The Geopolitics of Peak Demand

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

From 1973 to 2011, when policy makers in Washington thought about energy, they thought in terms of concerns about peak supply. These apprehensions were triggered by the oil shock in 1973 that roughly coincided with the peak in US domestic conventional oil production and rise in import dependence.

These conditions began to fade in 2011 with the significant rise of US tight oil production. However, an alternative perspective would suggest that the true end of the ‘peak supply’ era came in 2015 with the Obama administration’s decision to lift the ban on crude oil exports. Others would claim that the ethanol and fuel efficiency mandates under the Bush administration signaled the height of US gasoline demand. It could also be argued that the Obama administration’s decision to refuse a permit for the Keystone XL pipeline heralded a new political emphasis on climate change over energy security.

While these are big changes in the realm of energy policy, and US energy security has improved by many traditional metrics such as import dependence, it is not clear where US policy makers should direct their focus in a post-peak oil environment. Congressional testimony by Energy Secretary Ernest Moniz on September 16 suggested several directions, including the importance of bolstering resilience of energy infrastructure against extreme weather and cyber attacks.

The Obama administration has grappled with traditional energy security issues, including uncertain oil market dynamics with Libya in 2011 and the sanctions-driven disruptions of supply from Iran beginning in 2012. These events also substantiate arguments that as long the majority of global oil supply comes from geopolitically unstable countries, a continued emphasis on energy security remains prudent.

Nevertheless, it is clear that the Obama administration has steadily elevated the importance of climate change as the core focus of US energy policy. Most of the action around climate change in Washington has been tied to the Clean Power Plan (CPP) and the landmark regulation’s associated impact on electric power generation and demand for coal. Due to the longer-term policy signals getting a robust short-term boost from cheap abundant shale gas, the ramifications of a climate-centric US energy policy for the transportation sector and associated oil demand has received less attention.

Greater consideration is warranted. It is argued here that the potential peak in the United States and broader oil demand throughout the Organization for Economic Cooperation and Development (OECD), driven in part but not entirely by climate-focused energy policy in the United States and other major energy consumers, is likely to be the next big geopolitical development in the oil sector. The near-doubling of US oil production from 2007 to 2014 created one round of geopolitical shockwaves, and the stabilization of OECD oil demand is likely to be the next. The 2 Degree Scenario (2DS) projections predict an OECD demand peak in the 2020s and a non-OECD demand peak in the 2030s. While that forecast can be challenged on many fronts, consider the following implication if the peak demand scenarios associated with 2DS were to emerge: For oil-producing states with the unfortunate combination of high political risk and high production cost, an OECD demand peak will have clear detrimental effects. States depending on the Arctic for future supply, such as Russia, Norway, and Canada, provide an example of this dynamic, given the high break-even cost and environmental politics. The Canadian oil sands and Brazilian ultra-deepwater pre-salt could be challenged as well, as both countries are examples of higher cost sources of supply and have energy sector-specific political risk that exceeds more favorable macro country risk.

Fiscal and political stability among countries facing a more marginalized role in a shrinking global oil market will significantly deteriorate, creating economic dislocation and, in some markets, risks of regional conflict. Current crisis conditions in countries such as Venezuela and Nigeria due to $50 per barrel of oil could be a harbinger of longer-term problems in oil-dependent states such as Russia.

Organization of the Petroleum Exporting Countries (OPEC) states with substantial onshore conventional reserves but high political risk, such as Iran, Libya, Nigeria, and Iraq, will also offer more attractive fiscal terms, undermining the ability of those governments to extract rent and maintain networks of political patronage and minimum levels of social spending.
An OECD peak in the next few years would mean that an even greater share of global oil consumption will shift to China and India, as these non-OECD countries will receive more global demand, deepening the geopolitical and economic links between those regions and key suppliers in the Persian Gulf and the post-Soviet states.

OPEC could be broken, with dialogue among the “low-cost” and “politically stable” producers replacing the cartel. Most likely the key players here would be the Gulf Cooperation Council (GCC) countries led by Saudi Arabia, and the United States. While the cost of shale in the United States is far higher than in many OPEC countries, the industry preference for political stability, lower capital intensity, and ongoing technological innovation potential mean that the United States will probably outperform in attracting capital.

A key driver of the above will be technology innovation in the transportation sector, with governments competing to attract investment and create strategic industries in next generation transportation, echoing the “state capitalism” seen in the renewable power generation space over the past decade. As with renewable power generation, questions of reaching sustainable levels of capital and commerciality through volatile energy price cycles, and shifting priorities among governments will be a core challenge for the alternative transportation sector.

As mentioned, the timing of when demand for oil might peak and the extent of a demand peak (particularly in the non-OECD countries) are controversial within industry. Many oil bulls would argue that the apparent peak of conventional oil production around 2011 is the bigger story, as the economics and environmental sustainability of sources such as tight oil, oil sands bitumen, and certain biofuels remain uncertain. As such, the above geopolitical scenarios could evolve in very different directions. Yet the possibility of a demand peak has grown enough that governments and industry would be well-served to develop analytical frameworks to assess signposts of the peak itself and the challenging array of ripple effects on global geopolitics.

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: US President Barack Obama delivers remarks at a Paris Agreement climate event with United Nations Secretary General Ban Ki Moon and China's President Xi Jinping ahead of the G20 Summit, at West Lake State Guest House in Hangzhou, China September 3, 2016. (Reuters/Jonathan Ernst)