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Deutsche Bank: Oil to hit $175 a barrel by 2016, which “will drive a final stake into long-term oil demand,” spurred by a “disruptive technology” — “the hybrid and electric car, that will very likely have a far greater positive impact on oil efficiency than the market currently expects”

By Joe Romm

"Deutsche Bank: Oil to hit $175 a barrel by 2016, which “will drive a final stake into long-term oil demand,” spurred by a “disruptive technology” — “the hybrid and electric car, that will very likely have a far greater positive impact on oil efficiency than the market currently expects”"

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Deutsche Bank’s important new report, The Peak Oil Market: Price dynamics at the end of the oil age begins with a quote that is one of my pet peeves:

“The Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.”  Sheikh Yamani, Saudi Oil Minister, 1962-1986.

Great quote in a peak oil report except for one tiny point — we still use a lot of stones.  In fact, given that we have 6.7 billion people on the planet, I’m quite certain that we use a lot more stones than we did in the Stone Age.  I’m almost as certain that, as the DB report says, we will be using a lot less total oil in a few decades.  So the quote doesn’t work, and the report, while dead on in many parts, is still a tad off.

SUPPLY:  We expect increasingly chronic under-investment in new oil supply capacity. We believe that concentration of remaining oil reserves into OPEC government hands will lead to under-investment in new supply and higher volatility in regulatory and fiscal regimes, and more volatile pricing. Consumer governments are adding to uncertainty with total lack of clarity on environmental legislation/regulation outcomes. That deep uncertainty in supply and demand will likely disincentivise private sector oil supply investment, exacerbating overall oil under-investment, and leading to peak oil supply within the next six years. We see market maximum capacity at 90mb/d in 2016 – just 5% above 2009….

After a final price peak implied at $175/bbl in 2016….

Hmm.  The price spike sounds right.  But I don’t think the ultimate reason will be inherently chronic underinvestment — there’s simply too much money to be made at projected oil prices for producers.  And I don’t think the reason will be uncertainty surrounding regulation — again, there’s simply too much money to be made of projected oil prices and, over at least the next decade, climate regulations will focus more on coal than oil.

The reason for the price jump is that we’re running out of the easy supply.  That’s certainly the view of all the peakers I know.  And it’s the view of the International Energy Agency (IEA) and its chief economist, Dr. Fatih Birol (see World’s top energy economist warns peak oil threatens recovery, urges immediate action: “We have to leave oil before oil leaves us”):

Dr. Birol said that the public and many governments appeared to be oblivious to the fact that the oil on which modern civilisation depends is running out far faster than previously predicted and that global production is likely to peak in about 10 years – at least a decade earlier than most governments had estimated.

The IEA’s work makes clear that for oil to stay significantly below $200 a barrel (and U.S. gasoline to be significantly below $5 a gallon) by 2020 would take a miracle “” or rather 6 miracles see “Science/IEA: World oil crunch looming? Not if we can find six Saudi Arabias!“  See also “Merrill: Non-OPEC production has likely peaked, oil output could fall by 30 million bpd by 2015,” which noted,

Steep falls in oil production means the world now needed to replace an amount of oil output equivalent to Saudi Arabia’s production every two years, Merrill Lynch said in a research report.

I agree with DB report that hybrids and battery-powered cars are the big game changer (see “Climate and hydrogen car advocate gets almost everything wrong about plug-in cars“):

DEMAND:  We now have a “disruptive technology” in the shape of the hybrid and electric car, that will very likely have a far greater positive impact on oil efficiency than the market currently expects. There are two major issues that lead us to believe that oil demand peaks with lack of available supply within six years:

1. With reasonable assumptions, we find that by 2020 the global average MPG of newly purchased light vehicles will have increased by a bit more than 50% compared to 2009, from roughly 29 mpg to about 44 mpg. The impact will be concentrated in US gasoline, the largest single element of global oil demand (12%), and will be dramatic enough in its own right to cause the peak of global oil demand around 2016. We forecast US gasoline demand to fall to 4.9mb/d – about 46% from its 2009 level – by 2030.

2. Also undermining oil demand is a switch to $30/boe natural gas. Unlike oil, natgas is abundant, accessible, and cheap to develop; huge current price discounts caused by OPEC and under-investment will cause major switching away from oil.

That seems plausible.  Certainly, I have been arguing that natural gas supply appears to be much larger than people realized, and quite separate from petroleum supplies (see “Game Changer Part 1:  There appears to be a lot more natural gas than previously thought“).

But natural gas doesn’t substitute straightforwardly for oil in most applications, whereas it does substitute directly for coal, so I expect most demand growth to go into the electric sector.  Even DB writes (their headline, not mine):

Why no natgas vehicles? A dinosaur invents a meteorite?

Quite simply, our auto team, reflecting auto industry trends, see little significant penetration of natgas vehicles over the forecast period. The infrastructure required is excessively costly and time consuming to construct, the cost of that construction falls to energy supply companies who cannot develop the cars to use it, and the benefits in terms of efficiency are too little to attract consumers. Natgas vehicles are a red herring, in our opinion.

Similarly, electricity doesn’t substitute straightforwardly for oil in most applications.  It can substitute for oil in one or two relatively specific, albeit large, applications — short and perhaps medium-distance transportation.

So these DB conclusions are a bit puzzling:

PRICE DYNAMICS: as oil supply peaks, so oil demand will peak. But the fundamental mismatch in elasticities of supply & demand, time cycles of supply & demand and price mechanics of supply & demand will likely require a final upward price spiral that will serve to break US oil consumption short term, and shift it long term toward greater efficiency. US demand is the key. It is the last market-priced, oil inefficient, major oil consumer. We believe Obama’s environmental agenda, the bankruptcy of the US auto industry, the war in Iraq, and global oil supply challenges have dovetailed to spell the end
of the oil era.

After a final price peak implied at $175/bbl in 2016, we forecast oil prices will be under fundamental long-term downward pressure. This pressure will be potentially exacerbated by a reversal in OPEC strategy, away from supply limits, towards market share gains. We suggest $70/bbl oil in 2030 in a market that has shrunk to around 79mb/d – 8% lower than its current level, and 40% below consensus (IEA/ExxonMobil/NPC) forecasts.

While I think this scenario is possible, it just doesn’t strike me as likely.  The notion “as oil supply peaks, so oil demand will peak” is clever, but I think mostly a tautology.  There simply are far too many uses for oil and far too much growth in the developing world for latent demand to crash as fast as supply — in the absence of a steadily rising price.  I do expect peaks and valleys, with higher highs and higher lows, and the lows could certainly reach current levels again if we had another major economic crash in a decade.  But this forecast seems downright perverse:

DB price

I’d be happy to bet with anybody at DB the price trajectory after 2017 doesn’t look anything like that.

I agree with DB that technology will change the price point at which efficiency and alternative technologies make sense:

Right now hybrids make sense economically when oil is at about $100/bbl, or gasoline at about $2.75.  By 2020, those numbers will fall to $85/bbl, $2.30/gal

And I agree that the elasticity for demand will change as a result of technology in repeated price shocks:

In the future, lower oil prices will not encourage demand

A key conclusion from our estimated elasticities is that the line of demand growth becomes increasingly steep over time, essentially implying that there is increasingly little price elasticity of demand at low prices. This is a fundamental concept related to “disruptive technology,” whereby a move to a superior (more efficient) product is not reversed by the collapse in price of the former product. We believe that hybrid cars will be superior to combustion-only vehicles and consumers will be reluctant to switch back because of price volatility – i.e., they will fear, even if prices are low, that prices will rise again in the future….

The point here is that when the oil market breaks, the downward pressure on prices from a realisation that the market is contracting regardless of price, and abundant undeveloped oil preserves in major oil dependent producer economies, will exert further downward pressure on oil prices as the market contracts.

But hybrids and plug ins still use oil — as do jet planes and lots of other parts of the economy.  I’d love to believe, as DB projects, that new light duty vehicle MPG hits 95 (!) in this country, 106 in China, and 88 globally in 2030.  But that’ll only happen if the whole planet gets very serious about global warming  — which DB tends to dismiss, writing “We believe that CO2 limitations will be too economically challenging to fully progress globally” — not because oil peaks just once more in price and then spends the entire 2020s declining back to current levels.

Let me end, where I began, with our tremendous use of stones even though the stone age is long gone.  DB offers this flawed analogy early on its report:

DB Whale

The problem with this analogy is that kerosene was a terrific, versatile, abundant and direct substitute for whale oil in pretty much every major application.  Neither electricity nor natural gas have that kind of substitutability for oil

Perhaps oil prices won’t hit, say, $300 a barrel (in 2008 dollars), for a long, long time.  But they are far more likely to spend the 2020s well above $100 a barrel than below it.

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12 Responses to Deutsche Bank: Oil to hit $175 a barrel by 2016, which “will drive a final stake into long-term oil demand,” spurred by a “disruptive technology” — “the hybrid and electric car, that will very likely have a far greater positive impact on oil efficiency than the market currently expects”

  1. David B. Benson says:

    The latest issue of Scientific American has an article by Leonardo Maugeri entitled Squeexing More Oil from the Ground. He suggested various advanced technologies which will put off the peak for many decades. I dunno.

    On another topic, surely reformulating methane into butanol isn’t too expensive? Butanol has a greater energy denisty than gasoline and I suppose converting a gaoline ICE to use it is not too difficult?

  2. Bob Wright says:

    Another way of looking at this is “energy return on investment” (EROI). How much fuel energy is derived from the energy used to extract and refine the fuel? Coal might be 80:1, Saudi Crude might be 20:1, tar sands 5:1, corn ethanol 1:1…

    EROI has been dropping for all fossil fuels as we drill deeper for gas and oil, use more tricks like chemicals, water and steam to keep old wells going, and move to poorer coal grades. Some consider 5:1 as the minimum ratio to sustain society. Domestic crude is rapidly becoming useless as a fuel source. The Big Oil execs must get squeamish around the “Drill Baby Drill!” crowd because they know where all this is really going. Please do a thorough blog on this in the near future.

  3. Sasparilla says:

    This was a great article and excellent analysis Joe. I’m with you – we’re going to have serious pain on oil prices for a long time with higher highs and higher lows.

    I seriously doubt, with growing China and India that Oil demand will fall as fast or faster than production (China added a million barrels a day to demand just this year and had no problem increasing auto sales during 2008 and $140/barrel oil). We’re in for a quite a ride “over the barrel” as it were and I think it will destroy much of our global economy as a result of its price increases, as cheap labor won’t outweigh shipping costs (last summer when oil was high, as an example, it became cheaper to source steel here in the US instead of getting it from China).

    Another area of increasing demand not often looked at is the OPEC countries themselves, many have (now) large, fast growing populations who get oil/gasoline at set prices (not market based – and aren’t about to change to market based) and hence are not responsive to increases in world oil prices. Just my $0.02…great article.

  4. Barry says:

    Oil is still cheap at far north of $500 a barrel compared to doing the same task via human labour.

    We are going to burn it all unless we create enough sustainable, cheaper alternatives.

    The EROI is included in the price. And I’m sure people will continue burning oil even at negative EROI because of how portable, powerful and convenient oil products are.

    It is not just oil. We are constantly using far more energy than we need for just about any task just for convenience or status. Disposable batteries have a miserable EROI and a massive cost per unit of energy. Driving a luxury sports car requires many tons of extra fuel and many thousands of extra dollars compared to driving a hybrid.

    Don’t count on EROI or peak pricing to prevent all the conventional and unconventional oil from being turned to co2 and cooking us. We have to create cheaper sustainable alternatives in quantity so we can leave the fossil fuel in the ground.

  5. Greg says:

    I’m glad to see I’m not the only one bugged by Sheikh Yamani’s superficial – and flawed – analogy.

    On that topic, it’s also worth observing that the Bronze Age is still here (for the same reason), as is the Age of Water Power, the Age of Wind Power, and the Age of Steam. All of these things — and animal power, and wood — are used in greater quantities now than ever before.

    This points to another problem with Deutsche Bank’s assumption of a parallel to the transition from whale oil to kerosene. That transition happened when neither whale oil nor kerosene were fundamental to economic activity in the way that oil is now. The truth is that there is no parallel in history for peak oil.

    A better analogy might be along the lines of rebuilding the engines on a jet plane while it is in flight. It can be done, if you work on one engine at a time — so you have to start well before they might fail — and work carefully. So far, there’s little evidence of that happening.

  6. Rhonda Smith says:

    175 dollars a barrel? Makes sense to me. With the inflation and the crashing of the dollar, most of that will be a dollar crashing problem. We are cutting the value of the dollar in half again soon. Bread will be 10 dollars a loaf. If we ruule out some inflation, we can create a of of hydrocarbon liquids from coal at that price.

  7. John McCormick says:

    Joe, thanks for your analysis of this first global crisis followed soon after by hell and high water.

    The former crisis feeds into another on a more personal level.

    Assume Congress gets its act together and the President signs a serious carbon reduction bill. Energy costs rise to reflect the impact of its implementation. Consumers react by complaining about higher electric bills while the utility industry begins an aggressive shift to natural gas and that fuel becomes more expensive. Heating oil costs go into orbit.

    As we pay more for energy and the valule of the dollar continues to diminish and inflation and tax increases put a greater burden on families still in the work force (unemployment will continue to rise)how will homeowners and tenants afford to retrofit their appliances, lamps and HVAC to take advantage of energy savings at a premium cost of goods above the cheapest and least efficient models?

    Clearly, we are approaching a time when a better analogy than Greg’s might apply: we will attempt to build a jet plane while it is in flight.

    I see no way out for consumers without massive and generous federal subsidies to offset the cost of the efficiency premium and assistance to senior citizens, chronic underemployed, etc. to maintain a basic lifestyle. “Dollars for dishwashers” may have to become a permanent federal program.

    John McCormick

  8. Doug Carlson says:

    Wish you’d include a hyperlink to the original source of Deutsche Bank’s report, “The Peak Oil Market: Price dynamics at the end of the oil age.” Have searched, can’t find it. Thanks.

    [JR: It's not online. I got a review copy.]

  9. To the first commenter – that Scientific American article about how there’s plenty of oil was, well, ridiculous. It was written by an economist, not a geologist, and repeated all of the usual talking points used to assail peak oil. His basic argument was that technology will save us because it will open up more oil than ever. That’s not the issue — the issue is that even that new oil will be far more expensive to extract. The easy oil is gone – that’s the lesson of peak oil. The rest is details – hence the divergence of opinion between Deutsche Bank and Joe Romm. I’d tend to believe Romm. I have no idea why anyone believes oil, possibly the most useful fuel ever discovered, will be anything other than extremely valuable until there are practically no uses for it less. Which will be… never?

  10. David Doty says:

    The most disruptive development I’ve heard about for the next 5 years is that cars priced at $3300 are beginning to be bought by poor people in India, China, the Middle East, and Africa.

    Yes, we saw a 15% drop in oil consumption in the U.S. in 2008, but it took the combination of a depression, $140/bbl oil, and general agreement on the need to reduce CO2 emissions. The biggest factor was the depression.

    Yes, hybrids will help increase fuel economy in the U.S. and several other countries – perhaps by 1.5%/year – but that won’t begin to offset the growth in demand in the developing world.

    The IEA is currently predicting 1.7% increase in global oil demand in 2010, even though slow economic growth will continue. That growth rate is likely to continue for 4 to 6 more years. They are also saying currently producing oil fields are being depleted at the average rate of 6.7%/year.

    The gross contribution of biofuels to transport fuels globally in 2008 globally was about 3%, but the net contribution is only about 0.7% because of all the fossil energy used in their production. Cellulosic ethanol is dying even faster than I had predicted, and algal oil will be effectively dead within five years.

    There is currently no technology getting attention that will significantly limit oil price growth below $250/bbl. Fortunately, there is something in the works that will likely begin to get attention when oil gets back above $100/bbl, and that’s synthesizing all types of fuels (gasoline, jet fuel, diesel…) from CO2, H2O, and off-peak wind energy. In principle, it could compete even with oil at $50/bbl with the kind of off-peak grid energy prices seen in regions of high wind energy penetration over the past 6 months (under $15/MWhr). If the oil exporters are worried about future competition, it’s probably Windfuels. They know the facts on hydrogen and biofuels, they understand that future fuels must be carbon neutral, and some have been studying the papers and other detailed materials we’ve published on the DotyEnergy website.

    So yes, there is transformative technology coming, but it’s not coming very fast – mostly because the price of oil has for a brief period fallen off the radar screen.

  11. shannon says:

    $175/barrel I will need to be walking to work or use mass transportation. The law of supply and demand will not let that happen.

  12. Jon Everill says:

    Severe demand destruction even in prosperous nations will
    ensure that oil prices never reach astronomical levels
    for any length of time.
    It is thought that when oil costs in the US reach 4% of GDP
    then the US goes into recession. This level is currently only
    around $80/barrel.