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Is oil dead? ‘Black gold’ loses its sparkle

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A global pandemic, collapsing prices and the green energy revolution all spell trouble for oil. Are the industry’s current travails just another cycle in its history of boom and bust, or will 2020 emerge as a year when a once mighty sector went into terminal decline?

When you visit Masdar City, “you will see few cars driving around the streets,” says Chris Wan, chief architect working on the project close to Abu Dhabi. “Masdar City is designed to be people-centric rather than car-centric,” he continues. “For internal circulation, we have prioritised walking, and we are also experimenting with hop-on, hop-off autonomous electric vehicles to help people get around.”

Inaugurated in 2006, Masdar City provides a vision of what the world could look like if it were to wean itself off oil. Wan explains that the city is largely powered by solar energy farms, including the nearby 100MW Shams array, which, when launched in 2013, was the largest in the world. The urban space is designed to minimise energy use – narrow streets, thick walls and small windows keep out the Arabian heat. With fewer cars on the roads “it is also a safer environment for kids to play”.

What is especially remarkable about Masdar City is that it is situated in the UAE, a country whose economy, like many others in the region, has long been dominated by the export of oil (oil exports now comprise around 17 per cent of GDP, down from a high of 60 per cent in 1979). The city’s development, which is ongoing, shows it is possible to imagine a world that doesn’t run on oil – even in a country that was historically dependent on the stuff.

Imagining a world without oil appears especially urgent in 2020. This year has seen a combination of forces come together that have wreaked havoc on oil markets and thrown fuel onto debates about its future. What are the challenges facing oil producers, how significant will these issues be, and how is the industry adapting?

A forecast published in September 2020 describes how demand for liquid fuels “never really recovers from the fall caused by Covid-19, implying that oil demand peaked in 2019”. What is surprising about this projection is that it comes from BP, one of the world’s best-known oil producers. To be sure, this is just one model for future energy demand described in the firm’s annual Energy Outlook report (other models suggest a slower decline). Nonetheless, when an oil major is playing down the future of the industry, it suggests something significant is happening.

The oil industry has faced numerous headwinds this year. The most obvious, of course, is the Covid-19 pandemic. Lockdowns and travel bans around the world led to a slump in demand for fuels. With fewer people travelling by plane, train and automobile, oil prices turned negative for the first time in history in April (producers were essentially forced to pay customers to take crude off them).

What is it good for?

Oil be the judge of that

Whether you are driving a car, applying lipstick, or bagging up your shopping at the supermarket, you will be using products derived from oil.

Here are the top uses of black gold according to the US Energy Information Administration:

Transportation: 68 per cent (road vehicles, jet fuel, bunker fuel for shipping).

Industrial: 26 per cent (plastics, solvents, lubricants, fertilisers, pharmaceuticals etc).

Residential and commercial: 5 per cent (heating).

Electric power: <1 per cent.

Besides the pandemic’s immediate impact on travel, the changes in culture and behaviour the disease has wrought may also dampen demand for oil. Capital Economics, a research firm, points out that the massive rise in remote working means many millions of people are likely to commute less often to work by car. Simultaneously, the widespread adoption of video calling will cut demand for international business travel – so less jet fuel will be needed. What is more, a combination of new technologies and ‘deglobalisation’ could reduce the need for shipping, Capital Economics suggests. With 3D printing, a preference for short supply chains and ‘onshoring’ of manufacturing, we may well need less bunker fuel to ship goods around the world.

Then there is the policy response to the recession. Many countries have signalled their commitment to ‘building back greener’. Governments, especially in Europe, have made significant commitments to using the crisis as an opportunity to boost ‘green’ industries. This too could put oil out of favour.

While the pandemic is the biggest immediate challenge to oil, it has not been the only crisis facing producers. In March 2020, a price war between Saudi Arabia and Russia led to a significant drop in prices per barrel. Professor Michael Bradshaw, an oil expert at the UK Energy Research Centre (UKERC), explains the reason behind the spat.

Since 2014, American shale oil production has taken a growing share of the global market and lowered prices. This led the Organization for Petroleum Exporting Countries (OPEC) and other nations including Russia to try to stabilise prices by reducing supply. However, communication between Russia and OPEC broke down in 2020, as Russia continued to oversupply the market. Saudi Arabia responded by increasing production, leading to a price war.

Another factor weighing on the future of oil is the renewables revolution and the concomitant electrification of transport. Energy from renewable sources currently only makes up about 11 per cent of global energy supply, yet this proportion is increasing fast. A combination of improving technology, economies of scale and government incentives mean these alternative energy sources may soon compete directly with oil. And, crucially, electric vehicle sales are rising fast and will take a bigger share of the market over time. That, in turn, will reduce demand for petrol and diesel.

Oil firms are seeing another fundamental challenge: staffing. Thanks to a tarnished reputation and climate change concerns, it is becoming increasingly difficult to attract new talent in some countries. According to one 2019 study, the number of graduates applying to work at UK oil and gas firms dropped by 61 per cent between 2012 and 2017.

“We think we will see oil consumption down by 8 per cent in 2020 compared to 2019,” says Cailin Birch, analyst at research firm the Economist Intelligence Unit (EIU). “We don’t expect full oil demand to return before 2023.” She adds that prices per barrel will stabilise around the $45 mark (in 2010, by contrast, a barrel traded at $79). Although the EIU sees demand for crude creeping up after 2023, Birch says they expect global oil consumption to peak in the late 2020s – which correlates with Capital Economics’ view that ‘peak demand’ will arrive around 2030.

Does this mean that oil will be consigned to the history books within a decade? Not necessarily.

“If you look at the OECD [a club of wealthy countries], we actually had peak oil demand in 2005,” explains UKERC’s Bradshaw. However, “in the global South and non-OECD countries, we are not yet past peak demand”. Birch of the EIU points to the fact that China has increased oil consumption in the second half of 2020 as the government pushes to kickstart an industry-led recovery.

For Bradshaw, it is likely there will at least be one more cycle of oil demand. “The next question is what happens after we reach peak global demand.” Depending on who you ask, oil usage will plateau at a high level for many years, decline gradually or drop off very steeply.

The way that demand changes around the world will depend on a wide variety of factors too. Today, the well-known ‘oil majors’ – firms such as BP, Shell or Total – actually only hold around 12 per cent of oil reserves. The vast majority is in the hands of National Oil Companies (NOCs) such as Saudi Arabia’s Aramco, Russia’s Gazprom or Mexico’s Pemex. This means that even if firms like BP commit to becoming cleaner ‘energy’ companies, their influence is smaller than in the past.

NOCs will have a far bigger role in influencing future demand, and their actions may be unpredictable. For states that rely heavily on oil revenues, there is little incentive to cut production. Bradshaw points out that NOCs are aware that oil may be a resource with a limited future, so they will potentially try to produce more of it; it will be better to sell the resource at a lower price now than leave it in the ground.

There is also the question of need. Even if the whole world managed to electrify car and train transport, it’s going to be an awful lot harder to power ships and planes with anything other than oil products. Similarly, many industries, including plastics, chemicals, fertilisers and textiles depend on products derived from oil. Until alternatives are found, we’re likely to see continued demand for many decades.

Oil remains the world’s primary source of energy. The commodity has brought enormous wealth, huge advances in social and economic development, and countless inventions and conveniences. Yet it has many well-documented downsides. Burning oil-derived fuels is, of course, a major source of greenhouse gas emissions and air pollution. It has also fuelled corruption and been a significant factor in many an armed conflict. So, what might declining oil consumption mean for global society?

Bradshaw points out that many countries’ economies depend on oil, and that “increased competition for what demand is left is also a potential cause for volatility”. He adds that “new tensions will also emerge around low-carbon technology, so a world with less oil consumption won’t suddenly become more peaceful”. Struggles over supply of materials needed for EV batteries or solar PV cells could generate conflict in future, for example.

That said, Kingsmill Bond of think tank the Carbon Tracker says: “A world using more renewables will be a more local world, a more just world.” We might well see fewer fights over access to resources if countries can power themselves with cheap electricity generated on their territory. However, Bond notes this transition will be challenging. “Unless correctly managed, the switch will create instability because of the fragility of the petrostates.”

The question of how to manage this transition has not yet been resolved.

BP is not the only oil and gas firm talking down prospects for oil’s future. European oil majors have all recently come out with projections for declining demand and even commitments to achieve ‘net-zero’ carbon emissions. Bond is sceptical of some of these announcements: “Using their forecasts for the future of the sector is like asking a second-hand car salesman about the car you are buying from them.” Nonetheless, these statements are striking.

How are big oil producers adapting, then? Bradshaw notes that many oil firms are working to create a ‘narrative’ to show how they are resilient and future-proofed. Reports such as BP’s Energy Outlook are part of this communication strategy to show investors and customers the companies are adapting.

Some oil firms do seem to be putting at least some of their money where their mouth is. Shell, for instance, is currently building a 10MW electrolyser – the largest of its kind – at a refinery site in Germany to produce hydrogen using electricity from renewable sources. BP, Total and other oil majors have all announced similar investments in renewable energies, although most expect to continue producing oil for the foreseeable future.

The industry is also investing in becoming more efficient. Bradshaw points out that oil and gas firms have been big adopters of digital technologies to boost efficiency. “It is interesting to see how the shale industry responded to falling prices,” he says. “They relied on digitisation and machine learning for more effective reservoir modelling.” These techniques are also used to analyse offshore production, helping operators decide which hard-to-reach sites are worth bothering with.

Carbon Tracker’s Bond believes these firms can indeed play a part in our transition away from oil. However, he warns, “the experience of other technology transitions suggests this will be hard. You need serious committed and focused leadership, not fiddling around and greenwashing.”

Since the first modern oil well was drilled in 1859, oil has faced many downturns. Whether it was fighting over oil fields in the Second World War, the Suez Canal crisis, the 1973 oil embargo, the 1990 Gulf War or 2015’s price collapse, the industry is no stranger to crisis – and the good times always returned.

Is the story today really any different? Will prices not just bounce back once a Covid-19 vaccine is rolled out?

It may be too soon to say for sure, yet perhaps the biggest difference with the present crisis is that we are seeing genuine alternatives to oil emerge. A combination of renewable energy and electric vehicles means that oil is facing competition in the transport market – something that has never really happened before. In previous crises, there was no real alternative to oil for transport and industry, but new technologies could really change the equation.

Back in Masdar City, architect Chris Wan is talking about the “test bed” nature of the municipality. One current project is to design a building that is ‘net zero’ in terms of the carbon emissions it generates. “Building a net zero structure is actually very easy,” says Wan. “However, making it commercially viable and actually something people can afford to buy is the hard part.”

This perhaps crystallises the issue. For all our concerns about the climate or pollution, the thing that will most likely bring about the end of oil is economics – and whether alternative energy sources can be viably delivered at a cheaper price.

Who controls it?

Oil together now

OPEC countries control just under 75 per cent of the world’s oil reserves and produce over 40 per cent of crude oil output according to data website Statista. In all OPEC countries, it is national oil companies (NOCs) that oversee production.

OPEC is composed of 13 mostly Middle Eastern and African countries, plus Venezuela. In 2016, OPEC+ was formed which brought countries like Russia and Kazakhstan into the fold.

Until the last decade, the dominance of OPEC nations meant they largely controlled the market. However, growing use of shale fracking techniques to tap into hard-to-reach reservoirs has allowed non-OPEC countries, and especially the USA, to gain a larger share of oil production (almost all US shale firms are privately held).

On the other hand, the world’s ‘oil majors’ (Exxon Mobil, Royal Dutch Shell, Chevron, ConocoPhillips, Total, BP, Equinor and Eni) control just 12.3 per cent of the world’s reserves, according to IEA data.

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