Will the Oil Party end sooner then we think?

Mark Blood - Mon, 05 Dec 2016

Back in the mid to late 20th century the popular belief that oil prices would have to rise as supply inevitably declined gained hold in people’s minds and the term Peak Oil was born.

Back then it was assumed that the world’s oil reserves were much more finite and little or no consideration was given as to how this paradigm might alter with technological advancements and the shifting political landscape.

As recently as 2006 the Sustainable Energy Forum (SEF) was sounding alarm bells that crude oil production would peak and then decline posing a major economic concern for New Zealand. The SEF were emboldened to make these claims when reputable organisations such as the International Energy Agency were predicting that Peak Oil would occur sometime between 2013 and 2037. The Association for the Study of Peak Oil, comprising experienced petroleum geologists, went even further and predicted that peak oil production would occur in 2010. Really? 

Advances in drilling and production capability have opened the door to new discoveries in previously inaccessible deep water regions and shale basins. These new discoveries and the shale revolution, which has pushed US oil production to a 40-year high, have ensured plentiful amounts of oil in recent years, even as demand has continued to grow.

Disruptive Trends

Historically people have talked about Peak Oil and that there would always be a market for every molecule of oil produced.

Now disruptive trends, such as electric vehicles, advances in battery storage and governments turning against fossil-fuel usage, have come together with lower global growth expectations. Energy experts are now considering Peak Demand as the more likely outcome.

And that peak demand for oil may come sooner than we think.

According to a new World Energy Council report, titled “World Energy Scenarios 2016 – The Grand Transition”, demand for oil is expected to peak before 2030. This is in stark contrast to historic growth trends and the view of the OPEC cartel. The report suggests fossil fuel usage could fall to as little as 50 per cent of the global primary energy mix in one of the scenarios used, with very differing futures for coal, oil and natural gas.

A 2016 report by McKinsey is also forecasting that demand for oil will peak in 2030 at 100 million barrels a day, from current levels of 94 million barrels. McKinsey says shifting energy sector dynamics will depress energy demand despite an expected increase in the world’s population of around 36 per cent. It has to be said some of its reasoning is rather opaque.

But tellingly, even some oil majors are now beginning to recognise that the oil party may be ending soon. Only last month Shell warned that global oil demand could peak within as little as five years which is an extraordinarily short time frame.

Goodness knows how Shell can be so precise about its judgement on the time scale for peak oil demand. Shell is basing its prediction on the continued rapid advance of renewable energy and other disruptive technologies, such as electric cars, as well as changing political attitudes to fossil fuels.

For example, there is already a move by the German government that has cross-party support, to ban sales of petrol and diesel cars by 2030. If implemented it would likely spread to the rest of the EU and set off an avalanche.

All the main German car makers are racing for the electric car market. They have been joined by the UK’s Jaguar Land-Rover (JRL) marque, which since the launch of the I-Pace - essentially an electric version of the F-Pace - has pledged to make half its cars available with electric propulsion.

It is premium brands like Audi, Mercedes, VW and JRL that are providing the credibility and ‘coolness’ for customers to ditch petrol and diesel and switch to driving zero-emission cars.  

OPEC’S View

From the above commentary it would appear that Peak Demand is not too far away. It might seem surprising then that OPEC members are betting that global oil demand will keep rising way beyond 2030 and that fossil fuels will retain their overwhelming dominance over world energy deep into the 21st century. Let’s look at this view point in more detail to understand why.

OPEC has based its strategic planning on assumptions that the Paris climate accords which recently came into force will largely fail. Although the cartel says it supports COP21 it believes some countries will not meet or even come close to honouring their pledged emission targets and that energy use will continue as before. Their view is bolstered by Donald Trump’s election to the White House and comments he has made such as “global warming is an expensive hoax”.

The group's 2016 World Oil Outlook report released in November estimates that crude demand in the Reference Case (see chart below), will rise by a further 16.4 million barrels per day to more than 109 million by 2040, driven by economic booms in China, India, and emerging economies. It largely dismisses warnings that fast-moving technology for electric vehicles and power storage may soon transform the energy landscape beyond recognition.

Global oil demand: OPEC reference case and other scenarios. (Source: OPEC)

OPEC’s Reference Case predicts it will enjoy the lion's share of the expanding market, with its output of oil increasing by 12.6 million barrels a day, in contrast to plateauing and then falling production from the rest of the world within a decade. It assumes fossil fuels will make up 77 per cent of energy demand in 2040 with renewables accounting for a derisory 4.7 percent. This is a bold forecast and ignores any disruption to its business model.

The report’s long-range forecast shows the Middle East strengthening its position at the centre of the oil industry. It predicts output from US shale and Russian fields will fade, and high-cost drilling in the Arctic and ultra-deep waters is stymied. It further predicts that oil prices will double.

However, OPEC’S report comes at the same time as president-elect Trump vows to ease regulations for drillers and open federal land for exploration. It coincides with a new report by the US Geological Survey that confirms there are vast quantities of exploitable shale oil in the Wolfcamp area of the Permian Basin of West Texas that could rival Saudi Arabia’s giant Ghawar field and ultimately produce 6 million barrels a day at relatively low cost. If exploited this amount of oil would seriously dent OPEC’s view that it will enjoy the lion’s share of an expanding market.

Production from the Permian Basin is causing OPEC severe headaches. (Source: Permianshale.com)

The closest the cartel gets to admitting that peak oil demand may occur sooner as predicted by McKinsey and the World Energy Council is in the B scenario in the above chart which assumes a partial switch to electric cars by 2040.

And New Zealand?

NZ exploration and development for new deposits of hydrocarbons will likely continue for the time bring although at a more subdued pace reflecting the lower oil price. Even in a plateau or declining rate of global oil consumption where Peak Demand has arrived, there will still be an incentive to continue exploration and production activity to maintain reserves at least in the near term.

But a decade or so out from Peak Demand these activities are likely to be more curtailed and focused on selective areas. Frontier deep water will be the main casualty, not only because of the high geological risk but also the finite time available to accommodate the full exploration-appraisal-development-production cycle.

All this ignores the impact of what another disruptive technology would have on demand which could cause it to plummet. For example, both Airbus and Boeing are targeting new engine concepts for the next generation of commercial aircraft. Development of smart energy harvesting, blended hybrid engines and fuel cells to allow zero-emission electric taxiing will drastically reduce the amount of fuel burn.

In its favour, New Zealand’s sedimentary basins are gas prone and the outlook for gas appears brighter than for oil – at least according to McKinsey and the World Energy Council. The negative here is the growing competition from exported US shale gas and the maturation of China’s shale gas industry which will depress prices and stymie domestic development.

Conclusions

No organisation or individual can realistically claim foresight as to exactly when oil demand will peak. All we can be sure of is that there will be a continuing shifting balance between the need for oil to continue to play a significant part of the global energy mix and its eventual replacement by new energy technologies and political dictate.

It would seem that OPEC’s view appears optimistic and that the forecasts of the World Energy Council and McKinsey may be closer to the mark.

The oil markets are our best guide. And let’s not forget that they are also there to make fools of those who try to predict future demand and prices.