The Conference That Overshadowed OPEC

OPEC gathered at its 175th meeting on December 6 in Vienna. It had some tough decisions to make, and its oil ministers were undoubtedly keeping an eye on the much larger jamboree taking place in Katowice, Poland running December 2-14. The message from the COP 24 Climate Change conference will be that the world needs to do more to decarbonise and sooner -- or face environmental catastrophe.

The announcement made by OPEC was a larger than expected cut of 1.2 mpbd; but the news from COP 24 will carry longer-term significance. Both organisations are essentially looking at two sides of the same coin, but with conflicting agendas and time horizons that are steadily converging.

Firm oil demand growth

Regardless of its latest decision, OPEC can rest fairly easy in one respect. Leading economic indicators may suggest fragility in the world economy, but the demand outlook for oil remains relatively firm nonetheless.

The 90-day trade war truce agreed between the U.S. and China at the G20 meeting in Argentina December 1-2 provided an immediate boost to both business confidence and oil prices, only to see stocks fall again a few days later as the markets realised this was indeed a truce rather than the end of the war.

However, the IMF is still predicting global GDP growth next year of 3.7%, and an average annual increase out to 2023 of 3.64%, slightly higher than the 3.56% seen for the period 2013-2018. Despite buoyant sales of electric vehicles, and the competitiveness of solar PV and onshore wind in power generation, this economic growth will be relatively oil intensive, compared with what is expected in the future.

Oil demand is estimated to have risen by 1.3% (1.3 million b/d) this year and is forecast to grow by 1.4% (1.4 million b/d) in 2019, according to the International Energy Agency (IEA). This follows solid growth of 1.6% a year on average from 2015-2017. Not spectacular, but take into account the replacement of barrels lost to natural decline and there is plenty to keep the oil industry interested.

However, longer-term forecasts are much less encouraging and they have little to do with expected GDP and everything to do with policy, which is where COP 24 comes in. In its latest World Energy Outlook, published in November, the IEA sees global oil demand growth averaging 1.2 million b/d out to 2023 before slowing to 1 million b/d, which would mean market growth of less than 1% a year.

Worse is to come, with annual oil demand growth shrinking to just 0.25 million b/d towards the end of the 2040-time horizon, although the IEA sees no demand peak. Even this may prove optimistic. BP, for example, in its 2018 Energy Outlook, forecasts a peak in global liquids demand just before 2040. The world economy will continue to grow, but the oil intensity of that growth will fall substantially as a result of climate change policies.

Monster gap

The current strength of oil demand, underpinned by lower oil prices since mid-2015, compared with the long-term forecasts, highlights the huge gap between what is happening now and what is expected to happen in the not-so-distant future.

It is COP 24’s job to accelerate that future into the present. The evidence base presented at COP 24 makes it almost a foregone conclusion that there will be calls for deeper, earlier decarbonisation.

There is a huge difference between the IEA’s New Policies Scenario, for example, which assesses where the world is heading based on existing and planned policies, and its Sustainable Development Scenario. This effectively illustrates what needs to be done to limit the rise in global temperatures to below 2 degrees Celsius above pre-industrial levels. The answer, in short, is a lot.

This gap means pressure will grow for policies such as bans on new sales of internal combustion engines to be brought forward. Where they exist, such ‘bans’ currently earn governments green plaudits now, while pushing the policy consequences far into the future, beyond both immediate oil market and electoral concerns. COP 24 is likely to confirm that such policies need to arrive earlier.

As a result, OPEC must start to marry short-term decision making with long-term strategy. It will enter 2019 on a wave of U.S. shale oil, rising global oil inventories and increasing spare capacity. Despite Venezuela’s ongoing travails and U.S. sanctions on Iran, the outlook suggests softer oil prices unless supply is curbed.

This will not please OPEC’s finance ministers, but it should prove supportive of the IMF’s robust outlook for global GDP and thus oil demand.

Moreover, the adoption of new technology is price sensitive and the point at which electric vehicles become competitive with ever more fuel efficient conventional vehicles does not depend just on the price of batteries, but on the price of fuel. In the context of climate change, high oil prices simply remove the burden of subsidising alternative modes of transport.

Goldilocks zone

OPEC faces not just the dilemma of ceding market share to US producers, but the longer-term risk of leaving oil in the ground. It is this fear that is driving economic diversification strategies and natural gas investment.

However, the unfortunate truth is that OPEC members need high oil revenues to finance their own economic transitions in order to survive the broader energy transition. Moreover, many live very much within the short-term budget constraints of the here and now.

Lower oil prices would in fact achieve a number of goals for OPEC. They would stem the flow of U.S. shale oil, retard the speed of environmentally-inspired demand destruction, and allow the organisation to consolidate its market share and control of spare capacity, predominantly through the development of large onshore oil fields.

But as it stands OPEC lacks the stomach for another market free for all and does not have the power to push prices much higher without losing market control.

It thus has little choice but to aim for the goldilocks zone – a supply strategy that delivers prices that are neither too high nor too low. Meanwhile, it must hope that the decision makers at Katowice keep their climate change policies back-loaded rather than accelerating the pace of change.