Microeconomics principles

Cook and Cherney (2017) conclude in their Wall Street Journal article “Get Ready for Peak Oil Demand” that there is a major change occurring in the consumption of oil while world demand is projected to peak and decline in the coming years, a notion echoed by the largest oil firms. The advent of emerging technologies, such as electric cars, which are expected to reduce the volume of fuel used, is a significant contributing factor. Furthermore, the campaign for lower carbon emissions and the introduction of green energy options would most likely reduce demand for oil. Therefore, oil demand will reduce in the future but the authors pose a troubling question: When will the peak in oil demand materialize?

The question has caused a lot of controversy among different individuals because they cannot agree on a timeline when the peak is expected. Oil companies such as Exxon Mobile state that it will not happen anytime soon but others such as the Royal Dutch Shell argue that the peak could happen as early as 2025 or 2030. The authors identify three factors that have the greatest impact: technological changes, tougher climate change regulations, and the rate of growth in the developing world. The reality that there a peak oil demand is sooner than expected has a significant effect on the demand, supply, and the prices of oil.

Oil demand and supply

Over the past few months, the prices of oil have been falling because supply has been greater than demand. The price fell to a one-month low after the U.S reported that its inventory of crude and gasoline has increased. According to the U.S Energy Information Administration, U.S production rose by 3.3 million barrels, an event that shocked many individuals who expected that inventories would fall. The surge in production is seen as a derailment to OPEC’s, and non-OPEC members deal to cut production by 1.2 million barrels per day. Such a move was necessitated by the collapse in 2010-2015 as a result of overproduction by the oil producing countries. Also, slower economic growth from major oil consumers such as China resulted in slower global demand, and when supply exceeds demand, the prices will tumble. Therefore, it seems that the pledge to cut oil production by OPEC members has not alleviated fears of a global oil glut.

In the article, Cook & Cherney (2017) point out that estimating when the peak in demand will occur is causing a debate among major oil producers, and the three factors identified add to this uncertainty. The passing of tougher climate change rules that seek to reduce the emission of greenhouse gases will result in continued growth in adoption of renewable sources of energy. Companies are starting to evaluate whether these sources of energy will displace oil but according to a report by OPEC: World Oil Outlook (2016) predicts that oil will satisfy 53% of the world’s energy needs by the year 2040. The second factor that has a significant effect on the future of oil demand is new disruptive technology such as electric cars. There is an expectation that the adoption of electric cars will occur at a fast rate and the long-term effect would be to reduce the demand for oil. However, in spite of these two factors, OPEC: World Oil Outlook (2016) states that the total demand for energy is expected to increase by 40% by the year 2040, driven to a large extent by the growth in the developing world. Incomes in the developing world such as Africa are rising, living standards are improving, and the demand for more cars is expected to grow.

On the supply side, OPEC: World Oil Outlook (2016) expects that oil production will continue to rise to 2019 despite the falling oil prices and agreement to cut volumes and then fall slightly in the year 2040. Supply is to a large extent affected by the costs of production and by bringing in the theory of peak oil, these costs are expected to rise. With time, the oil reserves are projected to decline, and oil companies will need to explore oil sands projects which are expensive to produce. Also, they will be forced to expand in the deep waters such as the Arctic fields, and this increases the production costs. OKullo, Reynes, & Hofkes (2015) also point that higher production costs are expected because the oil companies will have to deal with increasingly complex geological structures.

As indicated earlier, there is a lot of uncertainty regarding the timing of the peak in oil demand with major oil producers disagreeing. The occurrence of the peak will lean heavily on whether people will adopt electric cars rapidly, the climate change rules will restrict the use of oil, and the developing world will grow at a slower rate than expected. However, an analysis of the situation shows that these fears might be far-fetched because the developing world such as Africa will contribute to over 93% of the future growth in the demand for energy. The energy needs of these countries are expected to increase as the major sectors of their economies such as transportation and industries continue to rise. Also, major oil consuming economies such as China and India energy needs are expected to increase and according to OPEC: World Oil Outlook (2016), China’s demand for oil is projected to grow by 1.8%, and India’s demand will grow by 4% to the year 2014. It must be pointed out that the adoption of electric cars poses the greatest threat to the growth of demand for diesel and gasoline. The mass adoption of these cars would mean that the use of diesel would significantly reduce the demand for diesel. The Global EV Outlook (2016) points out that as at 2015, there were 1.26 million electric cars on the road and they are crucial in meeting the 2030 goal of de-carbonization. By the year 2030, the use of electric vehicles is projected to increase by a factor of 80 to 120, and this means that the demand for oil will be adversely affected.

In conclusion, there are fears among the major oil producers that the peak in oil demand will occur sooner than expected. Tougher climate rules increased adoption of renewable sources, and technological disruption such as electric factors are factors that might contribute to the peak happening. However, there is uncertainty surrounding the exact timeline for this to happen and increased global demand, especially from the developing world is expected makes such concerns far-fetched. However, this calls for the oil producing companies to take proactive steps in their investment strategies to ensure that they are not caught off-guard.

References

Cherney, L., & Cherney, E. (2001). Get Ready for Peak Oil Demand. WSJ. Retrieved 11 June 2017, from https://www.wsj.com/articles/get-ready-for-peak-oil-demand-1495419061#

Global EV Outlook. (2016). Retrieved from http://ttps://www.iea.org/publications/freepublications/.../Global_EV_Outlook_2016.pdf

Okullo, S. J., Reynès, F., & Hofkes, M. W. (2015). Modeling peak oil and the geological constraints on oil production. Resource and Energy Economics, 40, 36-56

OPEC: World Oil Outlook. (2016). Retrieved from http://www.opec.org/opec_web/en/publications/340.htm