Change price crude oil

1. Oil price changes:
impact on kazakhstan’s industrialization process
February 20, 2015
OIL PRICE CHANGES:
IMPACT ON KAZAKHSTAN’S INDUSTRIALIZATION PROCESS
Kulseitov A.Zh., Chair of Board of Directors Kazakhstan Industry Development Institute JSC
The activity of Kazakhstan Industry Development Institute JSC is directly related to program
management of the 2-nd five-year industrial plan – a State Program for Industrial Innovative
Development of the Republic of Kazakhstan for 2015-2019 (SPIID). The program was
developed by a consortium of consulting companies. It involved 4 scenarios of industrial
development of Kazakhstan on the basis of 2 strategic conditions: world resource market
environment and integration trends inside macroregion.
Both conditions were positive at the time of program’s approval – the price of oil, the main
export resource of the country, amounted to nearly USD100 per barrel, and the rate of ruble to
dollar floated at 35, that didn’t raise questions with regard to integration processes.
These factors’ standing is well-known today. Adverse effects of their changes have been quite
distinct already: the public raises issues of the lack of budget funds, decline in domestic
economic activity, need for currency devaluation, and protection of internal market from Russian
goods. The economy still stays a resource-based economy; in addition, the oil price is an
exogenous factor that we have no impact on. However, understanding of these changes’ logics
and approximate forecasts for the near future will be the most important basis for taking
decisions on necessary adjustments to SPIID.
It is for these reasons that in early January last year we have proceeded with analysis aimed at
forecasting oil price changes over the short-term (until the end of 2015) and medium term period
(for 2015-2017), and making anticipation survey of their effects on implementation of state
program.
Tentatively we can distinguish two major factors influencing on any market segment: production
and consumption. At the same time, the black gold is being progressively transformed from
purely industrial product to investment instrument. It is suggesting about increasing influence of
the speculative component in pricing.
Oil consumption.
In favorable environment the world oil consumption increases by 1, 2 million barrels per day
annually on average (2004-2007; 2010-2013), and in 2013 it made about 91, 3 million barrels per
day.

2. Oil price changes:
impact on kazakhstan’s industrialization process
Figure 1: The World Oil Consumption Profiles, million barrels per day.
Source: BP Statistical Review of world energy 2014 workbook
The general trend marks an apparent global oil demand growth including effects of recurrent
world economic decline. In order to have a clear understanding of the processes on the oil
market it is relevant to consider a commodity composition of oil consumption in more detail.
About 70% of consumed oil falls to road vehicle fuel (gas, petroleum oil, and diesel).
Figure 2: Structure of oil processing over a period of time, million barrels per day
--- Light distillates (gasoline) --- middle distillates (petroleum oil, diesel)
--- Mazut fuel oil --- Other
Source: BP Statistical Review of world energy 2014 workbook
In this regard, the future development of automobile industry as major fuel user becomes crucial.
On one side, owing to new technology the vehicles become more fuel efficient and
environmentally friendly and electric cars will likely oust them from the market in the future.
But this trend could hardly be recognized as determinant over the medium term as aside from
structural modifications of engines, accumulator units, etc. it will be necessary to build
appropriate infrastructure (charge stations, vehicle service stations, new energy capacities, and
other). Therefore the change will be gradual, and this process will start in the most developed
countries, which demonstrate the trend for motor oil saving anyway.

3. Oil price changes:
impact on kazakhstan’s industrialization process
However in our opinion, the reduced motor fuel demand in the developed countries will be
surpassed by far by the rapidly growing states as China and India. It is related to the growing
automobile demand in these countries. As is seen from Fig. 3, there is curvilinear relation
between per capita GDP on EPC and car density for 1000 persons.
Figure 3: Dependence of income per capita and car density
GDP on EPC, thousand USD, 2012
Source: IMF World Economic Outlook Database October 2014
With increase in per capita GDP up to 20 thousand of USD there is a consumer boom up to about
400 vehicles for 1000 persons takes place. Afterwards, the market reaches saturation point (600-
800 cars regardless of income increase). The survey reports that with increase in per capita
income just only in China and India approximately by 1,5 times as much by 2019 (IMF forecast)
the car density in these countries will increase by 2-2,5 times, that is more than 200 million units.
The calculations show that this very factor with other conditions being equal will trigger for
increase in consumed fuel capacity by 7- 9 million barrels per day by 2020.
Speaking about the remaining 30% of consumption market, the oil and gas industry will continue
its planned development (see Fig. 2) due to objective global increase in population and
substitution of conventional materials at the consuming end (packing, construction materials,
household chemicals, and etc.). This demand will compensate for a gradual reduction of mazut
consumption in energy sector of the developed countries. Thus, if during the period from 1991-
2013 the mazut consumption reduced by 30% or by 3, 8 million barrels per day, then the
petrochemicals increased by 60% or by 7, 7 million barrels per day.
The times series analysis of oil consumption by OECD member countries and non-OECD
member countries has also confirmed a trend for oil consumption increase. As is seen from Fig.
4, while oil consumption in OECD member countries may decrease by 5 million barrels per day,
in non-OECD member countries it will increase by 14,6 million barrels per day, thanks to which

4. Oil price changes:
impact on kazakhstan’s industrialization process
the overall consumption is expected to grow by 2020 by 9,6 million barrels per day or by 10,5%
from 2013.
Fig. 4: Country-based forecast of oil consumption growth until 2020, million barrels per
day
Non-OECD OECD
Source: KIDI JSC
Thus, over the medium term we can predict with certainty a steady growth of oil consumption of
not less than 10-11% by 2020 from the current level. This factor will level up prices.
Oil supply.
If market of oil demand shows a steady growth, then supply market is quite ambiguous.
Traditionally, the ratio of stocks to output was used to forecast price trends. Figure 5 gives a
retrospective view of this index where a curve demonstrates how many years will the developed
recoverable oil reserves last at the current oil production level in each particular year. This index
has risen from 30 to 50 years for the last 30 years. It is connected to forced geological
exploration as well as to new recovery mechanisms. Consequently this factor counts in favor of
weakened trend of price increase over the medium term.
6 Figure 5: Ratio dynamics “Reserves / Output»

5. Oil price changes:
impact on kazakhstan’s industrialization process
----- Reserves/Production
Source: BP Statistical Review of world energy 2014 workbook
However, in our opinion during medium-term and long-term forecasts a thesis on exhaustibility
of mineral resources supported by the majority of experts considerably negates the effect of
positive dynamics of this ratio on oil price fall. This factor will dominate until humankind
transfers to radically new energy sources and material production technology.
So, what should be expected from oil production sector in the future near? To answer this
question we have analyzed the behavior of the major oil producing countries. The largest oil
producers are Saudi Arabia, Russia, and the USA, cumulatively providing about one third of the
world output (Figure 6).
Oil production in Saudi Arabia is being fluctuated from the beginning of 21 c. but increased by
150 thousand barrels per day on the average.
Oil output in Russia had been on the decline upon the breakup of the USSR, but started to rise
after 1999: in 1999-2004 by 650 thousand barrels per day, and its growth rate reduced in 2004-
2013 up to 150 thousand barrels per day.
Oil production in the USA had been smoothly decreasing until 2009, afterwards it had risen: in
2009-2011 by 300 thousand barrel oil per day, and in 2011-2013 by 1, 1 million barrels per day.
Figure 6: Oil production performance by countries, million barrels per day
----- Saudi Arabia ------ Russia ----- the USA
Source: BP Statistical Review of world energy 2014 workbook
Even the superficial analysis demonstrates that the behavior of the US oil producing companies
mostly affected on oil supply market during the last 3-4 years. The US companies were able to
sharply ramp up production after long-term drop, and have already come close to world oil

6. Oil price changes:
impact on kazakhstan’s industrialization process
producing leaders. In total, in 5 years the US companies increased production by 47% - from 6,
8 to 10 million barrels per day.
At that, the Saudi Arabia increased output by 0, 9 million barrels per day in total or by 8% during
the same period. And OPEC’s daily output increased by 0, 5 million barrels or by 1, 5% due to
production decline in Iran, Libya, and Venezuela.
Besides, some facts prove about systemic US government’s stimulation into lower oil production
before 2009 (environment, reserves for future generations, etc.), and also about cardinal change
of policy after 2009 – liberalization of oil export policy, active financing, relaxation in the
environmental requirements for shale oil fields, that have become a main instrument for
production ramp-up in US.
From this point of view, shale revolution is worthy of consideration. What are the prospects for
American shale oil production, and why shale gale is sometimes called a rigged one?
According to data as of 2013, the recoverable reserves of shale oil in the USA makes up 10
billion barrels in total (US Energy Information Administration), and the recovery rate reached as
follows 8 billion barrels per year (over half of the total produced oil in the USA). In other words,
under the present situation of affairs the USA would hardly take a risk of making long-term
plans on supply of US oil market based on shale fields with the reserves suffice for 5 years along
with a problem of highly questionable replacement of reserves.
Figure 7: Oil production profile by types in the USA, million barrels per day.
------- Conventional oil ------- Shale oil
Source: Bloomberg, EIA
It probably needs to give an explanation here. According to BP, the total oil reserves in the US
as of 2013 will last 12 years, but this index remains approximately at the same level during a
long time (from 1980), in other words, exploration of new fields covers annual oil production.

7. Oil price changes:
impact on kazakhstan’s industrialization process
But this model worked in sector of conventional oil recovery, which initially counts on longer
life of the project providing large investments in each deposit with longer life of wells. Long
term process considerably reduces impact of volatility in oil price factor and promotes financial
predictability of new developments.
However, shale oil wells are characterized by short usage period, therefore in order to maintain
production output it would be necessary to launch more new wells. With oil price downturn a
replacement of shale oil reserves would be a problematic matter because inducements to invest
into launching new wells will be not strong, which is confirmed by information about beginning
of mass closure of oil well derricks in the USA. At the same time, production output production
is continued to ramp-up on the remaining fields, which will bring them to earlier exhaustion.
Most of experts tend to believe that recovery on almost all the American shale oil fields is
economically feasible at oil price 70 USD per barrel, and 40% of the fields are not feasible at the
price 60 USD, and almost 90% at price of 50USD.
At the same time, the average cost of conventional oil production fluctuates in the major oil
producing countries: in Saudi Arabia – 25$, OPEC – 40$, Russia – 45$, USA – 50$.
Nevertheless, we encounter a paradoxical situation in which we can observe oil production
increase in the US, leading to fall in oil prices on the market and increase in losses of oil
extracting companies, operating in shale oil segment, and growth of lost profits on conventional
oil fields. Thereby, the world oil production overheating is being sustained.
If the actions of American producers can be hardly explained by purely economic reasons, the
Arab producers taking part in this game are quite pragmatic – they count on market share gains
on the assumption of their reserves and low production cost, but they are not likely to continue
ramp-up production in case of decline in output in the USA.
However further maintaining of growth in supply on account of American oil is possible only
during 6 or at least 12 months (a reserve of shale companies’ financial sustainability). At that,
sustaining the oil price at about 60 USD per barrel will be the main goal of this policy.
The lower price is quite hard to sustain because of speculative market’s striving to earn money
from oil cost increase, and because of fears to provoke a financial crisis on the American market
(damages of American banks and pension funds are variously estimated at $400 billion with oil
price $40 per barrel, and at about $200 billion with oil price $60 per barrel.
Thus, in 2015 we project sustaining the price level at $60-65, that will on one hand not allow
considerable negative effects on the Arab and American economies, and on the other hand will
put economic pressure on the main opponents – Russia, Iran, and Venezuela.
According to EBRD’s estimates, the Russian economy will decline by 5% in 2015 at oil price
rate of $60 per barrel. In addition, simultaneous sanctions and attacks on national currency may
bring to stagflation. Most probably Venezuela and Iran will also suffer heavy economic losses
and face economic slowdown.

8. Oil price changes:
impact on kazakhstan’s industrialization process
At the oil price $60 per barrel and the current production cost, gold and currency reserves in
Venezuela will hardly last a half a year, and in Iran – the reserves will suffice approximately for
one and half year. In this respect Russia is more stable – the reserves suffice for about 6 years,
additionally the war in Ukraine, sanctions and isolation make itself felt.
The reserves in Saudi Arabia make about USD 750 billion, while a budget deficit will make
USD 39 billion at oil price USD 60.
So, one might assume that a sharp decline in oil prices in 2014 was more likely caused by
rigging the market under influence of complex production-economic and geopolitical factors on
account of advance multimove manipulation of speculative market. One more proof of this thesis
is inactivity observed on the front of fighting with ISIL and in other Middle East regions. Any
escalation of tension will bring the prices to over $100 per barrel due to speculative expectations
of traders.
At the same time, the long term holding the prices down will likely bring to explosive
(speculative) price growth (above level of $100 per barrel), which will be fuelled by blowing off
“shale bubble”, and also by minor decline in reserves-to-production ratio (due to current
reduction of investments into oil exploration).
Proceeding from these assumptions we consider allegations of “the high black gold price gone
away forever” as wrong. We will probably already see its triumphant regain in 2016.
Over the medium and long term period the price will likewise have an upward trend related to
expansion in car density in the developing states and growth of petrochemicals consumption.
Even with all things considered we understand that forecast errors are made by the most
influential organizations like Credit Suisse and International Energy Agency. Oil prices
demonstrate exacerbation of volatility connected with growing market hypersensitivity to non-
economic speculative factors.
Therefore this analysis can’t claim a monopoly of absolute truth. The analysis was carried out in
early January 2015 when the prices moved up to USD 45 and the Government of Kazakhstan
had been preparing to take strong measures on sequestration and other anti-crisis actions. Our
main goal was to forecast an oil price range in order to determine measures aimed at adjustment
to SPIID.
On the basis of the performed analysis we have come to a conclusion that in the next year and a
half Kazakhstan will have to take the most radical steps to support industrial development,
economic diversification, improving competitiveness of local processing sector enterprises,
while oil market trends take the most optimal position. Kazakhstan is able to support its program
for industrial development at the settled down oil price (USD 60 per barrel), but it can’t afford as
before to take a relaxed look at ineffective steps and economic policy’s misfocusing.

9. Oil price changes:
impact on kazakhstan’s industrialization process
In other words, at the lowest oil prices Kazakhstan will drastically reduce financing of economic
diversification process, and at the highest price the political and business elite will have no
incentive to make quality changes.