Breaking the Habit

SPECIAL REPORT OIL November 26th 2016 Breaking the habit 20161126_SR_OIL_001.indd 1 14/11/2016 12:10 SPECIAL REPORT OIL Breaking the habit The world’s use of oil is approaching a tipping-point, writes Henry Tricks. But don’t expect it to end imminently AT THE TURN of the 20th century, the most malodorous environmental CONTENTS challenge facing the world’s big cities was not slums, sewage or soot; it was horse dung. In London in 1900, an estimated 300,000 horses pulled 3 Producers cabs and omnibuses, as well as carts, drays and haywains, leaving a On the oil wagon swamp of manure in their wake. The citizens of New York, which was home to 100,000 horses, suffered the same blight; they had to navigate 5 Investors Taken to task rivers of muck when it rained, and fly-infested dungheaps when the sun shone. At the first international urban-planning conference, held in New 6 Transport York in 1898, manure was at the top of the agenda. No remedies could be From oiloholics to e-totallers found, and the disappointed delegates returned home a weekearly. Yet a decade later the dung problem was all but swept away by the 7 Batteries Beyond lithium-ion invisible hand of the market. Henry Ford produced his first Model T, which was cheap, fast and clean. 8 India and China By 1912 cars in New York outnum- Different drinking habits bered horses, and in 1917 the last horse-drawn streetcar was retired 9 The future Into the twilight zone in Manhattan. It marked the moment when oil came ofage. That age has been one of speed and mostly accelerating progress. If coal drove the indus- trial revolution, oil fuelled the in- ternal-combustion engine, avia- tion and the 20th-century notion that mankind’s possibilities are limitless; it flew people to the Moon and beyond. Products that have changed lives—from lipstick to CD players, from motorcycle helmetsto aspirin—contain petro- chemicals. The tractors and fertil- isers that brought the world cheaper food, and the plastics used for wrapping, are the pro- geny ofpetroleum products. Oil has changed history. The past 100 years have been pockmarked with oil wars, oil shocks and oil spills. And even in the 21st century its dominance remains entrenched. It may have sped everything else up, but the rule of thumb in energy markets is that changing the fuel mix is a glacial process (see chart, next page). Near its peakat the time ofthe Arab oil embargo in 1973, oil accounted for 46% of global energy supply. In 2014 it still had a share of 31%, compared with 29% for coal and 21% for natural gas. Fast-growing rivals to fossil fuels, such as wind, solar and geothermal energy, together amounted to lit- tle more than 1%. ACKNOWLEDGMENTS Horses for courses Apart from those mentioned in the Yet the transition from horse power to horsepower, a term coined text, particular thanks for their help in preparing this report are due to: by Eric Morris of Clemson University, South Carolina, is a useful parable Gordon Ballard, Rita Brown, Jeff for our time. A hundred years ago oil was seen as an environmental sav- ¡ £ Currie, Christoph Fr ¢icki Hollub, iour. Now its products are increasingly cast in the same light as horse ma- Ron Hulme, Alexander Kemp, Paul nure was then: a menace to public health and the environment. McConnell, Mella McEwan, Russell Picot, Stephen Robertson, Adam For all its staying power, oil may be facing its Model T moment. The Sieminski, Christian Thimann, Jamie danger is not an imminent collapse in demand but the start of a shift in A list of sources is at Webster and Fiona Wild. investment strategies away from finding new sources of oil to finding al- 1 Economist.com/specialreports The Economist November 26th 2016 1 SPECIAL REPORT OIL 2 ternatives to it. The immediate catalyst is the global response to climate change. An agreementin Parislastyearthatoffers a 50/50 chance of keeping global warming to less than 2oC above pre-in- dustrial levels, and perhaps limiting it to 1.5oC, was seen by some as a declaration ofwar against fossil fuels. That agreement has been thrown into doubt by the election of Donald Trump, who has dismissed climate change as a “hoax”, as America’s next president. But ifbig energy consumers such as the EU, China and India remain committed to curbing global warming, all fossil fuelswill be affected. The International Energy Agency (IEA), a global forecaster, says that to come close to a 2oC target, oil demand would have to peak in 2020 at 93m barrels per day (b/d), just above current levels. Oil use in passen- ger transport and freight would plummet over the next 25 years, to be replaced by electricity, natural gas and biofuels. None ofthe signatories to the Paris accord has pledged such draconian action yet, but as the costs ofrenewable energy and batteries fall, such a transition appears evermore inevitable. “Whetherornot you be- lieve in climate change, an unstoppable shiftaway from coal and Western oil companies have struggled through the crisis oil towards lower-carbon fuels is under way, which will ulti- with a new cross to bear as concerns about global warming be- mately bring about an end to the oil age,” says Bernstein, an in- come mainstream. In America the Securities and Exchange vestment-research firm. Commission and the New York attorney-general’s office are in- Few doubt that the fossil fuel which will suffer most from vestigating ExxonMobil, the world’s largest private oil company, this transition is coal. In 2014 it generated 46% ofthe world’s fuel- overwhetherithasfullydisclosed the risksthatmeasures to miti- based carbon-dioxide emissions, compared with 34% for oil and gate climate change could pose to its vast reserves. Shareholders 20% for natural gas. Natural gas is likely to be the last fossil fuel to in both America and Europe are putting tremendous pressure on remain standing, because of its relative cleanliness. Many see oil companies to explain how they would manage their busi- electricity powered by gas and renewables as the first step in an nesses if climate-change regulation forced the world to wean it- overhaul ofthe global energy system. selfoffoil. MarkCarney, the governorofthe BankofEngland, has This special report will focus on oil because it is the biggest given warning that the energy transition could put severe strains single component of the energy industry and the world’s most on financial stability, and that up to 80% of fossil-fuel reserves traded commodity, with about $1.5trn-worth exported each year. could be stranded. The oil industry’s rallying cry, “Drill, baby, Half of the Global Fortune 500’s top ten listed companies pro- drill!” now meets a shrill response: “Keep it in the ground!” duce oil, and unlisted Saudi Aramco dwarfs them all. Oil bank- rolls countries that bring stability to global geopolitics as well as Which peak? those in the grip of tyrants and terrorists. And its products fuel This marks a huge shift. Throughout most of the oil era, the 93% ofthe world’s transport, so its price affects almost everyone. biggest concern has been about security of energy supplies. Co- Since the price of crude started tumbling in 2014, the world lonial powers fought wars over access to oil. The Organisation of has had a glimpse of the havoc a debilitated oil industry can Petroleum Exporting Countries (OPEC) cartel was set up by oil cause. When oil fell below$30 a barrel in Januarythisyear, stock- producers to safeguard their oil heritage and push up prices. In markets predictably plummeted, oil producers such as ¤enezue- the 20th century the nagging fear was “peak oil”, when supplies © § ¦¨ la and Nigeria suffered budget blowouts and social unrest, and would start declining. But now, as D ¥ergin, a Pulitzer-prize- some American shale companies were tipped into bankruptcy. winning oil historian, puts it: “There is a pivot away from asking But there have been positive effects as well. Saudi Arabia has be- ‘when are we goingto run outofoil?’ to ‘howlongwill we contin- gun to plan for an economy less dependent on oil, and an- ue to use it?’ ” For “peakoil”, now read “peakdemand”. nounced it would partially privatise Aramco. Other Middle East- Oil to fuel heavy-goods vehicles, aeroplanes and ships, and ern producers have enthusiastically embraced solar power. to make plastics, will be needed for many years yet. But from Some oil-consuming countries have taken advantage of low oil America to China, vehicle-emissions standards have become prices to slash fuel subsidies. tougher, squeezing more mileage out of less fuel. Air pollution and congestion in big cities are pushing countries like China and India to look for alternatives to petrol and diesel as transport fuels. Car firms like Tesla, Chevrolet and Nissan have announced plans for long-range electric vehicles selling, with subsidies, for around $30,000, making them more affordable. And across the world the role ofenergy in GDP growth is diminishing. Analysts who think that the Paris accords will mark a turn- ing point in global efforts to reduce carbon-dioxide emissions say global oil consumption could start to wane as early as the 2020s. That would mean companies would have to focus exclu- sively on easy-to-access oil such as that in the Middle East and America’s shale-oil provinces, rather than expensive, complex projects with long payback periods, such as those in the Arctic, the Canadian oil sands or deep under the ocean. et many in the industry continue to dismiss talk of peak demand.

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