Petroleum

The New Economics of Oil: How Peak Consumption May Arrive Sooner Rather Than Later

Rebalancing the Global Economy

In recent years, the global oil market has consistently been at the center of international economic discussions. The American shale oil revolution, China’s increasing demand for fossil fuels, the global oil supply glut, and new technological advancements in the fossil fuel industry have made the oil market stand out within conversations about economic forecasts. Questions about the rebalancing of the global economy, particularly with regards to China and other Southeast Asian countries, have had far-reaching impacts on the price and demand for fossil fuels. The rise of developing nations and the impact of new technologies have had tremendous implications for the economics of oil. Uncertainty surrounding the future demand for oil and the oil market in general have contributed to increasing levels of oil price volatility. While uncertainty remains, one thing is clear: the global oil market is experiencing a period of fundamental change.

New innovations and technological advancements have enabled oil producers to extract energy from the tar sands of northwestern Canada, discover massive reserves of shale gas within the West Texas  Permian Basin (resources that will last in excess of 75 years based on current consumption rates), and transform Brazil into the world’s fourth-largest oil producer as a result of the development of vast offshore pockets of oil (Freeland, 2012). New fossil fuel discoveries are becoming accessible for extraction because of the advancement of new technology for drilling and fracking.

While the conflict-burdened Middle East has traditionally been the world’s epicenter for oil reserves, new extraction technology has contributed to the rise of new global fossil fuel leaders in countries like the U.S., Canada, and Brazil. The advancement of the Keystone pipeline and technologies to assist in deep-water oil extraction have eased global concerns about the lack of easy-to-access oil reserves. However, even though new technology has opened up new supplies of oil from reserves all around the world, concerns about global oil demand have suppressed prices in recent years.

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Oil Price Collapse

From mid-2014 to the end of 2016, oil prices dramatically collapsed by over 65 percent (Arezki, 2016). Since then, oil prices have remained depressed and have contributed to increasing tensions among the consortium of the 14 Organization of the Petroleum Exporting Countries (OPEC). OPEC has a specific objective to unify and coordinate oil policies among its member nations to achieve consistent and sustainable prices for oil producers, while simultaneously upholding a commitment to supply the world with a reliable source of petroleum.

However, even with this objective, the OPEC cartel has been unable to prevent oil prices from sliding. Even though OPEC’s member nations still produce over a third of the global supply of oil, the flood of new oil from non-OPEC nations like the U.S., Canada, and Brazil has lessened the organization’s ability to control the price of oil and global oil production as a whole (Swarup, 2018).

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OPEC Struggles

In the past, OPEC has been able to seamlessly increase or reduce global oil prices through a series of coordinated efforts by its member nations, irrespective of the oil production that came from non-OPEC countries. Through the process of agreeing to either increase or decrease oil production, OPEC has been able to counteract efforts by other countries to influence the global oil market.

Following the persistent macroeconomic uncertainties from the pre-2010 global financial crisis, OPEC has lost its ability to stabilize oil prices. Starting towards the end of 2014, oil oversupply worries, speculation related to electric vehicles impacting oil demand, and even announcements that global policymakers have started to implement bans on fossil fuel-powered vehicles have caused oil prices to fall sharply. Moreover, mounting environmental concerns have also placed an increasing amount of pressure on OPEC’s plans and have led numerous financial institutions to remove their funds from fossil fuel portfolios.

The global oil market has come under pressure due to the dynamic shift to persistently low oil prices. The dramatic increase in the production of shale oil, through the advent of hydraulic fracturing and horizontal drilling, has contributed more than five million barrels of oil per day to the international market. This has added to the global oil supply glut that helped lead to the oil price collapse (Arezki and Blanchard, 2015). While the decline in oil prices reduced oil company investment in new technologies to pump out more oil, production rates have barely dropped, which has continued to drive down the price of oil. As numerous smaller shale oil drillers have declared bankruptcy, the future of the oil industry has come into question.

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Supply Glut or Peak Demand?

Has the decline in global oil prices come as a result of the supply glut, or from peak oil demand? This is one of the most difficult questions that energy analysts and global economists have been trying to answer. There are effective arguments for both sides of the question. The economists that point to the oil production glut as the main factor that has caused oil prices to stumble say that the rise of the U.S. as the world’s biggest oil producer has been the prime factor that continues to keep crude prices at near historic lows.

In September of 2019, the U.S. achieved a record trade surplus in oil-related products. The U.S. also exported petroleum to a record number of new global destinations (Toy, 2019). Some economists say that the rise in oil production has reduced fuel prices for consumers and manufacturers but has had an adverse impact on oil company jobs and investors hoping to turn a profit from the fossil fuel industry. In 2019, fossil fuels stocks within the S&P 500 marketplace have declined by over 12 percent and are the only sector in the stock market to drop during this period of time (Toy, 2019).

While some economists vehemently argue that the supply glut has been the chief contributor to the decline in oil prices, others point to the fact that oil prices may be moving lower because many countries have started to implement plans to abandon fossil fuels altogether. Demand factors have played a vital role in the global oil market. Moreover, oil consumption has grown consistently since 2011 (Baumeister & Hamilton, 2019).

In China alone, where domestic oil production has fallen by 15 percent, the country’s oil demand has skyrocketed by 30 percent. This represents an increase of nearly 14 million billion barrels per day since 2013 (Clemente, 2019). As the world’s largest importer of oil and gas, China now imports about 41.24 million tons of petroleum every day, equal to about 10.04 million barrels (Lee, 2019). However, even with the rise in Chinese energy consumption, some analysts question whether a decline in oil consumption in the worlds developed countries will offset the increasing demand for oil in countries like China, India, and other Southeast Asian nations.

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Forecasting Oil Prices

Is the shift to low oil prices temporary, or permanent? This is another important question that economists have been struggling to answer. Since oil is an exhaustible resource that will eventually run out, the price of oil will rise as its prevalence becomes scarce. Therefore, the price of oil would be likely to increase over time as its production becomes limited.

The notion of oil scarcity brings backs the question of whether oil consumption has already reached peak demand. Over the past quarter of a century, there have been four key principles that have helped economists understand the dynamics of the oil market: oil is a scarce resource; oil demand and supply curves are steep; oil flows from east to west; OPEC stabilizes the global oil market (Dale, 2016). However, as the oil industry has changed dramatically over the past decade, it is imperative for energy analysts to revisit these principles and update them to reflect the new economics of the oil industry.

The main factors that drive today’s oil market are much different than they were two decades ago. Throughout the past 35 years, the global economy has consumed roughly a trillion barrels of oil. However, during that same period of time, proven crude oil reserves have also increased by a trillion barrels (Dale, 2016).

For every barrel of oil that has been consumed, two more have been added to the global stockpile. Because of this fact, some industry analysts have started to view oil as an inexhaustible resource. Although, even if new discoveries of oil were to continue to uphold global oil supplies, concerns about climate change and increasing carbon emissions may result in new hydrocarbon discoveries being left in the ground. As a result of these concerns, a recent report from the International Monetary Fund (IMF) has revealed that global oil demand may peak before 2040.

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The Deceleration of Oil Demand

The IMF report highlights how the growth of oil demand could decelerate significantly over the next two decades because of major global reforms that are already starting to take place. The decline in global oil consumption would have a detrimental impact on many countries in the Middle East, who have predominantly centered their entire economies around the production of fossil fuels.

While some cities like Dubai have already transitioned their economies, many other regions of the Middle East have continued to experience intensive periods of economic volatility due to the dramatic swing in fossil fuel prices. Despite declining global oil prices, Dubai’s economic growth has remained robust. Leaders made the decision to move toward economic diversification. On the other hand, some countries like Qatar and Saudi Arabia have continued on their path of fossil fuel dependency. The IMF expects that these nations’ existing financial wealth could be largely depleted within the next 15 years because of a global shift away from fossil fuels.

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Peak Predictions

The IMF says that the long-term move towards energy efficiency and reducing carbon emissions have revealed “a strong and sustained declining trend in the global oil demand, after accounting for income and population growth” (Ellyatt, 2020). While new analysis suggests that global oil demand could peak by 2040, the peak could come much sooner.

Global leaders may develop swift policy decisions that call for stronger environmental regulations and investments in alternative forms of energy. Even though the growth in natural gas consumption is also expected to slow, IMF researchers envision that natural gas consumption will continue to increase for at least the next couple of decades as the world’s developed nations switch from coal toward cleaner-burning fuels (Ellyatt, 2020).

While the IMF report may seem like shocking news, especially for nations that are dependent on fossil fuels for economic growth, the prediction about a decline in global oil consumption is not a new revelation. In 2019, the International Energy Agency’s head of oil industry and markets division conveyed that oil demand may even peak in the early 2030s.

As a whole, the majority of economists believe that the world is moving towards peak oil consumption. However, there is less of a consensus about when that will occur. If a business-as-usual approach were to continue, with limited environmental progress being made on a global scale, the peak in oil consumption may not come for many decades into the future. However, as more countries adopt environmental goals developed by the United Nations, it appears likely that the peak will arrive sooner than expected.

Sources

Arezki, R. (2016). “Rethinking the oil market in the aftermath of the 2014-16 price slump.” International Growth Centre.

Arezki, R., & O, Blanchard. (2015) “The 2014 oil price slump: Seven key questions”. Vox EU.

Baumeister, C., & Hamilton, J. (2019), “Structural Interpretation of vector autoregressions with incomplete identification: Revisiting the role of oil supply and demand shocks”. American Economic Review: Vol. 109, No. 5.

Clemente, J. (2019). “China is the World’s Largest Oil & Gas Importer.” Forbes.

Dale, S. (2016). “New Economics of Oil.” Oil and Gas, Natural Resources, and Energy Journal.

Ellyatt, H. (2020). “Global oil demand to peak around 2040 or ‘much sooner,’ IMF says.” CNBC.

Freeland, C. (2012). “Actually, Fossil Fuels Are Here to Stay.” The Atlantic.

Mirzoev, Y., et al. (2020). “The Future of Oil and Fiscal Sustainability in the GCC Region.” International Monetary Fund. Middle East and Central Asia Department Research Department.

Mirzoev, T., & Zhu, L. (2019). “Rethinking Fiscal Policy in Oil-Exporting Countries.”

Swarup, M. (2018). “What is OPEC?” Al Jazeera News.

Toy, S. (2019). “U.S. Oil’s Growth Challenges Investors.” The Wall Street Journal.

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