The Future of Oil – IMF F&D
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- Authors: RABAH AREZKI, PER MAGNUS NYSVEEN
- Published: June 1, 2021
Overview and thesis
- A looming oil price super cycle—an extended period during which prices exceed their long-term trend—appears to be forming after a pandemic and a price war sent petroleum prices tumbling in 2020.
- Drivers of the potential super cycle:
- Pervasive supply shortages from the lack of investment that has continued since the 2014 collapse in oil prices.
- Reduced investment in shale oil production.
- Demand growth triggered by a strong recovery in countries such as China, a big stimulus package in United States, and global optimism about vaccines.
- The authors argue this could be the last oil price super cycle because major economies are committed to replacing fossil fuels and mass car manufacturers have committed to replacing internal combustion engine vehicles with electric vehicles over the medium term.
Oil investment crunch — findings
- Since 2014, extraction and exploration companies have reduced investment despite being highly profitable; production in oil fields and the number of wells are declining, and reserve depletion is rapid.
- The drop in both capital expenditure and replacement of oil reserves has persisted since 2014.
- COVID-19 has exacerbated the investment decline.
- Shale oil output dynamics:
- Shale oil output is now increasing by half a million barrels a year, compared with 2 million barrels a year before the onset of the pandemic.
- Shale producers have adopted a more cautious investment posture and will be operating with positive cash flows rather than directing cash flow toward investment spending.
- Reduced shale investment lessens shale’s role as swing production and contributes to the seeds of a price super cycle.
- Policy signal: the Biden administration’s announced ban on drilling on federal land in the United States is described as signaling a shift in federal government sentiment against the oil industry, though it will have little direct impact on shale production.
- OPEC is likely to increase production to counter upward pressure on price.
The debate over peak demand — findings and scenarios
- Some commentators and major oil market players, including BP and Shell, argue that global demand for oil peaked in 2019 at about 100 million barrels a day and that it will never again reach that level because of pandemic-related structural changes.
- Evidence cited for peak-demand view:
- Sharp reduction in oil consumption for transportation, including jet fuel, after March 2020 when travel collapsed; jet fuel consumption collapsed and only began to creep up as travel restrictions eased.
- Counterarguments and structural demand drivers:
- Rising living standards and a growing middle class in China and India will lead to increased demand for individual cars and air travel.
- In emerging markets such as China and India, any shift toward electric vehicles will likely be slower than in advanced economies given concerns over the availability of charging stations.
- Road fuel accounts for half of global oil demand; the rate of adoption of electric vehicles will, by and large, be the major driver of future oil demand.
- Combined scenario:
- Structural increases in oil demand, together with persistent reduction in production from insufficient investment, will likely precipitate—and keep alive for some time—an oil price super cycle.
- The key open question: will higher oil prices prompt more investment and lead to another price bust as in past cycles?
Technology and its consequences — findings and risks
- Major automakers’ commitments to electric vehicles and large investments in EV R&D are accelerating the transformation of the automobile market; Tesla’s stock market capitalization is cited as an indicator of the imminence of that transformation.
- Risks of rapid EV ramp-up:
- Overproduction could cause supply to exceed demand, leading to negative cash flows, illiquidity, and bankruptcies of car manufacturers.
- Consumer adoption uncertainty: consumers might resist if charging infrastructure is inadequate or if carbon prices remain less salient in purchase decisions.
- Interaction with oil prices:
- Mass manufacturing will eventually make electric-car prices attractive, and a spike in oil prices would hasten the conversion to electric vehicles.
- Thus this last expected oil price super cycle would be consistent with climate goals and commitments by large economies to net zero carbon emissions in the medium term.
Economic transition, stranded assets, and geopolitical spillovers — findings and policy implications
- Risk of stranded assets:
- Oil reserves, especially those with high extraction costs, may become less valuable and effectively stranded.
- Stranded assets could lead to severe economic woes, including bankruptcies and crises, and potentially mass migrations from populous oil-dependent economies, many in Africa.
- Regional spillovers:
- Oil-dependent economies in the Middle East, central Asia, and Latin America are important sources of remittances, employment, and external demand; their distress could overwhelm neighboring countries.
- Opportunities:
- Demand for minerals important to the energy transition will rise—examples cited include cobalt (essential for car batteries) and uranium (valuable as electricity generation moves away from fossil fuels and nuclear power becomes more attractive).
- Imperative for economic transformation:
- Oil-rich countries must diversify to become resilient to changes in energy markets.
- An appropriate governance framework to manage proceeds from oil in good and bad times remains important but needs to evolve given risk of stranded assets.
- Urgent reforms recommended for oil-dependent economies:
- Commit to reforms that lessen obstacles to innovation and entrepreneurship.
- Reform corporate governance and legal systems.
- Promote markets with no barriers to entry and exit.
- End favoritism for both state-owned enterprises and politically connected private firms to attract investment and change attitudes toward innovation.
- Example cited: Dubai transformed itself into a global trade hub facing depletion of its oil reserves.
Key exact figures and quantitative points
- 2014: collapse in oil prices initiated a persistent reduction in investment.
- 2020: pandemic and a price war sent petroleum prices tumbling.
- Shale output change: now increasing by half a million barrels a year, compared with 2 million barrels a year before the onset of the pandemic.
- Peak demand claim: global demand for oil peaked in 2019 at about 100 million barrels a day.
- Road fuel accounts for half of global oil demand.
- Transportation accounts for about a quarter of global energy-related carbon dioxide emissions.
Article: RABAH AREZKI and PER MAGNUS NYSVEEN, "The Future of Oil," F&D Magazine, June 2021.
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- Fin de partie
- The Future of Oil – IMF F&D