Two diametrically opposed views dominate the current debate about where the oil price is heading. On the one hand, there is the view that the price of oil will be "lower for longer", or even "lower forever", as the electrification of transport will eat away at oil demand more and more while, at the same time, technological innovation (shale in particular) will greatly increase economically recoverable resources. On the other hand, however, there is the view that the price of oil is set to explode, primarily due to underinvestment in the upkeep of brownfields, development of greenfields, and exploration for new resources.
Our view is that most likely, both will happen. How it is possible for the price of oil to go both up and not up, and what would that mean for the oil industry? We will explain.
Why the price of oil actually isn't that low
Contrary to general perception, the current price of oil is not very low. In fact, at a little over $50 per barrel, oil is trading slightly higher than its historic, inflation adjusted average of $47 per barrel, which in and off itself calls into the question the "spike" view: If the period 2001 - 2014 was a clear historic abnormality, why should one expect the price to return those levels?
Furthermore, we agree with the people in the lower for longer / forever camp that electric vehicles (EVs) will eventually offer better overall value to consumers than internal combustion engine vehicles (ICEVs) can, and that this will have a big impact on oil demand. (In fact, we have been highlighting this threat to the energy industry in articles since 2015, for example here, here, here and here.) However, two important things need to be considered in this regard. Related: Will Oil Demand Growth Be Enough To Tackle Inventories?
The first is that at present EVs do not yet outperform ICEVs comprehensively. While they offer a smoother ride, more passenger and storage space per square foot, and less noise and environmental pollution at a lower "cost of operation" (fuel and maintenance), in terms of "cost of ownership" EVs can't yet compete with ICEVs. Excluding subsidies the difference is said to be about $16,000 in the US, $18,500 in Germany and $13,200 in France, despite Tesla and GM reportedly selling their main EV models at a loss.
The second is that under the best of circumstances it will take the EV industry close to another decade to close this cost of ownership gap. (Why it is not a given that this will be achieved we explained here.)
Based on this, our assessment is that the electrification of transport will only slow down oil demand growth during the 2020s. It is after that, during the 2030s and 2040s, that the oil industry should expect to experience the really painful impacts.
Why the price of oil could spike before that
That leaves the period until the end of the 2020s, during which we believe overall oil demand will continue to grow (albeit slower than before).
Supply forecasts developed on this basis hold that more 20 million barrels per day of new production will need to be brought on stream until 2026 for natural production declines and demand growth to be properly addressed. According to WoodMackenzie, only half that quantity can be delivered by projects that are currently underway. The other half will need to come from still-to-be-launched projects (Pre-FID). But, WoodMackenzie says, many of these still-to-be-launched projects are uneconomical at oil prices in the $50s per barrel, meaning that they should not be expected to get the all-clear anytime soon. Since (non-U.S. shale) oilfield development projects can easily require 5 to 8 years to be completed, all this means that the seeds for a supply crunch in the period 2020 - 2022 are currently being sowed.
Of course, a number of things could happen that would prevent such an oil supply crunch, and thus an oil price spike. For example, oil demand growth could turn out to be less than expected at present, as energy demand growth already disappointed in 2014, 2015 and 2016 and could well disappoint again in 2017. On the supply side, BP and Statoil have also proven that project re-engineering can slash substantial amounts of off greenfield development costs, as a consequence of which more projects could end up receiving the go-ahead than presently is held possible.
But again, other "risks" such as the U.S. shale "growth over profits" mindset coming to an end, support the oil price spike theory, which leads us to conclude that in all, a tightening of the global oil market is indeed the most realistic expectation for the near future.
Why an oil price spike would be bad for the industry
If indeed the price of oil were to break through $60 per barrel again during 2018, and spike in the years thereafter ($80 per barrel? $100 perhaps?), the "cost of operation" benefit of EVs would be strengthened further, closing (at least part of) the ICEV advantage in "cost of ownership". In other words, an oil price spike would speed up the electrification of transportation, in particular in the Passenger Vehicle segment, as a consequence of which oil demand would peak earlier - not towards the end of the 2020s but perhaps during the middle of the 2020s already.
Related: Russia Claims To Have Invented Alternative To Fracking
Those with an interest in a long term future for the oil industry, such as the nations that own most of the oil still in the ground, therefore have an interest in preventing the oil price from going up too much. (Which in a way is ironic, since many of them are the ones working the hardest to push up the price.)
For a future oil price spike would not indicate a sign of recovery of the oil industry. It would more of a "last gasp" by the industry, establishing not much more than a last opportunity for those who do not own the lowest cost resources to offload their oil related assets for a favorable price.
By Andreas de Vries and Dr. Salman Ghouri for Oilprice.com
More Top Reads From Oilprice.com:
Dr Salman Ghouri is an Oil & Gas advisor with expertise in global / regional long-term forecasting, macroeconomic analysis and market assessments. He has developed… More
Comments
In response, Within weeks Vlad and his govt increase oil ten fold and flooded the international market with crude oil. Saudi Arabia and others started doing the same thing. Crude oil prices came down only, not gasoline prices.
Now the price of crude oil is about 47 dollars a barrel or so. Prices of gasoline at gas stations have not come down that much.
If we game that out, major reserveholders with low cost of production such as Saudi Arabia may move to close this gap. Indeed, they have the most to lose from a premature oil peak, especially where marginal producers lap up the last cream of the market. So whether we see low prices for ever or one last gasp of higher prices may well depend on how the likes of Saudi Arabia play their hand.
What is missing from this analysis is the role of heavy EVs. The commercial segment is scaling at a much faster pace than the passenger segment. 2016 may well stand as the year diesel peaked. If not, the diesel peak will likely come by 2021. Under a tight oil scenario on early 2020s, the price of diesel could prove to be price capped as fleet operators chose in real time between burning diesel or electric. In this scenario, refiners are under enormous margin pressure. Nearly all their profit would ride on just gasoline and jet, with diesel being sold at cost. The implication here is that the price of gasoline could skyrocket even as the price of crude languishes. Integrated old majors counting on one or the other for profitability could be disappointed with both the upstream and midstream outcomes.
So I encourage the authors and other analysts to look very closely at the potential for an early diesel peak. Strategic options close very fast if this is ignored.
GNE have been at or below the 2005 level for 11 straight years, through 2016, with the Chindia region consuming an increasing share of a flat to declining volume of GNE. The volume of GNE available to importers other than China & India (what I call ANE, or Available Net Exports) fell from 40 million bpd in 2005 to 33 million bpd in 2016.
Note that given an ongoing, and inevitable, decline in GNE, unless the Chindia region cuts their net oil imports at the same rate as, or at a faster rate than, the rate of decline in GNE, it's a mathematical certainty that the rate of decline in ANE will exceed the rate of decline in GNE and that the rate of decline in ANE will accelerate with time. Note that GNE in 2016 were at the same rate as 2005, but ANE declined at close to 1.7%/year.
If we extrapolate current trends, by the year 2034 the Chindia region alone would theoretically consume 100% of GNE.
In addition such industries rely on energy input for manufacture - natural gas is much cleaner than toil derivatives for this. It will take some serious cost reductions to replace such energy with electricity.
Oil & Gas production will be needed for a very long tome yet
The facts are OPEC and oil producers are doing their best to continue to live in a tight oil & gas world where they can dial back production and spike oil prices almost at will. The reality is new technology has vastly increased both the amounts of recoverable energy and the time it takes to get it to market even as the world is in the process of moving away, slowly but with increasing speed, with renewable energies that will eventually replace most carbon based fuels. EG: Wind, Solar, Nuclear, Hydrogen etc.
Meanwhile the longer everybody colludes to sustain the price of oil at $50 or push it up even higher the bigger the eventual price crash.
I think this has been the narrative for the better part of two years.
While it's going slowly the recent three month string of stock draws maybe showing the market is balancing...with Venezuela production in series doubt, Libya a mess and US Shale growth possibly leveling off the narrative maybe changing for the foreseeable future.
I agree with you that the possibility of a lot of supply still lurking however the futures curve is suggesting that's not the case.
Shark
This $ 47 average may be adjusted for inflation but not for the cost of extraction average. The easy barrels are extracted first then it gets a lot more expensive. $ 50 is low. If it continues a few more years we are going to see supply implosion and entire countries going bankrupt or in major distress. Call it Venezuela -itis. This may actually be good for the planet though as it's been proven that countries that rely mostly on oil for their GDP are typically dictatorships or undemocratic. With the free money gone the civil unrest will force changes. With major plays taking up to 8 years to go online, we could have up to that many years of a price spike. Boom and bust, rinse and repeat .