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Paris Agreement On Climate Change Goes Into Effect. What Does it Mean for Oil?

In November 2016, the Paris Agreement on Climate Change went into effect. A total of 193 Nations are signatories, 115 of which have ratified the convention, including the United States. The aim of the convention is:

"(a) Holding the increase in the global average temperature to well below 2 °C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5 °C above pre-industrial levels, recognizing that this would significantly reduce the risks and impacts of climate change;

(b) Increasing the ability to adapt to the adverse impacts of climate change and foster climate resilience and low greenhouse gas emissions development, in a manner that does not threaten food production;

(c) Making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development."

Countries further agreed to aim to reduce “global peaking of greenhouse gas emissions as soon as possible”. The agreement further described an incentive for and driver of fossil fuel divestment. Each Country is supposed to set its own “ambitious” goals that “represent progression over time” to achieve the worldwide goal determined by all countries. Interestingly, these goals are just that- goals. They are not binding under international law and the agreement itself provides no consequences if a country does not reach its intended target.

So, what does it mean for Oil and Gas? Luckily, the International Energy Agency, in its World Energy Outlook for 2016, addresses the issue. The full executive summary can be obtained by clicking here. (http://www.iea.org/publications/freepublications/publication/WorldEnergyOutlook2016ExecutiveSummaryEnglish.pdf). But here are the highlights:

  • Growth in energy-related carbon emissions stalled completely in 2015. This was mainly due to a 1.8% improvement in the energy intensity of the global economy, bolstered by gains in energy efficiency and expanded use of cleaner energy sources worldwide, mostly renewables.
  • An increasing slice of the roughly $1.8 trillion of investment each year in the energy sector has been attracted to clean energy, at a time when investment in upstream oil and gas has fallen sharply. The value of fossil-fuel consumption subsidies dropped in 2015 to $325 billion, from almost $500 billion the previous year, reflecting lower fossil-fuel prices but also a subsidy reform process that has gathered momentum in several countries.
  • The IEA used several different modeling scenarios to arrive at an aggregate likely conclusion to form their world energy outlook. For our purposes, we will look at the “main scenario” which assumes that all signatory countries will attempt to meet the requirements set by Paris, as well as existing environmental legislation, while its 450 Scenario assumes signatories adhere completely to the agreement. Below are some key quotes from the Report:
    • In our main scenario, a 30% rise in global energy demand to 2040 means an increase in consumption for all modern fuels, but the global aggregates mask a multitude of diverse trends and significant switching between fuels. Moreover, hundreds of millions of people are still left in 2040 without basic energy services. Globally, renewable energy – the subject of an in-depth focus in WEO-2016 – sees by far the fastest growth. Natural gas fares best among the fossil fuels, with consumption rising by 50%. Growth in oil demand slows over the projection period, but tops 103 million barrels per day (mb/d) by 2040. Coal use is hit hard by environmental concerns and, after the rapid expansion of recent years, growth essentially grinds to a halt. The increase in nuclear output is spurred mainly by deployment in China. With total demand in OECD countries on a declining path, the geography of energy consumption continues to shift towards industrializing, urbanizing India, Southeast Asia and China, as well as parts of Africa, Latin America and the Middle East. China and India see the largest expansion of solar photovoltaics (PV); while by the mid-2030s developing countries in Asia consume more oil than the entire OECD. Yet, despite intensified efforts in many countries, large swathes of the global population are set to remain without modern energy. More than half a billion people, increasingly concentrated in rural areas of subSaharan Africa, are still without access to electricity in 2040 (down from 1.2 billion today). Around 1.8 billion remain reliant on solid biomass as a cooking fuel (down by a third on today’s 2.7 billion); this means continued exposure to the smoky indoor environments that are currently linked to 3.5 million premature deaths each year.
    • A cumulative $44 trillion in investment is needed in global energy supply in our main scenario, 60% of which goes to oil, gas and coal extraction and supply, including power plants using these fuels, and nearly 20% to renewable energies. An extra $23 trillion is required for improvements in energy efficiency. Compared with the period 2000- 2015, when close to 70% of total supply investment went to fossil fuels, this represents a significant reallocation of capital, especially given the expectation of continued cost declines for key renewable energy technologies. The main stimulus for upstream oil and gas investment is the decline in production from existing fields. In the case of oil, these are equivalent to losing the current output of Iraq from the global balance every two years. In the power sector, the relationship between electricity supply and generating capacity is changing. A large share of future investment is in renewables-based capacity that tends to run at relatively low utilisation rates, so every additional unit of electricity generated is set to necessitate the provision of 40% more capacity than during the period 1990-2010. The increased share of spending on capital-intensive technologies is balanced in most cases by minimal operational expenditures, e.g. zero fuel costs for wind and solar power.
    • Countries are generally on track to achieve, and even exceed in some instances, many of the targets set in their Paris Agreement pledges; this is sufficient to slow the projected rise in global energy-related CO2 emissions, but not nearly enough to limit warming to less than 2 °C.
    • China’s major industrial energy demand is now past its high point and expected to decline through 2040, and its carbon emissions are expected to plateau only slightly higher than current levels (although it is expected to use 85% more energy by 2040). India is projected to drop its use of coal for power gen from 75% to 55% by 2040, although it is expected to see its electricity demand triple.
    • The U.S., EU, and Japan appear to be on track to meet their pledges under the Paris Agreement.
    • The worldwide stock of electric cars reached 1.3 million in 2015, a near-doubling on 2014 levels. In our main scenario, this figure rises to more than 30 million by 2025 and exceeds 150 million in 2040, reducing 2040 oil demand by around 1.3 mb/d.
    • For the moment, the collective signal sent by governments in their climate pledges (and therefore reflected in our main scenario) is that fossil fuels, in particular natural gas and oil, will continue to be a bedrock of the global energy system for many decades to come, but the fossil-fuel industry cannot afford to ignore the risks that might arise from a sharper transition. While all fossil fuels see continued growth in our main scenario, by 2040 oil demand returns to the levels of the late 1990s in the 450 Scenario, at under 75 mb/d; coal use falls back to levels last seen in the mid-1980s, at under 3 000 million tonnes of coal equivalent per year; only gas sees an increase relative to today’s consumption level.

Specifically, as to oil markets, the World Energy Outlook says the following:

  • A near-term risk to oil markets could arise from the opposite direction – a shortfall of new projects – if the cuts in upstream spending in 2015-2016 are prolonged for another year. In 2015, the volume of conventional crude oil resources that received development approval fell to its lowest level since the 1950s and the data available for 2016 show no sign of a rebound. A lot of attention is focused on the remarkable resilience of US tight oil output through the current downturn and its potential ability, because of a short investment cycle, to respond in a matter of months to movements in price. But there is a threat on the horizon to the “baseload” of oil output, the conventional projects that operate on a different rhythm, with lead times of three to six years from investment decision to first oil. We estimate that, if new project approvals remain low for a third year in a row in 2017, then it becomes increasingly unlikely that demand (as projected in our main scenario) and supply can be matched in the early 2020s without the start of a new boom/bust cycle for the industry.
  • Over the longer term, oil demand in our main scenario concentrates in freight, aviation and petrochemicals, areas where alternatives are scarce, while oil supply – despite a strong outlook for US tight oil – increasingly concentrates in the Middle East.
  • Total demand from OECD countries falls by almost 12 mb/d to 2040, but this reduction is more than offset by increases elsewhere. India, the largest source of future demand growth, sees oil consumption rise by 6 mb/d. On the supply side, projected US tight oil output has been revised upwards, remaining higher for longer than in last year’s Outlook, although non-OPEC production as a whole still goes into retreat from the early 2020s. OPEC is presumed to return to a policy of active market management, but nonetheless sees its share of global production rising towards 50% by 2040. The world becomes increasingly reliant on expansion in Iran (which reaches 6 mb/d in 2040) and Iraq (7 mb/d in 2040) to balance the market. The focus for oil trade shifts decisively to Asia: the United States all but eliminates net imports of oil by 2040.
  • A 1.5% annual rate of growth in natural gas demand to 2040 is healthy compared with the other fossil fuels, but markets, business models and pricing arrangements are all in flux. A more flexible global market, linked by a doubling of trade in liquefied natural gas (LNG), supports an expanded role for gas in the global mix. Gas consumption increases almost everywhere, with the main exception of Japan where it falls back as nuclear power is reintroduced. China (where consumption grows by more than 400 billion cubic metres) and the Middle East are the largest sources of growth.

So what does all of this really mean?

  1. Overall, the IEA expects global oil consumption to peak no sooner than 2040.
  2. While demand for oil for passenger cars drops, other sectors such as road freight, aviation, and petrochemicals offset the fall.
  3. Under the main scenario, demand reaches 103.5 million bpd by 2040, up from 92.5 mmbpd in 2015, with India being the leading source of demand growth and China overtaking the U.S. as the single largest producer.
  4. If all countries adhere too their promises, oil demand growth, oil demand growth will move at its slowest pace for more than 20 years but will be enough to offset a continued fall from OECD country demand.
  5. In the 450 Scenario, global oil demand peaks by 2020, at just over 93 million bpd. The subsequent decline in demand accelerates year-on-year, so that by the late 2020s global demand is falling by over 1 million bpd every year.

Overall, even if all signatory countries adhere to their ambitious goals, we are in no danger of oil suddenly disappearing as our main source of energy.

By: Ty Chapman

Five Star Metals, Inc.

Raising the Bar for Customer Service and Quality

Twitter: @FSM_TY

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