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May 10, 2018updated 11 May 2018 7:21am

What is peak oil? And what will happen to the industry if we reach it?

By Rachel Dobbs

For much of the last century, observers of the oil industry have debated when or if we might reach so-called peak oil — the point when the maximum rate of petroleum extraction is achieved.

Reasons for this peak have changed over the years, from production driven by supply, to production driven by demand. Most recently, BP has predicted that oil demand will peak by the late 2030s.

What is peak oil?

M King Hubbert, the geologist who first formalised the theory of peak oil in 1956, thought that oil production by the US would reach its pinnacle around 1970. For Hubbert, peak oil was predominately a supply issue, and he thought that given that the amount of oil under the ground in any region was finite, and that the discovery of new sources of oil must decrease over time, so too must possible extraction.

US oil production did reach a high point between 1965 and 1970, but the inevitable decline that Hubbert predicted failed to happen. Improvements in extraction technology and discoveries of previously unknown sources of oil have allowed production to remain high. Earlier this year, US oil production topped ten million barrels a day, the highest level seen since 1970.

Will we reach peak oil supply?

These days, it is generally believed that supply issues will not cause oil production to reach a peak. Anna Belova is a senior oil and gas analyst for GlobalData. She says:

While the supply of oil is indeed finite, I do not believe we would come close to approaching the supply limits in the next century.

The industry stills sees significant discoveries of conventional oil and even the opening of new oil producing regions, like pre-salt Brazil, offshore Guyana, and Arctic Russia.

Deepwater and ultra-deepwater costs have been reduced significantly from their peaks and such resources will drive a higher fraction of new production globally.

Furthermore, the technological innovations for oil extraction from very low permeability rocks and from narrow zones, which propelled the US to set record production levels over the past decade, are yet to be widely implemented on the global scale.

This view is shared by Spencer Welch, a director on the oil markets and downstream team at IHS Markit. He says:

The world will stop using oil long before it runs out. There is a famous saying that the stone age did not end because of a lack of stones, the same will be true of the oil age.

Will we reach peak oil demand?

A lack of constraints on the supply side does not mean that oil production will not peak overall. Instead, this peak will be dictated by demand.

Belova says:

The future of oil [is now] centred around the externalities of oil production and consumption, as well as the price that the market is willing to bear. Just as higher oil prices enable new oil extraction technologies, they also make alternative energy sources more competitive, reducing the demand for oil: the peak oil is likely to be determined by the demand curve.

Global oil demand is dependant on energy demand as a whole, oil prices, the cost and viability of other energy sources, as well as political and cultural shifts away from fossil fuel use.

Belova notes:

Present day growth in oil demand is driven by two factors: improvements in economic situation for large segments of global population, which drives per capita primary energy consumption and product demand, and continuing growth in world’s population.

As economies develop, their demand for primary energy sources stabilise (a person can only drive one car at a time, however gas-guzzling).

Furthermore, as economies develop, their populations also stabilise, thus ensuring a ceiling on the demand for all sources of energy.

Additionally, increases in oil prices, environmental regulations and concerns about energy efficiency typically lead developed economies to look to alternative sources.

For a long period, many analysts believed that demand for oil in emerging economies would balance out decreased demand in developed ones, with new economies emerging all the time. However, it no longer seems that all economies follow the same path.

Edward Morse is an American economist, and the global head of commodity research at Citi Group. He says:

There is empirical evidence that the increase in energy efficiency and the decrease in the energy intensity of GDP growth is following an identical path today in both emerging markets and advanced economies.

Energy intensity around the world is falling at a similar rate, and that means that oil demand per capita in places like China, India or Brazil will never reach the heights reached in today’s OECD.

Morse believes that the two key drivers of change to oil demand are government policy and costs. Both factors are in play globally. He notes that despite the US’s recent retreat from active government intervention in the area, global changes to oil demand are being forced through by shifting public attitudes.

This is coupled with what Morse calls “the phenomenal drop in the infrastructure costs of renewables”. Bolova agrees, saying that the main causes of reduced oil demand are increased accessibility of renewable energy sources and higher oil costs caused by tightened supply such as the recent actions of Saudi Arabia via Opec.

However, Morse notes that the most significant shift towards renewable energy has not yet been reached. He says:

What’s missing still is a breakthrough in battery power, which is required to transform interruptible sun and wind into a reliable and available 24-hour-a-day source of energy.

What does the future hold?

Over the next two decades, technological developments will further influence oil demand. Welch predicts that in the 2020s, efficiency improvements will have the biggest impact. While in the 2030s, fuel substitution such as electric vehicles will generate the most change (electric vehicles currently only account for around 2% of total car sales).

Welch believes that these changes will lead to a peak in oil demand around the late 2030s, in line with the prediction made by BP. This raises the question of what will happen afterwards, particularly to the oil industry.

Welch does not expect the subsequent decline in demand to be rapid, saying:

Although we expect oil demand to peak in the late 2030s, we expect the decline rate to be very slow. This is because, even at that point, world population will still be growing, car population increasing and oil will still be a vital source of energy right through this century.

This suggests that peak oil does not necessarily spell doom for the oil industry. As well as continuing production, albeit at a decreasing rate, the traditional oil industry may also adapt to meet new energy needs.

Belova says:

I foresee a pretty large role for the traditional oil industry in the new energy economy.

Large multinational oil companies participate in every stage of the supply process, from extraction to processing to retail delivery.

Even if oil extraction becomes less important, their expertise with processing of raw materials into lubricants, plastics, and chemical feedstock, in addition to automotive and jet fuels, will ensure that oil companies are here to stay.

Morse agrees, believing that oil companies that can adapt to new circumstances after peak demand is reached in order to survive.

He says:

The economic history of the world is filled with episodes of stranded resources and the industrial survival of the fittest, just as it is filled with the rise and decline of governing bodies.

Energy companies will have to adapt. Look at film companies or copier companies: some died out and others adapted.

The lucky ones, and those that plan a future “beyond oil” will be better off than the others.

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