As technological advances in transport and clean energy gain traction and countries begin to meet their climate change commitments, oil market forecasts will become increasingly complex and uncertain. However, it is likely that a sustained shift away from petroleum will have both positive and negative disruptions, with dramatic long-term impacts on oil-producing and developing countries. Innovative policy tools and continuous support will be needed to address the political and economic effects and maintain global stability.
Projecting Oil Demand and Prices
Oil’s indispensability was never inevitable. The fuel’s global reach was born from a series of circumstances—political, technological, and economic—that placed it at the center of the global transport sector, and in turn, made it a commodity of paramount importance to the global economy. Its unique energy density and transportability has provided modern mobility to many and supported an unprecedented period of economic development.
However, with these circumstances evolving, the preeminence of petroleum in the developed world is poised to flatten, and perhaps even decline, in the decades to come. What will happen in the developing world is less clear, as populations continue to grow and lower oil prices make driving larger vehicles more affordable. Far too little consideration has been given to the possibility of disruptive, rather than linear, effects of changes in oil demand, particularly when set against the backdrop of an existential challenge such as climate change.
A number of new analyses are beginning to explore possible scenarios for the future oil market in a carbon-constrained world. One such analysis, Oil Market Futures, was recently debated at Carnegie events in both Brussels and Washington and provides a particularly optimistic projection regarding future efficiency measures and low-carbon innovation in the transport sector and what it means for oil demand and price volatility.
In the “Technology Optimization” scenario of the analysis, countries respond to their climate commitments through new and strengthened technology-forcing policies (such as standards and subsidies) for light- and heavy-duty vehicles, as well as for passenger aviation and international marine freight transport. It is assumed that existing vehicle efficiency regulations (such as the Corporate Average Fuel Economy, or CAFE, standards in the United States or CO2 vehicle standards in the European Union) are strengthened and that such policies will be adopted by the rest of the world. It is a highly ambitious scenario that departs in many ways from the “business-as-usual trajectory” but is nonetheless plausible if countries make the transport sector a key focus of their climate change strategies.
Such a scenario would, according to the modeling, see global oil demand peak by 2025, avert a doubling of demand from 2015 to 2050, and save more than 55 million barrels per day by 2050 over the business-as-usual case. Oil-consuming countries would save an average of $330 billion per year in avoided crude oil purchases between 2020 and 2030; and volatility would also lessen, benefitting policymakers, businesses, and households engaged in planning for the future.
However, the analysis does not account for disruptions in, or challenges to, the projected smooth trajectory. A sustained, lower oil price born from shrinking demand may force major oil exporters to make painful though necessary adjustments, potentially leading to economic dislocations or instability. A steady decline in price will also call for more and more stringent climate policies to maintain a steady attenuation of global oil demand, particularly in developing countries in the early stages of household vehicle adoption.
The relationship between the oil market and global order and stability is extremely complex. While a difficult task, the international community must continuously anticipate, assess, communicate, and prepare for all the potential impacts of disruptive technologies and policies—even desirable ones—to ensure that the effects can be managed sufficiently. Only under such circumstances can the economic fruits foreseen in the Oil Market Futures analysis be fully realized.
Political and Technological Advances
Promethean changes are poised to reshape global transport and are occurring across three axes: fuel (from petroleum to alternatives), automation (from humans to algorithms), and ownership (from private household vehicles to fleet-pooled vehicles offering mobility as a service). They are, in some cases and to varying degrees, occurring completely independently of concern over climate change; though in many cases, they are aided directly or indirectly by a bevy of policies—from carbon pricing to CAFE standards—that encourage greater innovation and efficiency.
At the highest level, it is governments that are leading this charge. The ruling UK Conservative Party included in its 2015 election manifesto an aim for nearly all cars and vans operating in the country to have zero emissions by 2050. The Dutch Parliament recently passed a (largely symbolic) measure that will see the country strive to achieve zero emissions for all new car sales by 2025. Chancellor Angela Merkel’s Conservative government in Germany has set a target (likely to be missed though nonetheless significant) of 1 million electric vehicles (EVs) on the road by 2020. President Barack Obama established a similar target for the United States and recently earmarked $4 billion over ten years in the U.S. Fiscal Year 2017 budget for automated vehicle research and development. Norway’s political parties appear to have agreed to end the sale of petroleum-fueled cars by 2025.
Of these measures, Norway’s is likely the most achievable; the country already has the highest electric vehicle market share in the world (EVs comprise around 25 percent of all new vehicle sales, and they draw power from a nearly zero-carbon electricity grid dominated by hydro). Yet, Norway is hardly the fulcrum upon which the future rests and is more of an exception than the rule. It remains a small, wealthy oil exporter that has long sought to diversify. Norway’s electric vehicle market penetration is on a trajectory that exceeds even its own policy goals, let alone those of other countries (see figure 1).
In contrast, despite years of support mechanisms across numerous state and federal institutions, the United States has only succeeded in pushing electric vehicles into the market at a fraction of what numerous prior forecasts had predicted. Both private institutions (for example, Bloomberg, Deloitte, and Deutsche Bank) and international agencies (for example, the International Energy Agency) forecasted EVs to constitute anywhere from 2 percent to 6 percent of the U.S. market by 2016. However, EV penetration is currently hovering around 1 percent.
Developing Country Responses
Developed governments may be at the vanguard, but it is the developing world that will overwhelmingly determine the future demand for vehicles and oil via the sheer scale of growth and fleet turnover. Decarbonization of the developed world’s transport sector will mean little without coming to terms with the hundreds of millions of new drivers to be expected in China and India alone over the coming decades.
In developing countries, responses to lower oil prices illustrate the importance of policies that will avoid locking rapidly growing economies into high-carbon, inefficient vehicles and infrastructure. While the world reacted rapidly to the 2014 fall in oil prices by driving more with already-large vehicle fleets, the long-run implications of developing country responses are far more significant, with most citizens now purchasing their first vehicle faster than anticipated and purchasing larger and less fuel-efficient models than in the past (despite the reduction of fossil fuel subsidies in many countries). In China, for example, small cars now constitute only 50 percent of total sales, with sport utility vehicles capturing 35 percent of the market versus only 15 percent three years ago.
China’s Thirteenth Five-Year Plan (2016–2020) emphasizes moving away from heavy industry toward more consumption-driven growth. The implications for oil are not yet known though and will largely depend on the degree to which the transport sector is addressed. China’s newest coal policies, for example, have yielded only limited progress in combating chronically poor air that has beset Beijing and other cities. Other drivers of local air pollution, including diesel and other petroleum fuels, are likely to come under increasing scrutiny.
With a number of homegrown electric and autonomous vehicle firms in China, not to mention transport network companies such as Didi Chuxing, the country may come to see little difference between transport innovation and strategic industrial policy. In such a scenario, the transformation of China’s transport sector—and its export to the rest of the world—may occur at speeds not easily captured in linear forecasting models. Such disruptive change, though, is hardly guaranteed. Even its likelihood is the source of extensive legitimate debate among those seeking to understand the evolution of global oil demand.
Notably, it is India, not China, that has become the central driver of oil demand growth. India’s oil consumption grew by an average of 5 percent over the past decade and most recently overtook Japan to become the world’s third-largest consumer (after China and the United States). Considering that car penetration rates in India remain around 5 percent and car sales have been growing at nearly double digits amid falling oil prices, there is significant scope for sustained, rapid increases in oil demand if additional policy measures are not taken. In other words, in countries such as India, the Philippines, or Turkey, the price elasticity of demand remains too high without additional policy to successfully transition away from oil.
As other countries succeed in slowing global demand, oil prices fall and people in countries whose demand is most sensitive to prices immediately begin driving more or purchase new or larger vehicles for the first time, having a double impact. Concerns over other environmental challenges, such as local air quality, may impinge on the unadulterated growth in motor vehicles and oil use, as with New Delhi’s December 2015 decision to ban the sale of large diesel passenger vehicles. However, these more draconian measures are a reflection of the (often unintentional) “laboratories of policy innovation” that arise from a highly heterogeneous set of twenty-nine states and seven union territories; a more comprehensive, measured, national approach (for example, more stringent efficiency standards, better fuel pricing, and more transport innovation incentives) is needed to ensure efficient management of India’s oil demand—and energy security—in the decades ahead.
Oil-Producing Country Reactions
With a lasting change in the oil market, specific attention must also be given to anticipating and mitigating potential adverse effects in oil-producing countries. If the electrification and efficiency trends suggested by full implementation of the Paris Agreement indeed lead to sustained lower oil prices, the world is likely to look much different than that created by years of $100-plus oil prices. Saudi Arabia, Nigeria, and Venezuela will all need to make long-term adjustments.
Over the past several years, approximately 90 percent of government revenue in Saudi Arabia has come from oil sales, 75 percent in Nigeria, and around 50 percent in Venezuela. They each possess heterogeneous fiscal buffers to buy time for structural adjustments.
However, while Saudi Arabia in particular enjoys a strong fiscal position (foreign reserves of more than $580 billion), there is a major difference between a temporary downward oil price shock caused by oversupply and a more systemic trend precipitated by the proliferation of clean transport and energy efficiency advances. The latter requires a more fundamental rethink of oil market strategy, and of domestic and foreign policy, as a new paradigm is digested by key policymakers.
For Saudi Arabia, the switch from worry around peak oil supply to a newfound discussion over peak demand should not come as a surprise. In the months surrounding the Copenhagen climate accord, the U.S. ambassador to Saudi Arabia spoke of the Saudis’ deep-seated concerns “that a climate change treaty would significantly reduce their income.”
However, the adjustment shocks of “lower for longer” oil prices cannot and should not be viewed as wholly negative. Oil-consuming countries are not powerless to address the more pernicious consequences of their energy windfall, as the world uses less and less oil and turns to alternatives. Wealthy oil-consuming countries, in particular, could provide direct funds, technical assistance, or trade measures to help vulnerable countries adapt to the reality of long-term, low oil prices and find new directions for their economies.
While renewables investment in a country with as plentiful access to capital and as prolific solar resource potential as Saudi Arabia is a relatively straightforward proposition, it will be more complicated than simply erecting solar farms where crude oil-burning power plants once stood.
Reducing the domestic use of oil will allow more crude oil to be available for export, but this only stands to intensify, rather than alleviate, downward price pressures in global oil markets and Saudi Arabia’s concomitant overreliance on petroleum exports. Instead, the country must diversify its economy and sources of geopolitical strength if it is to prosper in a world facing the prospect of peak oil demand.
Saudi Arabia’s intriguing recent $3.5 billion investment in Uber, the ride-sharing platform, provides an interesting case study in fiscal diversification. The investment was purportedly driven by an interest to gain exposure to a company leading the disruption of modern mobility. For now, Uber operates a platform connecting drivers of primarily petroleum-fueled cars with ride-sharing opportunities. This may one day change—say, to a centrally owned and operated electric car fleet. Saudi Aramco, the national oil company, would by virtue of the fund’s investment presumably have privileged insight into shifts in demand for its most important product and could react accordingly.
Yet, adjustments in response to market shifts will inevitably face complications. In this case, the investment in Uber has drawn the ire of many Saudi women, who constitute 80 percent of Uber’s customer base in a country that still prohibits them from driving. The grievance stems from a sense that ride-sharing services have benefitted from a “captive” female customer base created by the driving ban and that the Saudi government is now in some way financially invested in the ban’s endurance.
These may be the inner workings of a single society, but there will—in accordance with unique circumstances and contexts—be similar challenges faced by other oil producers. The West would be well-advised to begin thinking proactively about how to interpret, shape, and strengthen the geopolitical realignments that are brought about by climate action.
Oil Market Outlook
The more that demand undershoots expectations, the greater risk that oversupply develops and prices are pushed lower, increasing the economic attractiveness of petroleum fuels.
Oil producers are most certainly betting on the status quo, according to their own forecasts of the most probable future. In its long-term outlook, the Organization of the Petroleum Exporting Countries (OPEC) projects that the global passenger vehicle fleet will double to more than 2 billion vehicles by 2040, with only 2 percent of this global fleet comprising plug-in hybrid, battery electric, and fuel cell vehicles. However, OPEC is basing this on the assumption that electric vehicle battery costs will fall by only 30 percent to 50 percent over the next twenty-five years, when, in fact, battery costs have fallen by far more than that in the past five years alone.
International oil companies similarly seem a bit too sanguine in their assessments of electrification. The most recent long-term BP Energy Outlook suggests that electricity will represent only 1 percent of all energy use in the transport sector in 2035. Even accounting for the efficiency advantage of electric drivetrains over internal combustion engines, this number seems cautious. ExxonMobil, a company known for its conservatism, seems to present a slightly more balanced future picture in its outlook, projecting that hybrid vehicles and plug-in electric vehicles will capture around 40 percent and 4 percent of the 2040 global automobile fleet, respectively.
While it is the role of governments to properly price the negative externalities of petroleum fuels, they also can support alternatives and efficiency in accordance with their positive externalities, including national security and energy security.
While the shale revolution has received much credit for its role in tipping the United States into the role of a net energy exporter, energy efficiency—including in the transport sector—has also played a crucial role. Sustaining annual efficiency improvements for passenger vehicles and extending standards for heavy-duty vehicles represent some of the best tools that policymakers in both the developed and developing world have to keep exposure to oil volatility in check, regardless of prevailing oil prices.
Eventually, efficiency policies should be complemented by other tools to manage the transition to cleaner fuels. For example, existing efficiency standards can be updated to encourage positive emissions outcomes from emerging mobility trends such as vehicle automation and transport networks like Uber. Working toward greater use of a single, holistic metric in transport policy—for example, grams of CO2 equivalent per passenger mile traveled—would allow the three levers of technology, driving behavior, and pooling to each contribute to decarbonization goals on a level playing field.
Additionally, more interdisciplinary work can and should be done to understand the intersection of two critical supply curves: that of the evolving costs and that of the evolving life-cycle greenhouse gas emissions associated with oil production. This knowledge, particularly when in the hands of investors and policymakers, can improve the efficacy of risk management and provide foresight into the future composition of oil market share.
Need for a Cohesive Strategy and Sustained Action
The world is replete with the corpses of errant forecasts and disproven theories about the future of oil supply and demand. The situation is no different today. While it is unclear precisely how action on climate change will play out, the majority of governments worldwide have certainly made the direction of travel clear: the global economy must be powered by something other than the combustion of fossil fuels in the twenty-first century. As the Saudis themselves are fond of recounting, “The Stone Age did not end for lack of stone.”
Technological changes alone will not be enough to meaningfully displace oil in the global economy. As the world uses less oil, prices will inevitably trend lower under the specter of oversupply. The moving target of traditional petroleum fuels will become yet more inexpensive, raising the bar that alternative fuels and technology platforms (such as hydrogen or electric vehicles) must meet. A wide menu of policy instruments—most significantly carbon pricing and intelligent standards—will be essential in maximizing the positive impact of technological change in the transport sector.
Done right, large-scale investment in the transition to alternative fuels, energy efficiency, and next generation technologies can provide tremendous returns to countries. However, for progress and broader global stability to be maintained, a more cohesive strategy that accounts for the reactions of oil-producing countries and developing world consumers must be developed. Only in this way can the incremental gains of the technology and policy vanguards avoid being “lost in transition” among larger global economic and geopolitical forces.