On Wednesday 6 the European Commission backed the European strategy as proposed by the Commissioner for Energy, Loyola de Palacio, to face the rise in the price of oil over the $30 a barrel mark (see daily bulletin of 7 September, p.5). Ms. de Palacio's paper analyses the factors of this price explosion, as well as the uncertainties regarding OPEC's ability to regulate prices. She proposes four lines of action: pressures on OPEC, competition between oil companies on the European market, promoting alternative energies and the cautious use of the tax instrument. We here publish this text in full.
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THE EUROPEAN UNION'S OIL SUPPLIES
AND MOVEMENTS IN OIL PRICES
(Information note from Vice-President Mrs de Palacio to the Commission)
I. CURRENT SITUATION
Oil prices have reached historical levels since the Gulf War. That rocketing of oil prices noted since early 1999 has triggered a debate covering the three components of the prices paid by European consumers: (1) crude oil prices, (2) refining and distribution margins and (3) the taxation of oil products.
Although the price explosion is clearly due to the crude oil market (it is of course, basically, the consequence of OPEC's production-restriction policy i.e. of its decisions concerning production quotas and also, to a lesser extent, to the weakness of the euro against the dollar), one should also consider the other price components in order to detect any room for manoeuvre at those levels.
Against this backdrop it will also be necessary to analyse the future impact of that increase and of the oil-price volatility on growth and inflation in the EU.
1. Crude prices
Apart from brief respites during April and around late July, crude oil prices now seem determined only to fluctuate within a band around $30 (for a barrel of Brent-quality North Sea oil): it had entered that band in February 2000 following an uninterrupted rise since December 1998, at which point it had bottomed out at $10 a barrel.
The main cause of the virtual trebling in prices during 1999 has to be sought in the restrictions in production adopted and actually implemented by a group of producing countries (OPEC and occasional allies). OPEC's behaviour, as a cartel, on this occasion gave the lie to a view held widely since the mid-80s, namely that OPEC is only a cartel in name and that we had entered a period of low, stable prices: a sharp fall in prices noted in 1998 was able to forge solidarity among OPEC's members (and some other producer countries) even if their interest continued to diverge structurally in the long term.
The tightening of production quotas imposed in a situation of lively demand (due in particular to renewed economic growth in Asia, continued economic expansion in the United States and stagnation of non-OPEC production following sluggish investment during the low-price period preceding the current surge) reduced oil stocks to a particularly low level in early 2000.
Some of these "underlying" factors are still enabling OPEC to continue to control the market and maintain tension on it by applying a production policy of keeping stocks in the consumer countries at a low level - and it will probably continue for the next year or two. The expansion of non-OPEC production, which reacts sluggishly to price movements, could, however, complicate the equation for OPEC in the longer term.
A major factor to take into account is OPEC's decision to introduce a price-band concept centring on a "target price" of $25 per barrel, with a floor at $22 and a ceiling at $28 (based on a composite OPEC barrel). The member countries have agreed to consult each other if the OPEC price falls through the $22 floor for 10 consecutive days or goes through the $28 ceiling for more than 20 days in succession, in order to adjust their output levels: those consultations would lead to intervention on the market in the form of cutting or boosting production by 500 000 barrels per day (one million barrels per day = 50 million tonnes a year). A striking factor in this agreement is Saudi Arabia's support since, shortly before, it had again expressed a preference for a price band lying between $20 and $25 per barrel for Brent quality crude, or in other words roughly $4 lower than the "OPEC price band".
In fact the "ideal price" from the producer countries' point of view must be a compromise between their wishing to maximise their short term income and taking account of the longer-term adverse effects of excessively high prices on those same earnings (expanding non-OPEC production and alternative energy sources, curtailing demand). Given the objective differences in the situations in the producer countries (cf. under item II.2.B), that "ideal price" is of necessity different for those categories of producer country: the decision on the (price) bracket is thus to some extent a shaky compromise (the "ideal price" in fact being close to the ceiling for some and to the floor for others).
When assessing the current situation it is important to bear in mind that, given that the range adopted is very wide, it constitutes a shaky compromise, as stated above, the machinery is in no way automatic and its effectiveness in stabilising prices is very relative. It must also be noted that "gently relaxing" production quotas in order to achieve a target price is an extremely risky, if not impossible, business. OPEC constantly fears deciding to raise quotas by too much, thus causing prices to plummet, as happened in late 1997 (moreover, that concern was mentioned again by the Venezuelan oil minister in late July). It can be said in conclusion that although the agreement on this machinery should make it possible to stop long-term prices rising above $35, it does not, however, guarantee stabilisation at the "target price" of $25, even in the more distant future. Everything seems to point towards oil prices remaining high. Our economy and policies will have to adjust to that new order.
2. Refining and distribution margins
The tacit question raised by motorists when they note that pump prices have rocketed is: "does that increase accurately reflect the rise in crude prices?" As shown [by the comparison of the movements] in average petrol prices in the European Union with "Brent" oil prices -, the answer up to March 2000 is "yes": one can see that in 1999 there were two closely correlated trends, with the rise in petrol prices lagging slightly behind that of crude oil. However, a split has been noted since March 2000, petrol prices changing less favourably than crude prices during the spring of 2000: very recently refining margins have thus reached levels that had no longer been noted since the Gulf War.
However, the most important fact to note is that the comparison between the consumer prices charged by Member States for oil products, exclusive of taxes and duties, reveals major differences. Thus, for example, the price, exclusive of taxes and duties of "Euro super 95" petrol was euros 452/1000 litres in the Netherlands, and euros 344 in the United Kingdom (euros 346 in France) in late May 2000, or in other words a 31% difference. Those differences had already existed before the current price explosion and thus have no causal relationship with this.
When recently monitoring the implementation of the Community's anti-concentration regulation the Commission's departments analysed the competitive situation as applying to fuel distribution in a number of Member States. It was stressed that, even though certain cost factors could vary among Member States, only oligopolistic behaviour and a lack of competition in distribution could explain such price differences. For example, French and British car owners benefit from the competition arising from non-specialist distribution (hypermarkets).
On the basis of such diagnoses the question naturally raised is that of any infringement, or otherwise, of competition law, and in particular the existence, or not, of cartels (pricing agreements). The national authorities in a number of Member States have begun to investigate this matter. In Italy and Sweden the competition authorities have imposed penalties on oil companies.
3. Oil-product taxation
The taxation of oil products is basically made up of two components: the major part (excise duties) consists of a fixed amount per litre (specific duties) whereas the other (VAT) consists of a percentage on value (ad valorem duties). To a certain extent that tax structure in Europe acts as a damper on price movements since the majority of taxes are constant per unit volume (and thus independent of price levels).
II. MEDIUM AND LONG-TERM PROSPECTS
1. Key figures
Combining, as it does, demographic growth (8 000 million inhabitants in 2020 and 10 000 million in 2050) and an annual world-economy growth rate approaching 3.5% over the next two decades, world energy demand should move from 9 300 million tonnes oil equivalent (toe) in 2000 to 15 000 million toe in 2020.
World oil consumption should be roughly 115 million barrels per day in 2020 as compared with roughly 77 million barrels per day in 2000, or in other words a 50% increase.
OPEC would cover 50% of that demand by producing approximately 55 million barrels per day, as compared with 32 million barrels per day in 2000. That availability of OPEC production is justified by a production-cost level which would continue to be extremely advantageous, even in a low-price scenario. It should be noted that the average cost of OPEC production is currently close to $2 per barrel. Major profit margins will provide an incentive that will be difficult to refuse. The volume of non-OPEC production, whose average cost is currently $5 per barrel, but with a marginal cost of more than $10, will be closely linked to price movements, since reserves will continue to be plentiful.
Gross domestic oil consumption in the European Union should alter four to five times less quickly than world demand since it should be 13.2 million barrels per day (660 million toe) in 2020 as compared with 12 million barrels per day (600 million toe) in 2000. It should be stressed that 93% of that increase would be accounted for by transport. The European Union (2.6 million barrels per day) plus Norway (3 million barrels per day) would produce roughly 6 million barrels per day in 2020 as compared with 7 million barrels per day in 2000.
As regards final oil consumption structure within the European Union (1995: 402 million toe, 2020: 487 million toe) only consumption by transport should undergo a significant increase, moving from 270 million toe in 2000 to 348 million toe in 2020. This sector would thus represent 71% of final demand for oil as compared with 7% for industry, 8% for the tertiary sector and 14% for the residential sector. As far as intermediate oil consumption by the electricity industry (1995: 75 million toe, 2020: 49 million toe) is concerned, fossil-fuel power stations would not consume more, in 2020, than 7% of our supplies. Non-energy consumption (1995: 80 million toe, 2020: 92 million toe) - mainly by petrochemicals - would represent 14% of gross domestic consumption.
2. Key factors to be taken into account
a) The environment
The European Union has set itself a target of reducing greenhouse gases, as covered by the Kyoto Protocol, by 8% as compared with the level reached in 1990, in 2008-2012. In 2010 CO2 emissions caused by oil product consumption will represent more than 50% of overall emissions.
Only the emissions from the transport industry should increase. In 2010 the latter would increase by 35% as compared with their 1990 level if deliberate action were not taken. A greater effort must therefore be made in this sector.
Furthermore the problems in this area are not restricted solely to the matter of CO2 emissions and to climatic change, but also to that of air pollution as a result of other harmful emissions, particularly in an urban environment. Of all of the gaseous pollutants transport is responsible for 12% of SO2 emissions, 69% of nitrogen oxide emissions, 64% of carbon monoxide emissions, 49% of volatile organic compounds (VOC) and 33% of particulates.
Although it is extremely difficult to quantify the externalities linked to transport, it can be noted that the areas calling for action by the public authorities mainly relate to the use of cars in cities and the carriage of freight by road over long distances.
In view of the major effort that will have to be made by this area under the Kyoto Protocol, radical action will have to be taken as regards the choice of transport modes. Those policies will, quite naturally, involve lower consumption of oil products.
b) Security of supply
The European Union's dependence on oil imports is already particularly high since it amounts to 75% this year. It is likely to increase yet further up to the year 2020, and exceed 85%. In 1999 43% of our oil supplies came from OPEC members (30% from Persian-Gulf region).
More than 70% of the world's oil reserves are to be found in OPEC's member states. In 2020 40% of the world's production will come from the Persian-Gulf region.
Recent events taking place on the oil market tend to prove that, even if OPEC is sometimes described as a weak, heterogeneous cartel, centripetal forces are prevailing for the moment. However, the interests and the constraints upon the sovereign States of which it consists are multiple and complex and to a great extent they diverge. Although certain of those Member States are in favour of maximising prices since they have low reserves, a great capacity for absorbing oil revenues, a high degree of production-capacity utilisation or a relatively low GDP, such as Algeria, Venezuela or Iran, others such as Saudi Arabia and other Gulf producers prefer to moderate prices since they have abundant reserves, low absorption capacity and often surplus production capacity: they therefore wish to avoid the emergence of substitute energy forms while at the same time wishing to maintain oil's position on the world energy scene in the medium and long term, together with their market share.
In view of the above it is of course no accident that Venezuela was one of those in favour of cutting production quotas in early 1999, when the price per barrel of crude fluctuated around $10 per barrel, that Iran and Algeria were particularly reluctant to relax the production quotas having been adopted by OPEC in March 2000 and that Saudi Arabia is at the moment discreetly releasing further quantities onto the market in order to dampen down prices.
Although, as regards the future outlook there is no need to fear a physical shortfall in the foreseeable future, one cannot anticipate OPEC's behaviour as a cartel and the political pressures or feelings which may sporadically influence its behaviour. One may, however, pinpoint several factors which are likely to have a decisive effect on price levels, namely the importing country's growth rate, the progress made in curbing demand, the addition of new reserves and the tightening of environmental protection standards. In the longer term, taking account of the concentration of reserves in the OPEC countries, apart from the changes in consumer behaviour and internal wrangling, it is technological developments which will pose the principal threat to OPEC, namely new production technologies in difficult areas, using unconventional oil, and the development of new substitute fuels and the associated technologies, for transport.
Finally, it must also not be forgotten that there is potential for an event - for example political and/or military - in an oil producing or transit region which suddenly disrupts a major proportion of the world's oil supplies. The security stocks and the crisis action as provided for under the aegis of the International Energy Agency and under Community law are the appropriate response to this type of threat: the work in this area must continue.
A Green Paper on the security of supply which should be adopted by the Commission before the end of the year will summarise the medium-term outlook (cf. item III.4).
III. ACTIVITIES ABLE TO BE CONTEMPLATED
1. Relations with the producing countries
Although it is in the long-term interest of both the producing and consuming countries to be able to see which way prices will be moving, it will also be necessary for that price to find its level on a competitive market and not in line with a group of producers' intention to maximise monopoly revenues. No other policy would be of benefit to either the consuming countries, which would be obliged prematurely to step up their investment in substitutes, or to the producing countries, who would see prices stagnate, in the long term this time, owing to curtailed demand for their products. Moreover, it is not in the short-term interests of the producing countries to undermine world growth, which is the potential victim of their current production policy.
Our message to the producing countries should thus be to focus on the world economy's vulnerability as regards any price rises resulting from an irrational approach to natural-resource management at world level and thus on the need, as part of sustainable development, to launch a constructive dialogue with these on better market transparency and operation.
Against this backdrop it would be useful to prepare a genuine thorough-going debate for the next Ecofin Council to be held on 29 September. Preparations for Coreper's expressing an opinion could run parallel to the OPEC meeting. That opinion would again mention the threat to world-wide growth which the current movements in oil prices are posing, and it would stress that the European Union awaited a decision on a substantial increase in production during the forthcoming meetings of OPEC's member States (in Vienna on 10 September for the ministerial meeting and on 27-29 September for the OPEC Summit in Caracas).
2. Competition policy in oil downstream industry (oil refining-distribution)
It is essential to promote a more open, competitive structure in the fuel distribution industry. A critical factor lies in the development of a genuine internal market for refined products (on the wholesale market) enabling all distributors to be supplied easily and competitively, including from other sources than national refiners.
To this end, a systematic comparison of the prices charged for oil products throughout the Member States would be useful in order to identify the disparities.
The Commission will stay in contact with national competition authorities in order to exchange experiences in this field. It will also continue to apply viligantly merger control rules in this sector, as in the BP/Amoco and TotalFina/Elf cases.
3. Utilization of fiscal instruments on oil products
Given the preponderance of taxes in the prices paid by the consumers of automotive fuel (for example, between 53% in Greece and 75% in the United Kingdom on Euro Super 95 petrol) the idea has been raised in certain quarters - and in particular OPEC - of attempting to dampen down consumer price rises in the consumer countries by easing the fiscal pressure.
That idea gives rise to serious objections: it could result in signalling to the producing countries that they may continue to push up crude oil prices without fearing any slackening in demand since the effect of raising crude prices on consumer prices would be offset by lower taxes.
Such an approach would transfer the equivalent of the tax abatement to the producing countries.
Moreover, bearing in mind transport and environmental policies, fuel taxes enable the negative externalities of transport and, in particular, road transport to be compensated if only in part.
However, one must not forget the impact of oil price rises on the hardest-hit professions and in particular on road hauliers. That impact is all the more sensitive since certain SMEs are already in a delicate financial situation. A temporary abatement of fuel tax for those professions could thus be contemplated by some of the Member States. The Commission will have to deliver an opinion on any such excise duty exemptions or reductions.
4. Making Europe's economy less oil-intensive
The oil-intensiveness of Europe's economy, i.e. the relationship between oil consumption and GDP, has already been reduced by a half as compared with 1973 (this in itself means that Europe's economy is less sensitive to the price explosion recently noted as compared with those in 1974 and 1979/80), even though, in the past, that lowering of oil intensity was due rather more to economic factors than to deliberate action by the public authorities.
In the cold light of day, this new expensive oil situation underlines the need to develop a new strategy with the aim of progressive substitution of oil by other sources of energy, increased utilisation of renewable and alternative energies, managing the demand, increase in energy efficiency and the promotion of energy savings. These will have to help, at one and the same time, to protect the environment (more particularly in view of the greenhouse gas problem) and reduce the vulnerability of Europe's economy in terms of outside energy supplies.
In this connection, in the key transport industry, managing fuel demand is also achieved by modifying modal shares, and in particular that for freight via a shift towards, in particular, rail and short-distance sea transport, by restricting the use of "conventional" personal motor cars in city centres and by promoting "clean" forms of urban transport.
These policies form an integral part of the Commission's strategic aims for 2000-2005. These will help to reduce Europe's dependence as regards oil supplies, a dependence causing a fragility that had been forgotten for the last 15 years.
Let us finally mention the matter of the future and the respective situations regarding the various energy sources (oil, coal, gas, nuclear power, renewables). This is covered by a Green Paper that is currently being prepared and is meant to be adopted by the Commission by the end of the year. Basing itself on a factual analysis of the energy situation in the European Union over the next 20 years, the Green Paper will put forward an overall strategy to improve security of internal and external supplies and provide responses to the problem of the Union's growing energy dependence on outside sources against the two-pronged backdrop of a widened Union and the Kyoto commitments.