Was 2019 the year of ‘Peak Oil’ ?

On 30/05 Ben van Beurden, CEO of Royal Dutch Shell, said in an interview to Bloomberg: “We do not expect a recovery of oil prices or demand for our products in the medium term”. In an earning call for Shell investors, he elaborated: “We are looking at a major demand destruction that we don't even know will come back”. A week and a half later, BP CEO Bernard Looney was interviewed by the Financial Times. He warned that the impact of coronavirus on crude oil consumption will last well after the pandemic, and that demand may never fully recover.

Although these statements were made by two of the top oil & gas companies in the world, they were largely ignored by the media. This is a bit unusual since they basically indicated 2019 was the year of ‘Peak Oil’. In other words: the time of ‘peak oil’ (which also means the peak of the oil & gas industry) is not in the future, but it has already happened last year.

Peak oil?

Peak oil is the theorized point in time when the maximum rate of extraction of petroleum is reached, after which it is expected to decline. The concept of peak oil is often credited to geologist M. King Hubbert, whose 1956 paper first presented a formal theory.

Most peak oil theories concentrate on depletion of oil resources (or supplies). After all, oil is a finite resource. When current resources are used up and the rate at which new resources are found declines, then alternative sources of energy must be found.

How exact can we expect peak oil theories to be?

Peak oil predictions have mostly failed, since they did not account for technological advances that enable oil extraction from unconventional sources. In accordance with the law of diminishing returns, these resources (like oil sands in Canada and shale oil in the US) are more expensive to produce then conventional oil, but are still viable resources if the price is high enough. Oil sands turned Canada into an oil producing country with one of the largest oil reserves in the world. Shale oil led to energy independence in the US - for the first time in almost 70 years.

However, Over the years, very few peak oil experts have seriously considered the option that Peal-Oil will be caused by a reduction in oil demand.

Zachi Yamani: a different approach

One single expert has expressed a different view on the subject of ‘Peak Oil’. He did so about 40 years before anyone else. Ahmed Zaki Yamani is a Saudi Arabian politician who was Minister of Oil (Petroleum) and Mineral Resources from 1962 to 1986, and a minister in the Organization of the Petroleum Exporting Countries (OPEC) for 25 years.

Ironically, Sheikh Yamani (Sheikh is a common title for an Arab leader or tribal leader) is not an environmentalist or a crusader against global warming. He is one of the most prominent figures in the oil industry of the 20th century. In 1973, he was the man behind the oil embargo on the west, which led to high inflation combined with economic recession in western countries in the 70th and 80th. From this expert’s viewpoint, one can hardly assume it to be a case of wishful thinking.

Where other peak oil predictions concentrated on the supply side, Sheikh Yamani always pointed with caution at the demand side. The 1973 oil embargo caused oil price increases by an astonishing factor of 4. Just to compare: if a liter of oil in the Netherlands costs around 1.5 euro, you can imagine the economic damage of a price increase to 6 euro/liter. Sheikh Yamani feared high prices would push Western countries to develop alternative energy sources.

What about alternative energy resources?

Zachi Yamani’s fears actually Came true. Following the 1973 oil embargo, France and Japan started investing heavily into nuclear power (78% of electricity in France and 30% of electricity in Japan are from nuclear power). Other countries switched from using oil for electricity to using coal. The embargo also prompted the start of the wind power industry (mostly in Denmark). Another result from the embargo was the big effort into the discovery of new oil reserves, which led to the development of the North Sea oil fields. In the end, these combined effects led to an oil oversupply 80th and to low oil prices (and as a side effect, it probably led to the collapse of the Soviet Union which relied heavily on revenues from oil).

Did COVID-19 expedite ‘peak oil’?

Before the outbreak of COVID-19, the predictions by IEA (International Energy Association) indicated global oil demand would keep growing every year and reach its peak in the mid-2020s and level out around 2030. The expected decline in demand would result from new technological developments. According to IEA, some 4 million BPD in global demand will be erased by the influx of electric cars looming over the world of transport. Another 9 million BPD will be eliminated by more fuel-efficient engines.

However, the COVID-19 crisis might change these predictions. The world economy has taken a big hit. Federal reserve chairman Jerome Powell has stated: “We are in the midst of an economic downturn without modern precedent”. Even Warren buffet is selling stock instead of buying. The Oracle from Omaha is famous for his strategy of taking advantage of market crushes by buying stocks on the cheap. Meanwhile, the world’s central banks are throwing money at the problem, but there is only so much that extra cash can do when nobody wants to invest or buy. A world recession (generally defined as negative GDP growth for 2 consecutive quarters) is eminent.

Recession

A typical recession in the US takes about 22 months (I will assume 2.5 years since the coming recession will likely hit harder than previous ones). A U shape recovery would take another 2.5 years before the world economy reaches its 2019 GDP level. That means the economy reaches a GDP level above 2019 will only be in about 5 years from now.

It remains to be seen how the recession will affect the sale of electric cars, but there is one thing it will not change: the rate of technological advancement.

The electric alternative

Electric cars (like renewable energy) are becoming more affordable every year. Even when oil prices are reduced, electric cars are still attractive economically due to lower fuel and maintenance cost as well as the important point they do not emit greenhouse gases. If electric mobility (cars, buses, trains and in the future also ocean vessels and aircrafts) will continue to increase and thus reduce oil demand, then 2019 might well have been the year of peak oil. In a bizarre twist, the 2019 daily oil demand is the round figure of about 100 million oil barrels per day.

What are the implications of peak oil on the oil industry?

The implications of peak oil are extensive. Oil is the most traded commodity in the world (about 30% of all trades) and it comprises about 50% of all goods traded via sea transport. For the oil & gas industry, the biggest problem is for their industry no longer a growing industry but rather an industry in decline.

Don’t get me wrong, oil & gas will not disappear from our world tomorrow. It will probably take 30-50 years to replace all transport modes with other energy sources and some chemicals and materials from oil production (30%-50% of oil produces is not for transportation fuel) will probably still be used long after we are all driving electric cars and heating our homes with heat pumps fed by solar panels. But a market in which demand is decreasing, is a very different market from the one of the past 100 years which only saw oil demands increase.

Diversification in the oil & gas sector

Some O&G companies have taken steps to diversify their products. For example, Shell leads Big Oil in the race to invest in clean energy. Its investments include offshore wind parks and floating wind. Equinor is also investing in offshore wind parks and is the world’s leader in building floating wind parks with the Hywind Scotland project and the coming Hywind Tampen project. Total is investing in onshore wind and solar parks. BP is also investing in renewables, mostly in order to decarbonize its business.

American O&G companies are still resisting changing their ways. Church of England investment manager Edward Mason, sees “a gulf opening between the European supermajors and the American ones”.

Changes in investments and profits

The aforementioned investments may only be a small part of the budgets of O&G companies. However, the larger the company is, the harder a course change is. Profit margins for renewables are smaller than those for oil & gas products, which can lead to difficulties to pay dividends to shareholders.

However, COVID-19 might change this viewpoint on investments and profits. Let’s look at an example from Orsted, previously known as DONG (Danish Oil and Natural Gas). This former O&G giant has divested from all fossil fuel activities and is now one of the world’s leading developers of offshore wind farms. It is expected to post (yet again) successful quarter results with EBITDA of ~$900 million. In comparison, the rest of the fossil fuel industry is expected to lose a Trillion dollars in revenues this year. The contrast could not be bigger.

The recent COVID-related drop in oil prices and the ‘first ever’ negative price resulting from lack of oil storage facilities at the expiry date of some oil future contracts, have made it clear that oil can be a very volatile and unstable business. In comparison, Solar and wind parks have steady prices (usually controlled by PPAs for up to 20-25 years) and have shown resilience during the COVID-19 crisis (as recently stated by the head of BP).

Summary

Despite the inaccuracy of almost all previous peak oil predictions, there is a strong possibility of ‘this time it’s different’. The COVID-19 crisis may well have caused a premature arrival of ‘Peak oil’. Although this point is mostly symbolic and its implication will only be fully understood in the future - as will the implications of COVID-19, this might be a tipping point moment. It is possible that this point will mark the formal decline of fossil fuel use and the general switch to alternative and renewable energy sources, also known as the ‘energy transition’.

Note:

The author of the post is expressing his own opinion. The views in the post are the sole responsibility of the author and do not reflect the views of any past or current employer (or their parent company or affiliates). A reference is made to all external data mentioned in the post. All external data mentioned in the post comes from public sources and does not violate Copyright law. Comments on this post are the sole responsibility of their writers and the writers will take full responsibility and liability.

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