Economic growth
Economic growth plays an important part in influencing the demand for oil and oil products, particularly in developing countries where strong economic growth tends to go hand in hand with increasing demand for oil.

Since the turn of the century, worldwide GDP growth has increased by an average of 4.4 percent per annum. This rate of growth is significantly above the long term trend rate, and represents an average increase of over 1 percent compared with the previous two decades. Strong growth in the Middle East and developing Asia has played an important part in this period of above-average growth.

The forces of globalisation, whereby national economies become more integrated into the international economy through trade, have resulted in this period of economic expansion being one of the most prolonged and synchronised in recent history. And whilst the current focus centres on forecasts of weaker growth or even recession in the US and other developed economies, against a backdrop of the crisis in credit markets, developing Asia and the Middle East continue to exhibit a robust economic performance.The interaction between slowing growth in the developed world and the continued expansion in developing nations will continue to exert significant influence on oil markets.



Crude oil demand
From 2000 to 2007 oil demand grew by 9.3 million barrels per day. To put this growth into context, this equates to the combined 2007 liquids production of Exxon, BP, Total, Chevron and ENI. The bulk of this additional demand came from non-OECD countries, with only 1.2 million barrels per day coming from the developed world. China alone accounted for around 30% of this or 2.8 million barrels per day.

It is evident that the process of industrialisation in China and rising living standards in developing Asia is increasing demand for oil. Based upon the experience of the US, Japan and Korea, there is some way to go before China and India follow the same path as other recently industrialised economies in the region.

Today, China and India consume just over 2 barrels of oil per capita per annum. In the US, consumption is 25 barrels per capita, and in Japan and Korea that figure amounts to 14 and 16 barrels per capita respectively. A mere addition of 5 barrels per capita in China alone, translates into a demand increase of 18 million barrels of oil per day, and would clearly add further pressure to the supply side. Each per barrel increase per capita consumption in India amounts to an increase in demand of 3 million barrels of oil per day.

So whilst there are various analysts forecasting a slowdown of oil demand based upon short term economic trends in the developed world, we believe developing Asia will continue to provide support to oil demand over the medium to long term.

 
Oil supply
Meeting the consumption requirements of an expanding world economy has become even more challenging. New supply additions from non-OPEC countries such as Russia and Brazil are projected to provide only modest short term supply growth. Given the pace of decline witnessed in some of the more mature producing areas such as the United States and North Sea, the medium term outlook for non-OPEC liquids growth looks set to remain relatively flat at best.

This increases the call on OPEC to fill the gap at a time when spare capacity stands at levels around half those seen at the turn of the century. The IEA’s outlook for OPEC spare capacity above, demonstrates the difficulty OPEC faces in parallel with the rest of the industry as producers aim to keep up with demand growth. The ability to sustain investment at levels capable of delivering the capacity expansion required to satisfy growing consumption will remain a challenge for OPEC and non-OPEC producers alike, particularly in today’s environment of tight markets for upstream equipment and services.

The result has been a significant upward pressure in the price of crude oil.


Resource access
Whilst there are still significant resources remaining to be developed, the key is ensuring that this can happen in a timely and orderly manner, within the constraints of the system.

Certainly, recent market price signals are pointing towards an era of relative scarcity and our challenge as a company is to position ourselves, whereby we continue to grow our reserves base and thereby increase our production levels within a climate of strong commodity prices. This will naturally flow through into value creation for our shareholders.

Our greatest challenge is to continue to develop our relationships with stakeholders in the key producing nations as well as prospective new areas, thereby maintaining a balanced portfolio. As a smaller independent company, which can make decisions quickly, we see this as an opportunity.


Cost pressure
Strong commodity prices have driven up company revenue and cash flow. In turn, and particularly since 2004, this has fuelled a surge in upstream investment, as National Oil Companies and International Oil Companies expand their budgets in an effort to increase resource and production levels in response to higher demand and higher prices.

However, the service sector, like the refining sector, has gone through a sustained period of underinvestment in both people and equipment. This dates back to the late 1980’s and 1990’s, driven by a period of low oil prices. In parallel, strong economic growth and particularly growth in developing Asia has driven up demand across almost all raw material markets, many of which are used in the oil industry.

The result has been a period of significant cost inflation within the industry, from drilling costs, to equipment costs, with particular upward pressure on costs of some of the more specialised equipment required for producing hydrocarbons. A lack of skilled people has created further pressure. Lead times for equipment have also lengthened leading to higher project management costs and a number of delays in project completion dates.

Recent research by IHS-CERA tracking a basket of upstream project costs demonstrates how costs have almost doubled since 2005.

Higher prices for services and equipment send a strong signal to add capacity, and there are signs that this is taking place. However, the long lead times required to construct the specialised equipment required, and train skilled people is likely to keep up pressure on costs in the short term.


Margins
Higher project costs have increased average finding and development costs for upstream companies three fold, from USD 5.00 per barrel in 2000 to USD 15.00 per barrel in 2006.

Higher costs coupled with increased technological challenges of developing the marginal barrel (e.g. deepwater or unconventional plays) are exerting pressure on margins.

Whilst absolute margins remain high, margins as a percentage of revenues are being squeezed.

Relatively higher government takes are also putting pressure on margins as contracts with higher government takes in times of higher profitability begin to take effect and governments introduce new measures aimed at taking a greater share of profits.