[Premium] Majors And Peak Oil Demand: Different Views

Oil markets have entered a new era, according to a new paper by BP chief economist Spencer Dale and the Oxford Institute's director Bassam Fattouh published January 15. This is one characterised by growing competition between the producers, as the age of scarcity – peak oil no longer meaning the reserves depleting faster than they are being replaced – gives way to an age of abundance.

Dale and Fattouh say: "The advent of US tight oil has fundamentally altered the behaviour of oil markets, introducing a new and flexible source of competitive oil. More generally, the application of new technologies, especially digitalisation in all its various guises, has the potential to unlock huge new reserves of oil over the next 20 to 30 years."

But while they draw comfort from the fact that oil production will continue for decades, Oxford economist Dieter Helm, using arguments from his book Burn Out, says in a critique published January 24 that producers are avoiding the bigger picture: "For what [the paper] says is that we are not going to head off climate change, and that they [producers] will in fact be part of the causes of the climate change the world leaders are trying to head off. They predict that oil production will continue to violate the Paris Agreement and probably by a large margin."

Helm argues in Burn Out that oil needs to be left in the ground if the Paris Agreement is to work, meaning that oil today is worth more than oil tomorrow, in general, as nobody wants to be left owning oil that is never produced. So the price trends towards zero, according to Helm.

However, Dale and Fattouh argue in their paper Peak Oil Demand and Long-run Prices: "Many of the world’s major oil producing economies, with some of the largest proven reserves, rely very heavily on oil revenues to finance other aspects of their economies. The current structure of these economies would be unsustainable if oil prices were set close to the cost of extraction." 

But reforming economies to make them robust in the teeth of such low prices is a long process, lasting decades. "It is not enough simply to consider the marginal cost of extraction; developments in these “social costs” of production are also likely to have an important bearing on oil prices over the foreseeable future," they say.

Helm takes a different view, calling this an "extraordinary argument", one that "fails to distinguish between what producers would like to happen, and the reality of the position they find themselves in.... Think what this argument means. It must be a necessary condition that the producers hold the marginal barrels as they – and crucially only they – have the low marginal cost resources. They must also be able to agree. They must not cheat on each other. They must be the swing producers. All these conditions have to hold – jointly." He doubts this is sustainable, even if "some of it has some traction in the very short term. It is true that Saudi Arabia and Russia held back increases in production over the last 12 months, but the US is now crossing the 10mn barrels/day production line."

Helm describes the production cut strategy as “slow suicide” as any "very short-term successes come at a heavy price: they induce supply from elsewhere, speed the transition to electricity for transport and to gas for petrochemicals, and give renewables a leg up."

On petrochemicals, gas is the immediate threat to oil, and shale gas has already made a big impact. Dale and Fattouh write about oil, not fossil fuels. It is perfectly possible that gas will have a longer transition life than oil, he says.

Not all the majors are equal either: for example, Helm says Shell has recognised that the future is "eventually electric" and therefore it needs to prepare itself for the transition, using gas. "It has begun to dip its toe in the electricity market, and it is trying to work out how to embrace electric cars. Yet even for Shell, the money is in the oil and gas, and these electric steps are set against a big move into US shale."