The First Law of Thermodynamics – Energy Is Becoming a Buyer’s Market

Energy cannot be created or destroyed, but can be altered from one state to another (1).

Oil Supply Dwarfs Demand – Official

“There is an abundance of oil: known resources today dwarf the world’s likely consumption of oil out to 2050 and beyond.” Spencer Dale, BP Chief Economist, from BP Energy Outlook, Jan 2017.

Here is a chart from BP in their latest annual Energy Outlook, that confirms as predicted, the oil age will not end due to lack of oil.

 

A key finding in BP’s Energy Outlook, that is discussed at length, is the fact that whilst proven world oil reserves have been growing at a rate of about 3% pa for the last 30 years, oil demand has slowed to under 1% in the past decade.

These Proven Reserves, technically and economically viable today, have also concentrated into three areas: OPEC, Russia and the US, three of the lowest cost regions for oil extraction and production in the world.

At the same time, oil demand has started to weaken considerably, and tend toward plateau, or even peak.

So, in BP’s straightforward analysis, looking out even beyond 2050, cumulative demand amounts only to half of today’s viably recoverable oil reserves.

Technology investment has done its part in providing enough resources – the industry players now have to figure out how to manage their exits.

We now enter oil’s long end game of managing deteriorating demand, and abundant supply.

Deteriorating Demand – Peak Gasoline

There is a detailed debate in the Outlook regarding transport fuel demand, as this is a key element of future oil consumption. It centres on EV penetration,  but in reality it’s the changing global structure of transportation that is more important.

Peak transport oil demand is imminent because the growth areas of oil consumption such as China and India, show very different characteristics to the current OECD transport picture, dominated by US consumption.

The US consumes almost 50% of global gasoline but with just 30% of its cars because it is a major outlier in terms of very high annual travelled miles and low fuel efficiency.

Global VMT per capita                  Vehicle fuel efficiency

  

Sources –     Australian Department of Infrastructure global review and  IEA, WEO 2016,

Future growth will therefore be shaped more by the way China, India and the EU use their vehicles.

As other studies have shown, they are likely to drive less, and be more fuel efficient.

BP looks at various downsides for fuel demand due to EVs or the emergence of mobility services such as autonomous vehicles – but the simple maths of the RoW usage patterns dominating future global demand suggest the following demand curve.

 

dollarsperbbl estimate: Based on following annual projections –  Global ICE fleet 900 million, 14,800 VMT per vehicle with -1%, pa decline.  fuel efficiency 8.5l/100km and decrease -2.4%, global fleet growth of 2%pa and annual scrappage of 4.5%, EV growth rates leading to 10% total fleet 2030, 20% by 2035 (35% of annual sales). 

This indicates fuel peak demand by 2019-20,  and the shape of the demand curve is in line with BP’s Electric Revolution scenario, which also includes ride sharing, and autonomous vehicle usage, not considered in detail in the above.

A near-term shallow peak followed by accelerating decline: the key message is obvious – to a good approximation we are at Peak Fuel demand.

A key point to note is that the shallow peak is a brute consequence of more compressed global driving distances and overall fuel efficiency, so-called automobility – and not reliant on EV demand; EV demand does kick in later, and creates the accelerated decline. But the saturated driving patterns cause the current demand squeeze.

To reiterate, whatever the future brings in terms of EVs, autonomous driving and mobility as a service, it certainly will not deliver another 250 million US-style vehicle drivers with high fuel consumption internal combustion engines, and large annual travel distances. That is the core difference, and why peak oil demand draws closer.

In terms of overall transportation, BP also looks to trucks for more consumption, but these are just as susceptible to the efficiency, electrification and travel trends as for cars. In addition, the major growth economies of Asia are moving into consumer-led growth rather than industrial and construction-led growth, reducing energy intensity.

As gasoline and diesel fuel make up around 65% of the total crude oil barrel, this plateau of fuel demand drives the total crude picture suggesting peak demand in imminent, in the 2019-20 timeframe – in contrast to the BP business-as-usual projections that has continued growth for the next two decades, but aligned with their downside scenarios.

The Abundance of Oil
However, in the shadow of BP’s statement about the “abundance of oil”, this milestone of a rapidly approaching peak in oil demand is almost a footnote,

Whether oil peaks now or sits becalmed for a decade, the aggregate demand requirement will fall within a relatively narrow aggregate range of 600-700 billion barrels out to 2035.

Either way, demand is “dwarfed” by the accessible reserves of up to 2.5 trillion barrels we have at our disposal, amounting to 3-4 times the requirement to 2035.

So, lost in the whole debate regarding the precision of when peak oil demand might occur is the oversized fact that after decades of pursuing greater than 100% reserves replacements and production increases at the cost of several trillion dollars, the national and international oil companies, along with newer players in the vast tight oil deposits of the US, have created a massive stockpile of accessible and economic oil resources, the majority of which will likely not be required.

Highlighting this, BP is questioning the industry orthodoxy – a reliance on smooth upward projections of demand, and constrained supply – that has caused most players to pursue these vast investments in exploration, reserves replacement and production.

And this orthodoxy has seen returns on equity shrink to below 2-3%.

The overall result – a massive over-abundance of stones oil.

BP is now calling this dislocation and suggesting a new set of strategies will be needed.

But for now, the central projections of BP’s Outlook clearly suggest they themselves will continue with the standard model.

So as of today, despite reserves dwarfing demand, the industry continues to add aggressively to the reserves base.

Exit Music and OPEC’s Dilemma

BP’s Outlook is quite forthright on what will happen next: as a result of the over-hang of reserves, and weakening demand, it expects the biggest three oil producers, OPEC, Russia and the US to step up production and investments to dominate market share – resulting in over 65% of the market by the 2030s at 70mb/d.

This would likely force the exit of many high cost producers, national and international alike, especially if the big three players were explicit in their aim.

Translating even proven reserves into production is no easy task – but the for the big three players it is far simpler than for the rest of the industry. As a group today they account for 70% of reserves, 55% of production, but only about 25% of industry capital expenditures – such are the benefits of being the low cost producers.

So, the bottom line is that they probably could follow this strategy, and dominate (declining) global oil requirements. The huge question is, will they? And how will international companies and other higher cost producers react?

That is a deep debate for another post – but at least consider this.

It still all likely hinges on what OPEC decides to do, as all the other key actors – IOCs, Russia and the US – are likely to continue to quietly pursue production growth, being their ingrained business model, and rational preference.

But as the world of oil – reserves, production, costs – is ultimately OPEC’s world, it’s their strategic choices in the coming months that will set the tone for the long future.

And the outcomes will be stark: hold back production and OPEC risks accelerating the flight of customers to alternative energy technologies and encouraging other oil competitors, but increase supply and OPEC is seen to force global prices downwards, with all that would entail, both geo-politically and economically for national industrial strategies.

BP believes it will be the latter – why hold on to an asset that is likely to decline in value – maximize its worth now instead. And with the IPO of Saudi Aramco looming, Saudi Arabia needs to reassure its investors that it can be a leader in the oil market.

If it constantly has to act to cut market share to accommodate competitors, the appeal of Aramco shares could be diminished.

BP’s now published prediction and the IPO likely accelerates OPEC.s increasingly binary decision – how to maximise the value of its titanic reserves: by restraining access, or by investing to maximise their consumption?

Place your buy-sell orders on Aramco’s pre-IPO shares.

A Buyer’s Market

Turning to the buyers.

What BP is hitting on is not only the fact of the huge growth in oil reserves – but that those countries such as China, India and the EU, who are heavily reliant on buying oil and gas have rapidly engineered alternatives to reduce future dependency.

Engineering discovered and developed oil and gas deposits into thermal energy, but it has also designed and improved wind turbines, large-scale storage batteries and high-voltage transmission cables, efficient photo-voltaic cells, dynamic demand-load software, and electric vehicle power-trains and low-cost Lithium-ion batteries, to create economically viable and usable energy at increasing scale.

As the latest Lazard study on levelled costs of electricity shows, these technologies, PV and solar especially, are now to a good approximation, equal in cost with conventional coal and gas thermal plants. Equally, the cost and performance of  EVs is improving  so rapidly, they will soon be price-equivalent to conventional internal combustion engines, with several models beating the critical $30,000 and 200plus mile range this year, and with energy consumption costs about 80% lower than gasoline cars.

Large energy importers now have an array of home-grown or internationally-manufactured solid-state electronic alternatives to importing thermal fuels.

Although this outcome is often hotly debated,and politicized, it is increasingly a flat technical choice.

Choice, not Necessity

Energy importers now have an increased set of options on which to build their energy strategies: what level of locally-deployed renewables for power assuming further cost reductions, what is the long-term view on coal and nuclear, what fossil-fuel import dependence to be exposed to, what policy incentives or penalties to deploy around EV and autonomous transportation technologies. And so on.

It switches their strategy from reaching out to fossil fuels out of necessity to meet future energy demands, toward optimising their energy requirements across a range of factors.

This will include the effectiveness of those strategies in regard to issues such as national health, local employment, long-term economics, export opportunities , and global stewardship considerations.

It will go far beyond the simple thermal mass balance of how much fossil fuel to import and pressurized infrastructure to build.

In the world ahead, each of these energy options and trade-offs will likely lead to different outcomes for major buyers of imported energy as they move toward more independently- manufactured alternatives.

But the critical point, that providers of oil and gas will be very aware of, is that if oil and gas prices are persistently high, and or their supply unreliable, major buyers are increasingly able to switch to genuine alternatives.

This switching may not be simple or easy, but it is increasingly economically viable and it typically offers other benefits such as air quality improvements, energy dependability or exportable manufacturing expertise, making efforts often worthwhile (2).

Energy is therefore looking increasingly a buyer’s market, as the technologies to create heat, light and transport are diversifying.

That doesn’t mean everyone will buy wisely, of course – Europe’s transport energy strategies remain unclear, but it does allow major new energy consumers in China, India and elsewhere to avoid a future dependence on oil and gas, and instead leap-frog to more efficient and sustainable sources.

In fact, a longer-term outcome is that the world may actually consume more energy overall, but as the First Law states, just in a different form.

The Bottom Line

A growing abundance of proven oil reserves in the world’s most cost-effective oil producing regions is now “dwarfing” declining oil demand, due to the rise of various alternative energy technologies. This is moving the oil sector toward a buyer’s market, as the increasing surplus of oil inventory faces competition from other energy sources such as cost-effective electric vehicles, changes in driving patterns, a reduction in energy intensity of developing markets and increasing energy efficiency.

BP’s calculations suggest that proven resources in the Middle East alone could provide all future global consumption required out to 2050, and that overall reserves are 3-4 times higher then expected future demand to 2035.

Major producers, especially OPEC, face a significant immediate dilemma: hold back production and risk accelerating the flight of customers to alternative energy technologies, or increase supply and force prices downwards with all that might entail for wider geo-political issues.

Major energy buyers such as China, India and Europe can now choose between a new suite of power and transport energy technologies, and develop a coherent energy strategy that maximizes benefits in terms of national health, economics, employment and future growth of skills.

Coda – The Second Law of Thermodynamics

Of that extra 600-700 billion barrels of crude oil we will use even in a lower demand 2035 scenario, about 500 billion will be lost as heat to the atmosphere, following the iron-clad Second Law of Thermodynamics, the bias for disorder in the universe.

500 billion barrels of rejected, expensively-extracted, produced, refined and supplied energy, just dissipated out into the cold void, lost for good, not converted to anything better.

So let us not mourn the passing of our reliance on thermal energy.

Its historic technologies have been a marvel, but they have also been, and remain, hazardous, inefficient and polluting.

Time to move on, thoughtfully.

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(1) – This is a compressed way of expressing the First Law of Thermodynamics, and it suits the theme of the post. There are more precise and technical ways to describe it – it may also be called The Principle of Energy Conservation. I hope the reader allows the license used here.

(2) – Some of this analysis will be covered in an upcoming post on the dimming future of gas demand, caught between resilient coal and high-performing renewables

 

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