NOV
14

Everything you need to know from IEA’s World Energy Outlook

 
Every year, energy analysts wait for the release of the World Energy Outlook, IEA’s definitive annual forecast of energy market trends. At first blush, it looks like smooth sailing for oil markets. Brent crude oil prices fell below $80 per barrel for the first time since 2010, and United States crude oil production topped 9 million barrels per day last week, the highest production level since before the 1980s. Meanwhile, non-OPEC oil production growth has outstripped demand growth for the past five quarters—and this unprecedented dynamic is expected to continue into 2015. With average gasoline prices holding comfortably below $3 per gallon for most Americans, it’s easy to assume that all is well. Not so, says IEA. In fact, the oil markets section of this year’s report is essentially an extended treatise on why temporary lows in oil prices not only don’t make the world more energy secure, but could ultimately undermine the reliability of oil supplies down the line. Last year, IEA’s Chief Economist, Fatih Birol, warned that “key Gulf producers have been adopting a 'wait and see approach' to investment, because of the perception that the US shale revolution would produce an 'abundance of oil',” and emphasized that if we want Middle East supply to exist in 2020, investments need to be made now. In the most recent release, even as U.S. production continued to increase, those warnings became even direr. “The global energy system is in danger of falling short of the hopes and expectations placed upon it,” the IEA said during the report release. “The short-term picture of a well-supplied oil market should not disguise the challenges that lie ahead as reliance grows on a relatively small number of producers.” But first, let’s look at a few of the topline numbers:
  • Oil demand is slated to grow by 14 mbd by 2040, in the “New Policies” scenario—IEA’s central projection. By that point, 75 percent of consumption will be in the transportation and petrochemicals sectors, where oil is most challenging to displace.
  • China will overtake the United States as the world’s largest oil consuming country by 2030, a projection that has remained the same from last year’s report. Chinese oil demand will climb rapidly through the early 2030s, but growth will quickly level off once reaching a saturation point for transportation demand.
  • Global demand will continue to shift towards non-OECD countries, which will account for roughly two-thirds of global oil demand in 2040 in basically all scenarios. OECD countries’ share of global oil use has already dropped off rapidly: The developed world consumed 60 percent of global oil supply as recently as 2000. Now, that share is only 45 percent.
  • For every barrel of oil eliminated by OECD countries (roughly 10.2 mbd over the projection period) two will be added by the non-OECD, with the China and India’s demand growth alone offsetting all of the OECD’s reductions.
  • The United States will see oil consumption decline by the largest absolute share: Our total crude oil consumption will drop from 17.5 mbd today to 13.4 mbd in 2040. For context, that 4 mbd of change is more than the entire continent of Africa consumes today (3.6 mbd). The large drop from the United States will materialize due to “large untapped potential” for fuel efficiency gains in this country, especially in regard to heavy-duty vehicles.
  • OPEC’s share of global supply will actually increase, from 40 percent now to 49 percent by 2040. IEA sees the sequence of events as follows: conventional supplies in Russia and Kazakhstan will decline, and their drop will coincide with a tailing off in U.S. shale production. As global demand growth will continue to increase during this period, the onus to meet that demand will move towards OPEC, as well as other large non-OPEC reserves such as the Canadian tar sands and Brazilian deepwater.
  • Transportation energy will continue to be dominated by oil; from powering its current share of 93 percent of global transportation, it will fall slightly to 85 percent. The largest declines in transportation-related oil demand will come from global efficiency improvements, rather than fuel-switching, or widespread adoption of alternative fuel vehicles. This is problematic, as it leaves this sector highly vulnerable to oil prices, which are unlikely to remain at their current lows in the medium and long-term.
The critical question, in IEA’s view, is who will “step up” once US shale production is no longer a sustained engine for global growth. This is perfectly illustrated in the following chart:

 

Through 2025, US shale production will serve as one of the largest contributors to global oil supply growth. But this is likely to drop off through the second half of the forecast period. The reason is the physical shortcomings of fracking and tight oil extraction: Although tight oil production has seen continued improvements, we are still in the early days of the shale boom. IEA presents the case that cost-optimization methods developed in the Bakken and Eagle Ford shale plays have probably reached their limit: Industry has succeeded in maximizing use of batch drilling and pads with multiple wells, improving equipment and crew utilization, and improved knowledge of the geology, but production costs are unlikely to decline further without major technological breakthroughs. Of course, there could well be a technological breakthrough, or alternately, other countries with shale resource endowments could find ways to bring those resources to bear. Given the impossibility of forecasting a major breakthrough, or significant shifts in shale production barriers in other countries, such developments are not modeled into IEA’s assessment. It’s worth noting that the United States is only home to 17 percent of global shale resources, currently estimated at 350 billion barrels. Needless to say, in IEA’s view, there will be signs of life in global shale production, but it is largely slated to remain a U.S. phenomenon.

Which leads us back to the major take-home message of IEA’s assessment: that a period of lowered prices will deter the necessary investment to ensure sufficient future production. Importantly, investment is not only needed to increase global supply, but also to maintain today’s current production levels. Conventional crude oil production from existing fields is set to fall by 58 percent by 2040, meaning that in addition to the 14 or more million barrels per day the market must create to meet new demand, it must also add an additional 38 mbd to offset these natural declines. For many producers, trying to extract more from existing fields is more economical than exploring for new fields in remote places, but further drilling or enhanced oil recovery techniques are required. To meet this goal, $29 trillion dollars of investment in upstream production, transportation logistics, and refining is required over the forecast period, reaching above $900 billion per year in the 2030s. Eighty percent of this will be to simply offset current production declines. And finally, no assessment of the potentially dire future of oil supply would be complete without mention of Iraq: the world’s last remaining vast sink of untapped conventional oil. Iraq has been a critical component of meeting global demand in virtually every major forecast, from IEA and other groups. Given the country’s current condition and the continued spread and entrenchment of the Islamic State, the future of its oil industry is in serious doubt.

 

Many times, Iraq has tried and failed to utilize its oil reserves, but every time production begins to increase, a conflict intervenes. A history of this is seen in the chart above, from SAFE’s Oil Security 2025 report of earlier this year. Production plummeted during the Iran-Iraq war of 1979, the Gulf War in the mid-1990s, and the second US-Iraq War in 2003. The current conflict between the Iraq central government and Islamic State in the country’s North has not yet resulted in a major supply disruption, as most of the country’s super-giant fields are located in the country’s South near the port of Basra. However, in addition to damaging export infrastructure in the North, the conflict has underlined the continued political hazards facing Iraq and the weakness of its national institutions. In IEA’s view, these troubles foreign oil companies and other sources of international investment. IEA has already dramatically revised their estimates from 2012, when the organization saw Iraq’s production reaching 9 mbd by the end of the decade, and now projects 4.6 mbd by 2020 and 7.6 mbd by 2035. Under current forecasts, Iraq is an imperative source of production growth needed to balance the market following the projected decline of U.S. tight oil around 2025. But the tight oil boom, when combined with Iraq’s current turmoil, could be enough to all but completely deter the necessary investment. Under such a scenario, we’ll be in dire straights indeed.