Oil demand for power generation has been in long-term decline since 1990 as countries have gradually displaced oil with cheaper feedstocks, primarily coal and natural gas. Since 1990, this process has freed up some 2 million b/d of oil for other uses. However, oil for power still accounts for just over 4 million b/d of demand or 4-5% of global oil consumption.
There are two reasons why oil-for-power use will buck its long-term trend in both 2019 and 2020, even though the secular forces pushing it slowly towards obscurity are now more powerful than ever before.
Iran’s use of oil for power generation is likely to rise sharply this year as a result of the re-imposition of US sanctions on the country’s crude exports from November 5 last year. Iran’s crude exports were estimated at between 1.1-1.3 million b/d in January and February, according to industry sources, down from 2.5 million b/d in April 2018 just before Washington withdrew from the 2015 Iran nuclear deal.
Iran’s internal response to sanctions in the past has been to increase oil burn for power generation, maximise refinery throughput and use petrochemical plant to produce oil products such as gasoline. In 2010, Iran’s oil use in power generation was about 225,000 b/d, but, by 2013, at the height of the earlier sanctions period, this had more than doubled to 471,000 b/d.
Since then its ability to export both gas and electricity to Iraq has increased. Tehran has every incentive to maximise oil burn at home to sustain the revenues gas and electricity exports provide. Power blackouts were also cited as a key grievance behind violent protests in the oil producing Basra region in Iraq last year. Given the failings of its own gas and electricity grids, Baghdad is equally keen to see these imports continue.
The US is thus engaged in multiple balancing acts when it comes to sanctions.
Although US officials have reiterated their desire to reduce Iranian crude exports to zero as they consider the extension and possible tightening of waivers from April, it is also a major supportive factor for crude oil prices. Higher oil prices hit the pockets of US consumers at a time of economic fragility just as presidential elections loom on the horizon.
Equally, forcing a reduction in gas and electricity imports from Iran to Iraq risks stoking social and political discontent within Iraq, which is also a major oil exporter.
US sanctions on Iran take barrels off the international market, but are also likely to see Iranian oil for power generation double from just over 150,000 b/d in 2017 to around 300,000 b/d or more in 2019 and 2020.
The second factor likely to push oil-for-power use higher in the next two years is the International Maritime Organisation’s 0.5% cap on sulphur in bunker fuels, which comes into effect from January 1 2020. A lack of conversion capacity worldwide is expected to see a temporary surplus of as much as 500,000 b/d of High Sulphur Fuel Oil (HSFO) as shipping turns to lower sulphur fuels.
While many countries which still burn significant amounts of oil for power - for example South Korea and Japan - will be blocked from taking this cheap feedstock by domestic air pollution regulations, others - particularly in the former Soviet Union and Middle East - do not face such restrictions. Cheap HSFO will temporarily displace other feedstocks in areas such as power generation, refinery own use and cement production.
2019 and 2020 are, however, likely to be the exceptions that prove the rule, although how long the US’s current sanctions regime lasts and how tightly it is applied are key uncertainties.
Oil’s demise as a source of power generation will continue in the longer term, owing to the rise of both gas/LNG supply and distributed renewable generation.
The largest use of oil for power is in the Middle East, most notably Saudi Arabia, but Saudi Arabia saw a peak in oil-for-power generation in 2015, while for the region as a whole the high point was in 2013, driven by sanctions-induced Iranian consumption. Gas in power generation in the Middle East has been rising steadily, displacing oil and allowing oil producers to sustain oil exports.
The region generated 840 TWh of electricity from gas in 2017 up 7.7% from 2016 and a jump of almost 50% from 2013, displacing predominantly direct crude burn and HSFO use.
Saudi Arabia, Kuwait and the UAE all have large gas expansion programs. By 2030, Saudi Arabia plans to add 93 Bcm a year of new gas supply, Abu Dhabi 31 Bcm and Kuwait 29 Bcm as all three start to more intensively develop non-associated gas reserves. This gas will be used to support oil field production, for power generation, in refineries and as petrochemical feedstock.
On the power generation side, growing gas use will be supported by the development of 5.6 GW of nuclear capacity in the UAE and large amounts of solar capacity. New solar projects announced across the Middle East and North Africa region exceeded 12 GW last year. Current plans suggest as much as 25 GW of solar capacity could be built in the Middle East by 2030.
Gas is also making serious inroads into other key oil-for-power markets. Mexico can expect to see oil demand for power generation fall as increasingly large amounts of US shale gas flood across its northern border. In Pakistan, oil use in power generation tripled between 2004-2014, but the country can now import LNG and is developing its LNG-to-power supply chain. Egypt has already curtailed its oil use in power generation as a result of developing its East Mediterranean gas reserves. Oil-for-power use in these markets will become an emergency back-up option.
However, oil in power generation faces other threats, namely distributed renewables and small-scale LNG as an alternative to off-grid diesel generation in remote areas. Renewable energy sources and batteries are competitive against diesel in island settings, while small-scale LNG infrastructure is expanding in the Caribbean. Both renewables and small-scale LNG can offer competition to diesel in large archipelagos such as Indonesia and the Philippines.
Micro-renewables are increasingly seen as a cheaper and more effective way of achieving universal electricity access targets in developing economies. Diesel remains expensive, but renewables can deliver small amounts of power for critical needs at much lower capital cost than the build out of electricity and gas grid infrastructure, delivering in terms of both capital and operating costs. Micro solar is proving popular in countries like Nigeria and Kenya where the alternative would be a small diesel generator. Electrification is progressing on a different path than before.
Given the rise in gas supply, both pipeline and LNG, oil-for-power use will eventually resume its steady long-term downward trend. After an increase in 2019 and 2020, a major downward adjustment could occur if there is a change in US policy on Iran after the 2020 presidential elections, at precisely the same time that the impacts of the IMO’s sulphur cap are being resolved.