The Fuse

The Return of “Peak Demand?” What the Future May Hold for Global Oil

by Gregory Brew | February 04, 2020

The outbreak of coronavirus has reignited the conversation around global oil demand.

On February 3, China warned that the virus would cut national demand by 3 million barrels per day (Mbd), spurring an emergency meeting of Saudi Arabia and Russia, the two major non-U.S. oil exporters.

On February 4, OPEC+ announced it would consider cutting production by an additional 500,000 barrels per day.

Markets, which had crashed all day February 3, were relieved. Prices stabilized in the low-$50s, having fallen by 20 percent since December. But BP has warned that the virus could hit global demand growth by 40 percent in 2020, cutting 300,000-500,000 barrels per day from markets.

Near-term problems have brought back concerns about the long-term viability of oil and gas.

Concerns over coronavirus come hot on the heels of the majors’ fourth-quarter earnings reports, which disappointed. BP’s profits fell from $12.7 billion to $10 billion in 2019. ExxonMobil reported profits of $5.7 billion, posting a 66 percent drop from the previous year. Jim Cramer of CNBC declared “fossil fuels are done,” citing divestment from institutional investors and malaise in the energy sector.

“We’re in the death knell phase,” said Cramer.

Near-term problems have brought back concerns about the long-term viability of oil and gas. “Peak demand,” a buzz-word a few years ago, has re-entered the debate, amid falling profits, stagnant prices, rising bankruptcy rates in the U.S. shale patch and the tepid performance of the Saudi Aramco IPO.

The conversation around “peak demand” has shifted since 2017-2018, when persistent low prices produced a discourse centered on the question of when demand would begin to slow. A variety of factors have affected this discussion: the rise of electric vehicles (EVs), slowing economic growth in the developing world, climate change and increased government regulation designed to cut carbon emissions.

As far as knowing when peak demand will hit, it depends on who you ask. The IEA predicts global demand will plateau around 2030, based on current trends in the transportation sector. In 2016, Shell predicted peak demand could come in the early 2020s. It’s a guess which has motivated Shell’s strategy of moving away from crude towards gas and gas.

According to a summary produced by BP in July 2019, most predictions have demand leveling off in the mid-2030s.

But as BP’s figures highlight, the issue of peak demand is tightly linked to the price and relative abundance of petroleum. Persistent high prices caused gasoline demand and oil consumption in the United States to peak in the mid-2000s, before falling sharply in the wake of the 2008 financial crisis.

After falling for several years, demand for gasoline and crude consumption picked back up in 2013, and have risen steadily ever since. “Peak demand” was a temporary phenomenon.

And it’s happened before. In the early 1970s, economists worried that demand growth—which had risen rapidly after 1945—would cause prices to climb to unmanageable levels. OPEC used the squeezed supply-demand balance to jack up prices 400 percent in the 1970s. But high prices, along with stagflation in the OECD economies, caused demand to level off in the 1980s, before another period of low prices picked it back up between 1986 and 2005.

The assumption that the world may one day run out of oil is no longer guiding expectations.

“The real significance of peak oil demand,” concludes BP, “is that it signals a shift in paradigm from an age of (perceived) scarcity to an age of abundance.” Low-cost producers, therefore, have a strong incentive to maximize output and squeeze out high-cost competitors, who may never get their oil to market. The assumption that the world may one day run out of oil is no longer guiding expectations. Instead, there may be billions of barrels locked away in the earth for want of a market.

The wrinkle for low-cost producers—the OPEC states and Russia, primarily—is the social cost of oil production. While the cost of production can be as low as $10/barrel, producers need higher prices to sustain their economies. Anticipating slower demand and lower-for-longer prices is the chief reason why Saudi Arabia, the most prolific low-cost producer, is attempting to move its economy away from dependence on fossil fuel exports. Peak demand may never come, but persistent abundance is already having an impact on the way major producers manage their resources.

The unknown variable is climate change. The most pessimistic models estimate major economic upheavals over the next 100 years due to the effects of a changing climate, including sea-water rise, coastal flooding, drought, famine, population dislocation, and desertification. Attempts to mitigate these effects will also play a role in measuring future oil demand.

What can we expect in the short term? Right now, the EIA expects demand to grow by 1.3 Mbd in 2020 and 1.4 Mbd in 2021. Coronavirus could take a bit out of that figure. But that growth will be easily met by production from OPEC, which has kept member production depressed in order to maintain prices. A large amount of low-cost crude from Venezuela, Libya, and Iran is being kept off the market due to geopolitical reasons.

If history is anything to go by, the persistent glut will continue to shape perceptions of the energy market for the foreseeable future. And that makes the discussion around “peak demand” somewhat academic. The key outcome, as BP notes, will be increasing competition over remaining markets. Even if the world weans itself off oil, the fight for consumers will get more intense than ever before.