World Energy Outlook 2015 (WEO) from the International Energy Agency (IEA) has taken observers by surprise. It’s the first Outlook published with Faith Birol at his new post as the Executive Director of the IEA, as Birol was, until recently, Chief Economist and Director of Global Energy Economics.
It wasn’t expected that Birol’s new role would have a significant impact on the organization’s perspective when it comes to oil market analysis. In addition to being as the group’s longtime Chief Economist and the overseer of IEA’s monthly oil market report series and WEOs in years past, Birol was active in speaking circuits, and had a clear perspective on various market dynamics: Notably, he spoke often on how low oil prices create long-term market risks, in the form of dramatic supply shocks and price spikes. He often advised policymakers and industry to remain vigilant on these concerns.
As recently as October this year, Birol was quoted in Bloomberg saying, “It will be a great mistake to index our attention to oil security to the oil price trajectory in the short term,” and that at current investment levels, “this will be the first time in two decades we will see oil investments declining for two consecutive years. One should think about medium and long term implications of this lack of investments.”
IEA expressed similar caution in 2015’s Medium Term Oil Market Report: Which was published ahead of schedule in February 2015 in order to respond to the then-recent oil price downturn. IEA wrote, “Looking at the medium-term consequences of this latest price plunge, the real question is not so much how price and supply growth expectations have been reset; nor whether a rebalancing of the market will occur—for that is inevitable. The issue is how the necessary rebalancing, and the price recovery that will accompany it, might depart from those that followed similar price drops in the past, and where they will leave the market after they run their course.”
For an analytical agency, there’s a current of “doom and gloom” in this assessment, especially when considered in the context of Birol’s public comments about underinvestment, and the risk it creates for heightened oil price volatility.
This tone is missing from IEA’s report, even as the low price environment drags on, and producers continue slashing capital spending. Instead, there’s a level of calm complacency.
This tone is missing from IEA’s report, even as the low price environment drags on, and producers continue slashing capital spending. Instead, there’s a level of calm complacency. “The plunge in oil prices has set in motion the forces that will lead the market to rebalance, via higher demand and lower growth in supply. This may take some time, as oil consumers are not reacting as quickly to changes in price as they have in the past, and, even though the rise of tight oil has created scope for more short-term flexibility on the supply side, there is still significant lag in the response of most sources of production to a change in price.”
IEA sees the oil market rebalancing at $80 per barrel at 2020, on the back of steady but slow demand increases of 900k b/d—too slow to mop up the world’s oil glut until the end of the decade.
Accordingly, in its central scenario, IEA sees the oil market rebalancing at $80 per barrel in 2020, on the back of steady but slow demand increases of 900k b/d—too slow to mop up the world’s oil glut until the end of the decade. Meanwhile the world’s developed economies quietly trim 10 mbd of demand during this time period, thanks to efficiency measure and alternative fuels. In the executive summary, the report describes that the short investment cycle of tight oil is able to respond quickly to upward price signals. Meanwhile, Iran and Iraq continue to add to OPEC supply, despite regional instability.
In other words: Smooth sailing. IEA doesn’t offer a single scenario where oil rises above $80 by 2020, even with demand on the rebound, and the stresses on the global oil industry. The reasons for this shift in perspective are unclear.
This is the first time since 2008 when IEA is projecting that oil prices will remain below $100 per barrel for any extended period of time—in spite of the fact that the Agency sees the need for $750 billion in worldwide upstream investment every year through 2040 to meet demand. $630 billion of that, equivalent to total annual industry spending over the past five years, is needed simply to compensate for production declines at aging fields—not even to bring new supply online.
Meanwhile, IEA says non-OPEC oil production will peak before 2020 at 55 mbd. Tight oil helps dampen prices in the medium-term, but supply is constrained by rising production costs as producers deplete “sweet spots.” Output reaches a plateau in the early-2020s at just over 5 mbd of production before gradually declining.
Cheap oil comes at a high cost
Regarding the low oil price scenario, IEA sees a possibility that oil prices will stay in the $50 range through the end of the decade, before rising gradually to $85 in 2040. Given the volatility of the past two to three decades, in which oil prices have bounced between $30 and $120 per barrel, the likelihood of such a low and stable price environment persisting for 25 years is a distant one. But probability aside, IEA notes that low oil prices would depend on the following circumstances:
- Low global economic growth, with global GDP growth roughly 1 percent below current assumptions
- A more stable Middle East, the resolution of disruptions in Libya, Syria, Iraq and elsewhere in the region, ability for those countries to weather dramatic shortfalls in oil revenues, and a fairly permanent decision on OPEC’s part to favor market share over high price
- Highly resilient non-OPEC supply, notably tight oil
“Lower oil prices are not all good news for consumers. The economic benefits are counterbalanced by increasing reliance on the Middle East for imported crude oil and the risk of a sharp rebound in price if investment dries up.”
In addition to a sluggish global economy through the forecast period—again, 25 years—there are a few other unwanted outcomes from low oil prices. First, the global energy system misses out on 15 percent of the fuel savings seen in the IEA’s central scenario, meaning that $800 billion of efficiency improvements in the transportation sector are foregone. Transition to biofuels, electric vehicles, and natural gas vehicles also slows significantly. Second, since oil from the Middle East is cheaper to produce and thus more viable in an extended low price environment, the world would be more dependent on oil from the region than at any point in the last 40 years. Third, low oil prices create greater risk for consumers of a sharp oil price rebound if investment dries up. And finally, the outlook for natural gas supply is grim as producers spend less on upstream investment.
So, although IEA sees a world of prolonged low oil prices as possible, it isn’t necessarily a world we want to live in. Low economic growth, the highest levels of dependence on Middle East producers since before the oil embargo of the 1970s, and greater risks of a sharp price rebound. While the tone of IEA’s report may be calm, many of its conclusions are cause for alarm.