China's economy will be larger than any other by 2035, the report notes. So rapid growth in automobile ownership is a safe bet.

But Opec's car ownership forecasts tell no one anything about how much or what kind of fuel - let alone what kind of engine - will propel those Chinese cars in 22 year's time. No wonder. Analysts of the automobile market say it has become extremely difficult to predict the future of engine technology, though they are unanimous in saying the potential efficiency savings, even in the internal combustion engine, remain huge.

In any case, China will have stringent fuel-economy standards by 2015. Opec includes those measures in its forecast, but is explicit that the outlook's central long-term oil-demand scenario does not include likely future legislation, or even policy changes already under discussion.

That's another problem with its forecast, because the chances that governments, including China's, are going to stop tightening fuel-economy standards between 2015 and 2035 are nil - and automakers know it. In any case, while car ownership numbers are useful, total miles driven is a far more relevant data point, but even more unpredictable. Owning a car doesn't mean much if fuel prices discourage you from driving it.

And consumers, even in the rapidly rising developing economies, will have every reason to conserve more energy, because Opec's outlook foresees only marginal price softening in the coming decades. In real terms, its basket of crudes will cost $104 a barrel in 2015 (just slightly beneath the average so far this year), $94/b in 2020, $96/b in 2025 and $100/b in 2035. (In nominal terms, that will lift oil prices to $160/b in 2035.)

Central to this outlook is Opec's view of production costs, which it implies have put a floor beneath prices, and the long-term frailty of unconventional oil as a alternative to the group's own supply. "The rising cost of supplying the marginal barrel has been, and remains, one of the major factors in making assumptions for oil prices," Opec says in the report, pointing out that from 2004-08 costs doubled.

But finding the cause of that inflation is not as easy as it looks. As Abdalla El-Badri, Opec's secretary-general, once pointed out to Petroleum Economist, many input costs - steel and iron, for example - rise on the back of strong oil prices.

Meanwhile, despite the decline of some members' market share in the US as North American supplies have surged in recent years, Opec remains sceptical about unconventional energy. Environmental concerns in the shale-gas sector, for example, are fading around the world, but not for Opec. The group once again lists them in the report as being among the "uncertainties" that could yet undermine shale-gas sector. Those concerns do not seem to have stopped Saudi Arabia, Opec's biggest member, from pursuing shale gas; or prevented Algeria, another member, from talking up its vast resource.

As for tight oil, Opec thinks it is a short-lived phenomenon: too costly to produce and too demanding of rigs and infrastructure to be replicated outside North America. Peak oil, this argument implies, is a real threat - for everyone but Opec.

As drillers exhaust the sweet spots in the US, the rapid growth in supply will come to an end, predicts Opec. "Analysis in detail" of the Bakken, Eagle Ford and Permian basin plays in the US has left the group forecasting that North American tight oil supply will amount to just 2.7m b/d by 2035, or barely half its level in 2015.

That's a bold prediction, especially for a group that failed to see the rise of North America's unconventional sector. It's also impossible to verify until the longer-term decline rates on which Opec is putting so much store are really known. The Energy Information Administration, for example, thinks that in a higher-case scenario tight oil could make up about half of US oil output of more than 10m b/d to 2040.

Meanwhile, ExxonMobil and others are wasting their time in Argentina's mammoth Vaca Muerta or Russia's 2 trillion-barrel Bazhenov formation. Tight oil beyond North America doesn't feature in Opec's central scenario.

But getting this outlook right matters a great deal to Opec, because supplies outside the group are threatening its market share, and only tight oil's long-term failure will staunch the bleeding.  Including natural gas liquids, Opec supplies last year accounted for 41% of the world's total. Its own numbers show this slipping to 38.5% of supply by 2020. Between now and 2018, the call on Opec's oil will fall from 30.3m b/d in 2013 to 29.2m b/d in 2018.

Only beyond then, by which time the tight-oil flicker will have been largely extinguished, believes Opec, will the group's market share begin to recover. By 2035 its supplies will have risen to 47.1m b/d, 43% of total global output of 108.7m b/d.

But the report's longer-term outlook for Opec's own supplies should garner at least as much scepticism as it heaps on global tight-oil prospects.

Opec has long maintained that, provided high prices persist, the group will add another 12m b/d to output capacity. Despite years of high prices, however, Iraq is the only Opec member that has been significantly adding to its production portfolio. Saudi Arabia has no intention of going beyond its capacity of 12.5m b/d. Others are struggling to keep their existing capacities intact.

So quite where Opec will get all the extra oil the world needs when, as it predicts, the tight-oil producers have shut up shop is not clear. But neither is the future of North America's unconventional oil industry or China's car sector. Maybe the world will need a lot less of Opec's oil than the group expects.

Table 1: World supply and demand outlook
Table 1: World supply and demand outlook
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