Paper shows perils of projecting oil demand
Global oil consumption could hit a massive 134 million barrels per day (bpd) by 2030, up from 85 million bpd currently, and demand is unlikely to peak in the foreseeable future, according to a recent academic paper.
While the projection has achieved widespread headlines, and been seized on by oil bulls as further evidence the world will struggle to meet rising demand, it is based on controversial assumptions about how emerging-market consumption will respond to increasing prices.
It is contained in a careful econometric study published by Joyce Dargay and Dermot Gately, “World oil demand’s shift toward faster growing and less price-responsive products and regions.”
Dargay and Gately’s figure is almost 20 million bpd higher than similar projections by the International Energy Agency (IEA) and the U.S. Department of Energy (DOE)’s Energy Information Administration (EIA), which are projecting global demand of 108 million and 107 million bpd respectively in 2030.
TWO MORE SAUDI ARABIAS
Most forecasters and oil producers are now working on the assumption global demand will peak around 105-110 million bpd sometime in the decade after 2020. But if Dargay and Gately are right, the world will need to find and develop much more oil. Oil production would have to rise 50 percent in just 20 years.
The extra output implied by the Dargay/Gately projection is equivalent to developing two new Saudi Arabias. It would be needed on top of massive new production required to compensate for declines at existing fields (many of which will be exhausted by 2030) and the 20 million bpd already needed to meet even the conservative growth forecasts the industry is using.
Dargay and Gately argue official projections are too sanguine: “Rapid demand growth is unlikely to be supplied by conventional oil resources”.
The “imbalance would have to be rectified by some combination of higher real oil prices, much more rapid and aggressive penetration of alternative technologies for producing liquids, much tighter oil-saving policies and standards adopted by multiple countries, and slower world economic growth”.
RESPONSIVENESS TO PRICE?
The vast gap (107 million versus 134 million bpd) stems from different assumptions about how emerging markets will respond to rising real oil prices.
Dargay and Gately assume demand outside the OECD and former Soviet Union (FSU) grows at an average rate of 3.9 percent between 2008 and 2030. This is slightly slower than in 1971-2008 (4.4 percent) but twice as fast as rates used by the EIA (2.0 percent) and IEA (2.5 percent) in their own long-term outlooks.
Adjusting for population, IEA has per capita consumption growth slowing from 2.54 to 1.10 percent; EIA has it slowing even more dramatically to 0.56 percent. The authors take issue with the realism of these forecasts. “None of the projections by DOE, IEA or OPEC have Rest-of-World per capita demand growing by even half its historical rate”.
LOW-HANGING FRUIT GONE
The predicted slowdown in per capita consumption growth assumes higher real prices ration demand and encourage widespread substitution and conservation programmes in emerging markets, just as they have in the advanced economies. Emerging markets can repeat the same revolution in efficiency and reduction in oil-intensity OECD countries managed in the wake of the oil shocks, according to the leading energy agencies.
For the authors, though, “The factors most responsible for reducing demand since 1971 cannot be repeated. Almost all the low-hanging fruit has now been picked; it cannot be picked again”.
They point out most of the reduction in global intensity between 1971 and 2008 came from phasing out the use of fuel oil for power generation and space heating in the OECD, and the collapse of industrial production after the fall of the Soviet Union.
Fuel-oil switching eliminated 7 million bpd of OECD consumption in 1978-1985 and another 2 million bpd in 2003-2008. Lower industrial demand in the FSU cut consumption another 4.5 million bpd. Neither reduction can be repeated.
Moreover, while fuel oil consumption in the OECD proved very responsive to increases in the price of crude, demand for transport fuels and petrochemicals responded far less. Transport and other oil demand increased more or less in line with rising per capita incomes.
END OF PRICE CONTROLS
The situation was even worse in emerging markets outside the OECD and FSU. For China, other emerging markets, and the oil-exporting countries themselves, the authors find no evidence that rising prices exerted any restraint on demand. Instead per capita growth grew almost as fast as per capita incomes.
The complete lack of price responsiveness in China and other emerging markets should give us pause. As the authors themselves note, “A reason for this may be that the domestic product prices set by the government of China were not directly related to crude prices, so that the crude prices used in the model are a poor reflection of prices actually paid by consumers”.
This is crucial. Price controls and massive subsidies ensured consumers across China, the rest of Asia and the oil-exporting countries faced no pressure to conserve or substitute oil use during the 1971-2008 period examined by the authors.
Only at the very end, in 2008, as the cost of subsidies became unbearable, did these countries begin raising retail prices, realigning them more closely with international crude, or phasing out controls altogether.
Rising real prices will make subsidies and controls wholly impractical in future. Going forward consumers outside the OECD and FSU will be much more exposed to price changes and their responsiveness is likely to increase accordingly.
Even transport demand is sensitive to price, as the authors show. The average weight of new motor vehicles in the United States fell 20 percent between 1975 and 1980 as purchasers and carmakers prioritised fuel efficiency.
It crept up again after more than a decade of low and falling real prices in the 1990s and early 2000s. But soaring real prices have put efficiency back on the agenda. The drive for greater economy is likely to be replicated in emerging markets as much as in the United States.
Finally, it is very dangerous to extrapolate from past demand in the OECD to future demand in emerging markets such as China. Even within the OECD, per capita demand for transportation fuels is twice as high in the United States and Canada because of the much greater distances involved than in Europe and Japan. OECD transportation demand is in fact an unreal average of two very different populations.
Given the greater urban densities in China and other parts of Asia, future demand will resemble Europe and Japan more than the United States. Europe and Japan’s success in curbing consumption by driving up efficiency and switching from gasoline to diesel is a much more relevant template for how emerging Asia and the Middle East are likely to respond to rising oil prices.
The Dargay/Gately paper performs a valuable service in showing how sensitive long-term projections are to assumptions about income growth, prices and behavioural change. But its projection of 134 million bpd in 2030 is unreasonably high. It assumes an unrealistic lack of price response.
In fact the differences are not as large as them seem on the surface. The authors themselves provide a range of projections from 112 million to 152 million, depending on price and income elasticities. The outcome is much more likely to be at the lower end of this range, reflecting more price response, putting them in the same ballpark as the major energy agencies.