You know the old adage, it takes two to tango. In the global oil market, this means the dance between supply and demand. As analysts and commentators analyzed the recent OPEC agreement to cut global production by 1.2 million barrels per day (Mbd), supply-side dynamics captured the limelight of intrigue.
But should supply always steal the show?
Over the past decade, global oil consumption has been the consistent through-line that drives the world’s thirst for new supply. This year, world oil demand is expected to average over 100 Mbd, a symbolic benchmark that is more than 13 Mbd higher than it was a decade earlier. The Asia Pacific region represents most of this consumption increase, accounting for more than seven out of every 10 new barrels of demand since 2008. This increase is not only enormous, on a per-barrel basis it is also the fastest rate of oil demand growth in history.
Against this backdrop, the International Energy Agency (IEA) last month released the World Energy Outlook (WEO). The WEO provides in-depth scenarios of future oil supply and demand, regional trends, and sector-specific growth. According to IEA, in two out of three scenarios, global oil demand does not peak before 2040. IEA’s New Policies Scenario (NPS), which incorporates “the likely effects of announced [government] policies” projects an 11.5 Mbd increase in global oil consumption to 106.3 Mbd in 2040. Through 2025, global oil demand will rise 1.0 Mbd and then slow to 0.25 Mbd thereafter because of China’s vehicle electrification policies and increased efficiencies in advanced economies’ vehicle gasoline demand. After 2025, IEA says, India and the Middle East take the mantle of global oil demand growth leaders.
The rise in global oil demand seen in IEA’s New Policies Scenario rest on several meaningful and interrelated dynamics. One is that oil demand in the aviation/shipping and petrochemical industries will rise faster than road transport through 2040. Since the availability of current substitutes and technologies are limited for aircraft and ships, and the plastics demand of developing economies is expected to grow markedly, IEA sees the aviation/shipping and petrochemical sectors as being more significant contributors to future oil demand growth than road transport. In OECD countries, IEA says higher rates of recycling will also displace new petrochemical demand.
Another dynamic is the world’s commitment to the 2015 Paris Climate Agreement. So far, the governments of many nations have indicated their sincere desire to achieve the agreement’s steep fuel demand reductions. As two leading contributors of future oil demand growth, China and India have each announced plans to transition their transportation fleets to electric vehicles by investing in infrastructure and supporting battery electric research and development. However, it is possible, and even likely, that the middle-road New Policies Scenario discussed above will be wrong. IEA does not, after all, issue forecasts per se, but scenarios based on current trends and policies. (If this sounds familiar it is because it is similar to the U.S. EIA’s approach with energy outlooks). If they are wrong, the consequences for global oil demand can be dramatic with either upside or downside risk.
On the one hand, IEA’s Sustainable Development Scenario (SDS) provides a glimpse of a world that fully commits to achieving international environmental, energy, and air quality goals. Rather than rising to 106 Mbd, oil demand peaks before 2030 due to the coordinated execution of fuel efficiency, renewable energy, and fuel-switching policies that promote road transportation alternatives like CNG/LNG trucks and electric vehicles. Demand only rises in sub-Saharan Africa through 2040, IEA writes. The result is world oil demand just under 70 Mbd in 2040. Including biofuels, which account for just under 10 percent of global liquids demand, the world consumes 77.2 Mbd in this scenario, equivalent to the global oil consumption of the early 2000s.
On the other hand, IEA’s Current Policies Scenario (CPS) envisions a world where the status quo does not change. Existing policies enshrined into law today are carried through into the future. This scenario yields an additional 14.2 Mbd of global oil demand growth to 120.5 Mbd in 2040. Europe continues to reduce demand through current policy that substitutes alternative fuels for gasoline and other motor fuels, while fuel demand in Africa, Asia, and the Middle East increases dramatically. Without policies that effectively curtail oil demand, consumption in these regions rise with the anticipated increases in gross domestic product and population, among other factors.
IEA’s scenarios reveal the long-term uncertainties brought about by future demand expectations. As one consequence of future demand expectations, oil prices vary across the three scenarios from the low-point SDS at $64 per barrel in 2040, mid-point NPS at $112 per barrel, and high-point CPS at $137 per barrel. Differences in demand also alter OPEC’s market share, which is lower in the SDS at 42.8 percent and higher in the CPS due to different assumptions about prices and demand for its crude.
The IEA does not weigh WEO’s scenarios according to likelihood; they are exactly as the IEA describes them—scenarios. In a volatile world, any unanticipated event could, and realistically will over the next two decades shift the demand trajectories to the upside or downside. Certainly, IEA has been wrong in the past and the agency will continue to be wrong in the future. A popular uprising in China or more stringent international climate agreement would move the needle toward or away from a world that has more or less demand for OPEC’s oil and pays higher or lower prices for crude. Over the long term, these changes will represent threats to U.S. economic and national security that are arguably as important as supply-side developments. The only real control the United States has is to pursue policies that achieve even greater reductions in oil demand.