Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Is the era of peak oil finally here?

Crude oil is a finite resource that must be discovered, extracted from the earth, transported often over vast distances to refineries, converted into various usable constituent products, and then shipped to disparate points of the compass to power much of the modern world. Until relatively recently, the debate over “peak oil” centered upon the date at which global supply maxed out and then began a precipitous decline as deposits ran dry.

Remarkably, the attention has now shifted from peak supply to peak demand. A general consensus has emerged suggesting global demand for oil will reach a maximum within a decade or two and then begin falling. The debate now centers not on if but when peak demand arrives. By at least one oil company’s reckoning, it may already be upon us, but in any event the era of declining oil consumption is in sight, with major implications for energy companies and consumers alike.

From the 1859 discovery of black gold in Pennsylvania until the early 1970s, US oil production fueled the American industrial juggernaut. Subsequent developments in geology and geopolitics led to a nearly 50% decline in US output and a dangerous dependence on imported oil, especially from the Middle East. As early as 1956, a geologist named M. King Hubbert warned of an imminent peak and decline in crude production beginning around 1970 in the US and 2000 globally. “Hubbert’s Peak” proved to be prescient as US production plummeted while Arab embargoes and energy crises dominated the next 2 decades.

Prescient, that is, until a most unexpected development: the shale revolution. Beginning in 2008, low-cost, abundant supplies released by new technologies like hydraulic fracturing in previously depleted fields triggered a sharp increase in domestic oil output that changed the game and allowed the US to regain the title of world’s largest oil producer. By 2020 we had become a net exporter of oil and petroleum liquids and attained a new all-time record for crude oil production of 13.2 million barrels per day during the first week of October. Suddenly “peak oil” no longer meant the onset of continually shrinking supply but the beginning of a steady fall in demand for petroleum. While the length of the runway for fossil fuels remains uncertain, the transition is clearly underway.

Two recent mega mergers in the oil patch bear witness to the unfolding regime shift. Exxon Mobil’s acquisition of Pioneer Natural Resources and Chevron’s purchase of Hess Corporation are consolidation plays intended to buttress proven, low-cost oil and gas supplies rather than making risky investments in deep water exploration or in distant and increasingly hostile environments. Exxon gains access to the Permian Basin, the largest and most productive US shale field, while Chevron adds rich shallow water deposits off the coast of South America and shale in the Bakken formation of North Dakota. Shale wells are relatively quick and cost effective to drill and can easily be scaled back or shut down during periods of excess supply, adding much needed flexibility to cope with short-term market volatility. These transactions provide evidence that the major oil companies expect fossil fuel demand to continue, but not indefinitely and probably not for too much longer.

The world economy is already much less reliant on petroleum products than it was 35 years ago. One important measure of dependence is called oil intensity, the quantity of oil required to produce $1,000 in real GDP adjusted for inflation. According to Columbia University, about 1 barrel of oil was required to produce $1,000 of GDP in 1973. Today, that number is less than 0.43 barrels, a 56% reduction in intensity thanks to substitution of alternatives like natural gas and renewables, as well as major advances in the energy efficiency of appliances and vehicles.

Transportation, which accounts for 57% of all global oil demand, is in the early innings of a transition as well. Today, electric vehicles make up nearly 10% of all passenger car sales, roughly tripling over the past 3 years. EV growth has slowed recently in the US but continues to accelerate in China, the world’s largest auto market. And the eventual deployment of vehicles powered by clean hydrogen with essentially no net carbon emissions is much closer to reality than previously believed. All these factors point to eventual demand destruction for fossil fuels.

But when? This is a question whose answer requires a healthy dose of humility, but consensus forecasts are converging on “sooner rather than later”. The British energy giant BP believes we are at the demand peak now, while OPEC (unsurprisingly) expects oil demand to increase until 2045 (Saudi Arabia depends on oil sales for 75% of its sovereign revenue). Splitting the difference, the International Energy Agency issued a new report last month predicting the peak in world oil demand around the year 2030, a mere 7 years away. The pace of the shift depends as well on the degree to which countries fully adopt the Paris climate accord reduction targets and could happen sooner if more progress is made.

Those of a certain age may recall the very real and frightening risk to the US economy from our heavy dependence on foreign oil and the near axiomatic certainty of its eventual depletion. Today we ponder the ultimate subordination of fossil fuels as the main source of energy powering the US economic engine. Nothing short of amazing.

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