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Why The Oil Industry Shouldn’t Fear Peak Demand

The OPEC drama is behind us (for now) with the cartel and its friends agreeing to a peak supply. But the topic that’s talked about behind the scenes in Viennese cafes is that of, “peak demand.”

The notion behind peak demand theory is fairly simple: some time over the next five-to-25 years many of us will hang up the gas pump nozzle for the last time. When that happens, the world’s insatiable consumption of more and more oil, growing year over year, soon to exceed an energy-obese 100 million barrels a day, will plateau and then start trending down.

Every pundit has an opinion about when peak demand will happen. Articles, podcasts and snappy videos mostly debate in what year our 150-year addiction to the product will begin to wane. Some think it’s as early as 2020; the authoritative International Energy Agency conjectures 2040. So there is a wide range of views.

Anybody with a spreadsheet can juggle cells and posit when the last growth barrel is likely to occur, but the real question is, “So what then?”

What does a peaking of oil market growth mean to producers? To investors?

“Oil is going to zero,” is a refrain that is often heard from the most ardent peak demand theorists, suggesting that the price of a barrel is going to collapse to nothing, and that all inventories will be worthless the day after the decline starts. That line of exaggerated thinking has some producers and investors worried, largely because the 150-year oil paradigm has been a pattern of year-over-year-over-year growth.

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Yet there are plenty of examples of consumer products that peak and then go into decline. For example, there is a hardly growth market for baby food or disposable diapers in countries where population is in decline. Yet these products aren’t given away for free by the store greeter just because fewer people are buying them.

In any maturing business environment, flat-to-declining markets make the battle for consumers’ business hyper competitive. In response, producing companies get rid of their unproductive assets (baggage) and shift their sole focus away from price. The emphasis moves lower down the income statement, toward how to cut costs, be more efficient in production and how to be profitable at lower prices. Conveyor belts become more efficient and the manufacturing emphasis shifts to just-in-time delivery and not being burdened with too much inventory. Leading companies place additional emphasis on how to improve their product offerings too – improving proverbial, “bells and whistles.”

Inefficient laggards who don’t adapt to the new competitive realities don’t survive the Darwinian cut.

Am I missing something? This sounds a lot like the oil business today. In the U.S. and Canada the migration toward “short-cycle” light oil plays represents a quantum shift in process efficiency and cost reduction. Product quality for light oils, as measured by their carbon intensity, can be half to one-third of heavier grades. Today’s wells are drilled and completed off of multi-well pads in a fraction of the time compared to only half-a-dozen years ago.

Related: Oilfield Services See A Silver Lining In The Oil Price Bust

Ten years from now, drilling and completing wells will be a robotic manufacturing process in places where the geology and local circumstance allows. Countries that invest in this expertise will be well able to compete in a flat or even declining market for product.

Producers in the U.S. and Canada are already leading the way. So when peak demand sets in, today’s progressive light, tight oil producers in North America will already be positioned as “lean manufacturers” that are able to respond to price signals much faster.

There will benefits to the era of peak oil demand even though there is no sign that it’s happening yet. When it happens, the industry’s emphasis will be on profitability and a leaner carbon product, not so much on growth at all costs. Ironically, the industry is already adapting to the inevitability of peak demand, whenever that may be.

By Peter Tertzakian for Oilprice.com

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