Oil, the impending supply cliff edge, and the beast from the east

Michael Baxter looks at oil and climate change.

Article updated: 6 March 2018 10:00am Author: Michael Baxter

Shale gas will enable the US to dominate the oil industry for the next half a decade, but then we will have problems, suggests a new report from the International Energy Agency. It could be right, but I see another problem blowing down from the Arctic.

The oil price matters rather a lot. Not only can it help determine the profitability of the world’s leading oil companies – that no doubt make-up part of your portfolio, and most certainly are an important part of the pension industry investments, its price can help influence the economic cycle. It is surely no coincidence that the oil price rose to close to $150 a barrel, an all time high, just before the 2008 financial crisis. It is no coincidence that the EU and US economies are seeing their best run of data in years, shortly after the oil prices fell to a 21st century low – around $30 a barrel at one point.

There are time lags of course, the economy is a complicated beast – in fact it was around 18 months ago when the oil price was hovering around $30, but these things take time to have an effect.

International Energy Agency

The International Energy Agency or IEA, has released a report predicting that oil demand will rise by 6.4 million barrels a day, in total, hitting 107 million a day by 2023. At the same time, it forecasts that the US will pump an extra 3.8 million barrels a day while OPEC will see an increase of 750,000 barrels.

In fact, it sees supply exceeding demand by around two million barrels a day by that date.

In short, if the IEA is right, the next five years will see US dominance accounting for 60 per cent of the increase in supply, making up just under 20 per cent of world supply.

Given these fundamentals, it is hard to see how the oil price could rise that much higher than the current price levels for a while.

Looking beyond 2023

But in looking beyond 2023, the IEA sees a problem. Fatih Birol, the IEA's executive director, put it this way: “The weak global investment picture remains a source of concern. More investments will be needed to make up for declining oil fields - the world needs to replace 3 million barrels per day of declines each year, the equivalent of the North Sea - while also meeting robust demand growth."

And that is the snag. Ever since the oil price crashed 30 months or so ago, investment in oil has crashed too. As global demand rises, there will come a point when shale gas is insufficient to meet demand. At that point, the oil price should go shooting up.

For some time, I have been predicting here that this could happen around 2020, if the IEA is right, it seems 2023 might be a more accurate date.

You might say, so what? 2023 is a long time off. And in a way you are right, the BP and Royal Dutch Shell share prices is not likely to be affected by these theoretical trends for some time. But it will be eventually, I think the next half a decade or longer will be kind to the oil majors.

Bigger fear

And yet I remain concerned.

I am not aware of anyone making the claim that the recent spell of cold weather contradicts the global warming hypothesis – I am glad, because such a claim would have made no sense. The key word here is global – it may have been cold in Europe, but average global temperatures have been creeping up for some time.

I do read, however, that an extraordinary heat wave in the Arctic, which may indeed have been down to climate change, could have been the cause of the so called ‘Beast from the East’.

‘Could have been the cause’ is not the same thing as saying: ‘It was the cause’. It is just that it does serve as a reminder. The threat of climate change has not gone away – and those who predict that climate change will lead to higher temperatures in the UK, creating a wine region, for example, to compete with and eventually outcompete the French regions, are making far too many questionable assumptions. Climate change may lead to higher global temperatures, and lower temperatures in the UK. We don’t know.

But as investors we can only deal with probabilities. We don’t know anything for sure. But there is a strong possibility that the evidence for climate change will become so strong over the next few years that, at a time when advances in renewables and energy storage create viable alternatives, we may see a popular backlash against all fossil fuels.

I am not sure when this will happen, but I do think the IEA is underestimating the odds of this particular disruption.

Looking ten years ahead, I think the prognosis for the oil industry is weak indeed.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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