Top Down: The Five Forces That Will Define the Oil Market – to 2023

Near-term oil market analyses emphasise decline rates and pessimistic outlooks leading to looming supply gaps.

However, a top-down view shows the opposite: the four major supply blocs – OPEC, Russia, US, IOCs – will all likely achieve near-term growth strategies, even as the more ponderous forces of declining demand start to dominate. Changing everything after 2023.

The Recent Failure of Bottoms-Up

It’s easy to get lost forecasting the oil business.

Bottoms-up analysis of oil supply over the past few years has been pessimistic, suggesting geologic decline rates of oil-fields is a harbinger of major supply gaps (and price spikes) to come.

The key assumption is that with ever-growing demand for oil, but major downturns in oil-field investments due to the price collapse in 2014-15, decline rates will start to bite, and force supply shortages.

In the event, however, OPEC and Russia have had to curtail supply to avoid a global glut, even though oil liquids demand has grown decently by around 1.5million barrels per day.

The supply pessimists are unbowed.

They now point out that, yes, supply has continued in non-OPEC countries due to prior investments paying off – but that pipeline will soon dry up, and field decline rates will kick-in to create a supply gap after all.

In fact, according to the FT this month, OPEC is practically banking on this scenario, to keep oil prices supported

And in an extreme variant of this analysis, BP’s latest Energy Outlook shows this chart in support of how average field decline rates of 3% pa would leave a supply gap of over 20 million barrels per day by 2025 (albeit with a scorched earth strategy of zero investment beginning right now).

Where are all the declines?

If these analyses are right, this is eye-popping headline news.

It leaves us, the world’s consumers, having to create two new Saudi Arabias (or USAs, or Russias) worth of oil production (net) within the next few years, or we miss demand by a mile.

This sudden supply chasm would be far worse than 2005-15, when prices gradually rose to $150/bbl: gasoline prices would spike above $5 gallon, air travel would be prohibitively expensive, and reduced trucking and shipping of goods would force GDP into a downward spiral: especially in the US which is a highly fossil-fuel dependent economy.

Because such an increase in supply is not feasible in that timeframe. you would therefore expect oil prices to be moving sharply upwards, and GDP forecasts revised downwards – right now – without the help of OPEC and Russia’s production cuts.

However, oil has not only needed OPEC and Russia’s restraint  but also the collapse of Venezuela’s output and the geo-political uncertainty surrounding Iran’s export future to underpin its current $60-70/bbl value – still 40% down from 2015.

And even if oil prices may take some time to react, you might expect capital markets to be pricing in major vertical movement in oil stocks, especially those hyper-investing in production growth such as Exxon.

But in fact not the case. Most oil stocks are becalmed, and have been for several years, and Exxon stocks have bombed in the last few months as investors spurn its growth narrative.

Note: S & P Global Oil Index

So – what gives ? Perhaps decline rates don’t matter as much as other factors after all.

Oil-field by oil-field bottoms-up analysis may be falling foul of what scientist Daniel Dennett called greedy reductionism – overlooking bigger scale factors by over-emphasising the micro ones.

Or in his words: “trying to skip whole layers or levels of theory in (a) rush to fasten everything securely and neatly to the foundation”

So – let’s try a top down, simpler analysis rather than using complex models or forecasts with diverse variables built up from smaller parts.

Plus – one other thing  – what we also need to do is focus on Crude Oil.

Supply and demand forecasts often conflate crude oil, the gooey black stuff, with a range of other associated, but quite distinct, chemicals: Natural Gas Liquids (NGLs), condensates, (slightly heavier gas fractions associated with crude oil production), and biofuels.

This chemistry lesson is important. It gets to the heart of why “oil” supply and demand issues may be getting confused.

Crude oil is what is required, via refining, to make critical transport fuels for passenger cars, commercial vehicles, planes and shipping. The associated gases and condensates are a by-product, which are used directly for the production of plastics and fertilisers  -distinct products and markets in their own right. Likewise, biofuels form a separate supply chain.

With the risk of stating the obvious, to understand the dynamics of the oil business, we need to focus on crude oil.

The Five Forces: Four Strategies and a Technology

The world produces (and consumes), to a good approximation, 75 million barrels a day of crude oil.

The top line number you will see in most websites and reviews, however, is close to 95 million barrels a day (b/d) of “oil” or oil liquids – but this is not the crude oil number; it’s crude oil plus another 20 million barrels a day of those other lighter, gaseous hydrocarbons and other fuels.

With this simplification we can divide crude oil demand and supply into five major categories: demand, and the four main sources of supply.

Crude demand, and its growth, is dominated by world road transport.

Many commentaries suggest that air and marine transport, and petrochemicals are the new core of “oil demand”. This is not the case for crude oil demand: 65% of crude oil is used in road transportation (via gasoline and diesel), and it remains the major growth market for crude.

The growth in world vehicle sales, and the advances of electrification (and supporting policies) into road transport are therefore the vital determinants of future crude oil demand. Their ultimate direction is clear: it is a decline in oil demand. Only the timing remains in dispute.

On the supply side, four strategies dominate.

70% of crude oil  is produced by just three supply entities: OPEC, Russia and the US.

OPEC (32 million barrels per day), Russia (10 m b/d) and the US (10 m b/d) generate roughly 52 million b/d of crude oil.

The fourth segment, rest of the world supply, contributes the remaining 30%, 23 million barrels per day of crude.

Each of the three large producers do not produce oil in an arithmetic, geologic way, driven by bottom-up individual well economic performance. They are working to macro-strategies, because their vast resources of crude and / or financial depth allow them to do so.

OPEC is attempting to control output by political will and maneuvering, Russia is restraining production to support OPEC pricing, and the US is in a high-growth, new technology / price-hedging paradigm that is developing increasing volumes of crude oil each year from mammoth shale basins.

As a consequence, these major producers aim to deliver more oil today than they are currently achieving.

Their near-term strategies are to increase their latent production, even if currently OPEC and Russia are restraining output, and the US is still ramping up.

This leaves  rest of world production as a residual between this controlled production and actual demand.

However, the Rest of World supply segment does not behave as a passive remainder – it follows the global growth aspirations of the world’s largest oil and gas corporations.

It is therefore a hard residual production segment, not a soft one, resistant to the moves of the major blocs.

The Five Forces

Source OPEC and dollarsperbbl estimate

So – key point – applying a bottoms-up 3%pa decline rate to global “oil” production is a misleading straw-man: in fact,  every one of the four major supply segments has the ability, and aspiration,  to increase production, irrespective of geology,  even politics, over the next 5 years (and perhaps beyond).

Moreover,  if an average decline rate is to apply at all, it would only be to the rest of world 23 millon b/d – so in BP’s chart instead of a 20 million barrel/day gap by 2025, the gap at worst would be 3 million b/d.

But the decline rate does not apply even here, as this segment is pursuing growth across most of its output with many locked-in projects in construction.

For example both BP and ENI who operate globally largely outside OPEC, have specifically noted they will increase production – net of decline rates – by about 1-2% pa over the next 3-4 years.

So – here is a first approximation of what the global future of crude oil supply – demand looks like over the next five years using just three simple assumptions based on the above – a base scenario:

• Demand for crude oil grows at 1% pa (roughly current rates)
• OPEC, Russia and US supply will supply at the rate they currently project for this year: OPEC staying at 32mb/d, the US and Russia supply 11mb/d each.
• Residual (rest of world) supply grows at 1% pa, net of decline rates, as described.


Note: Current, Base Estimate for 2023, and Bull / Bear Scenarios for Crude oil supply- demand balance: dollarsperbbl estimates

This leaves a gap of approximately 1 million b/d by 2023 – easily covered if OPEC were to chose to open taps just half-way back to 2016 levels.

This may be a clue as to why markets are somewhat sanguine (albeit edgy) about oil price and skeptical about expansive high-cost non-OPEC/Russia  investments.

However – not so fast: plausible scenarios appear on either side of this knife-edge supply-demand picture.

The Bull Case : Here demand increases by 1.5% pa, OPEC supply  faces continued supply crises in its ranks, and Russia and the US cannot supply above 11 mb/d. The rest of world production stays flat as decline rates negate on-stream production perhaps because of project delays that make it unable to respond to the supply gap:  a deficit of 4mb/d opens up, spiking prices.

The Bear Case: demand due to eg EV growth or policy development peaks in the period and falls back to 2018 levels; OPEC and Russia discipline cracks, and US growth stays robust; rest of world production stays to plan, up 1%pa. In this case a sudden OPEC pull-back or even coordinated decline across the residual production would have a limited impact on the supply surplus of 5 mb/d. Prices would collapse.

Of course in each of these states of the world, there would be various corrective actions  – but it does not take detailed scenario planning  to observe the core forces shaping the oil market today.

Shifts in either of the main producing blocs will overwhelm actions elsewhere.

And structural changes in demand will force moves too, with  OPEC likely to act first due to its governance structure. Russia and the US will first pursue their internal aims, and the resilient Rest of World bloc will still focus on growth targets.

World oil prices (and oil stock movements) may be just as simple as watching the developments in these five forces.

It remains difficult to make a call on the outcome: but the forces working on the Base and Bear scenario seem individually more likely and aligned than those in the Bull case.

But. But – Perhaps after a long stroll, we have just happened back on an oil market truism: the industry remains in tension, ready to make fools of us all, because it is largely shaped, right now,  by the moves of three huge supply blocs, and less by the rational precision of geologies.

Until 2023:  One Force to Bind Them All

Of course,  things change.

This all only holds until demand asserts itself (clearly) as the dominant force – when transportation electrifies at the margin and quickly beyond.

Oil is huge and dominant in the transportation corner of the energy world. But in a Darwinian twist it is almost completely dependent on the segment:  it is a niche into which it has adapted so well it now has no escape into other areas of energy production.

In 2017, for example, US gasoline demand at 9.32 million b/d was precisely flat, and vehicle sales were down 1.9%. The US consumes over 40% of global gasoline – this peak in the world’s largest market (by far) of consumer gasoline signals the risk to come.

As electricity encroaches on this coming peak at increasing pace, shrinking demand will become the dominant narrative of world oil.

As noted in several posts (eg here), and to be specific, we expect electricity to remove all marginal oil growth in transportation by 2023, forcing crude oil’s business trajectory into terminal decline.

Given that, the shape of the post-2023 oil market, is, as they say, another story entirely.

And the subject of an upcoming post.


————-    ————


Posted in Energy Technology, Industry Activity, Oil and Gas | Tagged , , , , | Leave a comment

Nine Orders of Magnitude: Wind, Solar and Lithium Will Take It From Here

“The future is already here – it’s just not adequately described” (dolllarsperbbl after William Gibson)

Energy Transitions Do Not Have to Take a Very Very Long Time

Vaclav Smil is wrong.

Smil is a leading and influential academic champion of the view our global energy system took a very long time to get established, and therefore will take a very long time to change: because that is the inherent nature of energy systems.

World energy currently relies on fossil fuels – they have been the most effective energy source, to hand, for the large-scale energy consumption of the past century of industrialization.

Smil uses this fact to extrapolate that all future energy sources will need a long time to replace this sort of system: the fact that nuclear and hydro have not managed to do so after 50 years of development is key evidence.

Thus, the hypothesis goes, the dominant fossil fuel energy system, whilst undergoing some marginal disruptions, will dominate global energy for many – many – decades to come, and perhaps even then its low-carbon exemplar, gas, will be the dominant fuel of choice.

The transition, in this view, and supported by most oil and gas firms, will be gradual, orderly and linear.

It won’t.

The world is now witnessing the clash of exponentially-growing manufactured energy with the dominant conventional base as they compete for the slowing growth in overall energy demand.

Conventional hydrocarbon energy is therefore being replaced by wind, solar, and large-scale batteries – at an accelerating rate.

This is why the transition to the new energy system will not be slow, it will be fast, and far from linear.

In fact, it is already here, staring us in the face.

The Extracted Global Energy System

Let’s take a step back to reflect on the major energy system we currently have.

Fossil fuels, nuclear and hydro power are generally non-manufactured: that is, they are not created via dedicated factory-line structures, but mostly by complex, at-site, custom-designed projects for both the raw fuel extraction, and via a similar process to create large thermal, nuclear or hydro power generation plants.

That is why today, for example, international industry exploration, extraction and facility construction costs for oil and gas ranges around $30-$50/bbl (including over-runs), before transportation and operational costs are considered (hence the necessity for $60/bbl oil).

Add to this the costs of building and running gas and coal power plants, and the conventional energy industry typical power costs have been stuck around the $60-120/MWh range for many years.

The result: these projects continue to take many years to build, and costs per unit of fuel have generally increased over time – as you would expect with complex mega-projects which have negative learning curves.

This makes the current global energy system not just expensive, but fragile.

There are few ways to make these difficult projects less costly over time, so they are vulnerable to even relatively slow demand and price movements.

Unmanufactured …. and Unscalable

As we have noted before, this extractive method of fuel construction and centralized power generation is unscalable.

That is, most extraction and power-generation projects tend only to be economic at one size – the very large.

This is not a feature of the current energy system, it is a bug.

Fossil fuels and utility plants require long-cycle investment and production because of their specific nature.

This was an effective technology during the heavy phase of global industrialisation, when energy consumption grew about 3% pa in line with GDP: fossil fuels provided rapid access to the calorific heft the hungry globe needed.

But the energy the world needs does not have to be provided in this fashion.

Now, as world energy demand grows only at around 1%pa, the incumbent, large and unscalable system is quickly losing out to faster, cheaper, innovative and more adaptable energy sources.

Nine Orders of Magnitude – Wind, Solar and Lithium Will Take it From Here

Wind, solar and electric power-trains based on lithium-ion batteries are an energy different in kind to fossil fuels, not just degree.

They are manufactured energy – based on solid-state, scalable, capture and conversion technologies, rather than unmanufactured extraction and centralised construction projects.

Their manufactured nature allows rapid incremental improvements to be made following classic learning curves, and their solid-state nature allows energy to be produced in a variety of sizes and forms.

At a stroke, fossil-fuel (or nuclear / hydro) deficient countries are unshackled from having to import energy, and can develop and deploy it themselves.

Lithium-ion batteries can scale from iphones to automobile powertrains and out in to massive power storage arrays.

Mass-scale manufactured energy can be introduced in measured, incremental amounts such as low-cost roof-top kits of a few kW, to giant deployments of solar and wind parks of over 1-3GW which can power millions of habitations and / or vehicles.

That is scalability of over a billion times, or nine orders of magnitude.

Note:  Lazard LCOE version 11.0, BEV/ICE calculations based on 20,000km pa, $2.75/US gal, current EVs at 17kWh/100km

Contrast this with thermal, nuclear and hydro plants which tend to run economically only in a far narrower, and costly, range of 100MW to 1,000MW, or one order of magnitude, at the very large end of the energy scale.

One way to summarise this colonization of the energy landscape is shown above – summarizing the 21st Century Energy Technology Spectrum from a single Watt (roughly the power of your iPhone charger), up to 5GW, the largest sized central power plants that can be built on earth, and all points in between.

The chart also notes Lazard’s levelised cost of electricity for each of the technologies – and, to sum up, the new manufactured technologies are now capable of power across nine orders of magnitude, and are economic today without subsidies.

They can take it from here already, but the transition is still gathering pace.

Manufactured energy’s scalability also breeds energy innovation at a rapid rate – and via manufactured technology it can be exported globally and deployed locally at digital speed.

Recent estimates of PV solar learning rates for example are a 25% price reduction for every doubling of capacity which currently takes about 2-3 years. This means prices and costs have dropped by 80% over the past 7 years.

Lithium batteries have seen similar cost reductions, and wind turbine capacity factors are now about the same as gas plants, an 80% learning improvement over 10 years, undermining rapidly aging arguments about intermittency.

Indeed, all these improvements re faster than expected by manufacturing techniques alone – transferred learning at a distance and the less-complex-to work-with solid form are likely key factors.

Result – the world of energy is now a far more innovative and crowded space than it was just a few years ago.

The diversity of competitors is also much higher as technology and manufacturing firms produce large-scale energy.

This is the world incumbents and new entrants alike need to deal with.

A Non-Linear Transition Gets Underway

The energy transition is shaping up to be a sharp, non-linear, and disordered process: the rapid improvements and innovations of manufactured energy will swallow all up incremental energy growth, forcing the traditional long-cycle system into rapid decline or reinvention.

This process is, naturally, being resisted by incumbents.

Chevron put it this way in their latest climate change resilience report

“In general, assets are forecasted to be used for their service life, this tending to slow diffusion of new technologies and energy transitions.”

Not the case.

source: Wikipedia

Witness China’s, breakneck deployment of over 50GW of PV solar (a globally-accessible technology) in 2017 – the equivalent generating capacity of around 15 large nuclear plants, or 20 closed-cycle gas plants – in a single year.

This supported China’s strategy to put on hold investment in over 400GW of coal mine projects, some of which were already in construction. In turn this prompted a free-fall in global coal extraction activity in the space of one year, 2016-17, with a 62% drop in coal project construction starts and a 48% drop in pre-construction activity.

Elsewhere, coal plants have been referred to as rejected teenagers with many of them being retired early in their life, due to poor economics and new emission-reduction policies: some will be only 7 or 8 years into existence before their boilers go cold.

As the report summarises:

“Two of the key drivers for long plant life — a stable pro-coal political climate and favourable economics — are evaporating fast. The politics of climate change are shifting, often across the political spectrum, with support for phasing out coal plants growing rapidly. The plummeting cost of renewable generation is making running existing coal plants ever more marginal.”

In the UK, coal fell to 7% of power generation in 2017 from 40% in 2012, retiring plants with many functioning years left, as wind and solar rose to 30% of generation.

These coal assets have indeed, as Smil would point out, survived a long time, but their eventual demise was sudden, and unlike Chevron’s base estimate, they are being closed decades ahead of their full service life.

The slow linear change hypothesis also assumes that long-established prime-mover energy technologies such as diesel and gasoline engines will not yield quickly to alternatives either.

Again – not the reality.

For evidence see the free-fall of diesel car registrations in Europe in the space only of just 2 years due to management incompetence, a raft of policy changes against diesel (and gasoline engines) and the rise of EV alternatives.

Indeed, the long asset-life of diesel cars now work against it: who now will be wiling to buy and hold a diesel car for years as the market for re-sale vanishes by the month– the diesel engine’s long-cycle life is accelerating diffusion rather than slowing it, bringing forward it’s exit.

The consequences for oil demand are grim: BP’s Even Faster Transition scenario in their annual energy outlook forecasts that fast EV adoption would remove 9 million barrels per day from today’s oil demand by 2040.

Even this is an upbeat assumption as the scenario mischievously assumes that trucks and freight vehicles will pick up the demand slack, and somehow remain fully immune to EV powertrain advances.

Already Here – The Transition is Starting to Bite

Chevron’s climate resilience report is symptomatic of the oil and gas industry’s fierce desire to have smooth growth continue.

It’s headline chart of expected oil demand show practically zero-diversity from a simple smoothly growing future of upward demand.

Incumbents should now reshape their base strategies away from assumptions of neat linear growth (or gentle plateaus followed by tidy linear decline). A quick refresher course on Joseph Schumpeter may be in order for all C-suite oil and gas executives.

BP’s Even Faster Transition is a decent start in stress-testing favoured assumptions and cherry-picked scenarios.

In this world, wind and solar rise to over 35% of global primary energy use by 2040, or an increase of over 4,000 million tonnes pa compared to today. They also compare this rapid rise to previous “transitions” of nuclear, which faded in the 1990s, and even the golden age of gas to show how big the coming transition may be.

Note: Left panel: growth in % share of primary energy; Right panel increase in million tonne per annum consumption, 2040 – BP Energy Outlook Even Faster Transition scenario; dollarsperbbl analysis

Fossil fuel companies cannot comfort themselves by noting that even under these scenarios fossil fuels will remain 40-50% of primary energy for a long time – some scenarios from IRENA and elsewhere see renewables achieving at least 65% share by 2050.

And even if it fossil fuels hang on in, it still spells long-term chronic decline of their market, like a country with decades ahead of negative GDP.

History shows that when effective new technologies are even at low market shares of 1-3%, they can disrupt incumbents significantly. The problem for today’s traditional players is that wind, solar and even EVs are already at or beyond this small share.

This transition is underway.

And if oil and gas companies are unwilling to stare at the future objectively, the stock market is doing it for them.

A Portfolio of ex-Titans

Witness the fate of GE’s belief, dominant still in 2017, of a smooth growth in demand for gas turbines for centralized power plants

It did not happen, even as GE absorbed Alstrom’s power division, leaving it with huge excess capacity.

Orders rapidly declined as wind and solar swallowed up incremental power demand, at lower and lower costs. GE’s woes are many, but its Power Division underperformance is a main contributor.

Reuter’s report that GE executives were well aware of the levelised cost curves from Lazard’s annual reviews, and that current auction prices of solar and wind being were dropping far lower than even efficient closed-cycle gas turbines.

But still they convinced themselves of the “slow-transition” hypothesis.

Ford, a late starter to the EV transition, still closely tied to F150 sales and the SUV gasoline model, has seen a similar free-fall in stock as its tech strategy seems to be wait and see and still at the concept stage.

Even mighty Exxon has seen a fall-off as its new project pipeline underwhelms the market, and looks to be at the high end of the cost curve, increasing the risk of stranded or wasted capital.

source FT

A portfolio of these three erstwhile titans of traditional US industrial sectors would have yielded a 30% capital loss over the past 3 years: Ford and Exxon chronically, GE suddenly.

The transition is amongst us, and it will not be slow, and it will not be tidy.

If oil and gas and related sectors want to be resilient in the face of these new technologies, their stress tests need to be a lot less smooth and comforting, and much more rough and disorderly.

Whether or not they like what they see, the unblinking market, constantly looking to the future, has a way of finding out anyway.


————-  ————-

Posted in Energy Technology, Oil and Gas | Tagged , , , , , , | Leave a comment

Chronicle of A Peak Foretold

“There had never been a death so foretold”
Gabriel Garcia Marquez, Chronicle of a Death Foretold, 1981

Peak Oil has often been foretold: but now Peak Sales of ICE vehicles, due to the rise of EVs, takes the oil industry’s fate out of its own hands.

What was a supply-driven narrative has become a story of demand.

Continue reading

Posted in Energy Technology, Industry Activity | Tagged , , , | Leave a comment

Oslo and Beijing are Transforming the World of Transport – and Global Oil Demand

Norway’s niche high-growth EV market could be dismissed as a small outlier – were it not for the fact that the world’s largest car market is following its path.

Our Friends in the North

Norway is the world’s fastest growing market for electric vehicles (EVs): in 2017 39% of car sales in the country were pure electric or plug-in hybrid EVs.

If (non-plug-in) hybrids are included, electrified vehicles made up 52% of the 158,000 passenger cars sold Hence, Norway became the first country in the world to sell more electrified cars in a year than traditional internal combustion engine (ICE) vehicles.

source – bestsellingcars blog

This is due in part to the Norwegian government’s target of zero sales of CO2-emitting vehicles by 2025, supported by policies such as tax exemptions and free parking.

If sales of EVs continue to grow at their current 35% pa rate, that target will be reached.

Continue reading

Posted in Energy Technology, Oil and Gas | Tagged , , , , | 3 Comments

Next Up – Why, if Norway is the highest growth EV Market in the world, is it using record amounts of diesel and gasoline ?


The answer to this will be in our next post here later this week.

Followed by – 2020: A New Era of Oil and Gas Megaprojects ?

Two questions to start the new year.

More to come


Posted in Energy Technology, Industry Activity, Oil and Gas | Tagged , , , , | Leave a comment