World GDP: Potential Impacts of High and Low Oil Prices

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Price paths in the IEO2007 high and low world oil price cases are not characterized by disruption but rather represent sustained movements relative to the reference case oil price path. The assumptions behind the oil price cases are that the price changes do not come as a shock and that the central banks of developed countries are able to carry out active monetary policies effectively, because core inflation does not get out of hand and exchange rates do not change from those in the reference case. Further, it is assumed that national fiscal policies do not vary from those in the reference case. If any of these assumptions were changed, the economic projections in the alternative cases would be altered. 

Global Insight, Inc.’s Global Scenario Model was employed to project the alternative paths of world economic growth in the high and low world oil price cases relative to the reference case. The figures below represent percentage differences, over time, in nominal world oil prices (left) and real world GDP (right) in the high and low world oil price cases relative to those in the reference case. In the high price case, oil prices rise steadily to 62 percent above reference case prices within 8 years (2014). Thereafter the difference widens gradually, to 76 percent above reference case prices in 2030. In the low price case, oil prices are 28 percent below reference case prices in 2013, after which the difference widens to 43 percent in 2030. 

Because world oil prices fall proportionately less in the low price case than they rise in the high price case (relative to the reference case), changes in GDP projections in the two price cases relative to those in the reference case are not symmetrical. Also, because most of the deviation from reference case prices in the high and low cases occurs by approximately 2014, differences from the reference case GDP projections are greatest at that point in time, then begin to narrow as the rates at which oil prices change become more similar across the three cases. 

Higher (and lower) oil prices relative to the reference case affect national economies both internally and in their interactions with other nations through exports and imports. In the short term, as higher oil prices feed through the economy and reduce purchasing power, real aggregate expenditures on goods and services decline.^a With aggregate demand for output falling behind aggregate supply, unemployment increases, energy-intensive capital stock begins to become obsolete, and real GDP is lower. 

In oil-importing countries that also have major oil-producing sectors, like the United States, higher oil prices increase the flow of economic resources into oil production activities. At the same time, national expenditures on petroleum imports increase, with negative repercussions for real GDP. Countries wholly dependent on oil imports, like Japan, are forced to spend more for their energy purchases. Oil-importing countries with export-dependent economies, like South Korea, are affected even more severely, as their energy expenditures climb while export revenues fall because worldwide demand is lower. In addition, with higher aggregate prices, interest rates tend to rise. Oil-exporting countries, like Saudi Arabia and Russia, see more revenue from their oil exports, boosting incomes and increasing their demand for goods and services and their real GDP.

Over time, the world economy adjusts back to its long-term (reference case) growth path. In the medium term, increases in unemployment lead to downward adjustments in wages and prices. In developed coun-tries, central banks react by lowering key policy rates, thus boosting interest-sensitive aggregate demand. After 2015, the rebound effects of lower employment costs, lower prices, and lower interest rates outweigh the contractionary effects of higher oil prices, leading to stronger real GDP growth and lower inflation. As aggregate demand increases in the oil-exporting coun-tries with higher oil revenues, their demand for imports grows, increasing the demand for exports from the oil-importing countries. As a result, in 2030, the world economy ends up with almost the same real GDP growth rate and unemployment rate as in the ref-erence case, although the composition and sources of world output, international trade, and capital flows are qualitatively different from those in the reference case.

Real GDP in the high and low world oil price cases deviates from its reference case path for a considerable period of time, but as the world economy adjusts to the higher or lower oil prices, the deviation becomes smaller. Thus, world realGDPin 2030 is approximately the same in the three cases. Using 2006 and 2030 as end points to compute average annual growth rates in world real GDP, the rates in the three cases are approxi-mately the same; however, that calculation does not portray adequately the dynamic movements of the world economy and the extent of the differences across the three cases. The present discounted sum of changes in real GDP over the projection period gives a better indication of net effects on the world economy. The sums of the changes in world GDP from the reference case (discounted at 7 percent) in the low and high price cases over the 2006-2030 period are $2,937 billion and -$4,226 billion, respectively, representing approxi-mately 0.3 percent and -0.4 percent of the sum of dis-counted real GDP in the reference case—taking into account factor displacements, dislocations, and adjust-ments as well as gainers and losers within and across countries.

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China’s Transportation Sector: Recent Developments and Long-Term Projections 

What happens in China in terms of liquids demand can have a substantial impact on world oil markets. China, with a rapidly expanding transportation sector, is the world’s fastest-growing oil consumer. In the past 2 years, China alone accounted for more than 30 percent of the world’s incremental consumption of liquid fuels.^a China’s strong growth in consumption helped to support high world oil prices in 2005 and 2006. 

Transportation use is likely to define much of the growth in China’s liquids consumption. An understanding of potential developments in China’s transportation energy use over the coming decades is important, because it can allow analysts to consider how China’s liquids markets will evolve and their potential impacts on world oil markets. 

Economic growth, rapid urbanization, and the emergence of a modern transportation system all have contributed to the recent increase in China’s liquids consumption. In the IEO2007 reference case, total liquids consumption in China is projected to average 3.5-percent growth annually—higher than the growth rate for any other country in the world—and to reach 32 quadrillion Btu (about 16 million barrels oil equivalent per day) in 2030. In comparison, U.S. liquids consumption grows at an average rate of 1.0 percent per year over the projection period, to more than 52 quadrillion Btu in 2030. China is projected to account for 28 percent of the total increase in world liquids consumption from 2004 to 2030 and for 14 percent of the world’s total consumption in 2030, nearly double its share in 2004. 

In the IEO2007 projections, China’s energy use for transportation grows at a rate that is only about 20 percent less than its GDP growth rate, and the transportation share of its total liquids use increases from 32 percent in 2004 to 47 percent by 2030. Similar trends have characterized other developing economies in the past, both in the west and in Asian countries, including South Korea and Japan. High rates of economic growth in developing economies (particularly if growth is linked to manufacturing) typically require increased transportation services to connect production facilities with raw materials and energy sources, and to transport manufactured goods to consumer markets in growing urban areas. In addition, rising per-capita incomes historically have been associated with rapid increases in personal travel by road and air. 

In China, most of the growth in transportation energy consumption is expected to be for road use (see figure on Transportation Energy use in China by Mode, 2004-2030). Total transportation energy use is projected to increase by more than 11 quadrillion Btu from 2004 to 2030, and road vehicles are projected to account for nearly 70 percent of the increase. Air, rail, and marine transportation modes account for 14, 12, and 5 percent of the projected increase, respectively. Factors affecting the projections for transportation energy use by mode include urbanization and expansion of the middle class, efficiency improvements, consumer preferences, costs, and lag times associated with infrastructure development. 

In the projections by travel mode, China’s energy use for air travel has the highest growth rate, consistently exceeding the growth rate for GDP despite the expectation of significant improvements in fuel efficiency for air travel (see figure on Average Annual Growth in China's GDP and Transportation energy Use by Moder, 2004-2030). Similarly, Boeing Commercial Airplanes has estimated that revenue passenger-miles in China will grow about 20 percent faster than GDP from 2005 to 2025.^b Energy use for rail transportation (both passenger and freight) increases more slowly, at about 75 percent the rate of GDP growth on average from 2004 to 2030.^c 

As China’s per-capita income rises, cars are expected to be the mode of choice for an increasing share of passenger travel, as has been observed in other developing economies. Buses and two- and three-wheeled vehicles, which accounted for 42 percent of road energy use in China in 2004, are projected to decline to a 26-percent share in 2030, while the share represented by cars and light trucks increases from 18 percent in 2004 to 33 percent in 2030 (see figure on China's Energy Use for Road Transportation by Vehicle Type, 2004-2030). 

The projections for road transportation assume that the ongoing development of China’s road infrastructure will keep pace with increases in vehicle use. From 1994 to 2004, the country’s total highway length grew at an average annual rate of 5.3 percent,^d and similar increases will be needed annually from 2004 to 2030. If the pace of infrastructure construction cannot be maintained, China’s transportation energy use could grow more slowly than projected. 

Consumption of all transportation fuels in China (with the exception of coal used in older steam locomotives) increases in the projections (see on China's Transportation Energy Use by Fuel Type, 2004-2030). Total liquids consumption for transportation in 2030 is projected to be 11.2 quadrillion Btu more than the 2004 total. Diesel fuel, gasoline, and jet fuel account for 46 percent, 36 percent, and 14 percent of the increase, respectively; and diesel fuel and gasoline together account for 80 percent of China’s total projected energy use for transportation in 2030. Consumption of diesel fuel is expected to increase more rapidly than gasoline use, however, because it is the primary rail fuel and a major fuel for marine transport, and because diesel-fueled trucks are projected to account for an increasing share of total fuel use by large trucks. Following historical trends, coal use in China’s transportation sector is projected to decline steadily, as diesel locomotives replace older railroad equipment.

^aEnergy Information Administration, International Petroleum Monthly (February 7, 2007), web site www.eia.doe.gov/ipm; and Short-Term Energy Outlook (February 2007), web site www.eia.doe.gov/emeu/steo. 

^bBoeing Commercial Airplanes, Current Market Outlook 2006 (Seattle, WA), p. 24, web site www.boeing.com/commercial/cmo/pdf/ CMO_06.pdf. 

^cThe energy use projection incorporates an estimated 15-percent efficiency improvement over the forecast.

^dNational Bureau of Statistics of China, China Statistical Yearbook 2005 (Beijing, People’s Republic of China: China Statistics Press), web site www.stats.gov.cn/tjsj/ndsj/2005/indexeh.htm.

Reassessing the Potential for Oil Production in Mexico

Projections for Mexico’s crude oil production in IEO2007 are much lower than those in IEO2006. In last year’s outlook, oil production in Mexico was projected to increase steadily, to 5.0 million barrels per day in 2030, despite an anticipated decline in production from the country’s largest oil field, Cantarell (see map).a IEO2007, instead, projects a decline to 3.0 million barrels per day in 2012, followed by a gradual recovery to 3.5 million barrels per day in 2030. The new assessment reflects the anticipated decline in Cantarell production, assumptions about announced projects and recent discoveries, and long-term assumptions about economic motivations and national oil industry policy that better reflect the country’s production potential.

Cantarell is, by far, Mexico’s most important oil field today. In 2004, Cantarell held more than 26 percent of Mexico’s total remaining oil reserves and produced 2.1 million barrels per day, accounting for more than 61 percent of the country’s total crude oil output.b Since its peak production in 2004, Cantarell has been in decline. According to Lui Ramirez Corzo, the former president of Pemex, the Cantarell decline rate is likely to average 14 percent per year from 2007 to 2015, implying that Pemex will have to develop other fields if it is to offset the decline.c

Crude oil production from the KMZ complex—consisting of the Ku, Maloob, and Zaap fields—has been discussed as a possible new source of liquids production. There have been reports that the complex could produce enough crude oil to compensate for the yearly reduction in production from Cantarell.d In 2005, the combined production of the KMZ fields was just 316 thousand barrels per day, or about 16 percent of Cantarell’s production in the same year; however, Pemex has estimated that KMZ could produce 800 thousand barrels per day by 2008. Achieving that goal would require 35-percent annual increases in production from KMZ from 2006 to 2008.

Although increasing crude oil production at KMZ would lessen the degree to which the Cantarell decline affects Mexico’s total output of crude oil over the next few years, total proved ultimately recoverable reserves at the complex are only 21 percent as large as those at Cantarell. Consequently, KMZ production cannot be sustained at the levels necessary to counteract Cantarell’s decline in the long run. If Cantarell does decline at the expected rate, production at the KMZ
complex would have to increase by about 17 percent per year to offset the lost production. Since 1993, when the three major fields at KMZ came on line, annual production increases have averaged 4 percent—significantly less than would be necessary to maintain Mexico’s current level of output. The IEO2007 reference case projects modest growth for KMZ production as a result of nitrogen injection.

The Tabasco state, containing the Jujo and Tecominoacan fields, is also frequently mentioned as an oil producing region with the potential to compensate for some of Cantarell’s decline; however, the two fields have combined proven ultimate recoverable reserves of only 1,690 million barrels, or 11 percent the size of Cantarell. In addition, their production levels have been declining for almost two decades, and in 2005 they produced a combined total of only 72 thousand barrels per day. Pemex has announced plans to increase production from the Jujo and Tecominoacan fields significantly by using nitrogen injection, but even with enhanced recovery, it is unlikely that their output will be sufficient to slow the rate of decline in Mexico’s total crude oil output beyond the short term.

The most promising possibility for offsetting the impact of Cantarell’s decline on the rest of Mexico’s crude oil production is deepwater production in the Gulf of Mexico, where recent discoveries include Chuktah-201, Nab-1, Noxal-1, and Lacach-1 (still under construction). Production levels from the deep water fields will depend on Pemex’s financial ability to implement the technology needed to access them. To date, the deepest production achieved by Pemex has been 3,068 feet. Lacach-1 is planned to reach 3,241 feet.e In the U.S. Gulf of Mexico, however, drilling depths routinely exceed 6,500 feet and can be more than 9,800 feet.

Pemex has been discussing the possibility of service contracts with foreign oil companies that have experience in exploring deepwater reserves, but agreements have yet to be reached. So far, the service agreements offered by Pemex would return set fees to foreign com-panies rather than allowing them to own shares of the oil produced or discovered, because a clause in the Mexican constitution bars foreign investment in the oil industry. Although the clause has allowed Pemex to maintain ownership of all its oil reserves, it also has prevented it from benefiting from technological advances that have allowed other national and major independent oil companies to improve their produc-tion opportunities.

Promising deepwater discoveries in the Gulf are taken into consideration in this year’s assessment of Mexico’s oil production potential; however, the IEO2007 reference case assumes a considerable time lag between the discoveries and the date when Pemex will have the technology necessary to develop the fields effectively, based on assumptions both about the technology and about the financial resources available to exploit the on deepwater exploration from 2000 to 2004, and it estimates that an additional $15 billion will be needed over the next 15 years to continue their development. Other estimates of the necessary capital investment are as high as $10 billion annually.

Financial resource estimates affect not only the IEO-2007 assumptions about Mexico’s deepwater resource development but also the assumptions about Pemex’s general exploration and development programs. Although Pemex increased the amount of funding allocated to exploration and development programs in 2005, it spent only $10.3 billion in 2004 and $10.5 billion in 2005.f By some estimates, Pemex may need to invest as much as $32 billion annually in exploration and development to prevent a sharp decline in oil production.g,h The lack of available funds is largely attributed to the redirection of company profits by the Mexican Congress to support government programs.

Mexico’s Congress annually approves the funding for and taxation of Pemex, incorporating the expenses and revenues into the national budget. Although Pemex typically has shown a net profit before taxes in recent years, the government has not returned sufficient revenues to the company for it to book a net profit after taxes. Between 2001 and 2005, taxes on Pemex operations averaged $3.8 billion more than its pre-tax income. As a result, Pemex has been unable independ- ently to increase investment in exploration. IEO2007 assumes that the trend of heavy taxation and minimal government financial support for expanding Thus, over the period from 2006 to 2015, the reference case projects an annual decline in Mexico’s oil production. After 2015, it is assumed that changes in current oil industry regulations, whether they concern taxation rates or rules about foreign investment in the sector, will be made when the country suffers a significant loss of profits from declining oil production. The current assumptions incorporate several different time lags for the implementation of new investment policies and the impact of increased funding for exploration and development. A 4-year delay, based on the world average, is incorporated into the long-term outlook for production increases after a significant increase in funding for exploration and development funding.

aThe Cantarell complex comprises the Akal, Nohoch, Chac, Akal, Kutz, Ixtoc, and Sihil fields. The largest, Akal, produced 2,079 thou-sand barrels per day or 90 percent of Cantarell’s crude production in 2004.

bI.H.S. Energy database. Unless otherwise noted, all data cited in this text box were obtained or derived from the I.H.S. Energy database.

cA. Harrup, “Pemex CEO Says Cantarell Decline by Average of 14 Percent per Year,” Dow Jones Newswires (November 16, 2006).

dPemex Online, Investor Relations, "Issues Related to the Cantarell Complex," (August 12, 2005), web site http://www.pemex.com/ index.cfm?action=content&sectionID=8&catID=428&subcatID=3679.

ePemex Online, web site www.pemex.com/files/content/dcf_ccw_0609_i_061105.pdf.

fPemex Online, Investor Relations, "Annual Report 2005: Business Highlights," web site www.pemex.com/files/dcf/ Businesshighlights2005.pdf. Assumed conversion rate is $0.09147 per peso.

gA. Harrup, “Pemex CEO Says Cantarell Decline by Average of 14 Percent per Year,” Dow Jones Newswires (November 16, 2006).

hC. Bremer, “Analysis—Mexico Seen Struggling To Stem Oil Output Decline,” World Oil Market Update (January 18, 2007).