Anything but oil
– John Kemp is a Reuters columnist. The views expressed are his own —
As OPEC ministers meet in Angola this week, they can congratulate themselves on a brilliant piece of market management.
Quick decision-making and aggressive output cuts over the last 18 months have stabilised prices at their highest level in real terms since the early 1980s. And this despite the deepest recession since World War Two.
The cartel has had plenty of help. Cheap liquidity from central banks has helped finance inventories, while continued enthusiasm from the investment community has encouraged the market to look past weak short term fundamentals and concentrate on the possibility of renewed price increases in future.
Ministers, led by Saudi Arabia’s Ali Naimi, can claim a large share of the credit: delivering timely and reasonably effective output cuts, limiting the stock build, and giving investors a reason to remain bullish.
But the body faces bigger problems as an “anything but oil” agenda swells with developed countries pursuing green agendas and seeking to insulate themselves from volatile markets.
Fears about the availability and environmental costs of combusting refined products have forged an unlikely alliance between the national-security right and environmental left around that agenda. It prioritises the use of other fuels (gas, coal, electricity, nuclear, renewables and biofuels) and new technologies (solar, liquefaction, carbon capture and storage) in preference to oil.
CARTELS SOMETIMES WORK
OPEC has proved cartels sometimes work, holding prices above the level that would prevail in a purely competitive market and speeding adjustment to shocks. But ministers need to recognise the challenges facing the organisation over the next two years will be at least as demanding as those since the financial crisis broke.
The biggest will be proving that the cartel’s oil can provide a competitive and reliable energy source in the decades ahead.
If not, their share of the global energy market will be whittled away by conservation and substitution policies, as well as a growing share for cheaper and cleaner burning fuels such as natural gas aimed at limited carbon dioxide emissions, and perhaps even coal (assuming carbon capture and storage can be deployed on a significant scale).
In the last five years oil has proved an expensive and unreliable energy source. Prices have gyrated wildly in response to instability in the Middle East, Nigeria and Venezuela; the producing countries’ apparent inability to bring on new capacity in a timely manner; and stalemate with the international oil companies over access to reserves. All of which have been amplified by the animal spirits of investors and speculators.
Consumers have been given an enormous incentive to switch as much of their energy use as possible into other fuels to insulate themselves from oil capricious vagaries.
PREMIUM FUEL NO PROTECTION
Not everyone has a choice. Refined products from crude oil (especially gasoline and diesel) remain premium fuels. High energy density makes them extremely efficient carriers of energy and the only realistic option for many transport applications.
But even in the transport sector, surging and unpredictable prices have resulted in demand destruction, especially in the advanced industrial economies, where the full impact of rising international oil prices has been passed on to consumers.
In the United States, the biggest energy user of all, the total volume of refined petroleum products supplied to domestic customers peaked in the summer of 2007, well before the financial crisis, and has been on a downtrend for two years.
Gasoline demand weakened noticeably from mid-2007 onwards as customers cut discretionary driving and switched from sport utility vehicles in favour of smaller and more fuel-efficient cars.
Following previous episodes of demand destruction, the cartel faced steep losses in consumption and was forced to buy back demand through a prolonged period of low prices in real terms. But this time much of the demand that has been lost has probably gone forever.
The combination of fuel efficiency measures and the ethanol mandate (passed in response to concerns about high and rising oil prices) have ensured that gasoline demand and petroleum consumption has probably peaked in the United States.
A LEGISLATIVE PARIAH
Much of that “anything but oil” agenda is now being firmly embedded in legislation. It will not be particularly easy to reverse, even if real oil prices stabilize or fall in future.
Failure to agree emissions reductions in Copenhagen and the uncertain prospect of the U.S. Congress approving a cap-and-trade programme next year provide a respite. But conservation measures, including vehicle fuel economy standards and the U.S. Environmental Protection Agency’s threat to regulate tailpipe emissions of greenhouse gases, are still forging ahead.
Meanwhile the competitive and legislative playing field is being tilted in favor of cleaner, greener fuels that are more abundant in the advanced economies, such as natural gas (including shale), bitumen sands, renewables, nuclear and coal.
The advanced economies have almost unlimited energy sources (including premium liquid transport fuels from Fischer-Tropsch liquefaction) at real oil prices well under $100 per barrel. Only a periodic collapse in oil prices has prevented these technologies being exploited more fully in the past.
Oil’s decline can be tracked in the recent editions of the International Energy Agency (IEA)’s World Energy Outlook (WEO).
In WEO 2004, the IEA projected OECD energy consumption would grow to 6,953 million tonnes of oil equivalent (mtoe) a year by 2030, of which around 40 percent would come from crude, 26 percent from gas and 17 percent from coal.
By WEO 2009, projected consumption had been cut as much as 17 percent to 5,811 mtoe (owing to a combination of the 2008 recession and the rising cost of all forms of energy). Forecast oil consumption had fallen even further, down by a massive 32 percent.
Oil is now expected to provide only 32 percent of primary energy consumption in the OECD in 2030, while the share from coal is up two percentage points and the proportion from nuclear, hydro and renewables is up almost 7 points.
OIL IS FOR POOR PEOPLE
OPEC’s customer base is increasingly concentrated in emerging markets, where economic growth, rising incomes and still-growing populations are boosting demand, and an extensive system of price controls and fuel subsidies has largely insulated consumers from the pressure to be more efficient.
Emerging markets show less enthusiasm for the climate change and anything-but-oil priorities of the advanced economies. Raising living standards for the rural poor and creating jobs for the growing number of over-educated and under-employed graduates in their urban centers is a more pressing priority than the remote risk of global warming in 50 years.
But if the advanced economies become more efficient and shift to cheaper and more reliable fuels emerging markets will come under pressure to follow suit or lose their competitive advantage. Intense oil use will be a handicap in coming decades.
Already most emerging markets have liberalized their price controls somewhat and scaled back subsidies that mostly benefit the middle class rather than the poor, when the doubling of oil prices in H1 2008 made existing systems unaffordable. China is now showing strong interest in coal liquefaction, gas from Central Asia, and greener solar power to cut oil imports. Others will follow.
If there is another spike in prices, demand destruction will not be restricted to the developed world. More volatility, especially on the upside, will only strengthen the determination of policymakers to reduce oil’s share in the energy balance.
OPEC has often called for “security of demand” to help it invest, matching the consumer nations’ call for security of supply. But unless the cartel can find a way to avert future spikes, demand security will remain an illusion, as consumer countries continue weaning themselves off an expensive and out of favor fuel.