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Prepared by


24 November 2016

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The Global Oil Market | A Review Paper Cape Otway Associates

The IEA secretariat has noted that ‘Oil markets have changed enormously since the first oil shock of 1973-
74.’ This paper addresses the question: How have the oil market and institutions evolved since the 1970s and
what new challenges will they face in the coming decades?

This paper has been prepared by Cape Otway Associates in response to a request from the Australian
Government on the need for a comprehensive review of the global oil market, its historical development—
with a particular focus on the past 45 years since the early 1970s—its current status and the outlook for its
future evolution.

The paper is intended to be a public document and aims to present a factual view of the present global oil
market, and of its historical development. Forward-looking views are presented in terms of the
continuation of observed underlying trends that display strong momentum—economic development and
demographics that are driving the shift of oil demand from west to east are a good example—as well as
turning points, historical patterns, the role of market, economic, technological and policy forces, new
developments and areas of uncertainty.

While the paper aims to be fact-based, in places, the implications or challenges arising from these shifts,
including for Australia, for other IEA member countries and for the IEA and other international
institutions are touched upon. Any views expressed in the paper are those of the author and should not be
construed as representing the views of the Department of the Environment and Energy, nor of the
Australian Government.

Cape Otway Associates thanks the many careful reviewers for their feedback, corrections and comments on
earlier drafts. Any remaining errors are those of the author.

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Cape Otway Associates The Global Oil Market | A Review Paper 63

Figure 47 Oil, gas, coal and non-fossil fuel as a share of world primary energy supply, 1965-2015

Source: BP, Statistical Review of World Energy, 2016

Figure 48 Oil share of primary energy in the world, and selected major economies, 1965-2015

Source: BP, Statistical Review of World Energy, 2016. * Asia Pacific here excludes Australia, China, India, and Japan.43

For developing economies the share is much lower than the world average. In China oil has a 19 per cent
share of primary energy, and in India oil has a 28 per cent share: markedly lower than the world average. It

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64 The Global Oil Market | A Review Paper Cape Otway Associates

is remarkable that the oil share in the rest of Asia Pacific is as high as in Japan, and that although the oil
share was not quite as high as Japan in the 1970s, the pattern throughout the over the past half century has
been very similar to Japan.

Asia Pacific countries in the chart include (in descending order of primary energy consumption) South
Korea, Indonesia, Thailand, Taiwan, Malaysia, Singapore, Pakistan, Vietnam, the Philippines, Bangladesh
and Hong Kong, as well as other smaller economies. Collectively, these represent 22 per cent of primary
energy consumption in Asia Pacific.

Oil import dependence is high and growing among Australia’s neighbours in the Asia Pacific region.

3.2. Change and continuity

The history of the industry’s development after World War 2 may be summarised in four phases:

Phase 1: Stability and growth with some signs of trouble—post-war and the early years of OPEC

Phase 2: Conflict and ‘stagflation’—the IEP Treaty and the formation of the IEA

Phase 3: Stability and growth in the ‘New World Order’

Phase 4: The ‘return of history,’ Chinese super-growth, financial crisis and stalled growth

3.2.1. Phase 1: Stability and growth—the early years of OPEC

OPEC was established in 1960 by Saudi Arabia, Iran, Iraq, Qatar and Venezuela. In 1967 there was an
embargo by several Arab countries on oil exports to the United States and the UK and other countries
associated with the Arab-Israeli Six Day War. The embargo was ineffective and short-lived, but in
hindsight presaged the 1973 embargo. United States military involvement in Vietnam was a source of civil
unrest and 1968 saw violence demonstrations in the United States and France. US dollar-gold
convertibility began to be tested, first by France, and then by other countries.44

Nevertheless, the period from 1965-1973 saw stable oil prices accompanied by substantial and accelerating
growth in oil demand. This demand growth was led by post-war America, the post-war reconstruction of
Europe and the re-industrialisation of Japan throughout the latter half of the Bretton Woods era.

In the late 1960s, oil prices actually declined by between 2.7 and 5.6 per cent per annum (averaging 4.0 per
cent) per annum while oil consumption grew by between 6.0 and 8.7 per cent (averaging 7.7 per cent) per
annum. In 1971, the annual average oil price level jumped by more than 19 per cent over the 1970 level.
World oil consumption increased by 6.0 percent, notably below the growth in 1965-70 and 1972. While
barely noticeable in Figure 40, 1971 may be seen as presaging the shocks of 1973-74 and 1979-80.
President Nixon closed the US dollar gold window on 15 August 1971, effectively ending the Bretton
Woods era; at around the same time, the Kuwaiti oil minister is reported to have asked: “What is the point
of producing more oil and selling it for an unguaranteed paper currency? Why produce the oil which is my
bread and butter and strength and exchange it for a sum of money whose value will fall next year by such-
and-such a percent?” (Yergin, 1991, p.595).

The 1960s saw a change in the contractual arrangements between host countries and international oil
companies (IOCs). The contract form that came to be known as a Production Sharing Agreement (PSA)
was first introduced by Indonesia in 1966. Over time, PSAs displaced concession agreements, which had
been the normal approach around the world since at least 1901 in Persia (Bindemann, 1999).

3.2.2. Phase 2: Conflict and ‘stagflation’—the IEP Treaty and the formation of the IEA

The period from 1973-1980 saw a number of significant international events, which had a material effect on
oil markets. These included: the Yom Kippur War and the Arab Oil Embargo in 1973; the formation of the
International Energy Agency in 1974; the Soviet invasion of Afghanistan in 1978; and the Iranian
Revolution and United States Embassy hostage crisis in 1979. The 1973 and 1979 events were
accompanied by steep price increases—five-fold in real terms—constraining demand growth. This occurred in
two steps. In the first step, the annual average oil price in 1974 was 217 per cent higher than in 1973, and
consumption was 1.4 per cent lower. Had consumption growth continued on trend, it would have been
between seven and eight per cent higher. These numbers give an indication of the short-run elasticity of oil

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148 The Global Oil Market | A Review Paper Cape Otway Associates

efficiency. Zunino et al. (2011) apply information theory methods (specifically the permutation entropy and
permutation statistical complexity) to the commodity markets allowing them for efficiency ranking finding silver,
copper and cotton to be the most efficient commodities. Wang et al. (2011) study the gold market and show that the
market becomes more efficient in time especially after 2001. Kim et al. (2011) use the random matrix theory and
network analysis to show that stock and commodity markets are well decoupled except for oil and gold showing signs
of inefficiency.
55 Fattouh and Van Der Linde (2011)
56 As the IEA’s official history notes: ‘High hopes for a constructive producer-consumer dialogue were seen in the
early years of the Agency, leading up to the Conference on International Economic Co-operation (North-South
Conference or CIEC) held in Paris in 1976-1977…it [subsequently] became clear in this period that little could be
expected from the proposed dialogue…’ (Scott, 1995b, p.325). The Agency’s objective in co-operating with non-
Member countries appears in Paragraphs 3-4 of the Preamble to the IEP Agreement where the Members state that
they are ‘DESIRING to promote co-operative relations with oil producing countries and with other oil consuming
countries, including those of the developing world, through a purposeful dialogue, as well as through other forms of
co-operation, to further the opportunities for a better understanding between consumer and producer countries,
MINDFUL of the interests of other oil consuming countries, including those of the developing world…’ (Scott,
1995b, p.327).
57 The US withdrew from Vietnam in 1975, a war that was part of a broader conflict in the Indochina peninsula, and a
chapter in the Cold War between the US and USSR.
In 2015, tensions in East Asia included disputed maritime claims in the South China Sea
58 Claude Duval, Honore Le Leuch, Andre Pertuzio, and Jaqueline Lang Weaver (2009), ‘International Petroleum
Agreements-1: Politics, oil prices steer evolution of deal forms,’ Oil & Gas Journal, 7th September
59 Exxon Corporation, the largest of the world’s ‘super major’ oil companies, with daily production of just under
4 billion boe, has a market capitalisation of about US$380 billion (as of 21 June 2015), currently the third-highest
behind Apple and Microsoft. Exxon (before 1975 under its former name Standard Oil of New Jersey) has been a
component of the Dow Jones Industrial Average US stock market index since 1 October 1928.
60 ‘Swing producer’ is not to be confused with ‘marginal producer’, which has become a common mistake with some
61 Prof Richard S Lindzen, MIT, "Taking Greenhouse Warming Seriously," Energy & Environment, Vol 18, No7+8,
62 Yergin (1991) p.720.
63 Sources: Muggeridge et al (2014), Schlumberger, Enhanced Oil Recovery, accessed 18 August 2016
64 Based on data from MIT, Observatory of Economic Complexity,
65 Quotas exclude natural gas liquids, but the difference is too large to be explained solely by that.
66 ‘Acceptance’ by IEA member countries of OPEC’s decision can be interpreted as either willing acceptance or
unwilling acceptance. ‘Willing acceptance’ would imply that the IEA member countries did not consider that OPEC’s
announced production cuts met the IEA definition of a ‘disruption to oil supply’ or did not consider that the
production cuts would cause ‘economic damage,’ or did not believe that the production cuts would really be
implemented as announced. These conclusions are based on (i) the fact that the announced production cuts were large,
(ii) the observation that they were of long duration, and (iii) the statement that ‘the primary purpose of an IEA
collective action is to mitigate the economic damage associated with a disruption of oil supply ’ (IEA, 2014, Box1.2,
p.20). Alternatively, if IEA member countries did consider that the OPEC production cuts met the IEA definition of a
disruption of oil supply and did risk economic damage, then the decision not to launch a collective action implies the
collective view of the IEA member countries was that it would have been counter-productive to launch an IEA
collective action in response, or that an IEA collective action would have simply been powerless to protect against
economic damage caused by the OPEC production cuts at that time.
67 Bagehot (1873), p.55
68 Bagehot (1873), p.51
69 Bagehot (1873), p.52-53
70 Other perspectives for looking at oil prices include the marginal cost of production, the ‘fiscal breakeven’ (price
required to balance the government’s budget) in key oil producing countries, particularly Saudi Arabia and other
OPEC members, and the market power of OPEC itself and its ability to influence prices.
71 Kilian (2014, p.141ff) describes the state of the art in the field, including three problems with the traditional
modelling approach, and three proposals in the literature for dealing with them, all three of which ‘… involve
major modifications of the baseline DSGE [dynamic stochastic general equilibrium] model of an oil-importing
economy to generate quantitatively important effects of exogenous oil price shocks on domestic real GDP.’
72 While this observation is true for the world as a whole, developing countries and emerging markets tend to go
through a phase of development involving increasing oil intensity of GDP growth. That is, oil demand can grow
faster than GDP. In cases where motorised transport had previously been under-contributing to the economy due to
lack of infrastructure, its growth is an important driver of overall economic growth and increased productivity. China
is a good example of this process. In 1978, China had no highways and 51,700km of railway operational length. By

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1988, China still had only 100km of highways and 56,200km of railways. By 2012, China had 95,600km of highways
and 98,000km of railways. Rail freight had grown to 3 trillion tonne-kilometres by 2012, but road freight had grown
to 18 trillion t-km. In addition to the development of a modern, high speed highway system on a continental scale,
China is also part-way through constructing the world’s largest high speed passenger rail network, and airport
infrastructure to serve a large country with 1.4 billion people. Growth in passenger transport by road, rail and air
shows similar trends to freight transport: enormous growth in rail passenger kilometres, accompanied by a declining
share of rail transport, from 46 per cent in 1990 to 34 per cent by 2008. By 2008, the rail system was already moving
more than 1.5 billion passengers more than 800 billion passenger kilometres, with an average trip length of more than
73 Presidential debate between Gerald Ford and Jimmy Carter, September 23, 1976
74 Carlos Pascual, is nonresident Fellow at the Center on Global Energy Policy at Columbia University, was the
founder of the Energy Resources Bureau in the State Department and served as the State Department’s Special Envoy
for Energy and Coordinator for International Energy Affairs from May 2011 through August 2014. He was
Ambassador to Mexico (2009–2011) and Ukraine (2000–2003), as well as Special Assistant to the President for
Russia, Ukraine, and Eurasia (1998–2000). He is currently Senior Vice President for International Energy at IHS.
75 Early US LNG exports via the Panama Canal are going to markets on the Pacific coast of South America, not to
Asia as originally envisaged when Asian LNG prices were much higher.
76 Last year China lifted part of the veil over its gold reserves, breaking a six-year silence to reveal holdings of 1,658
tonnes as of June 2015 against the previously reported figure of 1,054 tonnes. As of August 2016 it had 1,823 tonnes.
Beijing moved to a market valuation of gold, which, according to latest figures, is worth $70.5bn, although this makes
up only 2.3 per cent of total Chinese international reserves. China’s total official gold holdings are judged to be
sizeably larger. Metal from local mine production is believed to be held in a domestic account separate from the
international gold holdings. The world’s biggest official gold holder is the US, with 8,134 tonnes – more than four
times that of China and more than five times Russia’s 1,499 tonnes – followed by Germany with 3,378 tonnes, the
IMF with 2,814 tonnes, Italy with 2,452 tonnes and France with 2,436 tonnes. (Marsh and Robinson, 2016)
77 For example there is a an ‘inter government Russian-Chinese commission for energy cooperation,’ as described in a
Rosneft press release: involving China’s three largest oil companies:
CNPC, CNOOC and Sinopec. Project co-operation to date includes 20 and 25 year long term contracts for oil supply
to China and joint ventures for hydrocarbon production.
The eastern approach of partnerships between exporting and importing National Oil Companies, led by China
contrasts with the western model under which the US State Department provides diplomatic support for the overseas
commercial activities of leading investor-owned International Oil Companies headquartered in the US, the UK
Foreign and Commonwealth Office plays a similar role with leading UK oil companies, and likewise the French
government and other European governments with their oil international companies.
78 See also research by the Centre for International Finance and Regulation, as cited by Lowe (2014) at:
79 The 2014 data for the value of crude oil (and in brackets total petroleum and hydrocarbon gases) imported by
China, as a proportion of the total value of all imports from each country are as follows—Iran: 76 (77) per cent of
$25.3 billion, Nigeria: 57 (81) per cent of $2.5 billion; Russia: 56 (65) per cent of $39 billion; Kazakhstan: 49 (53) per
cent of $9.9 billion; Turkmenistan: no crude oil, but natural gas is 99 per cent of $8.7 billion. To put these numbers in
perspective, in 2014 China imported $1540 billion of goods, of which crude oil was 13 per cent ($207 billion) and
other hydrocarbons were 3.5 per cent ($55 billion). Data from MIT, Observatory of Economic Complexity,
81 OPEC, ‘About Us’, accessed 18 August, 2016.
82 OPEC, ‘Brief History’, accessed 18 August, 2016.
83 IEA (2015), Joint Ministerial Declaration on the occasion of the 2015 IEA Ministerial meeting expressing the Activation of
Association, November 18, Paris.

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