The Demand and Supply Cycle of Peak Oil

Much has been written on peak oil – the theory made famous by Hubbert which now bears its name. In 1972, Hubbert made an analysis that people born after 1965 will see the dissipation of oil use in their lifetimes. Hubbert did not see the emergence of China and its voracious oil appetite in the 2000s. Neither did he see the youthful population growth of the Middle East with its exorbitant oil subsidies. Yet, 40 years later the Peak Oil date has been pushed back time after another.

Peak Oil theory tends to parochially delve into the supply aspect. Hubbert based his theory that oil resources are finite and will eventually be depleted according to a famous bell-shaped curve below.

Hubbert peak oil curve

Peak oil advocates highlight that much of the world oil is supplied by giant oil fields – Ghawar (Saudi Arabia), Kirkuk (Iraq), Cantarell (Mexico) and Burgan Greater (Kuwait), which are rapidly aging. No new major oil fields have been discovered in the past decade. Further, Norway, Mexico and UK join a list of countries which oil production profiles follow the Peak Oil ‘curve’.

The author wrote in May 2011 that the hidden hand of economics is the best answer to peak oil. This can entail a demand and supply cycle of energy resources with an ‘affordable energy concept for all¹’ dictated by price as illustrated below:

The hidden hand of economics of Peak Oil

An analysis of trends in the energy sector reveals this hidden cycle at work. There was much public discourse on high oil and gas prices from the mid 2000s that partly arose from high demand in the developing countries. However it is these high prices that have hastened the development of alternative fuels (solar and wind in particular) and the present shale gas revolution. Already, the media has written a lot about about massive shale gas reserves. A massive potential exists too in new technologies eg coal-to-liquids (CTL), gas-to-liquids (GTL) and underground gasification of coal (UGC) that will greatly increase potential fossil fuel reserves.

The CTL and GTL technologies will increase the amount of transportation fuels from the more abundant coal and gas reserves². These technologies will not be economically feasible without the higher price of oil driving the push for innovation and efficiency. UGC in particular will almost triple the amount of coal reserves, converting underground coal reserves underground to liquid fuels. These new technologies will further push ‘Peak Oil’ later to the future.

Perhaps the greatest impediment to peak oil theory is the use of renewable energy – a potential game changer. According to Bloomberg New Finance in 2011, the total investment in renewables globally reached $260b with cumulative investment of $1t over the past 7 years. It surpassed the investment into fossil fuels for the first time. Most of the investments are into solar and wind energy. It is projected that in 3-5 years, the unit costs of electricity production from PV solar will be able to compete with that from fossil fuels. This is mainly due to the deluge of investment in China into the manufacture of solar panels, which lowers its production costs substantially. Already, the most efficient form of generation of electricity from wind energy is able to compete on a cost basis with electricity from fossil fuels generation.

The increasing oil consumption in the Middle East exporting countries may decrease their available volumes for export over the next decade. Increasing consumption was partly due to subsidies which alone cost $13b in Saudi Arabia in 2010.  This fact has not gone unnoticed in Arabian governments which have embarked on ambitious renewable projects recently. For example, Saudi Arabia is increasing its electricity generation mix of solar to 10% by 2020 to a few GW. Other countries like Oman and Abu Dhabi, and Egypt have embarked on similar solar and wind projects. This spurt of growth is all driven by the rising costs of oil and a need for fiscal balance. Even more interestingly, Qatar has not displayed much enthusiasm in investment in renewable generation – perhaps because of the availability of its own abundant gas reserves.

According to the BP World energy outlook 2035, renewable energy will contribute about 8% of world primary energy consumption. This compares with 1.3% in 2010.

If the trajectory of oil prices continues over the next two decades, expect this ratio to be even higher. Market capitalism will eventually dominate in this efficient allocation of resources.

BP share of world primary energy

Footnote:

1. The chief economist of Bp advocated in the recent statistical review that an affordable energy future for the world population is possible.

2. The reserves to production ratios of gas and coal are approximately 60 and 160 years presently, whilst that of oil is 50 years.

A case of déjà vu on oil prices?

Back in July 2008, oil prices slumped dramatically from the 140s to the 40s in a space of 6 months. Whilst not as dramatic, oil prices have fallen for some $20 over the past few weeks but have started to stay up this last week. With the world possibly on the cusp of a recession, it takes a little imagination to compare then and now.

What does the industry say?
With just three months before 2012, most banks have lowered their forecasts of Brent by some $10 to $110-115/bbl. Noteworthy is Citibank calling for a price drop by a further 10-20%. This time round, both the fundamental and speculative factors are at work – albeit differently.

Supply and demand driven
Both OPEC and the IEA have lowered forecasts of oil demand in the OECD countries by an estimated 300 kbbl/day. Whilst this demand is forecast to decrease, the oil demand growth in China and other developing countries is more than enough to make up for it. The growth in the developing countries is expected to reach 1.4 mb/day, topping overall growth forecasts to 1.1 mb/ day in 2011. Back in 2008, overall global demand destruction was about 1 mb/day.
The coming online of Libya and Kuwaiti crude, and supply curb lifts in non OPEC crude in the later part of this year are expected to add some 1 mb/day crude. In all, spare oil capacity is expected to be near 4.5 mb/ day, a level much higher than the 2008s.

Elasticity tug of war? Rangebound prices amid the tightness?

In a scenario of tight fundamentals, the price elasticity¹ of oil is normally driven by its demand elasticity. However, the present scenario sees both supply and demand elasticity of oil playing a part. On one hand, the slower economic growth and increased supplies drive down prices, Yet from a global point of view, global demand continues to grow. It pays to realise that WTI prices in the USA have been some $20 lower than the global brent benchmark consistently. Such lower prices mean no further demand swing destruction in the world largest oil market.

Regulatory landscape change
In an earlier article, the author likened oil prices to be running on gears. Perhaps the oil prices are running on a lower gear now with more regulatory oversight and transparency by the CFTC? Yet aside from higher margins requirement and more transparent reporting, the regulatory landscape has not changed much. The debate to implement position limits on funds/ banks – maybe the most stringent measure has been held back pending further analysis.

Footnote:

1- Notwithstanding supply has been maximised in a tight scenario and there are no more ‘surprises’ from sudden disruptions to existing infrastructure.

Peak Oil – The hidden hand of economics is the answer

Many in the industry have claimed that peak oil will arrive in the middle of next decade, when the voracious demand for oil consumes more than what OPEC and the other oil exporting countries can produce.  By then, oil demand is forecast to reach 100mb/day from the 87 mb/day today. Where is the world going to find the additional bbls of world? Much of the oil in the world is produced from giant fields which produce more than 2mb/day, including the giant Ghawar field in Saudi Arabia.

Saudi Arabia has chosen however to play its cards close to its hand, refusing to comment what its peak production is, although many have speculated these aging fields will soon decline fast enough. For a while, the recent financial crisis has raised concerns about new investments drying up for oil exploration. The recent oil spill in the Gulf of Mexico by bp has also put a moratorium on offshore drilling – a much needed source of oil for USA.  The increased production of renewables (bioethanol and biodiesel) is not projected to make up the deficit.

An interesting fact is that the WTI NYMEX Dec 2018 contract hit $100 in recent trading in anticipation that peak oil will arrive before that. The author begs to differ that peak oil will NOT arrive, at least over the next decade. An analysis into how oil is used will reveal much of it is used for gasoline and diesel ( > 50% ) in motor vehicles.  An industrial revolution in the 1850s saw the switch in use of wood to coal as new designs were made in chimneys and furnaces, hitting the death knell for wood as a fuel. Can the same happen for motor vehicles with the advent of electric cars, hybrids and higher fuel efficiency with the intensive research being done in this area? A shift towards these technologies can potentially reduce demand by up to 10-20 mb/day increasing towards the end of the decade as technology by learning occurs.

If, and that is only if before peak oil occurs or rather perceived to occur, oil prices will rise to make these technologies feasible even earlier, stemming further oil demand and increase in prices.  Otherwise, the rise in oil prices will see vehicle growth come to a standstill and a social revolution occurs with public transportation as the norm. Somehow the hidden hand of economics will adapt and reduce oil demand.

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A day after I wrote this note, Bloomberg came up with the article, ‘Toyota Targets $50,000 Range for Hydrogen-Powered Vehicle to Debut by 2015′
http://www.businessweek.com/news/2010-05-06/toyota-targets-50-000-price-for-first-hydrogen-car-update2-.html
Indeed technology is running with the economics.