The Uncertain Future of Oil Demand

Posted by Jeff Rubin on November 17th, 2014 under SmallerWorldTags: , , ,  • 3 Comments

At a recent investment conference sponsored by Royal Bank and Suncor I spoke about the likelihood that billions of dollars of carbon assets will never see the light of day. Contemplating the idea of stranded assets isn’t in either company’s interests, so both deserve credit for providing a discussion forum for a topic that’s going to become ever more important to investors.

After laying out my argument for why oil prices must fall in an emission-constrained future, I was asked a question that might seem straightforward on the surface, but in reality is anything but. Won’t falling oil prices always trigger a rebound in oil demand (and, by extension, an equally large bounce in carbon emissions)?

It’s a belief that many energy investors are likely clinging to these days. A 30 percent drop in global oil prices so far this year is stoking expectations that a big pick up in demand is just around the corner. In a world before climate change became a household term that may have been the case, but not any more.

Now, more of the world’s governments are turning their attention to how carbon emissions might be successfully managed without triggering an undue amount of negative economic fallout. To get a sense of the enormity of that task, consider calculations from the International Energy Agency that show global oil consumption will need to fall to 80 million barrels a day by 2035 if we’re to limit atmospheric carbon to 450 parts per million. That’s the threshold that the scientific consensus says we must not exceed if we’re to avoid the grimmer consequences of a warming planet.

It’s a tall order given the world currently consumes more than 90 million barrels a day and counting. Even if demand growth, currently moving ahead at more than 1 percent a year, were to stop dead in its tracks, oil consumption would still need to fall by more than 10 million barrels a day over the next two decades.

If that were to come to pass, the implications for oil prices would be dramatic. During the last recession, for instance, a drop in demand of 3.5 million barrels a day sent prices from a high of $147 a barrel to lows that dipped below $40. Regardless of where exactly crude prices would end up trading, it’s a certainty that once carbon emissions become more of a consideration the price of a barrel of oil will be heading lower.

Of course, the path from here to there isn’t exactly straightforward. Basic economics tells us that high crude prices curtail demand and induce new supply. At the same time, lower prices cause production to be shut in and encourage consumption to rise.

It’s a familiar pattern, but will it continue to hold true? Right now, there are big bets being made in both directions.

Elon Musk, the chief executive of Tesla Motors, for instance is investing $5 billion to build the Gigafactory, which will become the world’s largest production site for lithium-ion batteries. He can’t be happy to see the recent drop in oil prices already has more U.S. drivers switching back to gas-guzzlers. How many electric cars can Tesla really expect to sell if oil is $40 a barrel?

At the same time, how confident can you be if you’re Exxon and you just spent $13-billion in Alberta’s oil sands on the Kearl mine and have plans to pour another $9-billion into the project over the next few years? Can you trust that tomorrow’s rebound in demand will be lasting enough to make that investment pay off? Without higher oil prices, the Kearl mine suddenly becomes a sinkhole for shareholder capital.

And what about the global economy? Will it continue to lurch and sputter along with oil prices or will it eventually wean itself off the fuel? For that to happen, it will take more than the unfettered workings of the free market. The price of burning oil will have to reflect the cost of emissions and not simply the expense of getting the fuel out of the ground.

Is that happening yet? No, but the world is beginning to take more steps in that direction.

For the coming rebound in oil demand to be capped in a meaningful way, policy makers will have to decide it’s time to intervene. If taxes become a larger component of what motorists pay at the pumps then the world might actually have a shot at reducing demand to the 80 million barrels a day that researchers say might be sustainable for the planet.

Choosing that path would require countries shifting a good chunk of their tax base from personal and corporate income to carbon taxes collected from households and businesses. Of course, if our economies are to remain competitive while doing that it will also require the levying of carbon tariffs on goods from countries that don’t tax emissions like we do.

Those are big changes, no doubt. When faced with the alternative, however, does overhauling our tax rules really seem so daunting?

  • scissorpaws

    Dion’s “Green Shift” (borrowed from Canada’s Green Party) was elegant, simple, and would’ve been effective. Ironically, it would have also made the Keystone Pipeline a fairly easy sell to the US back in the days when it would have mattered. I suspect we’ll get the pipeline done about the time oil dips below $80 a barrel, meaning we’ll be losing money on every barrel we ship and it’ll all be to America’s advantage.

  • Carol987

    As long as financial and energy giants are more concerned about stranded assets than they are about climate change, what chance really do we have? They control Congress and the White House regardless of who wins elections. If the IEA is right and 80 million barrels a day globally is the limit for human sustainability, then this should be the top issue, maybe the only issue, driving political and media discourse until we have a solution. But we all know that will never happen unless people demand it. The IEA and other agencies like it need to become more publicly involved in getting out the message, building consensus and providing data that people can understand.

  • Steve

    My two cents: carbon assets are going to be left in the ground for a variety of reasons, not least of which is emission constraints (that I think is the least of the reasons given the power of corporations and financiers over government).
    Demand has likely cratered because of how we have begun to respond to limits to growth (something economists tend to dismiss): monetary policies that have loaded the world and its consumers and countries with unsustainable debt.
    This debt has been the primary reason for relatively recent growth, and therefore demand, that otherwise should have run aground years ago. That party, however, seems to finally be coming to an end (perhaps not, who really knows except in historical retrospect). Consumers and most countries are tapped out and having to either curtail demand or attempt to create it through unconventional monetary policies (that seem to just be making matters worse).

    Gail Tverberg (of Our Finite World) has some insightful commentary on this subject here:,