Okay. This is weird.
Perhaps the analysts in Citi’s commodities team (which includes the inimitable Ed Morse) didn’t get the memo? You know, the one about needing to talk up the old carbon complex as much as possible?
After all, how else do you account for the disruptive tone of the following summary points:
Global Oil Demand Growth – The End Is Nigh
The Substitution of Natural Gas for Oil Combined With Increasing Fuel Economy Means Oil Demand Is Approaching a Tipping Point
The combination of an accelerating push to substitute natural gas for oil and ongoing improvements in fuel economy is enough to mean that oil demand growth may be topping out much sooner than the market expects. The shift from oil to gas is already underway in the US, where the shale gas revolution is giving a large economic incentive to make the switch. As the US shift gains pace, politics, greater natural gas availability and environmental concerns are facilitating the trend into the global market, more than compensating for the narrower gas-oil spread.
Higher prices, the removal of many fuel subsidies and rising fuel economy mandates have dramatically improved the outlook for fuel efficiency in global automotive and truck fleets. Citi’s automobiles team estimates that new car fuel efficiency is now improving by 3-4% p.a., with trucks managing 1-2%. As cars make up ≈60% of the total global road fleet we conservatively estimate that new vehicles (cars and trucks combined) fuel economy increases by 2.5% p.a.
And then there’s this…
One of the many unforeseen ripple effects of the US shale revolution is a push to substitute natural gas for oil. This is set to accelerate with LNG already challenging diesel’s 13 mb/d heavy duty truck use globally but especially in China, bunker’s 3.7 mb/d seaborne market, and CNG and propane set for exponential growth not only in markets such as Brazil, Egypt, Iran and India, but in Russia and the US as well.
The ramp-up in US ethane-based petrochemical capacity starting in 2017 should displace some of its oil-based competition elsewhere. The petrochemical sector globally uses ≈5.4-mb/d of naphtha, some of which can be substituted by the use of ethane and propane. This will increasingly shift the pull on supplies from oil to natural gas as oil-based crackers in China and the Middle East will face increasing competitive pressure.
Oil-based power generation is increasingly being replaced by gas-fired generation. As much as 2 mb/d of power generation demand in the Middle East in total could be switched to natural gas by the end of the decade, and the increasing availability of LNG towards end-decade could back out other oil for power generation needs in India and Latin America amongst others.
The structural bull market of the previous decade was a result of surging global oil demand and consistently disappointing non-OPEC supply growth, compounded by a collapse in Iraqi and Venezuelan production. The outlook for each of these factors has now reversed, reinforcing Citi Research’s long term view that by the end of the decade Brent prices are likely to hover within a range of $80-90/bbl.
All of which seems to imply, above all, that Blake Carrington WAS right about shale oil all along (God damn you, Alexis!):
But more importantly, that 2008 may indeed have turned out to be the big reset towards renewable and efficient fuels that many had hoped it would be.
Which gives us an excuse to put up the following chart from the EIA last week (H/T Climateer Investing) which shows to what degree the relationship between US growth and electricity demand is changing:
As the EIA noted:
Absent a very rapid introduction of some new electricity-using device—perhaps electric vehicles—a sharp rebound in electricity demand growth is not expected. While there is always uncertainty about future electricity demand, the efficiency standards for lighting and other appliances that have been in place over the past few years will continue to put downward pressure on growth as new equipment is added and existing stock is replaced. For example, a new refrigerator purchased today uses less than a third as much electricity as one purchased in the late 1970s, despite the larger size of today’s refrigerators (see chart below).
The over-riding theme, even accounting for the adoption of electric vehicles, is that western economies are doing more with fewer resources.
And hypothetically, even if electric vehicles were adopted more widely, if the technology was coupled with self-driving technology — we could still see a reduction in hours driven as car pools became more intelligently managed.
But there’s more from the Citi note that’s worth noting. Take the following chart as an example:
In many ways, this chart beautifully illustrates how cartel actions designed to squeeze prices — and to maximize profits from a mostly monopolised commodity — end up becoming self-defeating in the long run.
The original Opec oil shock, the best coordinated public market squeeze of all time, had a major impact on demand trends.
From then on, even though much of the technology to induce more efficiency was already available, oil demand began to recover gradually because there was still no real economic incentive to shift from the established carbon complex system to a more efficient one. The run up in oil prices in 2008, however, changed all that. It provided the impetus needed to cut demand in a meaningful way for the first time since the oil shock.
Of course, whilst the first oil shock was engineered by Opec, it’s worth considering what really motivated the market squeeze that took place from the mid noughties onwards. The peak oil theory was a dominating theme during that time frame. But whilst the theory propagated the idea that we would soon reach peak production despite ongoing demand growth, causing an inevitable energy crisis, it seems instead to have predicted our journey towards self-imposed peak production and a well managed shift from one carbon source to another more efficient one.
Given the preponderance of the peak oil theory at the time, and the government mandates it inspired, it’s interesting to consider to what degree high oil prices were actually a function of an industry clasping to its old relevance but clearly aware of its eventual upcoming demise, thus unwittingly self-imposing a market squeeze designed to extract as much money from the sector for as long as it still could.
The speculator ramp-up in the futures market, in that context, may really have been about providing a profitable hedge for production at those inflated prices for as long as possible. Essentially, extending the period during which profits could be maximised for as long as possible. Or, in other words, extending how long the dying infrastructure could be flogged for the benefit of incumbent players.
As for the scale to which these shifts have hit the US above all other countries, the following charts tell the story glaringly well:
It’s a disruptive shift by anyone’s standards.
And one, as the Citi analysts also note, which is mostly to do with substitution towards natural gas:
This drop in oil demand is partly the result of natural gas getting substituted for oil in a variety of sectors. This development is taking root in the US due to the large gap between natural gas prices and oil product prices, but it should transfer across the globe, as in many countries the spread between oil and gas is still substantial, if not a bit smaller than the US. Even in countries where the spread is compressed – such as China – environmental concerns are bolstering the shift from oil to gas.
The full note (which is in the usual place) is definitely worth a read, since it also provides impressive statistics on global car-fleets and their modernisation rates, not to mention other complimentary shifts away from oil happening in developing markets as well.
In short, if the note is correct, the most under reported story of the decade may be financial markets having totally missed the point at which oil actually became a growing economic irrelevance rather than a burden.
Perhaps, it’s time for a “Hitler finds out he’s over-invested in oil” video?
Related links:
Is the commodity sell-off overdone? – FT Alphaville
Commodity encumbrance and Joseph’s storage play – FT Alphaville
Storage play by Glencore, Trafigura pushes up lead costs – Reuters
Slumping trade growth – and more oil Jedi mind tricks? – FT Alphaville
Scarcity amid plenty, oil edition – FT Alphaville
The oil-bound – FT Alphaville