Big Oil’s Business Model Could Be on the Verge of Failing

What happens when demand for oil peaks and starts to fall?

Mar 27 2018, 11:05pm

Photo by Dave Walsh/VW Pics/UIG via Getty

Time is ticking down for the world’s most powerful industry. Oil companies could only have a few years before demand for their product stops growing and begins to decline. Bank of America analysts predicted in January that an explosion of electric vehicles may “cause global oil demand to peak by 2030.” The influential credit rating agency Fitch Ratings said in February demand “could plausibly peak before 2030.”

Major oil companies are begrudgingly acknowledging the possibility. BP’s chief economist Spencer Dale dismisses the idea that electric vehicles are an existential threat to the petroleum business model. But he recently predicted that “oil used in the car market is essentially flat for the next 20 years”—at which point it could begin to decline. And on Monday, Shell said the peak could come slightly sooner, starting in the 2030s and leading to a 90 percent drop in oil consumption.

If and when peak oil demand occurs the world will still require a lot of oil. And obviously, that peak is still years away by any estimate. But it could cause investors to rapidly lose confidence in oil companies. “Very few investors would tell you they’re happy for their investments not to grow, for the company they’re investing in to simply tread water,” Luke Sussams, an analyst for the London-based financial think tank Carbon Tracker, told me. The world saw a preview of this sort of thing a decade ago, when a surge of renewables in Europe destroyed the region’s growth market for coal and natural gas. The continent’s utilities subsequently went into freefall, losing $560 billion in share value from 2008 to 2011. More recently, China’s efforts to shift off coal have helped drive much of the US coal industry into bankruptcy. “[Oil] companies really are at a fork in the road,” Sussams said.

Oil executives could prepare for peak demand by rapidly transitioning into lower carbon forms of energy. Or they could double down on fossil fuels in the hopes of making as much profit as possible before the market declines. So far they’re leaning toward the latter. Of the $15 billion in capital expenditures planned by BP only $500 million is for clean energy. “It’s a small percentage of their business model,” Sussams said. “As yet these companies are not driving the transition.”

The longer they wait, the more vulnerable these companies grow. Carbon Tracker estimates that $1.3 trillion of oil industry investments are at risk in a low-carbon shift. The industry could soon face “disproportionate levels of disruption,” Sussams said. Big oil’s business model, in other words, could be only a decade away from failing.

The concept of “peak oil demand” is much different than “peak oil.” In the 2000s, many prominent commentators argued that the world’s supply of oil was about to run dry. “We have reason to believe that we are at or near the peak right now,” the author and journalist James Kuntsler predicted in a 2005 interview with Grist. “In the next ten years, you will see the beginning of a major collapse of suburbia.” Instead, global oil production grew by nearly 20 million barrels per day, thanks in part to US oil shale drilling. Shell announced in March the discovery of a Gulf of Mexico oil field that may have 700 million barrels.

So it doesn’t seem likely that the world will run out of oil in the foreseeable future. But will people want to consume that oil? There is growing evidence that the world’s dependence on oil could be on the verge of an irreversible decline thanks to a drop in demand. Countries such as China, India, France, Norway, and Britain are floating plans to ban gas and diesel-powered vehicles. The price of lithium-ion car batteries is falling. Tesla now has a higher market capitalization than GM, BMW, and Ford even though electric vehicles represent only 0.2 percent of global passenger vehicles. Last year, BP predicted there could be about 100 million electric vehicles worldwide by 2035. This year it revised the estimate to 190 million. Groups like Bloomberg New Energy Finance, meanwhile, think it’ll be closer to 530 million.

Separating hype from reality can be difficult. For decades people have argued that new technology will kill off demand for petroleum, whether in the form of biofuels, compressed natural gas, methanol, or hydrogen. High hopes for electric cars in the 1990s failed to materialize. But the current threat to oil could be different. “We’ve had a lot of hype about electric vehicles but you’ve never had a lot of sales, and now we have quite a few sales—it’s a very real thing,” Michael Lynch, a Massachusetts-based oil analyst and Forbes contributor, told me. “That doesn’t mean that we’re going to have the kind of boom a lot of people expect—it’s still an open question.”

But the answer could be potentially devastating for oil companies. If and when investors become convinced electric cars will cause the industry to stop growing, they could start pulling out their investments. “Others realize more devaluation is on the way, so they want to get out before the drop: a trickle of divestment becomes a flood and the price collapses,” sustainability journalist Alex Steffen has predicted. “A crisis in investor confidence is the biggest threat to fossil fuel companies—not environmentalists, regulations, clean energy competitors or climate agreements.” For companies to avoid this, he argues, “they must spin a tale of future growth.”

This seems to be what oil majors like BP are doing. The company’s chief economist Spencer Dale recently co-authored a paper with Oxford Institute for Energy Studies director Bassam Fattouh downplaying future threats to the industry. “Even after oil demand has peaked, the world is likely to consume substantial quantities of oil for many years to come,” the paper argues. “Significant amounts of investment in new oil production is likely to be required for the foreseeable future. The date at which oil demand is likely to peak is highly uncertain and not particularly interesting.”

Sussams isn’t so sure. “The weakness in that argument is when you actually think about it from the investor perspective,” he said. “If all of a sudden demand goes to zero growth… that completely changes your perspective.” Some top investors are warning that the oil industry’s best days are behind it. New York–based investment manager James Chanos argued in a December interview with CNBC that growth in electric vehicles is “terrible for petroleum.” He continued, “I think that the whole move toward renewables is just not good for [fossil fuels] at the end of the day.”

Though the world will still burn oil for decades to come, a peak in demand could inflict financial damage on high-cost producers. It can cost up to $80 to produce a barrel of oil in Canada’s oil sands, compared to as little as $6 per barrel in Saudi Arabia. If electric vehicles take off and oil prices plunge, high-cost oil projects could become worthless. That logic undergirded Shell’s sale of $7.25 billion of oil sands projects last year. The head of Shell’s long-term planning team, Jeremy Bentham, recently described to Fortune an internal memo he wrote recommending the divestment. If Shell was someday stuck with billions of dollars of unprofitable oil sands reserves, Bentham said the company could be, “gosh, forgive me—fucked.”

Lynch agrees that certain oil investments are becoming riskier. “There’s enough uncertainty that you want some flexibility,” he told me. “If you’re a big oil company the oil sands don’t look like a place to put a lot of money right now.”

Yet oil executives insist there’s nothing to worry about. At an industry gathering in March, CEOs argued the market for oil could grow by tens of trillions of dollars over the coming decades. “The oil industry is doing a good job of saying the right things,” Sussams said. But if Bank of America and Fitch Ratings are right, demand for oil could peak in ten years or less. “That takes away the entire growth model,” he said. “Are investors going to be happy investing in companies that are going ex-growth?” History suggests not. Then again, people have been making predictions about oil’s decline for decades.

“This is one of those cases where you say, ‘Gee, I’ve heard it all before,’” Lynch explained. “But that doesn’t mean it won’t prove out this time.”

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Geoff Dembicki is the author of Are We Screwed? How a New Generation is Fighting to Survive Climate Change. Follow him on Twitter.