“I believe we may not see $100 (oil) ever again,” said Vitol’s Ian Taylor last week in London. His rationale for making such a prediction is the belief that global oil demand will peak in the medium term. “I have begun feeling that… we are coming to peak demand towards 2030,” said Taylor, the CEO of the world’s largest oil trader, as quoted by Reuters. Peak demand is the point at which the world’s oil demand stops growing for good—current global oil demand is 93 million barrels per day, with most estimates expecting that figure to grow to over 100 million barrels per day within the next five to ten years.
His comments come at a very curious time, given the current oil market situation, with prices in the $40-$50 range, U.S. consumption back on the rise, emerging markets seeing rapid economic development, and petroleum still making up more than 90 percent of transportation sector.
It’s premature to say that oil demand will peak anytime soon, or to pinpoint an exact timeframe when it will plateau and eventually decline. Global oil demand is made up of a number complex factors that are always in flux.
Taylor’s comments about peak demand (peak supply is out of vogue with the rapid growth of unconventional supply from sources such as shale) bring up a recurring topic that was discussed frequently over the past decade when prices spiked, U.S. fuel efficiency measures were put in place, and economic growth slowed. The concept became popular again a couple of years ago when Citi Research predicted peak demand by 2020 as a result of greater fuel efficiency and natural gas substitution, while a number of academics in California, led by Stanford’s Adam Brandt, explored peak demand by 2035 and forecasted all the way to next century. The Economist weighed in the debate, saying: “The world’s thirst for oil could be nearing a peak. That is bad news for producers, excellent for everyone else.”
It’s premature to say that oil demand will peak anytime soon, or to pinpoint an exact timeframe when it will plateau and eventually decline. Global oil demand is made up of a number complex factors that are always in flux. These include economic growth, population trends, consumer income, subsidy policies, engine technology, fuel economy, oil price volatility, and the performance of alternative fuel sources.
The weaker oil price pushes back the timeline for peak demand.
Given all the different variables, it’s hard to see demand peaking within the next 10-15 years. Here’s why.
- The price collapse of 2014 has made oil demand growth more sustainable longer term. Oil prices were well above $100 in 2013 when Citi published its much-discussed analysis, but circumstances have changed dramatically. It is up in the air how long low oil prices will persist, and how far prices will rise when they inevitably rebound, but it is clear that the weaker market pushes back the timeline for peak demand. Against the backdrop of lower prices, consumers and governments become more complacent about moving toward alternative fuel vehicles, or taking more aggressive measures to rein in demand. Consumers are also more responsive to policy efforts to reduce oil consumption when prices are higher—thus it’s no secret that the best way to curb oil demand is through higher prices. In this respect, Taylor’s comments were backwards—he said prices would not return to anywhere near previous record levels, yet he still sees demand peaking. The lower price environment has already set off a surge in driving in the U.S., the world’s largest consumer, with vehicle miles traveled reaching a new record. Longer term, the International Energy Agency (IEA), in its low-price scenario sketched out in its latest World Energy Outlook (WEO), pegs global oil demand at 107.2 million barrels per day in 2040, up 16.5 mbd from 2014 levels, and up almost 4 mbd from its reference case. To be sure, the IEA has been way off-target when making numerical forecasts about supply, demand, and prices, but its assumptions about the consequences of lower oil prices are sound: A weaker price environment stimulates the use of more oil, lessens incentives for increased efficiency, and undercuts investment in alternatives.
- Greater fuel economy in the U.S. and elsewhere will take a while to fully kick in and may in fact boost demand longer term. New fuel efficiency standards will keep demand growth in check, but they are not enough on their own to cause demand to peak. Improved fuel economy loses its effectiveness when it is combined with demand for both time spent on the road and larger vehicles. With efficiency gains, there comes a “rebound effect”—economic growth and cost savings that occur from better vehicle mileage end up bringing about longer distances traveled and in turn higher fuel demand. The U.S. saw this from the early 1980s to the mid-2000s, when corporate average fuel economy (CAFE) standards put in place in the 1970s helped reduce costs for drivers but also overlapped with strong economic growth and gasoline demand in the 1980s and 1990s. For instance, U.S. gasoline demand rose by 2.8 mbd over two and a half decades. It’s important to note that when gasoline demand declined in the U.S. from 2007 to 2012, it occurred more so because of recessionary conditions and high prices, rather than better vehicle efficiency. In other words, prices matter just as much, if not more than, efficiency standards.
With efficiency gains, there comes a “rebound effect”—economic growth and cost savings that occur from better vehicle mileage end up bringing about longer distances traveled and in turn higher fuel demand.
- Emerging markets need oil. The Economist, in its 2013 article, stated, “…it would be foolish to extrapolate from the rich world’s past to booming Asia’s future,” noting that “ever-tougher” fuel-efficiency standards in emerging markets and China implementing hybrids in its transit sector will choke demand. This is probably wishful thinking. Emerging markets are expected to increase their thirst for oil until they become mature economies, and this evolution will take decades. China’s economy will not pass the U.S. until the early 2030s. Diesel is needed to fuel economic growth, while gasoline will play a role in expanded car ownership for the middle class. India and China, for instance, are seeing rapid gasoline demand growth this year, trends that should continue, particularly if prices fail to rise substantially. China’s oil demand growth is expected to be 5 percent this year, or about .52 mbd this year, the highest since 2010. India, meanwhile, according to the IEA, will replace China as the main engine of demand growth in the coming decades, with demand rising by 3.7 percent per year through 2040. And it’s not just China and India that need oil, although they receive the most attention since they are the biggest growers. The IEA pegs Middle Eastern oil demand at 11.1 mbd by 2040, a 3.5 mbd rise from current levels, while Africa will grow by 2.5 mbd during this timeframe.
Petroleum-based products currently make up roughly 92 percent of transportation sector energy. This longstanding stranglehold will be hard to break.
- There are no large-scale viable alternatives to oil in transportation. Petroleum-based products currently make up roughly 92 percent of transportation sector energy. This longstanding stranglehold will be hard to break, and again, how this shakes out is largely dependent on price. According to projections from the Energy Information Administration, that share is expected to drop only to 88 percent of transportation energy by 2040. There are alternatives to oil, but many fail to deliver consumers the cost, performance and convenience drivers have grown accustomed to with gasoline vehicles—and few see large scale adoption for decades, without disruptive innovations or business models. With biofuels, their livelihood is largely reliant on government mandates as they are not economically competitive with petroleum-based products. The use of biofuels will grow, but will meet less than 4 percent of total liquids demand in more than two decades. Natural gas vehicles, a key factor in Citi’s outlook for peak demand by 2020, have made inroads in the trucking sectors, but given infrastructure constraints and reputation factors, they are unlikely to take off in the passenger car fleet. Vehicles that run on hydrogen are not only expensive, but face significant infrastructure challenges, as the cost of building a hydrogen fuel station is close to $1 million. Less than 20 hydrogen fueling stations currently exist worldwide. Electric vehicles are more affordable in terms of initial purchase cost, and infrastructure is robust with over 20,000 charging stations nationwide, in addition to the availability of home and workplace charging. However, there is still a consumer education barrier, and low gasoline prices make the value proposition of EVs less compelling. An extended period of low prices is likely to dampen electric vehicle adoption in a significant way. Then there’s the use of petroleum in aviation and industry, which both will struggle to find substitutes. In all, absent a black swan event in transportation, low oil prices are likely to keep us mired in the status quo.