Time to End the Oil Addiction?

Oil has dominated the wealth of nations for the majority of the 20^th century, often shaping the outcomes of wars and dominating the global geopolitical power. One can wonder, how has humanity come to such a reliance on oil?

The first account of the use of oil dates back to 347 AD in China, but the true potential of crude oil wasn’t realised until the 1850s during the industrial revolution. Until that point, much of the industrial and domestic energy demands were met by coal and whale oil, respectively. As the scarcity of whales drove up the price of whale oil, the demand for an alternative energy grew. The ability to extract kerosene from crude oil was the spark required for the oil revolution. The demand for oil has steadily increased over the next century, mainly driven by technological innovations, such as the internal combustion engine. The value of petroleum stems from its ease of transport and the density of energy within. Currently, the majority of crude oil is refined to transport fuels, including petrol, diesel, ship oil, and jet fuels, with a minor, yet, a valuable part made into bulk chemicals, which can be used to make commodities ranging from polymers used in clothing to pharmaceuticals used to treat cancer.

The benefits of oil have undoubtedly improved the modern society in the 20^th century. However, the negative consequences are often overlooked. To list a few, combustion of fossil fuels resulted in the increased concentration of greenhouse gases in the atmosphere, which has been linked to climate change. The chemicals used for the extraction of oil also have their associated environmental cost; these chemical pollutants often leach into the surrounding environments and into the food chain, which has been linked to adverse human health effects. The increased use of plastics, a commodity derived from oil, has also caused severe environmental damage in the form of micro-plastic pollution in oceans, which can also end up in marine food resources we consume. Additionally, our use of fossil fuels in transport has resulted in increased urban air pollution, which correlates to reductions in crop yields and respiratory health problems. As seen in the examples above, much of crude oil’s benefits have come at a cost to human health and the environment. So as we move further into the 21^st century, can we afford to be as reliant on this depleting resource?

Naturally, as we continue to consume this finite resource, supply available in the future decreases. Consequently, prices will increase and incentivise people to seek an alternative, similar to the whale oil scenario more than a century ago. Much of the price increase from $20 per barrel in 2003 to $147 per barrel in 2008 can be attributed to the peak oil hypothesis. However, the technological innovations in this recent decade have increased our ability to extract this resource more efficiently and in more challenging environments, allowing us to prolong our dependence on oil. Fracking and oil sand are just a few new terms that came about as a result of these innovations. These methods of extraction are arguably worse economically and environmentally compared to conventional extractions. For example, both fracking and oil sand consume vastly more water; the chemically polluted effluent is then released into the environment. Oil sand extraction, in particular, requires a substantial area of the natural environment to be removed for excavation.

The largest proven oil sand deposit is located in Alberta, Canada, amounting to 1.7 trillion barrels of oil, making this the largest oil deposit outside of Saudi Arabia. This resource covers 141,000 square kilometres of boreal forests and wetlands, which roughly equates to 90 times the size of London. These natural landscapes are essential to carbon sequestration and to provide habitats for thousands of species. Additionally, the energy return on investment for oil sand is also significantly less compared to conventional extraction. For every barrel of oil used for extraction, 25 barrels are gained from conventional methods, contrasting this to 5 barrels for surface oil sand extraction and to an average of 2.9 barrels as the depth increases. Evidently, the investments into these technologies are not only uneconomical but are also highly environmentally damaging.

Current Analysis

These technological innovations have implications on a global scale. Most importantly, the shale industry in the US has transformed the country from a crude oil importer to an exporter, overtaking Russia and Saudi Arabia to become the world’s largest oil and gas producer. This signifies a seismic shift in the world’s energy landscape and has been responsible for the dramatic collapse in oil prices since 2014, with recent data indicating that the US crude stockpile rose by 3.5 million barrels to an all-time high of 507 million barrels. This supply issue is now amplified by the lifting of sanctions on Iran and the geopolitical instability in the region. Much of the market share lost by Iran during the sanctions has been filled by Saudi Arabia. As Iran resumes its trade with the world, their thousand years long political conflict with Saudi Arabia is likely to hamper their ability to act rationally and control prices through limiting supply. This means OPEC, which is historically responsible for stabilising oil prices, may struggle to reach an agreement to limit production. However, the one distinct advantage these traditional oil exporters have is their low production cost. At a breakeven value of $10-25 per barrel, they can effectively price out their competitors in the US and Canada, which have a significantly higher breakeven value of $55 per barrel on average. At the current price of around $34, it is uneconomical for these companies to sell their products. As a consequence, much of the drilling activities have stopped in the US, denoted by a sharp fall in operational rigs to 502, a decrease of 765 from the previous year. The ones remaining in operation have chosen to store the excess supply. This record amount of stockpile is expected to take at least a few years to clear, which will continue to put downward pressure on oil prices shortly.

Looking at the demand side of the story, rapid demand growth in China has propelled the oil price to reach the historical highs in 2008. However, this engine of growth has declined in recent years, with the latest economic data showing a GDP per capita growth of only 6.9%, compared to the double-digit growth experienced in much of the 2000s. Citigroup has also recently revised global growth predictions down from 2.7% to 2.5%. This has not only impacted the demand for oil, but also other commodities, such as iron ore, steel, and copper, which is experiencing a similar slump in prices. This decrease in growth has been a direct result of increased corporate leverage in emerging markets, where this value has almost quadrupled between 2004 and 2014, reaching a value of $18 trillion. The increased debt load in emerging markets was a direct result of the substantial increase in credit available, made possible by the quantitative easing policy in developed countries after the 2008 financial crisis. This heavy debt problem in emerging markets will take at least three years to solve, with considerable government stimulus required to rebalance the economy. This is likely to result in slower growth in these regions. Another major factor slowing global growth is demographics. As the majority of the “baby boomer” in the developed world approaches retirement, the productivity of developed countries will decrease. These people also tend to consume less as they age, which slows consumption and demand. Additionally, China’s one child policy will take full effect within the next two decades; this is likely to put significant strain on their economy and hamper growth and demand worldwide.

The bleak outlook on the demand and supply of oil means that oil prices are unlikely to reach the historical heights it experienced for much of the last decade. Looking more into the future, one idea worth considering would be the rise of electric vehicles. As technological innovations continue to solve some of the key issues hampering sales, such as range and affordability, electric vehicles will become increasingly competitive. With Tesla, Nissan and Chevrolet bringing out their latest $30,000 model with a range of 200 miles this year, and other automotive manufacturers and tech companies investing billions into the electric vehicle market, the demand for oil will undoubtedly decrease in the future. The current oil glut we saw was caused by an oversupply of 2 million barrels per day. So if the electric vehicle can cause a similar imbalance from the demand side, it should cause a similar oil crash, and this may happen sooner than you think. 

According to recent growth figures, electric vehicles sales grew by 60% from last year. This is roughly equivalent to the growth forecasted by Tesla, where production is expected to increase from 50,000 in 2015 to 500,000 in 2020. Assuming Tesla can meet their forecasts, and their current electric vehicle market share remains the same at 10%, if each electric vehicle roughly displaces 15 barrels of oil a year, the next oil crash could occur as early as 2023. The ominous thing is that this crash, unlike the others, is unlikely to recover. According to Bloomberg research, it wouldn’t be unrealistic to believe that over half of the vehicles on the road will be electric by 2040. This new energy revolution could signify a substantial shift in geopolitical power and industries around the world, with major implications on the trillions of dollars invested in the oil and gas industry. This, however, maybe what humanity needs to end our addiction to oil.

Market Mogul