Peak oil demand and its implications for Gulf producers

A photo taken on December 14, 2017 shows flames rising at the Bin Omar natural gas facility, part of the Basra Gas Company, north of the southern Iraqi port of Basra. (AFP)
Updated 20 January 2018

Peak oil demand and its implications for Gulf producers

LONDON: Even if oil consumption reaches a peak and then starts to fall, the world will still need large quantities of oil for many decades to come.
The prediction is contained in a thoughtful paper co-authored by Spencer Dale, chief economist of BP, and Bassam Fattouh, director of the Oxford Institute for Energy Studies.
“Global oil demand is likely to continue growing for a period, driven by rising prosperity in fast-growing developing economies,” they wrote in a paper published on Monday.
“But that pace of growth is likely to slow over time and eventually plateau, as efficiency improvements accelerate.”
The implication is that consumption is likely to reach a maximum at some point and then start to fall, though the timing and magnitude of the peak are highly uncertain and very sensitive to assumptions.
And even once demand has peaked, consumption is unlikely to drop sharply, the authors argue, given the inherent advantages of oil as an energy source, particularly its energy density.
“Peaking oil demand is not expected to trigger a significant discontinuity or sharp fall in demand,” they wrote.
Under most scenarios, the world will still be consuming tens of millions of barrels of oil per day through the middle of the century.
There are sufficient known oil resources to meet all the world’s oil demand through 2050 twice over, according to BP estimates.
But given the natural decline in output from existing fields, substantial investment will be needed to turn those resources into reserves and produce them.
The predicted peaking of consumption, coupled with vast resources, and new production made possible by hydraulic fracturing and horizontal drilling have transformed the long-term outlook for the oil industry.
The dominant narrative, which before 2008 was characterised by fears about future scarcity and oil supplies running out, has been transformed into one about future abundance.
Some now worry that many of those resources will never be needed and may become stranded assets — a welcome development for climate campaigners but a potential problem for oil producers.
Peak oil demand signals “a shift in paradigm: From an age of scarcity to an age of abundance, with potentially profound implications for oil markets,” according to Dale and Fattouh.
In an era of abundance, oil markets are likely to become increasingly competitive, as resource owners compete to secure market share and produce their reserves rather than risk them being left in the ground.
“Faced with the possibility that significant amounts of recoverable oil may never be extracted, low-cost producers have a strong incentive to use their comparative advantage to squeeze out high-cost producers and gain market share.”
Better to have money in the bank than leave oil in the ground.
As the oil market becomes more competitive, low-cost producers will find it more profitable to switch to a high-volume, lower price strategy — in contrast to the old strategy of restricting volumes and raising prices.
The argument applies especially to Saudi Arabia, Kuwait and Abu Dhabi.
The implication is that many producing countries will see revenues and formerly high resource rents decline, to the benefit of consumers.
In theory, competition for market share should drive oil prices down to the marginal cost of extraction, which the authors suggest could be lower than $10 per barrel for the major Middle East producers.
But these countries rely heavily on oil revenues to fund government operations, defense, healthcare, education and social safety nets. They need prices well above the marginal cost of extraction.
To be sustainable, oil prices must be high enough to cover these “social costs” as well as the much lower costs of physical extraction.
The authors cite fiscal breakeven prices as a proxy for social costs and say breakevens for five major Middle Eastern producers averaged $60 per barrel in 2016 compared with a physical cost of production of just $10.
Many low-cost producers recognize the need to diversify their economies away from dependence on oil but experience suggests such transitions take decades to complete.
In the meantime, the authors argue, many low-cost producers will try to resist the shift to a higher-volume, lower-price strategy while they try to make progress with the transition.
The problem with this argument is that it makes oil prices a function of social costs. In reality, it is the other way around — price drives social spending.
Dale and Fattouh argue that “it is likely that many low-cost producers will delay adopting a more competitive strategy until they have made significant progress in reforming their economies. This is likely to slow the speed at which the new competitive oil market emerges.”
“The shift to a more competitive oil market environment won’t just happen on its own accord, it requires a critical mass of low-cost producers both to recognize the need to adopt a more competitive strategy and, more importantly, to have reformed their economies sufficiently for them to be able to adopt such a strategy sustainably.”
If social costs in many low-cost producing countries remain high, according to Dale and Fattouh, that is likely to slow the pace at which a more competitive market takes hold, until they can reduce them.
Fattouh and Dale assume that Saudi Arabia and the other low-cost Middle East oil producers can successfully exercise market power, restricting production to keep prices high.
But they are probably overstating OPEC’s market power.
In the 1980s, OPEC’s market power was broken by the emergence of rival oil supplies from the North Sea as well as Russia, Alaska and China. In the 2010s, its market power was hit by the emergence of US shale, Canadian heavy oil and deepwater projects.
In practice, prices have been driven by the cost of developing and producing alternative supplies outside the major producing economies of the Middle East.
The cost of these alternative supplies is well above the $10 physical extraction cost of the major Middle East fields — but it may or may not be high enough to cover their social costs.
In future, the major oil producers will also have to reckon with increasing competition from other forms of energy.
Dale and Fattouh conclude that social costs and the pace of economic reform in the major oil-producing countries will have a decisive impact on oil prices over the next few decades.
In practice, the opposite is probably true. Oil prices and the degree of competition from other sources of supply, as well as electric vehicles, will have a decisive impact on the producers’ social spending and the rate of diversification.
• John Kemp is a Reuters market analyst. The views expressed are his own.

Adnoc said to plan regional oil marker

ADNOC headquarters in Abu Dhabi. The company is considering dropping destination restrictions on all of its oil and allowing it to trade freely on the open market. (AFP)
Updated 3 min 48 sec ago

Adnoc said to plan regional oil marker

  • Aims to launch in-house trading for refined products to boost global clout

DUBAI: The UAE’s state-run ADNOC plans an overhaul for its trading operations as it seeks to emulate the success of rival oil majors and bolster its regional influence.
The company has splurged on hiring former employees of private-sector peers and wants to launch a regional oil benchmark, possibly this year, similar to international markers Brent and WTI, four sources familiar with the plans said.
The plan is not yet finalized and still has to be approved by UAE authorities, such as the Abu Dhabi Supreme Petroleum Council, the sources said.
ADNOC did not respond to a request for comment.
“ADNOC hopes the benchmark will allow it to earn more money and gain bigger prestige in the region,” one of the sources said.
The UAE, the third-largest oil producer in OPEC, behind Saudi Arabia and Iraq, pumps around 3 million barrels per day. It plans to boost output to 4 million bpd by 2020. Most of that oil is produced by ADNOC, based in the country’s capital, Abu Dhabi.
For many years it has traditionally sold oil directly to end-users, mainly in Asia, based on a retroactive pricing system rather than the forward pricing used by Saudi Arabia, Kuwait and Iraq.
Now, the company wants to launch full, in-house trading for refined products and crude as part of energy-sector reforms under Sheikh Mohammed and ADNOC Chief Executive Sultan Al-Jaber.
ADNOC is considering dropping destination restrictions on all of its oil and allowing it to trade freely on the open market, as part of a broader transformation to become more proactive and adaptive to market changes, the sources said.
“The idea behind trading is simple — the UAE sells its crude to someone like BP, which then takes it to the UK, where it is refined into jet fuel which then goes to refuel the UAE’s Etihad planes,” one source said, referring to the Abu Dhabi airline.
“So why can’t ADNOC capture some of the value of trading and the supply chain?“
ADNOC is venturing into oil trading as part of an international expansion aimed at securing new markets.
In January, it signed agreements worth $5.8 billion with Italy’s Eni and Austria’s OMV covering refining and a new trading venture to sell refined products jointly.
Over the past year, ADNOC has hired a raft of ex-Total traders, led by executive vice president Philip Khoury. The others include ADNOC’s head of crude, Emmanuel de Reynies, head of products Lionel Richardson, and Jean Marc Cordier, Francois Chupin and Aegidia Schnepp.
Traders from other oil majors and trading houses also joined, including Suzanne Mullen, previously of BP and Citi.
“These guys know how trading works, how benchmarking works,” one of the sources said.
ADNOC has held talks with French energy company Total and trading house Vitol as part of its new crude oil pricing and trading overhaul, the sources said, while beefing up its in-house trading team.
Total and Vitol declined to comment.
One of the options is for ADNOC to team up with a large player whose worldwide storage facilities it would use.
ADNOC is in talks for a stake in Vitol’s storage business VTTI, two of the four sources said.
VTTI owns storage in the Netherlands, the US, Asia and Africa. In the UAE, VTTI holds storage in Fujairah, a bunkering hub where ADNOC sends most of its crude, bypassing the often-troublesome Strait of Hormuz, which is further north. Around a fifth of global oil supply transits through the strait. Tensions between Iran and the West have contributed to fears of disruption there, sparking price rallies.


• ADNOC hires former Total traders in bid to rival majors.

• Seeks to turn Murban crude into benchmark.

• Moves seen as part of drive to increase regional influence.

Inside ADNOC, there are growing views that the company could turn its flagship crude Murban into a regional and possibly global benchmark more popular among foreign buyers by using its ability to export and store oil away from the strait.
Murban is exported from Fujairah and is relatively insulated from possible regional unrest, three of the sources noted.
The Abu Dhabi Crude Oil Pipeline, with a capacity of 1.5 million bpd, carries the bulk of the UAE’s crude production to ADNOC’s storage and loading facilities in Fujairah. ADNOC is also building oil storage under the mountains of Fujairah, with completion due next year.
So far, most Middle Eastern grades including those of Saudi Arabia are priced off the Dubai/Oman benchmark for Asian exports, off Brent-related indices for European exports and various US indices for US shipments.
ADNOC may announce plans to launch Murban as a benchmark as early as November and is talking to a number of exchanges including Intercontinental Exchange (ICE) and the Chicago Mercantile Exchange (CME), the three sources said.
ICE and CME declined to comment.
One source said ADNOC had made it clear during discussions that it was prepared to remove all restrictions on oil resales, a key condition for a crude grade to become a benchmark.
Other key conditions for the success of a benchmark are stable and fairly large oil flows and a developed derivatives market, allowing hedging and forward trading.
“The fact that ADNOC wants to turn Murban into a destination-free grade shows they are serious about making it a benchmark,” a source said.
Soaring US production of predominantly light crude could help Murban, also a light grade, become a benchmark even though most regional grades are heavier.