Rethinking the Medium-Term Demand Outlook for Oil

This article is part one of a two-part series.

While oil markets agonize over the possibility of a “production freeze” agreement among the Organization of the Petroleum Exporting Countries (OPEC) members facing political and economic distress from lower oil prices, much larger and strategic data points are receiving less attention. These data points, while too early to suggest are certain, would create a far greater set of problems for oil producers if they become structural trends—particularly for companies with higher cost resources and governments with unsustainable levels of petro-dollar spending.  In short, these data points can be categorized as signposts of a potential world of “peak demand,” or when forms of demand destruction will curtail and even begin to reverse global oil demand growth much earlier than anticipated.

One example of such a data point is the Obama administration’s push to invest in a “twenty-first century transportation system” by pledging nearly $4 billion over ten years to accelerate the development of driverless cars that could also usher in a new era of automotive technologies that would then proliferate the use of shared-robotic vehicles in urban areas as a way to reduce demand for fossil fuels. Similarly, Democratic presidential nominee Hillary Clinton’s campaign continually emphasizes pledges to cut US oil consumption by one-third. While previous presidential candidates and administrations from both parties have focused on cutting US oil imports, the current focus on overall consumption is striking. 

Another interesting data point is the effort by the government in the Netherlands to ban the sale of all new gasoline or diesel vehicles by 2025. While the prospects of these initiatives face a range of practical and political challenges, they do represent a clear sense that policy makers are looking for ways to solve the problem of greenhouse gas (GHG) emissions in the transportation sector by targeting oil consumption. 

These efforts will build upon existing initiatives such as US fuel efficiency standards for passenger vehicles and medium-heavy duty trucks, serving as a key factor in shaping a decelerating long-term demand outlook for oil. Evidence of this can be found in the International Energy Agency’s (IEA) World Energy Outlook. The 2007 edition of that industry standard report forecast global oil demand to be at 116 million barrels per day (MMbpd) in 2030.  The 2015 report predicts 2030 demand will be 99 MMbpd, just 4 MMbpd above current global consumption of around 95 MMbpd. 

Because of natural depletion rates and changes in industry investment levels, the amount of “new oil” required to hit 2030 demand will be far larger than 4 MMbpd.  However, it is undeniably lower than 2007 expectations. The implications of this are far from academic. Many oil companies and governments made planning decisions based on the outlook from 2007.  They are struggling to do the same today, based on the more conservative demand outlook.

To further add to the uncertainty, there is another layer of dynamics around carbon pricing and technology innovation in the transportation sector that is changing the historical econometrics around GDP/oil demand correlation and energy intensity. Here in the United States, the political environment remains unripe for a compromise on a carbon tax, but the issue will be revisited within the context of implementation of the Paris climate change agreement. Many players in the oil sector increasingly use a carbon tax as a basis for forecasting and planning upstream project economics, and are willing to support an economy-wide carbon tax as a matter of public policy.

Still, the overall uncertainty regarding the likelihood, timing, and scope of carbon pricing may make oil companies more risk averse about costlier projects, leading to supply shortfalls, and creating price spikes in the near future.  However, a supply squeeze of that nature will likely prove less significant over time than the degree to which policy makers are successful in achieving the Paris agreement framework for climate change mitigation in the transportation sector—the 2 Degree Scenario.

Transportation accounted for 21 percent of energy-related global GHG emissions in 2013, consequently, this sector can provide a helpful initial indication regarding the successful implementation of the Paris agreement.  The only way to achieve the goals laid out in the Paris agreement is the absolute reduction of oil consumption both through substitution of other non-fossil fuel technology and the combination of incentives and regulation to reduce usage of gasoline/diesel powered vehicles. However, that path is a long one when more than 80 percent of transportation worldwide is based on fossil fuels. Yet it is the direction that matters. Once industry and governments believe this path is inevitable, there will be less focus on timing and more focus on the transition. The transition to the world of peak demand is arguably already underway.

Robert J. Johnston is a nonresident senior fellow with the Atlantic Council’s Global Energy Center. He is also the CEO of the Eurasia Group. Follow the Eurasia Group on Twitter @eurasiagroup.

Image: Li Zengwen, a development engineer at Changan Automobile, tested a self-driving car in Beijing. (Reuters/Kim Kyung-Hoon)