One Last Boom?: Current Oil Prices, Supply, and Demand

Posted September 12, 2018

One Last Boom?: Current Oil Prices, Supply, and Demand 

Posted September 12, 2018

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The recent increase in oil prices to the $70 USD range (from a low in the $40’s) may well signal the last boom in petroleum prices we will experience this century. This is because current price increases are based on economic recovery in the US, continued global demand due to economic growth, and supply restrictions in OPEC producing countries. But if growth slows, OPEC quotas increased, or the US, Russia, and other players increase production, the current prices are likely to fall. Moreover, the growing conviction that peak oil demand is on the horizon suggests that eventually supply will outstrip demand. Scarcity will be replaced by abundance. But how realistic are any of these scenarios?

Oil Prices (per bbl current $USD) 1988-2018 (WTI)

Source: https://www.macrotrends.net/1369/crude-oil-price-history-chart

Demand Side: Slower Growth:

China is already experiencing slower economic growth than in the last 10 years. Its economy is transforming from being export led to one that is consumer driven. The rise of the Chinese middle class does bode well for automobile purchases and therefore increasing oil demand. Further, as China shifts from coal-fired electrical generation to other forms of power, some increase in fossil fuel demand can be expected. This, however, will likely be fueled by natural gas or nuclear energy as opposed to petroleum. Nor should we lose sight of the fact that China continues to innovate on solar power, battery technology, and other alternative energy sources.

On the Indian subcontinent, economic growth continues and India is highly import-dependent for its fossil fuels – proportionately even more-so than China. The growth of the US economy is continuing but will likely be moderated in late 2018 and up to mid 2020 by increasing interest rates. Growth in Europe is stagnant.

The net result of all of this is slower economic growth in the near term than has been experienced in the past several years. Slower growth means demand for oil is likely to grow more slowly as well.

Supply Side: Increased Production

The increase in US domestic production of oil is significant. The US is now the world’s largest producer of oil exceeding, as does Russia, even Saudi Arabia’s output. The macro-political fallout from shale oil (and gas) production in the US has, to date, been minimal. While the US is still a net importer of oil, it is now the second largest importer (behind China). The US is more self-reliant on its own oil production than anytime since at least the 1960’s. Russia has also ramped up oil production and is the second largest global producer and a net exporter with substantial markets in China and Europe. OPEC quota decreases have reduced, or at least limited, Middle-Eastern production. However, while production has been limited, capacity has not. Capacity still exists for increased OPEC production and reduced demand (or prices) will likely force OPEC into increased production to maintain constant revenue flows to central governments.

The net result is increased global production capacity which will put downward pressure on prices.

Oil Substitutes

Approximately 65% of global petroleum is used in the transportation sector. Increased fuel efficiencies, the substitution of electric or hybrid vehicles for petroleum power, even in goods transportation (largely trucking), will mean reduced petroleum demand. In addition, biofuels (while not necessarily reducing greenhouse gas emissions) are increasingly viable alternatives to conventional gasoline and diesel. Of course, it is unlikely in the medium term that petroleum substitutes will or could completely displace oil as a transportation fuel. Nonetheless, demand in the transportation sector is likely to decrease at an increasing rate.

For the remaining 35% of oil that is not used in transportation, much the same analysis is at play excepting petrochemicals where oil substitutes are not readily available.

Conclusions:

The long-term outlook for oil is not bleak. Nor is it bullish. Increased production, the increasing availability of substitutes, and slower rates of economic growth all point to this conclusion. If prices for oil drop, however, this will set in motion self-corrective forces. It will take longer for substitutes to become economically viable, production will decline from high cost sources, and the market for oil will stabilize. Barring extreme shocks such as war in the Middle-East, the imposition of unprecedented and unexpected carbon taxes, or other unforeseen events, massive increases in or declines in oil prices are not on the horizon. But another oil boom is not on the horizon either. If what we are seeing is an oil “boom”, it is likely the last one.

There are numerous implications of this for oil producers, consumers, and economies. Some of the most obvious are:

1. Net exporters of oil (including Canada, Russia, and OPEC) will increasingly be competing for a shrinking market. There will be a short-term rush to capture market share and build infrastructure to deliver it. We see this already in Canada but approval mechanisms here are cumbersome. Russia and the US are at an advantage here where approvals seem less encumbered. Middle-Eastern capacity already, to a large extent, exists.

2. The decreased dependence of the US on imported oil will augment US political independence and a willingness to experiment with unilateralism in foreign policy and forge new and different relationships with Middle-Eastern states.

3. Canada’s continued reliance on the US as the single market for oil exports will increase Canadian dependence on the US.

4. China and India are both growth markets but India is heavily reliant on the Middle-East and China on both Russia and the Middle-East. Look for China to attempt to continue to diversify its supply by purchasing assets in other producing countries where there is a reasonable probability that production can be exported to China.

5. Domestic (Canadian) investment in high cost long-term production capability will decline in favour of short-term rapid ROI from existing oilfield depletion.

6. Oil security of supply issues will lead to domestic exploration and development in China, India, and other emerging markets.

7. The economic viability of oil substitutes will diminish as “peak oil” demand approaches.

8. There is little reason to panic that oil prices, in the short run, will drop. In the long run, as substitutes are found in the transportation sector, as production capacity increases in the US and elsewhere, and as the movement to carbon taxes increases consumption costs, prices are likely to fall in relative terms. How much is the question. Decide. Wisely.

(c)Integrated Analytics & Research Ltd.

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TALKING POINTS: SOME CURRENT OBSERVATIONS ABOUT WORLD OIL PRODUCTION

Posted September 12, 2018

The following observations are from various sources. They are meant to stimulate thought. For exact sources and detailed analysis, please contact the author.

THE US IS AN INCREASINGLY IMPORTANT PRODUCER

1. The US is the world’s largest oil producer, exceeding Saudi Arabia.

2. The US produces roughly 2.5 times as much oil as Canada.

3. The US is increasing self-reliant on its own production – producing over ½ of its needs.

4. US imports of oil are diversified. Each country exporting to the US needs the US more than the US needs any one of them.

5. Imports from Canada are about 10% of US demand.

CANADA IS IMPORTANT BUT PERHAPS LESS SO THAN MANY PEOPLE THINK

1. Total Canadian proven reserves are about 170 billion barrels or about 10% of global reserves.

2. Canada’s oil production is only slightly more than China’s and is less than ½ of Russia’s.

3. Canada exports about 2/3 of its production – almost all to the US.

4. Canada needs the US market more than the US needs Canadian production.

5. The entirety of Canada’s proven reserves would satisfy US consumption for 23 years.

6. US consumption is 7.26 billion barrels per year. It has proven reserves of about 44 billion barrels.

THE GLOBAL MARKET MUST BE CONSIDERED

1. Russia produces more oil than Canada and is a net exporter of oil.

2. Russia’s major export markets are Europe and China.

3. China imports over 70% of its oil.

4. India has about 6 billion barrels of proven oil reserves and imports approximately 80% of its oil primarily from the Middle East.

5. India’s demand for oil is 6 million barrels per day (4 times Canadian consumption) and is increasing rapidly.

OIL IS IMPORTANT BUT …

1. Growth in global oil demand is slowing.

2. Proven oil reserves are increasing with new discoveries and recovery technologies.

3. “Peak Demand” for oil is likely to occur in 20-30 years.

4. At current consumption rates, the world has 53 years of oil remaining.

6. Increased energy efficiency and oil substitutes are contributing to a reduction in oil demand but economic growth is contributing to increased demand.

7. About 65% of oil is used for transportation.

8. Oil accounts for about 37% of total US energy consumption.

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