Energy Markets Do Work, Vitol Group President and Chief Executive Ian Taylor Tells Attendees at International Petroleum Week Conference

LONDON, Feb. 22, 2011 /PRNewswire-USNewswire/ -- The following are remarks by Vitol Group President and Chief Executive Ian Taylor:

Ladies and Gentlemen, thank you very much for the introduction.  It's a real pleasure and an honour to give this speech. A special thanks to Rosneft for their sponsorship of the event.

As I think I am one of the first traders to give this speech I know a few of you will have probably bet on the length of my speech.  I hope you have bet on a short one or otherwise I think you will lose.

Today I want to focus on the changes that are happening in our industry and the responses we are seeing. I want to emphasize my key point that energy markets work and work well despite what can be challenging circumstances and rapid changes.  As we see today on a minute by minute basis, we certainly live in interesting times…

As you can see from my lack of hair, I have been around a long time - I have sold VLCCs of Dubai at 7$/bbl in 1987 and sadly bought VLCCs of Nigerian at 147$/bbl in 2008.  Since then the oil price fell to $35 in December that year and today is above $105. The huge global recession of 2008-09 resulted in the first fall in oil demand in 30 years. It was followed in 2010 by the second largest annual increase in demand in the last 30 years.

A decade ago we were in the middle of a seismic upheaval in the industry. The independent majors were consolidating, driven by a need for greater scale, while national oil companies were expanding outside their borders for the first time.

Despite many changes, wars, hurricanes, increasing environmental pressures, frequent price hikes and collapses – who remembers $10 oil now, but it was a reality during the Asian financial crisis in 1998 – and against a backdrop of population increase and economic growth, the energy sector has constantly met demand with rarely a serious supply shortage.

That's a tribute to the industry. It's a tribute to its dominant can-do mindset. And it's a tribute to the open market system.

As an industry we are always under the spotlight of the politicians and the media. But we have much to be proud of. I've been in this business for 30 years. What impresses me most is the sector's endless capacity to handle every challenge thrown at it.

Provided markets are allowed to work, provided risk exposure is managed properly, provided we're encouraged by governments to introduce new technologies and new ways of doing business, I'm confident our industry can go on meeting growing energy demand to 2030 and well beyond.

But meeting this growing demand will not be easy. For a start, the context keeps changing. If you look back only a decade we operate in quite different circumstances today.

Let me give you a few examples:

• The search for new hydrocarbon resources has taken the industry into ever-riskier places. Deeper waters. More extreme climates. More fragile natural environments. Less predictable political and financial jurisdictions.
• State-controlled hydrocarbon producers want more direct involvement in the business both upstream and downstream.
• Financial players have become major participants in the futures markets
• And the IOCs are re-inventing themselves again, basing their futures squarely on the upstream – exploration and production – at the expense of integration with refining and marketing.  

As examples of this last point:

Shell is divesting downstream, both in retail and refining. At the same time it is focusing spending on new upstream projects having reported falling production in six of the last seven years.

BP is reducing its refining and marketing footprint and shrinking activities where margins are poor or where there is over-capacity. Texas City and Carson are the two latest additions to the refinery "For Sale" list.

The steady, transformation at ExxonMobil away from downstream activities is even more striking. In the past decade we believe Exxon has sold ten refineries, 140 terminals, 40 lube plants and 20,000 retail sites. Nine of the eleven capital projects it completed in 2009-10 were gas-related.

In reaction, the markets are working and new players have moved in to pick up the slack. To give two examples. Ineos now has 60 manufacturing facilities in 13 countries in Europe, Asia and the US and has just entered into a JV with Petrochina.  Valero operates 13 refineries in North America and has become the largest independent refiner on that side of the pond.  

I'm a trader so you would expect to hear a trader's perspective. Our business, too, is experiencing rapid change. Nothing stands still. Traders are, by necessity, at the forefront of change – we adapt to changing circumstances or we fail. Unlike an IOC, we start with a blank sheet of paper each year. Nothing is guaranteed. We have to search ceaselessly for the next deal and the next innovation.

There's more competition from new players. There's greater market transparency and more regulation. There are new arbitrage plays. And we're all taking selective positions on real assets and moving into new markets.

Allow me to briefly mention my company, Vitol. We are, first and foremost, a physical trading company. We ship nearly 400 million tonnes of crude and product a year. We identify imbalances between supply and demand and act quickly to restore equilibrium, around the world.

Our strength lies in anticipating and reacting to change. We don't take unnecessary risks. We're not speculators on absolute price movements. It may surprise some of you to learn that we actually prefer lower, rather than higher prices.  High and rising prices increase dramatically our working capital requirements and result in ever greater margin calls.  Both of which are not good for your cash flow.

Right now, like others in our sector, we're investing selectively further along the supply chain, recently focusing on some downstream operations.

Last Saturday we announced the acquisition of Shell's downstream businesses in 14 African countries. They will continue to display the Shell brand. But in partnership with an African Investment firm, Helios and with Shell retaining some equity, we will run them, invest in them and grow them, in a region that shows strong growth prospects.

We're also creating an aviation fuel supply business called Vitol Aviation. We're helping to lead international efforts to monetise carbon assets. We have a global network of oil and gas terminals. And we're growing our E&P interests in Ghana and Cameroon.

We are playing our part in the rapid and extensive re-shaping of the global energy business - perhaps the single most defining characteristic of our industry today.

The underlying pressures driving this renewal are well enough known.

Population growth – an additional 80 million new customers for commercial energy each year. Rising energy consumption - especially in emerging economies which now account for close to half of global demand. Worrying issues around climate change. Resource nationalism. And anxieties about energy security.

Should we as an industry be overly concerned about the future given these pressures?

The line between confidence and smugness is a fine one. Yet the reality is that time and again our sector has demonstrated its ability to rise to a new challenge. I think it will do so again.

The last decade was characterized by tightness along the whole energy supply chain but we have currently moved into a period of surplus. OPEC has an estimated six million barrels a day of spare capacity. Iraq's capacity is growing fast, with huge reserves. There are surpluses in the tanker business.   Even LNG terminals are in surplus. But these surpluses appear to us to be cyclical rather than chronic. Indeed there are already some signs that some of the surplus in the refining industry is receding.

What is clear is that markets have worked; price does its job. High prices have led to plentiful supply and are making some fuels more economic. New sources of energy are being discovered including recent material discoveries offshore Brazil and Ghana.  Here we are proud to be involved in the marketing of the new Jubilee crude.

Shale gas is another example.  Since 2008 Shale gas production in the USA has increased from 5MM cubic feet/day to over 15MM cubic feet/day and by 2015 is projected to be a third of lower 48 production.  By 2020 Shale oil could make North Dakota more important to US energy security than Alaska.

New markets are appearing. LNG is becoming a liquid market. Vitol is already selling LNG to many customers worldwide, sourcing supply from multiple locations. A growing spot market will emerge.

New technologies will continue to be pivotal. Power generation will account for some 60 per cent of the growth in global energy demand to 2030. Finding how to improve power generation efficiency must be one of the main prizes on offer to the industry today. Another is finding the best way to create a lower carbon future by deploying new technologies at scale, such as carbon capture and storage.

In terms of demand, the Chinese –the key driver of global demand increase in the last decade - are diversifying their energy mix rapidly. Much greater reliance is being placed on renewables, nuclear and domestic coal options. In the medium term this will ease pressures on oil and gas supplies.

But that is enough of these longer term and structural issues. Given my background, you may want to hear something about oil prices.

Right now we believe that global economic conditions are positive.  Energy demand is robust, mainly in the emerging economies.  Stocks, though declining, are at comfortable levels. And OPEC so far shows no inclination to increase production.

There is huge and unexpected political uncertainty in most parts of North Africa and the Middle East and this can be expected to support prices. And we know that there is significant passive fund money invested in all commodities and probably more to come. So in our view further price rises are possible in the short term. But if OPEC put more barrels on the market, prices should stabilise in the $90-100 range or even fall back a bit further.

We all know predicting oil prices is a fool's game. And the inflow of financial funds to oil markets in the past five or six years has made that even more the case. Vitol does not trade the flat price of oil; the risk and volatility in oil prices means that we hedge all of our physical trade. To do this we need to use futures and derivatives markets – without these we would not be able to ensure that oil moves around the world efficiently. We are therefore concerned that some of the possible regulatory changes that are being considered will severely hamper the industry's ability to trade and deliver energy.

We recognise that high prices hurt consumers and economies. We welcome regulation that may prevent some of the larger swings in prices that we have seen. But regulators need to be clear about where the problem comes from. It does not come from those of us in the physical markets since we are by definition short in derivatives markets.  Not wishing to point fingers but oil stocks are higher today than five or ten years ago while oil prices are five times as high.  The difference to me seems to be the long only financial money sitting on the futures exchanges and that needs to be better understood. Its difficult to get a pure number for energy only, but we estimate that financial investments in all commodities have increased from a small amount to over $350 billion in the last 10 years.

Finally I want to say a little about the relative price of WTI.  A WTI/Brent spread today of around $11/bbl falls very firmly in the camp of a development that none of us would have believed two years ago.  But the spread is for us entirely understandable; it is the simple result of supply being greater than demand but with no mechanism to allow demand to increase. The logistical constraints restrict how much oil can be moved out of the price setting region. It may take many months before any logistical changes can be made that will allow demand for WTI to increase to meet supply.

But while the price action can be understood it nonetheless raises significant issues for our industry. There are essentially only three crude oil price benchmarks in the world and one of them is currently compromised. In the short term it means that the more reliable Brent futures contract will take centre stage but longer term an alternative to WTI will be needed as Brent is also a small volume crude.  Perhaps now is the right time for major oil producers to consider using the DME contract to set prices and to allow the industry to develop the new risk management tools it will need in the future to manage the many challenges that will undoubtedly face.  Then we would have a futures contract backed by the world's largest source of crude oil at 20 million b/d and rising.

Forty years ago the first microprocessor was invented and North sea oil production began in Norway. Since then the world's population has doubled, global GDP has risen by more than threefold and energy consumption increased two and a half times. Yet we coped. As an industry we rose to the challenge.

Markets worked.

Today we face new challenges. Our industry is needed as never before. Energy remains the driver of economic progress for all nations. I firmly believe that we, the industry, will continue to rise to these challenges based on the adaptability, creativity and performance-driven mentality that have been enduring characteristics of our sector.

Thank you for listening and have a great week.

SOURCE Vitol Group