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Disruptive Economics Accelerating Global Energy Change

Commodities / Crude Oil Jun 05, 2012 - 05:37 AM GMT

By: Andrew_McKillop

Commodities

Best Financial Markets Analysis ArticleOil analysts already integrate “disruptive technology” in the shape of hybrid and all-electric cars in their forecasts of probable, at least possible decline in the total oil demand of the world's two-largest car fleets - in the EU27 and USA - and in the world's fastest-growing fleets of China, India and other smaller emerging economies.


Forward forecasts of fuel demand per vehicle are now so low they overcome any fleet-total fuel demand effects due to fleet size growth, at least for the US and Europe. Expressed in miles per US gallon terms or litres per 100 kms, the results may be radical by as early as 2020, and revolutionary by the 2025-2030 period. For the US fleet whose total size, currently 200 million may attain almost zero annual growth, new car additions or replacements by 2020 could average 44 mpg (5.3 litres/100 kms) compared with 29 mpg today. For the EU27 fleet of 215 million cars already at present close to 6.5 litres/100 kms on average, radical gains in fuel efficiency are unlikely in the short-term to 2020, but average trip lengths and trip numbers-per-year are already in decline.

For these two mega-fleets whose combined size is about 45% of the estimated total world fleet (925 million cars, defined as vehicles below 2500 kgs weight), their total fuel consumption is estimated at about 8.6 million barrels a day (Mbd) for the US fleet but only 4.7 Mbd for the European fleet, giving a current combined total of about 13.25 Mbd. Relative to total OECD consumption of 44.25 Mbd as of February 2012 using IEA data, these two car fleet's oil demand is about 30% of total. Other road, rail and marine transport oil demand in OECD countries adds at least another 5 Mbd to this 13.25 Mbd total, further raising the role of transportation in oil demand.

Already the 2007 rate of US car fleet oil demand - about 9.2 Mbd - was a historic high. According to US EIA data, the fleet's demand has fallen by about 0.54 Mbd since 2008, especially in years 2008 and 2011. In Europe, the average rate of car fleet oil demand contraction in the Union since 2006, using Eurostat data is 2% per year but this rate may easily grow, to 3%-per-year or more, certainly after 2020, but also possibly before. The effect of these trends to 2025-2030 become dramatic: US gasoline and diesel fuel demand could fall to 4.9 Mbd, and EU27 car fleet fuel demand could fall to 4 Mbd by 2025-2030 even assuming only a "trends continued" forecasting scenario.

Total combined savings would therefore be about 4.3 Mbd, which is more than the total oil production of any OPEC state except Saudi Arabia.

ECONOMIC RUPTURE
As oil supply peaks, this cuts total global supply growth to zero annual growth, and driven by multiple and converging factors global oil demand will also peak. The previous or most recent paradigm for this event, the date of which is set for 2017 by the IEA without providing details of the mechanism, can be briefly described as follows.

Unrelated or disconnected global oil supply-demand elasticities, notably caused by unrelated time
mechanisms controlling supply growth and demand growth will require a final upward price spiral and peak, usually set at around $175 - $200 per barrel, to trigger the rapid and final shift through zero demand growth into reliable and sustained annual declines of oil demand, reducing total world demand to 60 - 70 Mbd or less, by 2035 (compared with 89.9 Mbd today, using IEA data).

The price factor is usually treated as predominant, that is higher prices cut demand, especially US oil demand because the US economy and energy-economy are beleived to be market-priced and oil inefficient, while non-US members of the OECD group are believed to have more complex, only partly market-based oil pricing and are also more energy efficient. In particular this "economic model" has many problems explaining fast oil demand growth outside the OECD group, in countries with much lower average incomes.

This economic disruption model is as noted above "classic", and firstly assumes oil prices can attain and sustain, for a certain period of time, about $175 - $200 per barrel. We can today call it the "pre-2008 model", due to the massive changes taking place in the global energy economy since 2008 or slightly before, which include and integrate multiple market, non-market and policy changes as well as fundamental economic change. Giving 2 examples of these many changes, we can ask what chance or likelihood is there for oil prices hitting nearly $200/b when global natural gas prices can only and will only decline to 2020, and European energy transition to renewable energy has already reached such extremes that Germany is forced to give electricity away for free on "green power Sundays" ?

According to the IEA, state subsidies to fossil fuels attained about $409 bn in 2011, proving that oil prices are not "pure market" and never will be. On the upstream, and a form of subsidy (that is misallocation), global major energy companies holding about 75% of global oil capacity, analyzed by Citibank and Deutsche Bank spent an increasing amount on oil & gas exploration and production (E&P) through 2000-2011. This was estimated as rising from a total of around $150 bn annually in 2000, of which two-thirds was spent on oil E&P, to a peak of more than $450 bn in 2008 of which about three-fifths was spent on oil E&P, but since 2008 this has flattened to around $350 bn (annual rate for 2012 based on Q1) today, with less than 60% of this spending going to oil E&P. Overall, for 2000-2011 the increase of net oil production capacity from this spending was an annual average of 1.75%. Conversely their gas reserves and gas production capacity have respectively risen by more than 10% a year and over 6 % a year. Including shale gas reserves, reporting of which is complex and difficult to compare with conventional gas and oil, these unconventional gas reserves have risen by hundreds of percent since 2000.

The writing is on on the wall for oil investing versus gas investing, made even more certain because shale gas exploration, and stranded gas exploration can both yield major oil condensate finds, as well as extractible gas resources. The classic economic paradigm for "Peak Oil" in 2017, on the supply side, can or may come well before this date simply due to falling oil E&P spending or investment, but only under intense geopolitical stress (Middle East war) can we expect this to be accompanied by $200-dollar oil. Oil prices by 2017 may be rangebound in the $50 - $75 per barrel range, in 2012 dollars, which spells serious problems both for the global energy majors, and oil exporter countries. This price range can be compared with current energy prices in boe terms (barrel oil equivalent) for natural gas and coal. Gas as of early June 2012 in the US is priced at less than $16 per barrel-equivalent, even if Asian and European prices are well above $65 per barrel-equivalent, while global coal prices are around $25 - $30 per barrel-equivalent. For the upstream "fuel" supply to unconventional and new renewables (excluding biofuels), eg. windpower and solar power, this price is $ Zero per barrel-equivalent. Oil was too expensive, and stayed too expensive.

DISRUPTIVE CHANGE AND THE END OF OIL
The most likely scenario, today, is for the current sell-out on oil markets to bottom, or flatten from about $75/b for WTI with a considerable compression of the Brent-WTI premium. The $75/b level is claimed to be a Saudi Arabian "nice price", by its oil minister, from which oil's share of the energy market will not suffer too much erosion, but this is now outdated thinking.

Separating the economic recession-effect, from the price-effect and other factors (like technology change) driving down oil demand to a likely "surprisingly high" real market price of close to $75/b for oil replacement at current rates of world demand (89.9 Mbd) are difficult but from 2012 and going forward we can expect global oil demand to start shrinking - with or without recession. The period of 2012-2015 is therefore critical for analyzing and predicting this global energy mega shift.

Economic change towards resource-lean, resource-conserving economic models and paradigms was already a policy poster child, often muddled and bundled together with heroic myths like the "fight" against global warming, but the present OECD-wide recession and economic slowdown makes for radical changes when the end of the tunnel is reached. Energy saving and efficiency will become even more interesting when, on the one hand, "free power Sundays" as in Germany, today, become more widespread due to spiralling growth of wind and solar power, and on the other hand when or if filling station oil prices reach the April 2012 EU27 average of about $350 per barrel.

These energy prices are impossible to coexist together - and oil will be the big loser. The energy major corporations, and oil exporter states will at some neartime stage start to show signs they understand this, and have strategic responses to this endgame. Outside of energy commodities, the role of "embodied energy" commodities, starting with energy intense metals like aluminium or copper will likely show advanced signals of change - possibly including a serious narrowing of price differentials between energy commodities and non-energy commodities, that is price growth of the second.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2012 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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