Forget price slumps. Oil’s days have always been numbered

Tumbling oil prices have brought a re-assessment of the world’s energy mix. Jules Gray asks if it’s time that we start to seriously look at alternative sources of power generation

 
A slippery future: business pundits such as former Saudi oil minister Sheikh Yamani have predicted that over the next few decades, demand for oil will rapidly decrease as new technologies evolve
A slippery future: business pundits such as former Saudi oil minister Sheikh Yamani have predicted that over the next few decades, demand for oil will rapidly decrease as new technologies evolve 

The dramatic collapse in the price of oil over the last 12 months has caused panic around a world so reliant on the fossil fuel. Oil has become the dominant resource of the world’s energy mix over the last century, meaning that the bigger consumers of it would likely welcome a rapid reduction in cost. However, what it has really done is bring into focus the prospect of a world where stocks of oil are scant and energy is provided by alternative sources.

While the end of oil has been long predicted, the last 12 months of increasing production – led largely by the Organisation of the Petroleum Exporting Countries’ (OPEC) Saudi Arabia – has shaken up the oil markets, closing many prospective wells elsewhere and leading to people starting to think again about newer sources of energy. The day when oil is no longer the go-to fuel might just be getting closer than many had imagined.

As discussed in the last issue of World Finance, there has been a concerted effort to phase out fossil fuel use in recent years, but it has so far failed to bring about a meaningful shift towards renewable energy. However, the falling price of oil and the subsequent closure of many unprofitable wells mean that there could now be a proper shift away from polluting energy sources in favour of cleaner sources.

US shale industry productivity

Oil barrels per day:

308,700

March 2011

372,757

March 2012

817,428

March 2013

1,004,803

March 2014

Natural gas, mn cubic feet per day:

360,497

March 2011

626,262

March 2012

876,497

March 2013

1,112,944

March 2014

Indeed, many people – including the World Bank’s Jim Yong Kim and the IMF’s Christine Lagarde – have called for nations collectively to wean the world off fossil fuels by cutting subsidies. The oil, gas and coal industries have all enjoyed extremely generous government subsidies around the world for many years. In 2009, a meeting of G20 leaders led to a commitment to axe many subsidies, but six years later little has happened. This has been in part because of the financial crisis, but also because of the sudden boom in shale oil and gas discoveries.

The shale revolution
The global energy landscape has changed considerably over the last few years thanks in large part to the shale revolution in the US. It has taken away the reliance on foreign oil and gas in the US and Canada, creating a booming North American industry in the process. It has led to panic among nations like Saudi Arabia that have enjoyed a huge amount of demand for their plentiful crude oil resources, as they no longer hold as much sway over energy markets.

However, the plunging price of oil has dealt a blow to the industry, with many projects relying on high prices to justify exploration and the relatively high cost of production has meant that a falling oil price has led to many projects no longer being deemed financially viable.

At the same time, the continued blocking of the long-proposed Keystone XL pipeline by President Obama has meant the oil industry won’t be able to tap into all the resources it had hoped for in the future. Despite this, some in the industry believe that the cost of drilling for shale oil and gas will continue to fall, meaning that many of the projects will be viable soon enough.

The fall in the price of oil, however, is likely to be long term. Regardless of the shale revolution, many commentators think that oil’s days have been numbered for some time, and the normal safety net of the past is no longer willing to sustain stable prices. OPEC, the group of countries that have held a sway over the global price of oil, has faced the most difficulty from the last year, yet is also largely responsible for the fall.

Dominated by Saudi Arabia, OPEC has traditionally prevented prices from dropping too low, maintaining a semblance of stability in an industry that so many are reliant upon. However, instead of propping prices that were falling as a result of increased supply from the US shale boom, Saudi Arabia has driven up production levels as a way of crushing this new competition.

The reasons for this ramping up of production have caused much debate, with many saying it is Saudi Arabia’s way of stopping the US shale revolution, while also applying further pressure to the struggling economies of its’ oil producing rivals Russia and Iran. However, it seems more likely that the country has realised that its vast deposits of oil may not be so in demand in the not too distant future.

In fact, some within the regime have predicted the decline of oil for many years. In 2000, former Saudi oil minister Sheikh Yamani told that new technologies would mean far less demand by 2030. “Thirty years from now there will be a huge amount of oil – and no buyers. Oil will be left in the ground. The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.”

Yamani also correctly predicted that discoveries of oil would continue to remain high over the medium-term, but that eventually newer technologies would lead to oil’s downfall. “On the supply side it is easy to find oil and produce it, and on the demand side there are so many new technologies, especially when it comes to automobiles.”

He was also correct in predicting a major crash in the price of oil. “I have no illusion – I am positive there will be some time in the future a crash in the price of oil. I can tell you with a degree of confidence that after five years there will be a sharp drop in the price of oil.”

Fast-forward to last year, and the predicted crash finally began to materialise. Whereas in previous times of price instability Saudi Arabia has led OPEC towards slashing production, this time it refused. Because of its cheaper production costs compared to rivals Russia and the US, Saudi Arabia has been able to take a hit on profits that others could not justify.

According to a January article by Elias Hinckley for , the Saudis might be looking at the long-term implications of a world no longer reliant on oil. “Saudi Arabia has embarked on an absolute quest for dominant market share in the global oil market. The near-term cost of grabbing that market share is immense, with the Saudis sacrificing potentially hundreds of billions of dollars if low prices persist.

“In a world of endless consumption, this risk would be hard to justify merely in exchange for a temporary expansion of global market share – the current lost revenue would take years to recover with a marginally higher share of global supply. But in a world where a producer sees the end of its market on the horizon, then every barrel sold at a profit is more valuable than a barrel that will never be sold.”

Saudi Arabia’s declining oil empire

Saudi Arabia, the world’s biggest crude exporter, shipped

5.7%

Less oil overseas in 2014 than it did in 2013

Shipments averaged

7.11m

barrels a day; down from an 11-year high of

7.54m

barrels a day in 2013

In December 2014 exports dropped

5%

from November to

6.9m

barrels a day

Sustainable alternatives
As oil sees a sharp decline, other technologies are finally beginning to show their potential. Many countries have long dodged climate change regulations, but there have been signs recently that countries are beginning to take the issue seriously. Both the US and China have signed up to relatively strict carbon emissions targets in recent months, while US companies increased their investment in clean energy technologies last year to $52bn. China followed suit, with an investment last year of $89bn in clean energy technologies, a huge increase of $19bn on 2013’s figure (see Fig. 1).

Although governments enthusiastically backed many renewable energy technologies with generous subsidies at the turn of the century, a number of leading companies failed to turn their clean energy operations into profitable businesses. These included solar panel maker Solyndra, which severely damaged the reputation of the industry when it was declared bankrupt in 2011, despite a series of government loans.

However, the solar energy industry has certainly bounced back from a number of setbacks a few years ago. Prices of solar panels have fallen sharply over the last five years, and a number of observers are predicting that the industry will surpass more polluting fuels over the course of the next decade.

The IEA released a report last year that suggested by 2050 the world’s electricity supply would be provided largely by solar power. According to the report, two solar technologies – solar photovoltaic (PV) systems and solar thermal electricity (STE) – could result in a 27 percent of the world’s energy supply, meaning it would be the dominant form of power generation. This would also result in the prevention of six billion tonnes of carbon dioxide emissions, which represents more than all of the US’ current energy-related carbon dioxide emissions.

The IEA’s Executive Director Maria van der Hoeven said, “The rapid cost decrease of photovoltaic modules and systems in the last few years has opened new perspectives for using solar energy as a major source of electricity in the coming years and decades.” Despite this potential, she added that upfront capital costs are still relatively high. “However, both technologies are very capital intensive: almost all expenditures are made upfront. Lowering the cost of capital is thus of primary importance for achieving the vision in these roadmaps.”

Fig 1 New Investment in clean energy by region

According to a study conducted by independent German think tank Agora Energiewende in February, solar power is emerging as the cheapest power source for many parts of the world. The study also suggests that this has happened far quicker than many had predicted.

Dr Patrick Graichen, Director of the Agora Energiewende, said in the report, “The study shows that solar energy has become cheaper much more quickly than most experts had predicted, and will continue to do so. Plans for future power supply systems should therefore be revised worldwide. Until now, most of them only anticipate a small share of solar power in the mix. In view of the extremely favourable costs, solar power will on the contrary play a prominent role, together with wind energy – also, and most importantly, as a cheap way of contributing to international climate protection.”

A changed perspective
Another report that followed in March by Deutsche Bank suggested that solar power will generate as much as $5trn worth of revenue by 2030. This would represent 10 times the figure of today, driven by the dramatically falling cost of building solar plans. The bank’s report represents a significant endorsement from a major financial institution more concerned with profit than environmental causes.

Whereas solar previously represented a costly technology propped up by government subsidies, it is now seen as a financial viable investment, says Deutsche Bank. “…we think solar has now become an investable sector and over the next five to 10 years, we expect new business models to generate a significant amount of economic and shareholder value. Looking back eight to 10 years ago, the solar industry was in the primitive stages and mostly dependant on government subsidies. Most companies that came to the public market were manufacturing businesses earning above-average returns due to unsustainable government subsidies.”

The report adds that the financial crisis may have been what really spurred on the growth of the industry. “The global financial crisis that resulted in the demise of several solar companies was really a blessing in disguise. The financial crisis really acted as a catalyst that resulted in reduction of solar hardware costs. Emergence of innovative financing models by companies such as SolarCity and NRG really acted as the second catalyst for further reduction in solar financing costs.”

Deutsche Bank analyst Vishal Shah added, “Over the next 20 years, we expect nearly 10 percent of global electricity production to come from solar. Bottom line: we believe the solar industry is going through fundamental change and the opportunity is bigger than it has ever been before.”

While solar has had a resurgence, there has also been a concerted effort to get tidal energy contributing more to the world’s power generation mix. The UK has been particularly keen to harness the oceans surrounding it, with a series of projects being developed off the coast of Wales, Scotland and northern England.

In March, a 70km-squared tidal lagoon off the coast of Cardiff was announced that would be able to generate up to 2,800MW and power every home in Wales. In Japan, the country’s New Energy and Industrial Technology Development Organisation unveiled a $501m tidal energy project.

The scheme, in partnership with Toshiba and IHI Corp, will look at ways in which Japan can find alternative sources of sustainable power in the aftermath of the Fukushima nuclear catastrophe of 2011. It is the nuclear power industry that took such a serious hit in 2011 because of the reactor leak in Japan. The German Government was quick to announce a phasing out of the technology in the aftermath, with no more nuclear power to be used in the country by 2022.

Belgium and Spain unveiled similar plans to axe nuclear power from its energy sources, while France – traditionally a big supporter of the tech – has said it will scale back some of its own power plants. However, with dwindling resources of oil, nuclear power is certain to play a prominent part in the makeup of the world’s energy mix in the future. China has begun heavily investing in nuclear power plants after four years of no development, while Russia and India have plans to invest in their own projects.

Oil price per barrel

The shale revolution in the US – which many countries are themselves hoping to replicate – has delivered huge amounts of liquefied natural gas (LNG) to the market. LNG has become a hugely important part of the world’s energy mix. According to a report by Bloomberg, this year will see shale become the second most valuable commodity in the world after oil, with trade exceeding $120bn. By 2035 it is expected to be the second most used source of energy, according to Total, moving ahead of coal. The North American shale gas finds have proved a boon to the many providers there, while countries like Iran are eager to come in from the international wilderness and sell their huge deposits of LNG to the rest of the world.

Seize the day
The falling price of oil is not expected to be a freakish short-term blip for the market. Many observers expect oil prices to remain low for the foreseeable future, which could prove to be a problem for the global economy. With oil prices remaining low (see Fig. 2) and a rise not looking likely in the short-term, the prospects for the global economy seem quite stark.

ExxonMobil CEO Rex Tillerson told a conference in March that the price is unlikely to increase anytime soon, spelling bad news for the global economy. “People need to kind of settle in for a while. There’s a lot of supply out there. And I don’t see a particularly healthy world economy”, he said.

Some observers, however, feel that the decline in price of oil could be a huge opportunity for the world to embrace alternative methods of power. Ben Goldsmith, founder of leading European sustainable investment firm WHEB Group, told World Finance that the falling price of oil over the last 12 months has presented the world’s governments with an opportunity to invest in cleaner forms of energy production.

This, he says, can be achieved through slashing the generous subsidies that the oil industry has enjoyed for many decades, and instead diverting the money towards renewable technologies: “The recent sharp drop in the oil price presents governments around the world with a unique opportunity to cut back subsidies for both the production and consumption of oil. Such subsidies are unaffordable in many cases, unnecessary, and act as a drag on the development of clean, renewable alternatives. By cutting back the subsidies the playing field is levelled, and the clean energy revolution will move on even faster.”

Goldsmith says the attractiveness of clean energy is its stability compared to the highly volatile fossil fuels that have been traditionally used. “As we have seen, the prices of oil, gas, and coal move up and down like a yo-yo. Clean energy offers a completely non-volatile alternative to these unreliable, volatile and polluting forms of energy. This predictability is one of the key benefits of clean energy.” While the day when oil is no longer the dominant fuel has yet to come, the past 12 months could prove to be the turning point for how the world decides to power itself in the future.

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