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Fixation on timing of peak oil is ‘misguided’

Financial Times, 18 January 2018
The electric car revolution and stricter global rules on emissions have focused debate in the energy sector on when decades of growth in oil demand will eventually peak. But Spencer Dale, chief economist at energy major BP and former Bank of England policymaker, has challenged the industry to come up with a better question. In a co-authored report with Bassam Fattouh at the Oxford Institute for Energy Studies, which reignited discussion in the oil industry this week, they argue the sector’s fixation about the timing of peak demand is “misguided”.

Rather, they argue that the wider ramifications of any peak are really what the industry needs to grapple with. For example, how big oil producer countries reconfigure their economies and energy policies to cope with an industry in structural decline, even if oil consumption remains robust for years to come. And, what this might means for oil prices. Forecasts for when a peak occurs span a 25-year period, with those estimating an earlier timeframe basing predictions on the rapid adoption of electric cars and harsher environment regulations. BP’s base case has oil consumption growing until 2040, while rival Royal Dutch Shell said a peak could arrive in the next 15 years. “Peak oil demand signals a break from a past dominated by concerns about adequacy of supply,” the paper says.

Any peak in oil demand, the paper argues, could set off increased competition among oil rich countries as they rush to pump barrels out of the ground to avoid stranded resources. This could also spur a fall in oil prices and lower extraction costs. This is one result of the energy “paradigm shift”, from one of perceived “scarcity” of recoverable resources to one of “abundance”, the paper adds.The paper acknowledges the difficulty big producers face in cutting reliance on oil income and changing from a mentality of maximising revenue — such as Opec’s attempt to cut production to bolster oil prices — to pursuing market share, by selling as many of its barrels as possible before a severe demand decline.

But here lies a point of contention, even for those who support the authors’ broad view. Jamie Webster at the BCG Center for Energy Impact says the argument that countries will strive for higher volumes at lower prices, to take advantage of their cheap costs of production, would assume every nation is thinking for the long-term.“History tells us that it’s all about revenue maximisation for these producers, however they get it, even if it is through enacting production cuts as they are now,” says Mr Webster.

Separately, the paper argues if oil demand flattens out, or even declines gradually, the industry will still require substantial capital expenditures to recover large quantities of oil for decades to come. The decline rates of existing fields means that the industry will need to replace the equivalent of 3 per cent — or more — of global production each year just to stand still, says the paper.Such an outcome, however relies on investor confidence in financing the industry. This is why the timing question matters. “When that shift occurs, from a growing industry to one in decline, you change investors’ perception,” says Jason Bordoff at Columbia University’s Center on Global Energy Policy.

Despite the paper arguing for a strong need to invest in future production, a structural downswing in the industry, would see investors demand higher rates of return, says Mr Bordoff. This could impact on the cost of capital for oil companies, which feeds into the availability of funds for new production.“It becomes a self-fulfilling prophecy — tighter markets, followed by higher prices, and this would again lead to another global push away from oil into other fuels,” Mr Bordoff adds.

Another point emphasised by the paper is that oil as a transport fuel is “unlikely to be materially displaced for many decades.”But, Cuneyt Kazokoglu, head of oil demand at FGE, says the report misses the potential for governments to make radical changes on climate policy, energy efficiency and fuel substitution. “What if China says they are going to ban combustion engines? What if a country has oil but governments don’t allow you to use it?,” says Mr Kazokoglu. His comments come as the UK, last year, followed France in announcing it will ban the sale of all new petrol and diesel cars by 2040.

Regional policy differences could also impact on demand for certain refined fuels, meaning some parts of the barrel “peak” before others, Mr Kazokoglu adds. This thinking has spurred Opec’s largest producer Saudi Arabia to invest in chemicals to “future-proof” its oil riches.“The significance of peak oil demand is more nuanced.

It’s not about when it happens, I agree with the authors of the report on that, but it’s about where it peaks and which fuels peak,” said Mr Kazokoglu.“One big picture view about peak demand is not enough.”