The puzzle of future oil pricing

Peter Garforth says global petrochemical demand factors extend beyond immediate fuel needs.

By Peter Garforth

A rewarding aspect of writing this column is the reader feedback. A Plant Services reader recently raised a question that served as a useful reminder that oil and natural gas are much more than fuels: They are also key feed stocks to the plastics, resins, and fertilizer industries. The reader's question was deceptively simple: “How long will my customers benefit from the low price of resins made from the recent dramatic drop in oil prices?"

Here is my reply: If I knew the answer better than anyone else, I would probably be quietly stashing away billions of dollars! The main factors driving oil prices are, unsurprisingly, demand and supply.

Demand is obviously driven by the growth and efficiency of the three main sectors using oil: transportation, petrochemicals including plastics, and heating.

By far the largest use is transportation. One oil executive called the use of oil in vehicles the equivalent of burning Picassos. It’s a one-way process using one of our most valuable commodities, with no recycling and an overall efficiency under 20%. Driving this up is growing global wealth and more cars; driving it down is steadily increasing vehicle efficiency, improved urban design, better mass-transit options, and the beginnings of electrification, including hybrid and fuel-cell vehicles. Economic growth is currently outpacing efficiency and electrification, but we could be approaching a tipping point.

Oil heating is mostly found in northern climates in buildings. Its use is being driven down by rising building efficiency, modern urban heating systems combined with cogeneration, and the use of biofuels as heat sources. So again, the question is how fast these efficiencies and fuel swaps reduce the demand for oil as a heat source relative to the global economic growth that, conversely, increases it. When systems reach critical mass, as in most of Scandinavia and much of Germany, heating oil use plummets.

In the petrochemical industry, the growth pressure is unquestionably greater than the efficiency potentials. The global industry has done a pretty good job of squeezing out inefficiencies over the past four decades. There is still vast room for improvement in recycling and reuse, but this is unlikely to slow overall growth very much.

The fears of the 1970s and 1980s that we would run out of new oil supply have largely been allayed. New sources coming on stream include shale deposits in the United States, Canada, and elsewhere. The greater fear now is supply interruption from political crises. However, if we stand back from the drumbeat of cable news cycles, the world’s supply portfolio is not that badly balanced, so political crises are probably less of a risk than they may seem on first glance.

Environmental legislation aimed at mitigating climate change also could drive oil prices higher. By far the biggest of impact would come from the globalization of some form of carbon constraint. A carbon tax at the current taxation levels in British Columbia would be about $12/barrel; at Sweden's taxation level, it could be as much as $60/barrel.

This would penalize the least-efficient and largest users – transport and heating – putting massive downward pressure on demand because of accelerated efficiencies and technology substitutions. So exactly what this will do to the price of oil for the petrochemical industry, which is more efficient and does not burn oil, is uncertain. It is likely to be much less onerous than the headline carbon cost would suggest.

The other environmental cost risk is from public pressure to reduce the risks of exploration accidents, fracking, and transportation by rail and pipeline. Even the most stringent view of this is hardly likely to exceed $10/barrel.

In my estimation, the downward pressures on demand from more-efficient use, recycling and technology changes will begin to outpace the upward pressures from economic growth. The upward pressure on cost from supply constraints are modest, short of a total collapse of Middle East supply in the near term. The upward pressure from carbon pricing and other environmental and safety regulation are real and could probably globalize to the $10 to $20 per barrel level over the next 15 years.

The bottom line: The $100 per barrel cost was probably a market aberration, and $30-60 per barrel feels right. That being said, energy markets have a bad habit of making fools of fortune tellers.

I always encourage people to take both the most and least optimistic views of future energy prices and regulation. Doing so will let them examine how various scenarios will affect their business so that they can more effectively create plans to win (or at least survive) within the entire range of risk.

If we try to pick a fixed view of the future, the risk of personal views interfering increases exponentially. The climate denier will minimize the risk of carbon taxes; the news addict will overestimate the supply risks; and the environmentalist will be overly optimistic about the progress of efficiency and technology. With a risk-adjusted view of the future trends, there is room for everybody’s opinion and a higher likelihood that a more-robust plan will result.

Read Peter Garforth's monthly column, Energy Expert.

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