What About the Demand-Side Warning?

It’s interesting how peak oil continues to grab the headlines. If you log on to the Independent newspaper this morning the “Exclusive” headline is “Warning: Oil supplies are running out fast.”

The paper’s story was based on an interview with Fatih Birol, the lead economist with the International Energy Agency (IEA) who talked how depletion from existing oilfields is more than twice what it previously predicted.

He quoted the findings of the IEA’s assessment of 800 oil fields, which that were declining at nearly twice the rate previously calculated.

The Independent’s exclusive is actually not really new, although it certainly grabs the head-lines. It is a story that came out last year, and which I blogged on here.

Whilst a peak in supply has to be taken seriously – we need to look at what has happened over the last eighteen months to see the other side of the energy debate.  We have just been through an energy supply crunch, which meant the price of oil rocketed which forced people to start using less energy.

Indeed, in early June 2009, BP’s chief executive Tony Hayward conceded that as the oil price went over $90 consumers ‘began to change their behaviour’ and that there was significant ‘elasticity of demand above $100 a barrel’.

High sky prices means that people switch from oil to other forms of energy, and once you have invested in solar, wind or a hybrid car you are unlikely to switch back to oil.

This switch- coupled together with increases in energy efficiency mean that actually demand for oil is stabilising rather than rocketing. Moreover, the growing international pressure to finally deliver political and economic solutions to climate change can only further reduce the demand for oil.

All this means that, in the longer-term this stabilisation could move into steady decline forcing an irreversible structural change in the way we consume energy. All this is bad news for the oil majors, who still have a highly blinkered mentality when it comes to oil, summed up by the Republican panic mantra of “drill baby drill!”

But what happens when no one wants what you are drilling for?

These issues are explored by a briefing published by Greenpeace, Platform and Oil Change International that was mailed to 200 oil fund managers last week. It offers difficult reading for any oil exec, throwing some of their conventional assumptions out of the window.

The big oil majors are currently throwing billions into developing unconventional tar sands, which are more capital intensive to produce, and are therefore only profitable with a high oil price. Yet it is this very high oil price that is forcing consumers to switch away from oil.

As the briefing paper points out the expense of bringing unconventional oil to market means “that the sustained oil price needed to do so is dangerously close to a ‘break point’ price beyond which oil demand is constrained via changes in consumer behaviour and reduced economic growth.

Lorne Stockman, the author of the report argues that “A peak in oil demand was barely discussed even a year ago, but now it is a viable idea. When it happens, I wouldn’t want to guess, but it will happen sooner than we thought. There has been lots of talk about a supply peak, but it is good to start talking about a demand peak, and that has huge implications for these companies.”

Lorne adds: “There is something more structural going on. Governments are beginning to act, and not just the Obama administration. In the EU, the policy driver is climate change, and in China and the US, it is about energy security and the vulnerability of the economy to volatility in the oil price.”

If you want to try and dismiss the report as green hogwash you might want to read the interview it contains with Marc Brammer, the Head of Business Development for Europe at RiskMetrics Group.

When asked the question: “Do you think oil companies have the right strategies in place today to cope with future oil price volatility?” Brammer replied “The short answer is no. The industry was never set up to deal with the present market conditions. In the past the industry could always depend upon sizable expansions in cheap reserves. Now, significant new finds are more expensive and that doesn’t even begin to address the new environment wherein externalities will have to be priced back into the resource cost.”

Brammer concludes that “In general oil companies need to start seeing themselves as energy service companies as opposed to drillers and refiners of a specific commodity.”

Ironically, as any reader of the blog will know this is exactly the opposite of what the oil majors – Shell in BP – in particular have been doing.

So their whole business strategy is based on avoiding peak oil when actually its peak demand they should be worrying about.