Oil: How imminent is ‘peak demand’?

Summary: Experts disagree about when we will hit peak demand for oil, but as technological change continues to accelerate potential investors in the Aramco IPO should weigh its timing very carefully.

We are again grateful to Alastair Newton for the article below. He worked as a professional political analyst in the City of London from 2005 to 2015. Before that he spent 20 years as a career diplomat with the British Diplomatic Service.

The appointment on 8 September of Prince Abd al-Aziz bin Salman as Saudi Arabia’s energy minister led to a flurry of speculation as to the implications for two issues, ie the Kingdom’s oil pricing policy and the proposed Saudi Aramco IPO.

On the former, the Financial Times (subscriber access only), quoting unnamed analysts, went as far as to suggest that “the reshuffle would send shockwaves through the global energy industry at a time when Saudi Arabia — the de facto leader of Opec — and its oil-producing allies have struggled to raise crude prices”. So far, at least, this has proved pretty wide of the mark. When financial markets reopened on the morning of the 9th, the uptick in the price of a barrel of Brent crude was a less than remarkable 1.1%. Furthermore, even this was driven in part by a general move to ‘risk on’ assets (in which ‘family’ oil is included) which had nothing to do with ministerial shuffles in Riyadh!

This (lack of) investor reaction is entirely consistent with the view which many pundits expressed when the news of the Prince’s appointment broke, as reflected in Arab Digest’s 13 September newsletter, ie that it would mean “no change in the policy of delivering higher oil prices…”. Given how knee-jerk and herd-driven investors can be (see, eg: this link), I was a little more nuanced in my posting on the Arab Digest Facebook page at the time, suggesting that it was “harder [than working out the new ministers stance on the Aramco IPO] to say what it may mean for the other big question, ie the price of oil”. However, as I continued:

“Patently, the current price per barrel is languishing well below a balanced budget level for the Kingdom, as has been the case throughout this year. And I remain of the view that Crown Prince Mohammad bin Salman, in cahoots with Russia in particular, will look to push it higher if he can. But in the face of growing concern over global economic growth prospects – compounded, of course, by the Trump trade wars — it is hard to see Riyadh having much success on this count.”

Furthermore, to the extent that the 10 September increase in the price of crude was a reflection of the change at the helm of the Saudi energy ministry, such sentiment seems quickly to have been put to one side to judge from the price dip (of over 1.1%!) which followed later in the week on the back of the announcement that President Donald Trump’s hawkish National Security Advisor, John Bolton, had left the White House (thereby fuelling — in my and others’ view unrealistic — expectations of some near-term easing of Iran/US tensions).

Indeed, even the 12 September OPEC+ announcement that Iraq and Nigeria had agreed not to exceed their output quota (and that Saudi Arabia would continue to pump below its) failed to stop a continued softening of the price of crude through the week.

All this being said, the minor fluctuations in the oil price during the week or so immediately following the appointment of Prince Abd al-Aziz will almost certainly pale into insignificance compared to what we are likely to see when markets re-open on 16 September. The 14 September drone attacks on the Abqaiq oil processing centre and the Khurais oilfield in Saudi Arabia have highlighted both the war risk to oil in the Gulf region (which markets have largely shrugged off in recent months) and the related vulnerability of major oil infrastructure in the Kingdom. The bulk of this article was written before the attacks took place; and it will ‘go to press’ before the full extent of the damage — and, therefore, the likely severity and duration of cuts in Saudi output — are known. But their significance should certainly not be underestimated in that they demonstrate a more developed Houthi capability than we have previously seen to inflict serious damage inside Saudi Arabia (and not necessarily just to oil installations — think, eg, about desalination plant vulnerability); indeed, as the BBC’s Jonathan Marcus has written, to pose a strategic threat to the Kingdom. Ceteris paribus, as some of my economist friends like to say, this ought to lead to a sustained higher oil price than we have seen for some months — and, quite possibly, since October 2018 — for some time to come… but not one which is likely to be of much benefit to Saudi Arabia itself until it has restored at least a sizeable proportion of its lost capacity.

Additionally, we have to consider what wider consequences there may be to the strikes. Readers will note that I have credited the Houthis with these attacks, notwithstanding US Secretary of State Michael Pompeo’s assertion that “Iran has now launched an unprecedented attack on the world’s energy supply” — an entirely predictable response, in my view, irrespective of available evidence (and it is notable that Mr Pompeo has, to date, only claimed an absence of hard information, tweeting that: “There is no evidence the attacks came from Yemen”). Although Saudi Arabia has (so far) not pointed the finger of blame at Iran (the line from Riyadh to date being that this was a “terrorist attack” — which may have a bearing on the  claim by a Houthi spokesman in Beirut that the strikes were carried out in “co-operation with the honourable people inside the kingdom”), Riyadh will undoubtedly be quick to cheer Washington on if, as is likely, the Trump Administration looks to squeeze Iranian oil exports still harder, consistent with Mr Pompeo’s stated aim of ensuring that: “Iran is held accountable for its aggression”.

In any case, if there was ever any realistic hope of imminent Iran/US talks (even semi-casually in the margins of the forthcoming UN General Assembly) these attacks have almost certainly killed that off. But, given Mr Trump’s clearly- and oft-stated aversion to such, I do not expect to see US military retaliation of some sort against Iran as a direct consequence. Nevertheless, the inevitable general heightening of tensions does mean that the possibility of some sort of clash in the Gulf region involving Iranian and US forces, either by design or miscalculation, has risen.

The bigger picture 

Reverting to the original aim of this article by turning to the ‘long-term’, even the impact of the drone strikes on the oil price may well prove to be relatively ephemeral. And, certainly, in no way do they diminish the challenge which Saudi Arabia itself faces if it is indeed trying to push up the oil price with an eye not only to the Kingdom’s fiscal balance but also in an attempt to justify MBS’s USD2 trillion valuation of Aramco prior to an IPO (see, again, Arab Digest’s 13 September newsletter). Indeed, by highlighting the vulnerability of Aramco infrastructure to ‘war risk’, they are only likely to push valuations down, in the near-term at least.

Furthermore, any potential investor (at least outside Saudi Arabia itself — see the 13 September ‘Comment’ on the aforementioned Arab Digest newsletter) is likely to be thinking hard about Aramco’s longer-term value too. Which gets us to the thorny issue of forecasting ‘peak demand’ for oil.

I was drawn to consider this question again late last month when the Arab Digest editorial team sent me this article drawing on a BNP Paribas study which concludes that: “whether in the form of gasoline or diesel, oil’s days as a fuel for [light-duty vehicles] are clearly numbered because our…analysis shows that the economics of new wind and solar projects combined with [battery electric vehicles] are set to become irresistible”.

Delving further into the generic issue, I quickly came upon this very pertinent quote from energy guru (and friend and former colleague) Nobuo Tanaka, back in March 2018: “I believe this is part of Saudi Aramco’s motivation to undertake an IPO as they think peak demand might happen before it is expected”. Earlier in the same article, Tanaka san had cited the IEA’s estimate (at the time) that: “peak demand would not happen before 2040”; but he also acknowledged that: “if climate and technological change accelerates, demand for hydrocarbons except for gas will taper and this will happen more quickly”.

2040 is, of course, still a long way off (though not that far in major capital investment terms). However, at the other end of the scale, Carbon Tracker, a think tank, published a report a year ago forecasting that peak demand could come as soon as the mid-2020s. As Forbes’s Dan Eberhart noted in a critique of the report, this forecast is, on the face of it, consistent with some headline-grabbing thinking-out-loud by Shell CEO Ben van Beurden earlier in the year; but Mr van Beurden did place some major qualifications on this idea including, perhaps most importantly, full implementation of the 2015 Paris Accord which is certainly not the track which the Trump Administration in the United States is following. Nevertheless, even in the US all is far from as Donald Trump would have it. An increasing number of states and cities have declared their determination to uphold the Paris Accord — even in the face of pushback from the White House; and it may be only a matter of time before growing popular concern over, and opposition to, Mr Trump’s climate policies (ie, in a recent poll, only a 32% approval rating which is well below his overall — and surprisingly stable — rating) drive the President to consider whether his current stance could threaten his reelection prospects next year.

Somewhere in the middle sits a 2016 report by McKinsey which sees peak oil demand around 2030 at under 100mbpd. The report is helpfully ‘forensic’ in its scope, taking into account structural shifts which reduce energy intensity as economies develop, highlighting the role of light vehicles in reducing oil demand (see above), and clearly differentiating between oil demand for energy generation and for chemicals. I find the latter point especially interesting, with the authors reflecting clear evidence that “mature markets” had reached “saturation point” for plastics almost two years before the global drive against single-use plastics in particular really took off.

Put all this together and it is not hard to agree with Forbes’s Mr Eberhart who concluded his critique of Carbon Tracker’s analysis as follows:

“The problem with peak oil demand forecasts is that there are too many variables at play. Good luck trying to forecast how rapidly the low-carbon energy transition will play out. Small changes in assumptions – about technology development, the penetration of electric vehicles, the cost of renewable and alternative energy sources versus conventional fossil fuels – can lead to vastly different conclusions. The energy transition will happen over the coming decades, but an array of political, economic and social considerations will determine how long it actually takes to ‘de-carbonize” the entire global energy system, if ever.”

Nevertheless, as the new Saudi energy minister gets stuck into the Aramco IPO it is also worth keeping firmly in mind — as decision makers in Riyadh seem to — the probably prophetic words of one of his illustrious predecessors, as recalled by Tanaka san at the end of the article I referred to previously, as follows:

“The key point I would like to leave with your readers is one made some time ago by former Saudi Minister of Petroleum and Mineral Resources and Minister in OPEC Sheikh Ahmed Zaki Yamani which is that the Stone Age didn’t end because we ran out of stones. Rather we evolved and over time new technologies emerged as a result.”

One does not have to be a disciple of Ray Kurwell and fan of his ‘law of accelerating  returns’ to acknowledge that the pace of technological change continues to increase. And to recognise, therefore, that, in considering the Aramco IPO, investors would do well to weigh the timing of peak oil demand very carefully.

Footnote: Early day trading in Asia on 16 September saw the price of Brent crude rise by over USD10pb (19%) to almost USD72, before some easing (driven by profit taking). Although this is a four month high, it is still well below the USD86pb of mid-October 2018 anticipating US oil sanctions against Iran; and below the consensus for Saudi Arabia to balance its budget.

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