Will the combination of a weak economy, increasingly scarce and expensive oil reserves and falling demand spell disaster for the world’s biggest oil companies in 2020?
Greenpeace advances this argument in a rather unconventional attack on unconventional oil published today. The campaign group argues that unconventional oil (particularly from tar sands, as the environmentalists call them) is too expensive for the world economy, and that this doesn’t bode well for the oil majors.
The paper says demand simply might not be there for oil at that price in another 10 years’ time – pointing to falling medium-term demand forecasts from international organisations and the US government and to China’s determination to control its own energy destiny.
It goes without saying that Greenpeace’s objective is to get investors in the likes of BP, Shell and Exxon – which all publish their second-quarter results this week – to wonder if the longer-term outlook for the companies is less rosy than their share prices would suggest.
But the argument brings together so many elements of the energy debate that have changed in the past six to nine months.
It’s a little complex so here are what are to us the key points:
1. Tar sands oil is expensive
2. Oil above $90 hurts the world economy
3. Demand for oil might not continue its unstoppable rise in the medium to long-term, because of both the economic downturn and increasing concerns, especially from China, and especially about security of supply and price volatility, but also climate change
4. Oil companies increasingly rely on tar sands and other unconventional oil; many of these projects won’t come to fruition until 2020, by which time the energy demand environment may have changed so much that it is not economical to produce it
Let’s look at these one by one:
1. Tar sands and unconventional oil is expensive
There is little debate here. An analysis by the FT in December estimated new Canadian oil sands developments requiring $60 to $85 a barrel, and although those costs are likely to be somewhat lower now as oil services costs have fallen, they would increase again if oil prices rose. Shell in a presentation last month revealed some of its oil reserves require prices over $70 a barrel. The wildcard here is a big technological improvement.
2. Oil above $90 hurts the economy, leading to reduced demand
We’ve written here several times about James Hamilton’s econometric study of how oil prices contributed to the US going into recession between late 2007 and mid-2008 (see ‘Was the US recession caused by the oil shock of 2007-08? and ‘If high oil prices caused the recession, the low oil prices should...’ In what is probably the other most significant study on this subject, a paper by Douglas Westwood Energy Research posited that all of the six US recessions of the past 37 years were preceded by oil price spikes. Nouriel Roubini is, naturally, a believer and Andris Piebalgs, EC Commissioner, says prices above $80 could be difficult in the current environment.
Comments by BP’s chief executive, Tony Hayward, on launching the company’s annual statistics review that $90 per barrel was ‘about right’ suggest that even in the oil industry, the impact of oil prices on today’s economy is viewed seriously.
The report also points to a study by Cambridge Energy Research Associates that interest in other sources of energy, such as renewables, are spurred by oil prices above $100 – $120 a barrel.
3. Demand for oil might not continue its unstoppable rise – because of both the economic downturn and increasing concerns, especially from China, about security of supply and price volatility but also climate change
This is the most difficult point to support. A large proportion of the expectedincrease in oil demand is expected to come from China. The report says:
With OECD demand in decline, China’s share of global primary
energy growth in 2008 grew to 75%, while its oil demand
grew 3.3 % in the face of a global decline of 0.6%. It is clear
that China now plays a pivotal role in the global oil demand
trajectory. In short, its demand growth could outweigh declines
elsewhere, whereas a more restrained rate of post-recession
demand growth could signal a demand peak.
It also references another paper, this one by Arthur D. Little’s Peter Hughes, which considers that China is taking much more aggressive steps to reduce its dependency on fossil fuels than many people realise. It also highlights to China’s increasing efficiency requirements for its cars and its focus on becoming the world leader in electric car design and manufacture. This is a good point, but whether China’s drive for efficiency will offset demand growth is impossible to know. The IEA in its latest medium-term oil outlook makes clear that economic growth is still the major factor influencing oil demand. However the report points to recent changes in the medium-term demand outlook:
The IEA report suggests that in the medium-term at least that
depends on economic growth. The IEA presents high and low
economic growth scenarios in its forecast for oil demand
reflecting the uncertainty surrounding the duration and depth
of the current recession (see box 1). The high growth scenario
certainly foresees demand in non-OECD countries growing to
overtake the decline in the OECD. But in the low growth
scenario, non-OECD demand would be sluggish and barely
make up for the decline in the OECD.
The IEA’s medium-term oil outlook report, released last month, does say that ‘oil intensity’ – a measure of oil use against GDP – will decline an average of 2.4 per cent between 2009 and 2014, compared with 2.1 per cent in 1996 to 2008. From the IEA’s report:
However, these efficiency assumptions could prove too timid. Indeed, rather than pondering whether demand will be ‘destroyed’ or ‘suppressed’, a more pertinent question is arguably whether the ongoingshift towards greater energy efficiency will be more pronounced than in the past. As much as we attempt to account for what, in our view, are discernible structural adjustments technological breakthroughs or new policy initiatives could bring forward still stronger efficiency improvements even more rapidly than we currently expect .In such case, even under conditions of strong economic activity, greater efficiency advances could still result in lower oil demand growth.
4. Oil companies are increasingly dependent on high-cost sources of oil such as tar sands and deepwater offshore.
Greenpeace present this graph to outline this:
It should be noted that this refers to resources, not proven and probable reserves figures that are more closely watched by investors. Greenpeace argues this makes them vulnerable to the other factors listed.
What’s it all mean?
There are some credible reasons to consider Greenpeace’s argument seriously. It brings together several ideas that are increasingly being talked about in the energy world.
At the same time, it’s possible to argue that these factors might not pull together into some kind of perfect storm for the oil companies, but in fact have the opposite effect: demand and production could keep prices in some kind of sweet spot between $60 to $90 where oil companies could profit from their tar sands and deepwater offshore oil without harming economic growth.
Incidentally, a couple of reports suggest that tar sands are not necessarily that much more polluting than conventional oil.
But demand destruction, the impact of oil prices on the global economy, and the economics of unconventional oil are likely to be talked about much more over the coming months.
Peaking oil demand? (FT Energy Source)