Philippine Business Magazine: Volume 13 No. 5 - Forecast

Crude Reality

With oil prices likely to remain high for now, the key challenge is the search for alternative energy resources

By Karen B. Bitagun

Country chairman of Shell companies in the Philippines Edgar Chua thinks oil prices are likely to remain high in the coming months

Forecasting short-term oil price movements is a good way to make yourself look stupid,” quips Edgar Chua, country chairman of Shell companies in the Philippines. No one can really predict exactly how much oil prices will reach in the coming years, but according to Chua, not knowing the figures is no excuse not to be prepared for possibly higher oil prices in the future.

Citing market prices of oil products as of June 2006, Chua agrees that the prices have really become far from affordable. In the international market, unrefined crude hit US$66 a barrel, while prices of diesel and unleaded gas reached US$88 a barrel. Meanwhile, liquefied petroleum gas was selling at US$470 per metric ton.
All over the world, people are asking, how did we end up in this situation? According to Chua, the doubling of oil prices in the past three years can be traced mainly to a number of economic and political factors.

Roots of the Problem

One reason for high oil prices is the ever-increasing energy demand in China, India, Japan, and the United States.

China’s large population requires greater quantities of oil. In the past few years, with China jumping into the globalization fray, it has become more aggressive in revving up its industries and in producing at maximum capacity. It is now one of the fastest-growing economies in the world.

To produce at maximum capacity, Chinese factories are requiring greater quantities of oil

Meanwhile, India’s emerging economy and highly industrialized Japan are also requiring greater quantities of oil to fuel their economic activities. As for the United States, the world’s top oil consumer, it has been using up oil faster than it can store the oil. Every time its reserves go low, the market becomes jittery.

Oil-producing countries like Iraq, Nigeria, and Venezuela, as well as oil companies in the U.S. Gulf Coast, are uneasy about the reported output shortfalls because, on their part, they are already producing at full capacity. Iraq produces 900,000 barrels per day; Nigeria, 550,000 bpd; Venezuela, 400,000 bpd; and U.S. Gulf Coast companies, 320,000 bpd. In spite of their abundant production, these suppliers are pressured to produce more to meet the growing global demand.

Another factor that has been pushing up prices of refined products is the lack of refinery plants. In the U.S. and Europe, most of the existing refineries are more than 30 years old and are in need of repairs. In addition, the operations of U.S. Gulf Coast refineries, due to their location, are easily disrupted by hurricanes.

Beyond the economics of supply and demand, local terrorist threats and political unrest, as well as international geopolitics, can startle the world oil market and create spikes in pricing. For instance, recent oil price surges were attributed to rebel attacks on Nigerian oil facilities (Nigeria is the world’s eighth-largest oil exporter) and to Iran’s resumption of its nuclear program. Iran has been resisting calls to halt its program, saying that it just wants to harness nuclear power for energy use and not for producing weapons of mass destruction. Wary of Iran’s true intentions, several countries have been prodding the United Nations to sanction Iran, but coming down to hard on the Iranians could have negative consequences. If sanctions are imposed, Iran, the world’s fourth-largest oil exporter, could retaliate by halting its oil exports and consequently disrupting the entire oil trade.

The Local Oil Industry

The Philippines is still dependent on oil imports. In fact, 41% of domestic oil in 2005 was imported.

Like the U.S. and Europe, the Philippines is saddled with the problem of having a limited oil-refining capacity, as only the three big oil firms—Shell, Caltex, and Petron—have the capacity to process oil locally and what they produce is not enough.

The situation could have been worse had the oil industry not been deregulated in 1998. Oil deregulation has opened up the market to small, independent players and led to price competition among players. Nevertheless, the industry faces many challenges.

Local oil firms, particularly those engaged in refining, storage, and retailing, have been forced to absorb more costs. Dealers, too, are being burdened not only with a number of additional costs but also with the high landed cost of fuel since most of the refined oil products sold at the pumps are imported. Because of these factors, it is unlikely, for now, that consumers will see pump prices go down. “Prices won’t lower because dealers want a decent profit,” Chua explains.

Non-cost factors also hound the industry. “There are competitive pressures, price sensitivity, and changes in fuel capacity, to name a few,” says Chua. Moreover, policies also affect price setting, especially the 70% input value-added tax cap for industries, the net income after tax burden, and the tax credit certificates. Smuggling, on the other hand, continues to be a headache for oil companies

Oil Outlook

Although the global oil supply is said to be enough, the demand for oil is simply growing faster than production. “What to expect in the coming years is a sensitive issue,” says Chua. “Energy conservation is good but can only do so much. Our goal should be to become energy-independent. So the key challenge is to search for alternative resources. The proposed mandate for biofuels, such as coco-biodiesel and ethanol, is very promising. High oil prices will be there but technologies will be competitive.”

“In the coming months, do not expect lower prices, although it is possible. But looking at things, oil prices will remain high, if not higher,” concludes Chua.