Analysts have rarely been so divided on their views of where the oil price is going, writes Geoffrey Styles, Managing Director of independent US-based consultancy GSW Strategy Group. This is because the market is in the grip of a number of contradictory trends. Styles takes a closer look at what they are and how they might play out.
Oil experts are deeply divided in their views on the future of what is still the world’s key commodity. This divergence was on display at the CERA Conference in Houston earlier this month, which brought together industry executives, consultants, media, and government officials from around the world. Although I didn’t attend in person, the organizers provided extensive streaming coverage of keynote talks and interviews with thought leaders.
From OPEC oil ministers and the head of the International Energy Agency, we heard that the world could be headed for another supply crunch within a few years, due to low investment following 2014’s oil-price collapse. I’ve mentioned this concern before.
By contrast, the major oil companies seemed more cautious. Low oil prices caught many of them with big, expensive projects underway–too far along to stop but undermined by prices now far below the assumptions on which they were justified. Cash flow seems to be a higher priority than growth. “Peak demand”, when global oil consumption stops growing and might begin shrinking, could also arrive within ten years or so, at least according to Shell’s CEO, further disrupting markets.
Renewables were discussed frequently, but shale was arguably the star of the segments I watched. Big companies touted their shift toward shale assets that can be brought into production quickly, while independent E&P (exploration and production) companies highlighted both the upside and limitations of focusing on the core, or most productive, cost-effective portions of various shale regions.
Respected voices in the industry–or at least closer to it–have begun to raise the possibility that the shift to renewables and EVs might accelerate, affecting demand sooner than expected
With these large, and to some extent mutually contradictory trends in play, any kind of straight-line extrapolation from current or past conditions of price, supply, or demand seems sure to be swamped by uncertainties. Rather than putting my thumb on the scales for one view or another, my best service just now is improving our understanding of these risks and why they look so uncertain.
On the supply side, the relationship between short-cycle and long-cycle investments is especially interesting and a source of great uncertainty. Short-cycle supply, mainly from shale or “tight oil” wells that can be drilled and brought on-stream quickly and for only a few million dollars each–but that also tail off quickly–was the main factor in the drop from over $100 per barrel to less than $40 just a couple of years ago. It now provides many of the lowest-risk, most attractive opportunities available to the oil and gas industry. Yet the more short-cycle oil is developed, the longer the recovery of long-cycle investment is likely to be delayed, because shale is effectively putting a low ceiling on oil prices and will consume ongoing cash flow to sustain it.
Impending gap
Long-cycle oil, which still accounts for over 90% of global supply, is an entirely different domain. It consists mainly of large conventional oil fields that were developed years ago and continue to pump oil with relatively little continuing investment. It also includes new, big-ticket projects in places like the deep waters of the Gulf of Mexico and offshore Brazil, that add to growth but importantly offset the natural decline rates–often 4%-10% annually–that eat into the output of older oil fields every year.
Hundreds of billions of dollars of planned investment in long-cycle projects was deferred or canceled since 2014. Because such projects take years–sometimes decades–to develop from discovery to production, this investment drought implies a hole in future production. That shortfall hasn’t appeared yet, because projects like BP’s Thunder Horse expansion that were begun when oil was still over $100 are still periodically starting up. The impact of the long-cycle gap might also shrink or vanish entirely if enough short-cycle oil is developed in the meantime.
We might never notice this impending gap, if demand growth slowed sharply from its recent rate of more than 1 million barrels per day per year, or even started to fall. Not so long ago, few could imagine oil demand falling without hitting a wall on supply–so-called “Peak Oil”–but now it’s almost harder to envision oil demand continuing to expand in light of competition from renewables, substitution from electric vehicles, and constraints imposed by climate policies intended to comply with the Paris Agreement.
Only as EV sales ramp up and conventional cars are retired in large numbers would they start to make a serious dent in oil demand
The big uncertainties for these changes are time and scale. The Solar Energy Industries Association (SEIA) forecasts US solar power growing from 42 Gigawatts (GW) last year to nearly 120 GW by the end of 2022. However, that would leave solar generating just 4% of US electricity, even if electricity demand didn’t grow at all in the interim. Nor does solar power compete with oil, except in the few remaining places–mainly in the Middle East–where lots of oil is burned to produced electricity, or when it powers electric cars.
Big jump
With regard to EVs, Tesla’s goal of producing 500,000 cars per year by the end of next year is impressively big. However, even if those Teslas replaced only conventional cars of average fuel economy, all of which were then scrapped–unlikely on both counts–they would reduce US gasoline demand by less than 0.2%. It would take more than six times as many EVs to offset last year’s growth in US gasoline demand of 1.3%. Only as EV sales ramp up and conventional cars are retired in large numbers would they start to make a serious dent in oil demand. How long will it take to reach that point, and how much would a big jump in oil prices within the next few years nudge it along?
Until recently, most of the speculation that the transition away from oil and other fossil fuels could happen faster came from outside the industry. Lately, though, respected voices in the industry–or at least closer to it–have begun to raise the possibility that the shift to renewables and EVs might accelerate, affecting demand sooner than expected.
To be clear, I am still convinced that constraints on how fast capital stock turns over–vehicle fleets, HVAC, factory equipment, etc.–impose a speed limit on any large-scale transition like this. However, careful examination of the last 20 years of oil prices provides ample proof that smaller-scale shifts can have large impacts. From the Asian Economic Crisis of the late 1990s, to the massive price spike of 2006-8, followed by the financial crisis, the Arab Spring, and the shale boom, we can see that supply/demand imbalances of no more than about 2-3 million barrels per day–say 3-4% of production or consumption–were sufficient to drive oil prices as low as $10 and as high as $145 per barrel.
When we combine the big, new trends outlined above with normal uncertainties about the economy and then factor in the extreme sensitivity of oil markets to relatively modest surpluses and shortfalls, predicting the likely path for oil looks very daunting. The factors driving it may be changing, but accurate oil forecasting remains as challenging as ever. That same realization stimulated interest in scenario planning more than 40 years ago, focused on the insights available from considering multiple possible futures, rather than just one.
Editor’s Note
Geoffrey Styles is energy expert, advisor and communicator. He is Managing Director of GSW Strategy Group in Virginia, an energy and environmental strategy consulting firm helping organizations and executives address systems-level policy. This article was first published on his blog Energy Outlook and is republished here with permission.
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Duane Hurne says
I wonder if another development has been factored in: There is also a shift to electrification of mass transit. Bus fleets are changing because of the lower cost of operation, which is dropping. Retired buses are either scrapped or put to use in other mass transit applications lowering the number of individual trips. If you add in the prospect of autonomous driving for both buses and autos, there could be a dramatic shift in car ownership for long trips. On demand use of autonomous vehicles/mass transit because of lower cost and improved convenience may change oil demand, since they are likely to be electrified. I’m also a user of an electric bicycle. It’s an amazing invention that saves an enormous amount of time in traffic for a single auto commuter. Just seems to me there are lots of things coming together to change oil demand. Combine that with the drop in average wages for a sizeable portion of the population, it becomes a perfect storm.
Tilleul says
A regular car is used only 400 hours per year, electric cars are aimed at being autonomous car that will be used continuously instead of sitting in a parking doing nothing.
And don’t forget oil is not all about cars, Proterra is having quite a good time with its electric busses. Considering electric buses offer a leap in quality for the public transportation industry and cheaper costs you will get a shift from individual car ownership to quality public transports too.
Oil will not be destroyed by a single product, it will be destroyed by an industrial ecosystem. Nokia got its value suddenly destroyed because they did not understand Apple and Google were not eating their market share with devices but with a mix of hardware, software and orgware innovations. The oil industry does not realize they are getting destroyed by energy sources but by energy services.
David Drury says
A very good article. I did smile a little at the title, though. To my mind oil prices have been impossible to forecast since the 1970s. Dieter Helm’s recent book “Burn out: the endgame for fossil fuels” has a nice graph to show how the IEA has consistently got oil price forecasts massively wrong – so wrong that it seems they are doing worse than a random guess. And I think there are studies that back this up – none of the forecasters do really any better than a rule that says “whatever oil prices are now, let’s assume they will stay like that forever.”
But I think that what has changed is that in the past there was some consensus of what the story was, even though it subsequently turned out to be wrong. Pre the 2014 price crash it was something like: “oil is a finite resource, we need more and more and it’s getting harder to find, so prices are only going to go up, and the days of sub-$100/bbl oil are gone for good.” And so for investors to say “yes, but let’s be conservative and base our economics on $75/bbl” seemed reasonable and prudent.
Now there are too many possible stories – e.g. (a) $50 oil is here to stay and shale will stabilise the market at that level (the forward curve is consistent with that), or (b) the cut-back in non-OPEC conventional investment will come back and bite us and we are in for $100 oil in a few years (the IEA central case), or (c) shale costs are still coming down, production is still increasing, there is more shale outside the US and oil demand will peak, so prices are only going down from here.
Better stick to roulette – at least you know the odds there!