The Fuse

IEA Warns Oil Demand Won’t Peak Before 2040, Supply Risks Abound

by Nick Cunningham | November 17, 2016

Royal Dutch Shell made headlines in early November when its CFO Simon Henry said that the company expects oil demand to peak within the next five to fifteen years. That echoes comments from the CEO of Vitol, the world’s largest oil trader, who sees oil demand hitting a peak around 2030. In fact, more and more estimates have emerged within the past year that see oil demand facing long-term decline. They differ on the inflection point, but the growing consensus is that peak oil demand is much closer than we once thought.

In its latest World Energy Outlook (WEO), the IEA says it does not see peak oil demand before 2040 unless governments around the world step up their policy efforts to find alternatives.

The International Energy Agency (IEA) is not so sure, however. In its latest World Energy Outlook (WEO), the Paris-based energy agency says it does not see peak oil demand before 2040 unless governments around the world step up their policy efforts to find alternatives. Even after assuming the international community fully implements the 2015 Paris Climate Accord, which appears to be a long shot, oil demand will continue to grow for at least another two and a half decades. Not only could demand continue to climb steadily in the decades to come, but oil supplies could fall short of what is needed as early as 2020 due to a severe drop off in upstream investment. The IEA urged oil and gas companies to be vigilant about investing today in order to bring supplies on tomorrow. “The era of fossil fuels appears to be far from being over,” the IEA wrote in a statement.

EVs take a bite out of demand

Electric vehicles (EVs) are making rapid progress with increasing sales, but are not yet a panacea for significantly curbing oil demand growth. Battery costs have declined by roughly 65 percent since 2010, and sales have grown briskly, albeit from a low base. Automakers are planning to unveil about 19 new EV models over the next three years, substantially expanding options for consumers. Perhaps the most notable are Tesla’s Model 3, an EV with a range of 215 miles and a price tag of about $35,000, and the Chevy Bolt, which will travel an estimated 238 miles on a single charge and cost slightly more than Tesla’s. There are also many other new EV models that will hit the market soon, as carmakers race to capture a share of the young but fast growing market.

As battery costs continue to decline, EVs could reach price parity with conventional vehicles as soon as the early 2020s, according to Bloomberg New Energy Finance. Battery prices have plunged from $1,000 per kWh in 2010 to just $350/kWh in 2015. Analysts usually peg $150/kWh as the threshold that EVs will need to breach in order to beat conventional vehicles on price, and BNEF believes that is only a few years away. If that is the case, the adoption of EVs could begin to pick up pace, potentially capturing more than a third of the global auto market by 2040. That would displace roughly 13 million barrels per day of oil demand.

In the IEA’s 450 Scenario, EVs could erase 6 mbd of oil demand, but still not enough to force overall peak demand before 2040.

But the IEA is not as optimistic. The agency only sees EVs displacing 1.3 mbd of oil demand by 2040 in its central New Policies scenario, which assumes some level of climate policy going forward but not an all-out effort on behalf of governments around the world. By contrast, in the IEA’s 450 Scenario, which assumes a much more aggressive effort to cut down on greenhouse gas emissions, EVs could erase 6 mbd of oil demand, a more substantial figure, but still not enough to force overall peak demand before 2040.

Demand still rising

Global oil demand surged in 2015 as prices collapsed, fueling a driving boom around the globe. Demand has since slowed a bit, but continues to grow, and the IEA expects that trend to continue over the next few decades, anticipating a growth rate slightly below 1 mbd each year through 2040.

But the source of demand shifts geographically. Fuel efficiency and the adoption of EVs should lead to absolute declines in demand in the U.S., Europe, and Japan, while the IEA also expects the ongoing transition in the Chinese economy away from heavy industry to put a dent in the growth of Chinese oil consumption. The focus of demand shifts from the developed world and China to other fast-growing countries, with a particular emphasis on India. Worldwide oil consumption in the IEA’s main scenario (New Policies) expands by 11 mbd between now and 2040, with India accounting for 6 mbd of that total.

As of now, there are no viable alternatives for petroleum-based fuels and products in aviation, petrochemicals, and long-haul trucking, three sectors that the IEA says will account for all of the growth in oil demand going forward and more than offset declining demand for oil from EVs.

By 2040, due to efficiency, technological innovation and some degree of climate policy, oil demand ends up 13.5 mbd lower than it otherwise would be if today’s policies are left unchanged (the IEA’s so-called Current Policies Scenario). Nevertheless, the IEA warns, demand still grows on an absolute basis under its main outlook, even with greater efficiency and innovation. In the New Policies Scenario, crude oil demand rises from 92.5 mbd in 2015 to 103.5 mbd in 2040. Only in the IEA’s 450 Scenario will oil demand decline over the forecast period, peaking in 2020 at just over 93 mbd. But there is little sign as of yet that the international community will take the radical steps needed for that future to be realized.

One problem for the campaign to displace oil is that there are not alternatives in many sectors in which oil is used. Electric cars can replace the internal combustion engine, but as of now, there are no viable alternatives for petroleum-based fuels and products in aviation, petrochemicals, and long-haul trucking, three sectors that the IEA says will account for all of the growth in oil demand going forward and more than offset declining demand for oil from EVs. Even in the 450 scenario, which includes a dramatic reduction in demand for oil in transport because of widespread adoption of EVs, the IEA believes that demand in the petrochemical sector will be unchanged from the more modest New Policies Scenario. In other words, the IEA does not envision a scenario in which aggressive policies can meaningfully squeeze out oil demand in the petrochemical sector. That is largely true for aviation and freight transit as well.

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Supply crunch in the near-term

“It becomes increasingly unlikely that demand (as projected in our main scenario) and supply can be matched in the early 2020s without the start of a new boom/bust cycle for the industry.”

Even as demand continues to rise, supply might struggle to keep up, at least in the medium term. Oil fields suffer from some level of natural depletion each year, which requires new discoveries and drilling in order to prevent overall output from declining. The world loses the equivalent of one Iraq every two years due to depletion, the IEA says.

The oil industry has not had a problem with meeting demand up until now, with global output rising inexorably for decades. But the collapse of oil prices over the past two years has caused drilling to grind to a halt and investment to dry up. After hitting an all-time high of $780 billion in upstream investment in 2014, global spending fell by $200 billion in 2015 and is expected to fall by another $140 billion this year. That, of course, has serious implications for global oil supplies. In 2015, the volume of new oil discovered around the world dropped to its lowest level since the 1950s—and 2016 looks no better. Similarly, because of ongoing low oil prices and severe cuts to capex, the volume of oil receiving final investment decisions for new drilling plunged to its lowest level in seven decades.

With very few new projects going forward, the industry may run into a shortfall of supply three to five years from now as those deferred projects fail to come online. The IEA warns that if the oil industry keeps investment low for a third consecutive year in 2017, “it becomes increasingly unlikely that demand (as projected in our main scenario) and supply can be matched in the early 2020s without the start of a new boom/bust cycle for the industry.”

 

 

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