The Future of Oil
Frontispiece: The Miraah Project on the Amal Oil Field in Oman. (Source: Using Solar Energy in Oil & Gas, Jane Whaley).
In the middle of an increasingly fractious debate about the global future of oil, I hold the view that oil will remain necessary for the energy transition and decades beyond. People targeting big oil companies to stop production through divestment and prosecution would be better served to focus their energies on oil demand destruction, especially where oil is combusted for energy in transport. Nevertheless, oil companies can and must reduce the GHG intensity of their oil production activities, because in a world of decreasing demand or at least perceived abundance of supply, the lowest cost ($ and CO2e) will be preferred. This will be especially true if carbon is taxed. Investors interested in oil may still find value in companies with diversified approaches to energy, especially in which oil is efficiently produced at the lowest carbon intensities. Countries wholly or largely dependent on oil for their economies need to reduce their energy demands and diversity their supply sources, and developing countries not yet dependent on oil have a wonderful opportunity for a more sustainable development.
The world consumes as much as 100 million barrels of oil each day and that demand continues to increase. Oil fuels a global economy, but burning it for energy also drives anthropogenic global warming (AGW). The world is on an unsustainable path. During 2019 the social debate on oil and other fossil fuels has accelerated. On one side are those that are demanding stringent action against oil companies including divestment and prosecution to radically reduce fossil fuel production. At the other extreme are oil industry advocates, particularly in North America, peddling various forms of denial that AGW is a risk that needs any attention.
As an energy transition eclectic my bias is to the middle ground where the complexity of the challenge is met: how do we energize our economy, deal with energy poverty and reduce GHG emissions to levels commensurate with 2ºC or less warming trajectory? As we enter a new decade - the “climate decade” - how do we accelerate our actions in meeting this challenge?
In this post, I share some observations and thoughts about oil and conclude with some recommendations to various stakeholders.
“There is a growing mismatch between societal demands for action on climate change and the actual pace of progress, with energy demand and carbon emissions growing at their fastest rate for years. The world is on an unsustainable path.”
Figure 1: World Oil Demand in early 21st century (Source: Peak Oil Demand and Long-Run Oil Prices, Oxford Energy Institute)
Demand
Figure 1 illustrates a number of scenarios for oil demand for the next two decades. Some profiles, like the IEA’s Current Policies projection, see oil demand only increasing by 25% or more in the period. These profiles are commensurate with elevated risk of climate change impact from a much hotter world than today. However, even the projection of reducing oil demand, the IEA’s Sustainable Development path, still holds that oil demand will be above 75 million barrels per day in 2040. The Sustainable Development scenario is consistent with less than 2ºC warming but projects an oil consumption during the next two decades of over 280 billion barrels.
Figure 2: Transport emissions by sector in the IEA’s Sustainable Development scenario (Source: IEA)
Oil demand is dominated by its use as a fuel in transportation which drives a global economy and provides mobility for people in developed countries and increasingly in developing countries. Figure 2 illustrates the projections of emissions from transport in the IEA’s Sustainable Development Scenario. Much of the opportunity to reduce emissions in this way lies with consumer choices including mode of transport, choice of cars for personal travel, and preference for products from across the world. For developed countries like the United States, this cultural challenge was exemplified by some of the discussion of my #greatamericanevroadtrip posts on LinkedIn last September. Technology is quickly providing solutions to these problems, such as electrification and use of hydrogen, but meeting this challenge of drastically reducing oil demand lies with consumers and policy-makers who influence consumer habits.
There is also an important linkage between oil and other fossil fuels to renewable and other lower carbon energy sources. For example, coal, in the manufacture of steel, and oil in the manufacture of plastic and related products, is still currently requisite for the manufacture of wind turbines and other machines for renewable energy. For example, oil is required for heavy transport of turbine components. The foams, resins and polymers used to construct the blades of a 5 mW turbine require about 1300 barrels of oil to be made. With current manufacturing and transport technologies we need fossils fuels to effect the transition away to low carbon fuels.
This point about oil required for the manufacture of wind turbine blades also underscores the final future of oil - as a feedstock for materials that underpin the manufacturing of necessary and more luxurious goods we use. Think for example plastics and polymers used in medical applications. About one fifth of today’s oil demand is used in manufacturing materials and hence products. While we can do a much better job of making more many products more durable and/or easier to recycle, and we can manage waste so much better, oil will remain a much needed manufacturing feedstock.
Supply and Cost of Supply
Perspectives on the notion of “peak oil” (supply) have varied and changed for decades and recently the same discussion has been similarly diverse. Richard Lyon, a fellow BP alumni, has recently written a thought-provoking series of essays on oil demand and resource availability. He concludes that the supply of oil to fuel the transition to a largely renewables energy future is not sufficiently durable, particularly in the context of our debt-ridden global economy. Another view from a current BP employee, their chief economist Spencer Dale, is that there is plenty of oil reserves and resources available to meet demand (Figure 1). Nevertheless, meeting that demand requires new investment in oil exploration and for sure development. Figure 1 illustrates how the supply-demand gap quickly widens in the case of no further investment from today allow a 3% decline to reduce supply unchecked. There is further complexity in the rising cost of supply of oil. While technological and efficiency improvements continue to make a big difference, breakevens for oil are significantly higher than when I started my energy career 30 years ago, even allowing for inflation. This reflects the increasing difficultly (= energy required) in extracting the remaining oil - exemplified by low permeability unconventional resources such as shale oil.
Figure 3: Supply curve for oil in 2018. (Source: Rystad Energy)
There are further influences on overall cost of supply that are worth noting. Firstly, Middle Eastern oil producers typically require a much higher price for their oil than basic cost of supply. This is because their economies are built on oil so that social and infrastructure improvement and their own energy diversification requires more income from their singular product. For example, Saudi Arabia needs an oil price of more than $60/bo for their production to fund social costs; it costs around $10/bo to produce. Nor is the North American shale “phenomenon” likely to be a durable low-cost alternative for the world. US oil even after a decade of amazing growth, is still only 16% of world supply. There are technical problems emerging from over-drilling of shale that are leading to faster base declines. Further the US shale industry has funded its recent growth with 100s billions of dollars of debt contributing to businesses with poor returns and fragile economics. In terms of business breakeven as opposed to well breakeven, more than 60% of Permian production needs oil prices north of $60/bo (Brent) for companies to return a profit. Thus although Figure 3 suggests that there is a now of about 1 trillion barrels of resources that can be delivered to market at less than $40/bo, the reality is that those producers need $20/bo more to cover their total costs.
I conclude that there is more than sufficient oil to cover the transition to reduced demand, but only with continued investment to install new production capacity to offset decline. However, this scenario is economically fragile for at least two reasons. Firstly there is a ceiling of affordability for oil price, higher than which recession occurs because products become too expensive to make and deliver. Secondly, if policy and market sentiment against oil becomes over-zealous, and capital for new investment is too severely reduced, a real supply shortfall will occur again resulting in higher prices and recession. Said another way, we run the risk of undermining the transition itself, in effect a grand “throwing the baby out with the bath water”.
A future beckons when we energize our economy without burning oil, but ironically we need oil to attain that future. The speed of attainment is actually in the hands of consumers and market policy makers - particularly for wasteful use of oil as a fuel. There is no better way to influence the behaviors of oil companies and their investors. Once completed a much smaller oil industry will remain to serve the manufacture of the many derived products that underpin our modern society in all its facets.
Figure 4: Major Oil Producing Countries; 2018 proven reserves and 2015 GHG intensity of production. (Source: Data - BP Statistical Review of World Energy and Global carbon intensity of crude oil production, Science 2018. Graphic - Capriole Energy).
Carbon cost of supply
In 2018 it is estimated that world GHG emissions were around 42 gigaTonnes (gT). Most of that - 88% - is related to fossil fuel combustion. But a significant amount of emissions also comes from the extraction of oil partly due to energy used in the extraction process but mostly because of flaring and venting of associated gas. In the previous section it was revealed that we need at least 280 billion barrels of oil in the most ambitious scenario for demand reduction to 2040. Figure 4 illustrates the disposition of proven oil reserves by country - where the oil is likely to be sourced. It also depicts the GHG intensity (as CO2e per barrel oil) as an average for each country. For now we can ignore Venzuela because although that country has 17.5% of the world’s proven reserves as depicted in Figure 5, it only has 1.6% of world production. So the big contributors to meet demand in the next two decades are likely to countries that have both the resource base and the infrastructure to deliver the oil to market. It is important to note that the major reserves-rich countries have a wide variation in the carbon intensity of their production, ranging from 28 kg CO2e per barrel oil (bo) in Saudi Arabia to nearly 4 times that in Canada. Saudi production is relatively low in carbon intensity because of the ease of lifting oil from giant fields with strong natural depletion mechanisms and good flaring/venting controls. Canadian crude oil is biased towards oil sands in which the oil is highly energy intensive to extract and treat for export. US crudes are are relatively carbon intensive, averaging more than 2 times the Saudi benchmark.
Figure 5: Major Oil Producing Countries; 2018 production and estimated associated GHG emissions. (Source: Data - BP Statistical Review of World Energy and Global carbon intensity of crude oil production, Science 2018. Graphic - Capriole Energy).
These estimates allow the estimation of emissions associated with oil production in 2018 (albeit using 2015 GHG intensity estimates). Figure 5 illustrates the much-heralded point that the USA is currently the world’s producer of oil, thanks of course to the “shale revolution”. America also claims number one spot for emissions associated with oil production - nearly 1.2 gT. Saudi Arabia is number 2 producer, but only number 5 emitter, behind Russia, Canada, Iran and Iraq.
There are least two important implications raised by this analysis. Firstly, the global oil industry is major source of emissions solely from producing, treating and transporting oil and petroleum products. As such it represents a major opportunity to reduce global emissions through a combination of better resource management, energy use improvements through efficiency and substitution, and radically improved control of gas flaring and venting. The second implication I want to highlight here is the carbon cost of oil production is quickly becoming a factor for consideration for consumers right through the value chain. When carbon pricing is applied at borders and at other global scales, this will make some crudes even more expensive to produce than others. For example, Canadian heavy oils, already one of the more costly crudes to extract, would be $10/bo more expensive by a $100/tonne carbon tax. This should be additional incentive for the industry to radically reduce its emission intensity.
Drilling down in the USA
Having looked at the global picture of oil production supply and demand, together with carbon intensity, I now want to look at the USA more closely. Although the current federal government policy of “energy dominance” and rollback of environmental regulations, apparently in service of ease of doing business, does little to incentivize the US oil industry to be less carbon intensive, it is certainly driven to reduce the cost of supply as described above. Furthermore, carbon intensity will become increasingly important as investors, consumers, activists and state governments insist on change.
Figure 6: Selected 2018 oil production and emissions intensity by basin. For Permian, Williston (Bakken), Gulf Coast and San Joaquin the data are for the oil and gas operations for an operator (including reported emissions from gathering and boosting) across the basin area. For the Deep Water Gulf of Mexico (GOM) the 6 selected data are for fields/platforms. (Source: Data - DrillingInfo, GoMSmart and EPA; Graphic - Capriole Energy)
Illustrated in the chart above is the GHG emissions intensity of a selected range of oil operations in five basins in the US. Four are distributed company oil operations - typically hundreds of wells - in lower 48 onshore basins with various amounts of unconventional shale oil. The fifth is the deep water GoM including 6 field operations concentrated into a single floating production facility plumbed to subsea templates with a few tens of wells, operated by various companies. There are several observations to be made of this information:
Firstly the weighted average emissions intensity of the selected examples in Figure 6 (22 kg CO2e/bo) is considerable less than the 2015 US number reported in Figure 4. That’s largely because the methodology of Masnadi et al. (2018) is more comprehensive than mine, including a wider range of settings and for example all operations to the refinery gate.
The Permian, Eagle Ford and Bakken show a similar range of intensity of emissions and appear to illustrate that better performance is really down to the level of diligence and investment in emissions control, and meeting or exceeding regulations (Figure 7).
It’s hard to make a comparison between unconventional and conventional oil production with the data available. I will point out that operator Gulf Coast 6 only does conventional, no shale, and has a significantly high GHG intensity than the others which all have shale in their portfolio.
The Californian operations appear to generally reflect their relatively high energy intensity of production (e.g. steam injection) there although the top producer (San Joaquin 1 in Figure 6) is reported as having an exceptionally low emissions intensity.
Offshore deep water production systems are inherently much less GHG intensive operations than onshore distributed systems because of tighter (federal) controls by regulation on faring, leaks and general emissions. Note that when an offshore field is depleted (for example GOM 6 in Figure 6), the emissions intensity increases because of the energy needed to to keep the facility running even at the lowest production rates.
Figure 7: Comparison of GHG intensity performance of two operators in the Permian Basin (Source: as per Figure 6)
Conclusions
I suggest that there are a number of important implications for all stakeholders in the energy transition from this discussion. Firstly, for those interested in climate action but with a pragmatic understanding of what constraints and boundaries control the actions that can be taken:
Policies, investment and community action needs to be aimed at oil demand destruction, particularly demand for oil as a fuel. The biggest opportunity lies with mobility and goods transport. For example, populous cities, by accelerating the uptake of EVs (e.g. BEVs for cars and lighter trucks and hydrogen FCEVs for heavier trucks and buses), can not only only make a significant contribution to global emissions reduction, but also can improve air quality for citizens. Selective and thoughtful policy measures such as sector carbon pricing and specific regulations on vehicles such as projected but legislated banning of gasoline and diesel vehicles can accelerate progress.
Prosecutions and divestment from non-OPEC International Oil Companies is ill-advised. If demand is not reduced, OPEC will only fill the need. The way to influence the behaviors of energy companies is by shifting their market as per the point above. In addition, several IOCs are earnest in their commitment to be leaders in the energy transition and we need their capabilities.
While burning oil is everybody’s problem so is the unabated combustion of coal and natural gas. There are other real opportunities to reduce emissions and yet maintain economic growth as reducing remain on oil. Fuel substitution, changing technologies, and carbon capture and sequestration are important opportunities for harder to abate sectors. For example, the substitution of coal by natural gas in power generation in the United States are been the majority contributor in emissions reduction. Intuitively it feels like that there is further opportunity in this sector, both in the US and elsewhere.
Oil companies need further (global) regulation control on both the reporting and reduction of GHG emissions in oil operations. This ia an agenda item of the Oil and Gas Climate Initiative. In the United States, onshore regulations need to be brought up to par with those offshore.
Secondly, for boards of oil companies, in the interest of the long-term health of their firms:
Rigorous and repeated testing of the company’s asset portfolio for financial viability in a reducing oil demand scenario. Reducing demand will likely enhance a perception of abundance of supply so this exposure can be measured with low price scenarios.
A total view of cost of supply is required. Not only do companies need to drive their costs down in a manner that doesn’t increase operational risk, but measurement and reduction of emissions intensity is a significant overall cost factor, especially if a carbon tax is introduced.
A focus on incumbent oil resources, already more or less connected to production infrastructure, or infrastructure-led exploration, is probably preferred to rank wildcat exploration and development in new frontier areas. Goldman Sachs’s recent pledge not to fund drilling in the Arctic, or for that matter new thermal coal mine and power generation, is commensurate with that strategic approach.
A strategy that involves as much as possible renewables and other lower carbon energy technologies needs to be considered by oil companies. While this is a clearer opportunity of the biggest oil companies, there are also opportunities for smaller companies, for example integrating renewable sources of energy into their production systems.
Thirdly, for investors:
As a yield play, oil companies that are diversifying to be energy companies and reducing their $ and carbon cost of supply should be more resilient to perceived abundance of oil and hence lower prices. A capital demands for big oil projects falls, and project financing covers big renewable projects, more oil cash may be returned to shareholders.
The fate of smaller independent oil E&Ps, especially perhaps in the United States where many firms are debt-laden, looks perilous. Surely only the best with the lowest cost of supply and lowest GHG intensity and the ability to grow organically by amalgamation of fair-priced assets will survive.
Finally, for countries:
Those dependent already depend on oil, whether indigenous or imported, need to focus on demand destruction and energy diversification.
For developing countries, for example in Africa, there is a huge opportunity to design a future infrastructure that allows for mobility with much reduced oil demand.
I researched and wrote this though piece to test and understand my intuition that oil needs to be part of the energy transition. Furthermore, as a potential advisor or non-executive I am available to energy companies who want to embrace the energy transition as an opportunity and need help with strategy, governance, capability and so on. Energy demand and particularly lower-carbon energy supply is also a huge risk to the rest of industry and commerce. Plan C Advisors is available to help the boards of companies of many different sectors consider and act on these and other climate-related risks.