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:
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:
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.