The Imminent Peak Oil Demand Myth

| About: The United (USO)


Soon after peak oil supply theory became widely denounced in the wake of the shale boom, more and more voices proclaimed that peak demand will soon happen.

Breaking down GDP growth and oil demand relationship into components in a simple formula suggests that there is no evidence of it starting to occur, or that it will soon.

Formula could be affected in future by technologies such as EV's, but likely will not happen for decades to come.

This concept has been going around for a while and seems to be gaining more and more traction. It started soon after the shale boom, when it was widely publicly proclaimed that we will never ever reach peak oil production. Theories started to emerge that oil will soon peak due to lack of demand, rather than lack of supply. More and more prominent voices are being added to this chorus. The latest was the CEO of Shell, who stated this month that demand could peak in five years.

The IEA recently waded in on the subject. It was the first major voice of reason in my view. They do not see peak oil demand at least by 2040, due to the fact that there are few alternatives to oil. I want to add to that argument by pointing out the fact that there is no evidence of oil demand slowing down in relation to economic growth. It is important to point out the oil demand growth relation to the level of global economic growth. There is a very well defined relationship between the two. It seems that the public lacks a clear visualization of it, even though we do acknowledge it on a regular basis. For instance, Whenever the IEA, OPEC or the EIA release an oil demand forecast, one of the main factors they cite is economic growth.

Click to enlarge

Source: EIA.

I looked at this relationship in the past, including it in articles whenever the issue of peak oil demand had to be addressed. I was mainly trying to answer the question of how much oil is needed in order to allow for a certain rate of global economic growth every cycle. It is sort of almost like answering the question of how far one can go on a tank of gas in any particular car. I came up with the following relationship, based on historical data.

1.5 (rate of efficiency growth) + (rate of oil supply growth x 2 (rate of increase of less oil intensive service sector as society becomes more wealthy) ) = GDP growth rate.

The formula was meant to figure out maximum potential growth allowed by the supply of oil, with real growth usually ending up a few tenths of a percentage points bellow the maximum.

For the current cycle, we have been experiencing global economic growth rate of about 3% since 2008. In the past nine years since 2008, global demand for crude oil and production increased by about 6 mb/d, or about .9% per year, according to EIA data. I am looking at crude oil only, not total liquids for this exercise. If we look at how the reality of the current economic cycle fits in with my formula, we see that it is a pretty good fit.

1.5 + (.9 x 2) = 3.3% maximum potential global economic growth.

The relationship may be off by a few percentage points on occasion, if we go back to past economic cycles, but it is usually off by just a few tenths of a percentage points. For instance, during the 2001-2007 economic cycle, a broad global real estate bubble was in large part responsible for skewing the DGP growth/oil demand growth ratio, in large part because we were counting the sale of houses that were far more expensive than they should have been. Interestingly enough, if we were to calculate the relationship over both the current and the previous economic cycle, the formula remains more of less intact. This means that the current relationship pattern is holding more or less in place. There is therefore no evidence that in the absence of a severe slowdown to an average yearly global economic growth rate of 1.5% per year or less, there is likely to be a peak in oil demand. We may see occasional declines during recession years, but that is about it.

Likelihood of GDP growth/oil demand relationship changing in the future.

I do believe that lack of robust global economic growth will most likely impact global oil demand. For instance, a further downshift in growth from about 3% per year in the current cycle, to perhaps 2.5%/year in the next cycle, which I do believe will happen, will shift demand for crude oil down to just .5% per year, if the values of the factors involved in the formula remain the same. But in reality, a long-term slowdown in economic growth will not on its own cause a peak in demand. If there were to be a peak in demand, it would have to come from a very dramatic technological shift in the way we approach public, private and freight transport.

In this regard, some people seem to believe that the current rate of growth in EV's is likely to be the thing that will cause a decline in crude oil demand. Fact is however that EV's currently make up about .5% of new cars sold per year. That rate is growing, but I do believe that it would have to reach a volume that would be at least twenty-fold compared with current sales levels in about a decade, in order to reach the point where the number of ICE cars on the world's roadways will no longer continue to increase. The way we have to think about this is as follows; Current car sales are in the 100 million units/year range. If average yearly new car demand increases by only 1%/year, in a decade's time we would need 10 million EV sales just to keep ICE car sales at current rates. But if total global car sales will increase by 2%/year, then we would need to see 20 million EV's sales volume ten years from now. I personally do not believe that we will see more than 2-3 million EV's sold/year in a decade's time. Even that will only happen if current global subsidies of about $10,000/EV on average will continue to be maintained. EV sales will increasingly become a burden on taxpayers if they continue to need this subsidy, while sales volumes increase.

We should also keep in mind the fact that personal vehicles are not the only consumers of crude oil. Aviation, freight transport on land and on water, construction machinery and other users will not see their demand for crude curtailed by EV's in any way. There are few viable alternatives to oil which can make a significant dent in the current growth trajectory in these fields. Natural gas has been presented as a viable alternative for the trucking industry, but to date the conversion to natural gas has not made huge inroads.

There is also something that needs to be addressed in regards to the effect that a slowing global economy will have on increasing efficiency. While new technologies such as EV's coming on the market in greater numbers might increase the 1.5% variable in the equation, which represents efficiencies gains, a slower growing economy might decrease it, because technological innovation tends not to make it on to the market when the economy slows. For instance, a slower economy will cause firms to defer investments, such as new factories and choose to stay with existing older ones. Any new technologies they might have otherwise introduced, which would have made the new factories more efficient will not be able to penetrate to a sufficient degree if business investment slows due to lack of economic growth. Even the EV subsidies will be more likely to be scrapped as governments will have to deal with a worsening fiscal situation and the need to invest in other projects, which might soak up the slack in the labor market, such as construction of infrastructure.

Some people might be wandering at this point why I did not deal with growth in efficiency and growth in the less oil-intensive services sector as one factor. The reason for that is because we also have to account for the growth in the services sector in relation to the size of the overall economy when economic growth causes societies to become wealthier, as a separate factor, which is a byproduct of growth allowed by the increase in oil supplies to the economy. A wealthier society, especially when it means gains in size and wealth of the global the middle class, leads to an outsized increase in the service sector in most cases. The service sector tends to be less energy-intense than other sectors of the economy, which is why every 1% increase in oil supply/demand will have twice the effect on the economy.

If the economy slows, the 2x multiplier will most likely shrink. If too much of the slower economic growth gains will go to the global 1%, it might even lead to the global service sector starting to shrink, meaning that the multiplier might drop bellow 1x. A slowing global economy might in fact lead to crude oil demand not declining by as much as one might think in the longer run. This is why I think it is important to break down the relationship between economic growth and the need to increase oil supplies into the formula I fit the relationship into. We need to understand how different parts of the economy will behave under certain conditions.

In conclusion, peak oil demand will happen eventually, if the world reaches a similar situation to what we see currently in Europe, with population growth stagnated, the economy more or less stagnated as it is in Europe, with average yearly GDP gains in the .3% range since 2008, as well as a strong commitment to environmentalist ideology, leading to measures such as high sales taxes on gasoline, mandatory emissions standards, and so on. The world would also have to reach an infrastructure availability level that we see in Europe, because otherwise construction will lead to a lot of oil demand growth. The world is currently very far from resembling Europe in most of these respects, therefore the world is far from peak oil demand.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.