What Happens When We Hit Peak Oil Demand

Retro Filtered Image Of Heavy Machinery At A Texas Oil Field With Copy Space

Introduction

For years analysts whispered – and eventually yelled – about “peak oil” or the idea that the world would soon see maximum oil production, followed by a continuous decline that would undercut global economic growth among other dire outcomes. But a combination of technological innovation and record-level oil prices proved otherwise. Today the conversation has turned instead to when the oil market is likely to experience “peak demand”.

We’ll set out here to explain what drives this demand trend, what challenges and opportunities this trend creates, and offer some answers to those questions.

Let’s accept as a baseline that current long-term trends in world energy markets will continue, so that somewhere around 2035-2045—if not sooner—we’ll reach and pass peak demand for oil products (and fossil fuels more broadly). The trend will be driven by scientific and technological developments—primarily the efficiencies gained from increased automation and digitalization—as well as the widespread adoption of alternative fuels and renewable power sources. Governments will also contribute as they expand climate-friendly policies.

Over the last decade or so, a series of market shocks—the 2008 financial crisis; the U.S. shale revolution; and the oil price crash of 2014—demonstrated that global oil companies are nothing if not resilient. At the same time, though, markets, investors, governments, and regulators monitor business strategies closer than ever. It’s not likely markets will suddenly become more rational or climate policy more certain.

  • From a policy perspective, IEA experts estimate that if the world adheres to the climate change targets laid out in the Paris Climate Agreement, the share of energy investment in fossil fuels needs to decrease to 40 percent by 2030—a $1.6 trillion cut. In 2017, however, the global share of investment in fossil fuels actually increased (fractionally) to 59 percent.
  • A new study from the Carbon Tracker Initiative seems to back up the IEA. The CTI authors predict that under a business-as-usual scenario the world will require a $4.8 trillion investment in oil, gas, and thermal coal between 2018 and 2025. That investment could be considerably less if governments pass more aggressive policy initiatives that reduce greenhouse gas emissions. If over that time the global average temperature rises 1.75 degrees Celsius, the required fossil fuel investment would drop to just $3.3 trillion. This would put all extra energy industry spending at risk.

So yes, oil companies clearly have a lot on the line, both financially and reputationally. Some small companies have commitments to major pre-existing investments—in some cases intractable commitments to invest or deliver—that could drive them to bankruptcy. But companies with more robust balance sheets and extensive private equity resources have developed a few common strategies that blend diversification, cost-cutting, and slimming their portfolios.

  • Business diversification ranges broadly because oil and gas companies have such different starting points, from scale to geography, resource types, technology access, and reach from upstream to down. For instance, one company might redirect investments to modernize its refineries to stay in line with demand for specific products, and another might choose to shift its focus toward carbon-free energy sources by doubling down on R&D or aggressively pursuing inorganic M&A-based growth.
  • The data on diversification plans is scattered, but it’s also illuminating. For example, CDP research estimates the business diversification budgets of the world’s 24 largest oil companies in 2018 is only 1.3 percent of total capital expenditures. European oil-and-gas majors devote up to seven percent of total capital expenditures to renewable energy generation, which gives them a solid head start over companies from the U.S., China, and Russia. In 2017, industry investment in renewable energy generation more broadly accounted for between one and three percent of total renewable energy investment.
 

Table – Sample Business Diversification Strategies Among the Majors

CompanyRenewable Energy Investments
BP

– Owns 1.4 gigawatts (GW) of American wind power and solar leader Lightsource BP

–  50-50 joint venture with DuPont (DowDuPont) in next-generation renewable fuels

Chevron

– Small investments in projects spanning wind power, solar, and geothermal that can power a combined 113,000 US homes

–  Leader in renewable diesel infrastructure

ExxonMobil

– A $500 million joint venture with Synthetic Genomics to genetically engineer photosynthetic algae to produce renewable crude from sunlight and carbon dioxide

– A $1 billion/year allocation to conduct basic research in low-carbon technologies

Royal Dutch Shell

– A 44% stake in solar developer Silicon Ranch ($217 million), acquiring on-site power generation management company MP2 Energy

–  Investments in Solar Frontier, Tier 1 PV Module Supplier of Japan through 100% investment by subsidiary Showa Shell Sekiyu

–  Green energy division to invest in wind energy

Saudi Aramco– Announced $5 billion investments in renewable energy to set up 10 GW capacity from renewables by 2023
Statoil– Announced $200 million investment in renewables by 2022 through a new fund—Energy Ventures—which will invest in renewable energy startups in form of minority stake
Total SA

– Roughly $160 million investment across 20 startups involved with solid-state lithium ion batteries, microbial fuel factories, and enhanced cellulosic sugar recovery

– Acquired 60% controlling stake in American Solar energy firm Sun Power ($1.4 billion)

– Goal of generating 20% of its business from low-carbon products within 20 years

In the context of the downward trend in global fossil fuel demand, this diversification doesn’t necessarily track with panic or even dwindling growth potential. Companies are simply reorienting supply to meet new market demands. We forecast that growth potential will stay steady in the face of factors driving the drop in demand for oil products.

“Demand for fossil fuels will be rising in the developing world for the next 20-30 years.”

Of course, different regions of the world will experience different effects to different degrees. Factors such as scientific and technical development, the reduction of energy intensity, and the introduction of new technologies are themselves influenced by a number of conditions: the current level of scientific and technological development; economic scale; financial resources to invest in new technology; access to foreign advanced technologies; and the feasibility of introducing new technologies.

For instance, low wages in many developing countries will constrain automation, which itself will help determine growth rates in productivity and income. Low-income developing nations will turn to existing technological solutions to solve social and economic problems. Take the growth in electric vehicles (EV), for instance, which in developed countries comes at the expense of government subsidies. Additionally, EV purchasers mainly represent high-income demographics. Developing countries with low incomes won’t be able to afford significant subsidies, and their income brackets are significantly skewed, which means the most likely scenario for those countries (at least in next 10-20 years) is continued growth of a fleet with traditional internal combustion engines.

This indicates that demand for fossil fuels will be rising in the developing world for the next 20-30 years.

The likely stagnation and eventual reduction in global petroleum demand—and the consequential drop in oil prices—will give an advantage to companies with lower unit-costs for extracting a barrel of oil. This is mostly due to less capital-intensive production conditions as well as the level of operating costs.

Companies can achieve cost optimization a few ways. For instance, they might invest in the development of less capital-intensive deposits, including foreign ones. Companies can also try to keep operating costs consistent with levels after the 2014-2015 oil shock. They might also lobby for economic policies designed to maintain relatively weak national currencies. Further, oil companies can ramp up automation and digitalization processes, which will increase their productivity and efficiency. For example, it’s already technologically possible to automate the installation and assembly of pipes for drilling rigs, as well as install remote control mechanisms in oil fields.

Oil companies can also influence the speed of development in renewables and carbon-free transportation to keep prices low for oil and oil products. To that point, it’s worth noting that alternative energy development slowed significantly when global prices for hydrocarbons dropped. In other words, low oil prices ensure there’s a demand for petroleum products. If companies can influence oil prices, they might even be able to increase that demand.

In order to respond to the challenges ahead, oil companies must constantly monitor a few things: traditional sales markets; innovations in alternative energy and carbon-free transportation; and environmental targets set forth by individual countries and international agreements.

“Major companies have more than enough resources to adapt supply and business strategy to emerging markets such as renewables and natural gas, and many are already taking significant steps to do so.”

Downsides of Energy Transition

The negative effects of the coming energy transition will likely fall on countries that depend heavily on crude oil exporters and who hold extensive securities issued by oil producers.

According to Carbon Tracker, the coming energy transition will affect an array of sectors, not just fossil fuel stocks. Beyond the obvious areas of coal, oil and gas, these include capital goods (such as gas turbines), transport (such as coal ports), and transportation. Directly impacted sectors comprise up to a quarter of equity indices. And looking to the debt markets, we note that fossil fuel and related sectors comprise nearly a quarter of the total corporate bonds followed by Fitch, and a slightly larger share of the bonds covered by Bloomberg.

Conclusion

It seems clear the global demand for fossil fuels will over the coming decades stagnate and, at some point and at some rate, decline. A combo of technological advancements, new climate-friendly government policies, and shifts in pricing and consumer preference will all but guarantee that shift. This isn’t, however, the last gasp for energy companies that trade heavily in oil and oil products. Major companies have more than enough resources to adapt supply and business strategy to emerging markets such as renewables and natural gas, and many are already taking significant steps to do so. “Peak demand” might sound intimidating, but there’s also a well of opportunity to be tapped.

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