The Rise and Fall of Black Gold

By Ed Rawle

Is peak oil demand just around the corner?

The market used to worry about peak oil supply. Now the focus has shifted to peak oil demand as the industry witnesses a structural decline in demand from the developed world and questions the appetite of the emerging world to grow at the insatiable rates experienced over the past 15 years.

Specifically, the pace of technological change—in transport and energy storage, among other things—is fueling the debate.

Oil demand has already peaked across much of the developed world, starting with Japan in 2000. This contrasts with the emerging world, where oil demand continues to grow rapidly. OECD (Organisation for Economic Co-operation and Development) demand appears likely to revert back to structural decline by 2020, wiping out more than 3 million barrels per day (b/d) by 2035. While low oil prices have supported a resurgence in OECD demand since 2014, this price effect is already fading, and we expect it to reverse as oil prices rise into the 2020s. Notably, OECD demand is weighed down by government policy and auto technology, which have already and will continue to push vehicle fuel efficiency improvements and drive fuel substitution. Together with slow or no growth in the working-age population and a mature transport sector, we see OECD transport oil demand fall significantly through the 2020s.

In contrast, non-OECD demand will likely continue to grow to 2035, driven by rising income levels and a growing middle class that boost the desire for mobility and the use of transport fuels. Demand for consumer goods, including plastics, and the need to move freight in an increasingly consumer-driven world will invariably drive oil demand higher. However, government policy, auto technology, and demographics in some countries also play a role in non-OECD demand. While these factors may not lead to a drop in non-OECD demand, they do curb the pace of growth, which is expected to decelerate over time. As in the OECD, this deceleration is mainly felt in the transport sector. Non-OECD demand is expected to grow by nearly 16 million barrels per day by 2035.

Growth in transport stutters: Gasoline is the weakest link

Of the 96 million barrels of oil consumed every day, almost 60 million are consumed in the transport sector. As technology advances—both in terms of the fuel efficiency of internal combustion engines and the move to hybrid and electric technology—the transport sector will have the most impact on oil demand.

Global growth in transport demand may likely stall by 2030, with gasoline demand hit the hardest. Globally, gasoline demand is expected to peak by 2030. It’s a double whammy for gasoline: In the next decade, it’s a fuel efficiency story. Post-2025, it’s an electronic vehicle (EV) story as the ramp-up in EV penetration displaces significant volumes of gasoline demand. The impact of peak gasoline on overall oil demand into transport is tempered by increasing demand for road freight and air travel.

The petrochemical sector is one of the few bright spots for oil demand

Petrochemical feedstocks make up just over 10 percent of total oil demand, but we see significant growth for the next 20 years. Feedstocks are forecast to add 6 million barrels per day to total demand by 2035—growing 50 percent from today’s 12 million barrels per day. Feedstocks include naphtha, liquefied petroleum gas (LPG), and, notably, ethane—considered “oil” when consumed by petrochemical plants as a feedstock.

Demand from all other sectors accounts for the remaining 30 percent of total oil demand. A continued decline in oil used to generate power offsets modest increases from the other sectors, leaving demand in this combined category basically flat through 2035.

To summarize, we don’t foresee peak oil demand before 2035. But we do see a stall in demand growth in the transport sector, driven by peak gasoline demand by 2030.

Although oil demand is expected to grow to 2035 on aggregate, it’s minimal compared with what we’ve seen over the past 20 years. The prospect of peak oil demand is very real.

What does the prospect of peak oil demand mean for oil producers and refiners?

From an investment perspective, the possibility of peak oil demand could reduce upstream interest and investment in exploration. We’ve already seen a move away from high-risk frontier plays, where upfront costs are high due to a lack of infrastructure. A focus on better-understood basins and near-field opportunities could persist as we continue to transition to a smaller, more efficient exploration industry. Investment in high-cost enhanced oil recovery projects to maximize reserves recovery from late-life fields could also be at risk.

There are also supply-side implications from the rise of petrochemical demand versus the stall in transport demand. Liquids from natural gas production will likely become a significant and growing feedstock for petrochemicals. Unlike oil, growth in gas supply remains relatively robust through 2035 and is a growing focus for upstream investment.

Turning to OPEC (Organization of the Petroleum Exporting Countries), neither market share nor revenues are likely to be significantly affected by slowing demand growth to 2035. This is because non-OPEC production plateaus late in the next decade and then declines to 2035. As a result, OPEC needs to increase its productive capacity to meet demand. Those OPEC producers with rising production can expect higher oil revenues next decade as their market share rises while the supply-and-demand balance tightens and prices increase.

However, OPEC producers cannot ignore the prospect of peak demand. They need to prepare for a future with less dependence on oil. As an organization, OPEC does not currently have an explicit strategy to reduce its reliance on oil demand. But some OPEC nations have made this part of their domestic strategy, such as Saudi Arabia through its Vision 2030, which seeks to develop non-oil-focused sectors of the economy, including healthcare, tourism, and defense.

In the downstream sector, our demand outlook poses a number of challenges to the refining sector. As demand for jet fuel (kerosene) and diesel fuel (gasoil) grows against a backdrop of declining gasoline demand, the refining sector reverts to being distillate-led. This transition is further supported by the forthcoming marine fuel regulation, which mandates that the international shipping community use fuels with 0.5 percent sulfur or equivalent as of 2020—down from today’s mandate of 3.5 percent.

The forecast decline in gasoline demand provides an opportunity for the naphtha currently converted into gasoline components to be used as petrochemical feedstock. However, the petrochemical sector typically targets the lowest-cost feedstocks, which can be ethane or natural gas liquids (NGLs) derived from gas processing facilities.

So, we don’t expect the petrochemical sector to be the savior of the oil market and drive prices higher.

Specifically, the projected decline in gasoline demand in OECD countries poses a challenge to refiners in the Atlantic Basin because it requires coastal refiners to become competitive in distant export markets. As oil demand growth slows in the non-OECD, refining capacity additions required in Asia for the next 20 years will be approximately half of those built in the last 20 years. The competitive nature of new facilities ensures they operate at high utilizations, requiring other assets to operate at lower levels. As a result, the pace of such capacity additions in non-OECD countries could raise the threat of closure for Atlantic Basin refiners.

So, oil demand is not expected to peak, but it won’t grow at the pace the industry has seen over the past 20 years. The oil industry is right to be concerned and should start to plan for the future.

Ed Rawle is chief economist at Wood Mackenzie, a Verisk business.