With the global energy supply “surfing a technological wave” while energy demand has softened, it seems increasingly clear that world energy markets are in a state of flux, Spenser Dale, BP group chief economist, commented during a June 8 webcast, when introducing the BP Statistical Review of World Energy for 2016. BP publishes its energy review annually, using a mass of data from a wide range of sources to assess the dynamics of energy markets over the previous year.
In 2015 cyclical weakness in the world economy and sluggish growth came on top of a gradual transition in recent years to slower growth in energy demand. In China, in particular, the strong growth in energy consumption associated with industrialization is waning, with growth in energy demand slowing to its lowest rate since the late 1990s.
“The days of double-digit Chinese growth led by energy-hungry industrial production are behind us,” Dale said.
The age of plenty
Overall global energy demand grew by just 1 percent in 2015, a growth rate almost half of the average rate over the last 10 years. At the same time technical advances, as typified by the shale oil and gas revolution in the United States, have resulted in huge energy productivity gains, increasing the abundance of global energy supplies.
“This is truly an age of plenty,” Dale said.
And the technical advances have not just impacted fossil fuels. Advances in other energy sources, wind and solar power in particular, have been particularly striking, with solar power production increasing more than 60-fold in the past 10 years, for example. The international agreements made during the Conference of Paris meetings in 2015 will likely lead to new policies, shifting the fuel mix to lower carbon fuels, with renewable energy sources and natural gas being the main beneficiaries, Dale said.
Clear impacts
The twin forces of slower demand and abundant supply had some clear impacts on energy markets.
“Most obviously and somewhat predictably, energy prices fell sharply in response to the imbalance between demand and supply,” Dale said. “Prices of oil, natural gas and coal were all sharply lower.”
And the extent of the price fall in part reflected the fact that key suppliers, in particular OPEC oil suppliers and Russian gas exporters, did not make offsetting production adjustments to help stabilize prices: Ceding market share to support pricing becomes less attractive when the underlying cause of the supply and demand imbalance is likely to persist, rather than be short lived, Dale said.
However, it has now become clear that pricing is working in the energy markets, with low prices boosting demand and putting the brakes on production.
“An adjustment process does appear to be underway, which bodes well for future market stability,” Dale said. “Markets in which prices work tend to be more stable.”
Curiously, the recent rate of decline of energy intensity, a measure of the amount of energy used per unit of production, continued at around 2 percent per year, despite the sharp drop in energy prices, a drop that might have been expected to cause energy efficiency to slacken.
The oil market
When it comes to the oil market, oil demand grew strongly in 2015 at a rate of 1.9 million barrels per day, a rate of increase well above historic averages. The strength of oil demand tended to occur across the world, except in oil exporting countries. With lower fuel prices encouraging the purchase of consumer oriented fuels and services, the strengthened fuel demand particularly impacted gasoline and jet fuel, rather than the demand for fuels destined for industrial applications.
But 2015 also saw oil supplies grow at a significantly faster rate than oil consumption, with supplies rising by 2.8 million barrels per day. That was the strongest rate of growth since 2004. Supplies from Iraq and Saudi Arabia in particular rose to record levels.
In the U.S. there was a continuing major cutback in drilling rig activity in shale plays, but this reduced activity was somewhat offset by increased productivity. And, given the sunk capital in conventional oil fields, the production from these fields was less impacted by the drop in oil prices, Dale said. Ultimately, U.S. oil production in 2015 did increase by about 1 million barrels per day, despite the drop in shale oil activity, although this increase was less than the increase seen in 2014. U.S. supply growth in 2015 proved to be the largest of any oil producing country, with the U.S. remaining the world’s largest oil producer.
In 2014 and into 2015 oil prices fell sharply in response to the excess of supply over demand, before rallying somewhat early in 2015 as demand for oil strengthened and U.S. shale oil production passed its peak. But prices then fell back in response to increased Saudi Arabian and Iraqi production, dropping to around $36 in December.
A question of timing
But, with an estimated fall of $160 billion in investment in oil and gas projects in 2015, the apparent resilience of oil production is more a question of timing than strength, Dale suggested. Capital expenditure has continued to fall sharply this year. A key risk now is that this dramatic fall in investment will cause over tightening of the market in the future, he said.
With continuing strong demand growth and a further slowdown in supplies outside OPEC, the oil market should come broadly into balance in the second half of this year, Dale said. However, rather than solving the oversupply problem, the balancing of the market will simply prevent the oversupply from becoming worse, he said.
“The market will only truly return to normal when the sizable (oil) stock overhang has been worked off,” Dale said.
The price pattern of the current oil price drop appears to follow that of the decline in the mid-1980s, rather than the patterns of the more recent declines in 1997-98 or 2008-09, Dale said. It is probably telling that the mid-1980s decline was, like the current decline, driven by an oil oversupply, while the later two declines were caused by sharp contractions in demand growth. And, while the demand contractions reversed quite quickly, causing the oil price to also rapidly rebound, the oversupply in the 1980s took longer to resolve. By analogy, the current oil price slump may take longer to recover than the demand driven events, Dale suggested.
“The impacts of supply shocks tend to be far more protracted than those of demand shocks,” he said.
However, in the downstream end of the oil business, the low oil prices have driven high refining margins and strong refinery throughputs, causing a buoyant year for refining in 2015, Dale said.
Natural gas
When it comes to natural gas, growth in production remained relatively strong in 2015 but demand outside the power generation sector was subdued, causing prices to fall sharply. The price fall helped the market to rebalance as a result of increasing gas usage in power generation, the most price sensitive sector of gas demand, Dale said. But overall gas consumption did increase in 2015, enabling gas to continue to gain a growing share of the total energy mix, he said.
Demand for gas was particularly weak in Asia, primarily as a consequence of slowing demand growth in China. The United States continued to dominate worldwide gas supplies, accounting for more than half of the increased global production. U.S. shale gas drove all of this increase, with conventional gas production declining, Dale said.
Natural gas gained market share from coal in several major power generation markets around the world but especially in the United States, where gas has become price competitive with coal.
Worldwide production of liquefied natural gas has accelerated, but, with decelerating consumption in East Asia, LNG transportation flows have tended to move west to the Middle East, North Africa and Europe. At the same time, there has been a sharp narrowing in LNG price differentials between Asia and Europe. And Russian gas prices in Europe may also have moved down below their normal oil indexed level in response to competition with LNG.
“We are moving towards a globally integrated gas market,” Dale said.
