Oil used to be king. However, Kim Isykan from Truewealth Publishing tells us why the days of the Black Gold are numbered and what that means for the markets…
Someday soon, we’ll run out of oil… and civilisation as we know it will come to an end. As fossil fuels become increasingly scarce, we should prepare for a world of $200 oil, 50 percent annual inflation, and global resource wars.
At least this was the future suggested by “Peak Oil”, a theory that for decades shaped scientific and popular views of the oil supply.
But, it’s becoming obvious that the peak oil theory is wrong. In fact, the future will likely be shaped by the opposite of peak oil: Peak Demand.
“Peak Oil” contended that world oil production had topped out and was in terminal decline. This meant that at some point in the not-to-distant future – maybe 30 or 50 years—there would be no more oil to take out of the ground.
Meanwhile, energy demand, driven by population growth, would continue to accelerate. This would be bad news for oil-poor nations.
But for energy-rich nations, and the global oil and gas industry, peak oil envisioned a future of ever increasing energy demand and rising petroleum prices.
But peak oil has gone the way of the flat earth theory, Martian canals and Y2K. Governments, energy companies and investors now must adapt to a new reality: The global economy of the future will be dictated not by declining oil production, but by declining oil demand.
Peak oil was widely popularised by M. King Hubbert, a U.S. geologist. In a 1956 paper, he predicted that U.S. oil production would peak sometime in the early 1970s then decline. He also predicted world oil production would peak around the year 2000, before declining.
He based his theories on the observed rise, peak and depletion of production from individual oil wells and oil fields. According to Hubbert, the production life of an oil well – and by extension that of global petroleum reserves – resembles a bell curve.
“Hubbert’s peak,” as the theory is often referred to, gained notoriety when U.S. oil output did in fact peak in the early 1970s. The consequences at the time for most global petroleum consumers were significant – surging gasoline prices, rampant inflation, and fear that oil-rich countries would dictate the world’s economic future.
The future of declining oil supply and surging energy prices suggested by peak oil motivated governments and entrepreneurs to begin research and development on alternative and renewable sources of energy.
Then everything changed
Then, in 2009, something unexpected happened: The bell curve of declining U.S. oil production began to rise – slowly at first… then it began to accelerate. In 2008 the U.S. produced five million barrels a day. In 2015, it produced 8 million barrels a day – not far below the supposed peak in 1970.
What happened? Technology. It disrupted the energy industry just like it’s disrupted so many other dimensions of society.
Peak-oil theory didn’t anticipate the development of methods that allow producers to wring oil and gas out of previously inaccessible rock formations.
One technology – hydraulic fracturing, or “fracking” – has proven especially revolutionary. In fracking, chemically slickened water and sand are pumped into “tight” shale rock formations, creating thousands of fractures. This allows previously locked energy molecules to seep into a well.
Fracking now accounts for more than half of all U.S. oil output, according to the Energy Information Administration. The subsequent surge in American crude production is one of the main reasons why there’s a global oil glut.
Fracking is more expensive than traditional oil extraction, so when oil prices drop below roughly US$50 per barrel, fracking production falls. However, U.S. fracking production has proven surprisingly resilient in the face of lower crude prices, as technology improves and makes the process more efficient.
And other countries have only begun to adopt fracking. The oil shale rock formations responsible for the boom in U.S. production are widespread throughout the world. It’s estimated that Europe has more recoverable shale gas than the U.S.
As countries from Russia to China expand modern global oil production technologies, additional supplies of petroleum are inevitable.
Peak Oil has given way to Peak Demand
While geologists and oil analysts debate the timing or even the existence of peak oil, a new view on the future of energy has emerged: Peak Demand.
According to a recent report by the World Energy Council (WEC), global energy demand growth will slow down, peak before 2030, and then begin to decline. The group of academics, energy companies and public sector organisations outlined a “fundamentally new world of the energy industry” calling it the “grand transition.”
The green revolution has just begun to gain traction, according to the WEC report. The “phenomenal” growth of solar and wind energy is predicted to continue, while coal and oil will fade from the energy mix. Solar and wind accounted for 4 percent of power generation in 2014 but could supply up to 39 percent of the total by 2060.
Hydroelectric and nuclear power are also expected to grow.
The adoption of electric vehicles (EVs) is expected to increasingly cut oil demand. Improvements in battery technology and falling costs will increase the popularity of EVs – by 2030, carbon-powered vehicles (ones that use petroleum) will likely be the exception rather than the norm.
The report states that fossil fuel usage could drop to 50 percent of the primary energy mix in one scenario – with very differing futures for coal, oil and natural gas. However, in all scenarios the aggregate use of carbon-based fuel is likely to peak within the next 30 years.
Oil will continue to play a significant role in the transportation sector representing over 60 percent of the mix in all scenarios to 2060, and natural gas will continue to increase at a steady rate.
The concept of peak demand has major implications for oil companies and oil investors. Increasingly, the prospect of “stranded assets” – oil and gas reserves that might not get produced because of terminally low prices – has become a topic of discussion.
In the near future, oil companies may be faced with large write-downs as in-ground assets become uneconomical to extract. In such an environment, the shares of many oil companies would be poor investments.
But according to the WEC report, the most profound effect of peak demand and stranded oil resources could be geopolitical. Because much of the world’s oil and gas reserves are under state control, peak demand could destabilise entire countries. Where might Saudi Arabia, Iran and Russia be without their oil revenue lifeblood?
In fact, Saudi Arabia may already see the writing on the wall: Earlier this year the Saudi government announced plans to diversify its oil-centric economy. According to Crown Prince bin Salman, “…within 20 years, we will be an economy or state that doesn’t depend mainly on oil.”
Russia, though, has shown little inclination or ability to innovate or diversify its hydrocarbons-dependent economy. Peak Demand could pose a grave challenge to Russia.
It may be too early to sell your oil stocks because of peak oil demand. However, you should be aware that a global economy long influenced by fossil fuel scarcity is transitioning to a world characterised by declining oil demand and evolving energy technology.