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Andreas de Vries & Salman Ghouri

Andreas de Vries & Salman Ghouri

Dr Salman Ghouri is an Oil & Gas advisor with expertise in global / regional long-term forecasting, macroeconomic analysis and market assessments. He has developed…

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The Next Oil Price Spike May Cripple The Industry

Oil

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

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  • Idon'tknow on August 21 2017 said:
    what about the inflation in rear earth metals? Lithium price has increased by 4 times and only 160,000 EV has been manufactured in 2016. I heard each Tesla needs 70 kg of Lithium and 60 kg of Cobalt. There is only one active Cobalt mine in the world and it is in Congo. I don't know, like your previous articles your numbers don't add up. again good for a 10 year old essay with the subject of "why an EV is good!!!
  • Jon on August 21 2017 said:
    Some years back, when crude oil prices was about $ 100 a gallon, price of gasoline at gas stations was very high. Some rural farm brothers in the deep south of the USA wrote emails either to Vlad or to Rusia govt. , email address as available on the Internet, to do something to decrease the price of gasoline at his local gas station in America.
    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.
  • J P DeCaen on August 21 2017 said:
    Very insightful, but is the oil industry paying attention?
  • Bill Simpson on August 21 2017 said:
    Oil demand won't peak before oil supply does. Population increase in Asia and Africa will see to that. So expect a big price spike around 2022.
  • onesecond on August 22 2017 said:
    I agree with this assessment except that it is fallacy to believe that Tesla is not making money on its car sales. They are only in the red overall because of massive expansion expenditures, which the financial sector understand so they have no problem to get money from investors. Therefore I would put the crunch time that EVs will deliver on oil sooner.
  • Dan on August 22 2017 said:
    EVs will be replaced by a more reliable transportation, natural gas vehicles. The long term upkeep cost for a natural gas vehicle is much less. My four year old smartphone is just getting 4 hours before I need to recharge. There is no long term dependability in EVs to offset constant costs of battery replacement and that is extremely expensive.
  • Jhm on August 22 2017 said:
    Wow, this is perhaps the best article I have read to this site for addressing the real vulnerability of the moment for the oil industry. EVs and other technologies are steadily eroding demand. Production technologies are enabling a lower cost supply up to a point. But it is not at all clear that this will bridge to the ultimate decline of demand to commence in mid to late 2020s. So a tight supply in the early 2020s would make EVsore attractive sooner and could just accelerate the whole timeline.

    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.
  • Jeffrey J. Brown on August 22 2017 said:
    For several years, I've been tracking the combined net exports from the top 33 net exporters in 2005, what I call Global Net Exports of oil, or GNE, which are calculated in terms of total petroleum liquids (BP & EIA data bases).

    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.
  • Pickard Trepess on August 22 2017 said:
    This article basis the use of oil as almost exclusively for transportation. However, the feedstock for industry is another important use of hydrocarbons. Plastics and many other industries rely heavily on gas as the basic building block.

    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
  • Andreas de Vries on August 23 2017 said:
    To Jhm on the subject of diesel demand, excellent point. We did actually look at this subject for another article here on Oilprice, "Can We Expect Oil Demand To Slow Anytime Soon?" from August 8 (http://oilprice.com/Energy/Energy-General/Can-We-Expect-Oil-Demand-To-Slow-Anytime-Soon.html). In it we separated road transport into passenger vehicles, light duty vehicles, heavy duty vehicles and busses, and then for each of them looked at the trends affecting their oil demand to develop an understanding of far off they are from reaching peak demand.
  • John Brown on August 23 2017 said:
    There is still a glut of oil sloshing around the world despite all OPEC, and those working with OPEC, can do to pull back production, and of course when any country pulls back on production their unused capacity goes up, so if you look at the glut of oil that is increasing as U.S. production increases there is NO REASON why oil should be over $30 a barrel. Its certainly not in tight supply. If you take a look at the glut and increasing production, and then add to it the massive idle production capacity you have to wonder if there is any reason oil shouldn't be selling for $20 a barrel or less.
    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.
  • Mark M on August 26 2017 said:
    @john brown

    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
  • citymoments on August 28 2017 said:
    It is absurd to think that electrical car will replace petrol car after 2020, what is certain is we will ran out the metal of Li after 2020, your laptop computer will cost you more than 6 thousand dollars ( now it is approaching 4 thousand dollars). All those green and renewable energy talks are economic scams, crude oil will be over $150 after 2020 and stay high for a long time to come. The only way to avoid this energy crisis is to conserve our consumption and reduce global population to under 4 billions which requires compulsory birth control among developing nations, though given we are governed by pathetic corrupted politicians, I am pessimistic about the security of our future energy.
  • citymoments on August 28 2017 said:
    Tesla has never made a dollar since it was listed on Nasdaq, the loss became bigger and bigger as it is expanding its production. It keeps issuing new shares to lure foolish investors, it only sell most of its cars in California as the state government subsidies $7000 for every car purchase. This is not innovation, this is socialist robbery from profitable enterprises to support losers.
  • Citizen oil on September 06 2017 said:
    "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"
    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 .

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