Peak oil demand or peak oil supply?

I recently contacted Mark Lynas, and proposed to him that he would read our upcoming book The World After Cheap Oil (Routledge) and provide us with a possible review or an endorsement. Alas, he was too busy, which I appreciate wholly, as he is doing great work. He also did mention that (without wanting to judge our book without reading it) he thinks we are more likely to look at peak demand rather than peak supply, when it comes to peak oil. He was, in his own words, not a big believer in the peak oil as it is commonly seen.

The thought on peak demand versus peak production placed itself in my brain, nagging me. So in this post I try to open a little bit on how I see the relationship between peak demand of oil and peak supply of oil, and what the recent events might implicate.

First, to talk about peak demand of oil is to assume there is a working market for oil. This, I’m glad to say, largely holds true as the global oil market is not only the biggest commodity market, but also one of the most open one. There are some trends that are moving it to a more closed one and disrupting local price signals. These are discussed more in our book (Export Land Model and resource nationalism, just to name two). But for the time being, there is a rather open, global market for oil.

Demand and supply

How do we define demand, then? It is the amount of oil that the world as a whole is willing and able to buy and consume at a given price. To put it simply, our demand for cheaper oil is larger than our demand for more expensive oil. So if the prices rise, demand is destroyed, and the absolute amount of peak demand gets lower (this also leads to slower growth in demand over time). And if prices fall, people find new wonderful uses for oil and can afford to use more of it. Demand for oil rises (and demand for its possible non-oil substitutes and efficiency-investments fall).

What defines supply (or production) then, you might ask? On a longer time-frame, it is the amount of oil that can be produced daily (for example, or annually) at a given price with the technology at one’s disposal. Price is the more important factor, since it is also a big driver behind technology development (the relationship goes both ways). Another definition would be that it is the amount of oil that oil producers are willing to produce and release to market at any given moment. This is the situation when there is relatively large amounts of easy spare capacity available. The relationship between peak demand and peak production becomes ever tighter as the oil market gets tighter (meaning a shrinking spare capacity).

So when we talk about peak oil, whether it is peak demand or peak production, we always need to add ”at a given price” to the sentence. This means the market price, the price of production and the amount of costs that the oil companies manage to externalize and the amount of different subsidies they manage to lobby for themselves. Taxes, on the other hand, do not have that big a difference in the total demand, as taxes are recycled back into the economy through public sector jobs, social security and other services (taxes enable consumption elsewhere compared to high price of production which does not – at least in the same sense).

Oil prices

The prices of oil have roughly quadrupled in a decade, as demand grew faster than our ability to add new production. Prices would have risen even more if we could afford them. It just happened that our economies went into recession when prices got to the range of 100-120+ US$ / barrel. And then it happened again a few years later.

At current prices, the western economies and people are hitting their peak demand, and there is evidence that we are adjusting to a lower level of demand (not voluntarily, but because of rising unemployment and inability to pay for oil). Our economies are not growing much, and our oil use has been falling for a decade in most cases. China and other growing and developing countries have been pricing us out from the oil markets, as they have bought all the oil we could not afford. They seem to have more productive use for their next barrel than OECD-nations do.

Investments vs. prices

The recent developments, where many international oil companies have grown their CAPEX-investments in new oil production 5-fold since the start of the century, and have still failed to grow their production, are a strong indication of an approaching peak oil production at current prices. It is even more so, as many companies (Shell, ExxonMobil, Eni etc.) have decided to slash their 2014 investments by 5-20 percent in order to keep their ability to pay dividends to their stock owners. As a big surprise for many, the companies have not been able to transfer their growing investment costs into oil prices, as the world has been unable to pay higher prices. This fact, if it stays with us for longer, will sweep the rug from under most IEA (& co) predictions of future oil production, as they all assumed that the rising costs can be transferred to prices.

Involuntary peak demand

So it is not very sensible or helpful to argue whether we are facing peak demand or peak production. Currently they are largely the same thing. And it bears reminding that in the west we are hitting peak demand largely involuntarily. Yes, young people are not getting their driver’s license, but a study found out that the main reason in U.S. (around 80 percent of the time) is because they don’t have a regular, full-time job. So the reason for not driving is because they can’t afford to drive, and don’t have a regular job to drive to. So it’s not that much because they do not want to drive (although there is hope that ”not-driving” will become some kind of accepted social trend as it is becoming a reality for many young people).

Of course, some reduction is due to better mileage and alternative ways to heat homes and other efficiency-gains. But given that many of the countries hit by the euro-crisis have lost almost a third of their oil demand in just a few years, I would have to argue that most of the lost demand is due to economic problems.

This means that if their economy starts to grow, so will their demand for oil. For the economy to start growing, oil prices would have to fall, and / or efficiency would have to go up (meaning more can be paid for oil as it is used more efficiently). There is not much signs currently that oil prices could go down, save for some short market disruptions or as a result of large scale economic crash.

So it would seem that we could be hitting peak demand, peak ability to pay for oil, and in a few years’ time, peak in oil production. Demand can’t be higher than supply, as the price will see to it that the two always match each other, more or less.

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I will continue on this subject with a sample chapter from the book The World After Cheap Oil that summarises how and where demand for oil will be destroyed and with what consequences. So stay tuned! (like the book on facebook here and get notified on new articles).