Have Oil Prices Passed Their All-Time Peak?

Have Oil Prices Passed Their All-Time Peak?

17th November 2014

This is the third in a series of energy business insights commissioned by GCA from independent author and energy finance expert Barry Aling.  In it he looks at the post 1970s history of oil price and the drivers behind it and examines in detail the relative pressures and trends in supply and demand that shape the oil price trend and in particular those that are driving the recent large shifts in pricing across the world.  With the landscape of supply and demand history established, Barry takes a look forward towards long term trends and the changing role of OPEC producers and examines what the future might hold for the OPEC partnership, US Shale oil and the forward price of oil.

Barry Aling is a director of City of London Investment Group plc.  During his 40-year career he has worked extensively in international capital markets, including Phillips & Drew, W.I. Carr and Swiss Bank Corporation and is a former director of Gaffney Cline & Associates and Asset Management Investment Company plc.  The views expressed here are entirely his own.  

Key Facts

  • Rising OPEC spare capacity signals supply competition

  • Shale oil a “game-changer” – to create a price war with OPEC?

  • Market weariness with geopolitical disturbances

  • Long-term decline in global “oil intensity” continues unabated

  • China’s oil thirst accelerates the quest for gas as a transport substitute​

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Rapid demand growth from developing industrial economies such as China and a plethora of geopolitical disturbances have been key drivers behind a five-fold increase in oil prices since 2000 and, with both factors continuing to weigh on markets, it is tempting to assume that further price inflation in the medium to long term is inevitable.  However, there is growing evidence that the more recent decline in prices reflects transformational changes in the pattern of global energy supply and demand which may mean that the price of $145.61 per barrel [1], achieved in July 2008 as shown in Fig. 1, proves to be a watershed high point for a commodity that so dominated global economic development in the 20th century. 

Advances made over the last decade in the recovery of unconventional resources, notably from hydraulic fracturing of “tight oil” formations represent the “game-changer” in global oil supplies while the ongoing process of substitution and application efficiencies are making a significant impact on demand growth.  The realisation that these evolving market dynamics may cause oil to be viewed increasingly as a “20th century commodity” in the global economy must prompt the more oil-dependent exporters such as Saudi Arabia, Russia and the Gulf States to weigh carefully their production and pricing strategy.  In such a scenario, the ability of exporting nations to secure price increases through production cuts is compromised, presaging more overt price competition within OPEC as well as with the newer export entrants such as Brazil.

Figure 1 - Oil price 1970-2014 Actual vs. Real Terms Rebased

Source: BP “Statistical Review of World Energy, 2014, Notebook”

Long-Term Trends - Falling "Oil Intensity" = Slow Demand Growth

OPEC’s decision to exercise its cartel power in the early 1970s, which resulted in a quadrupling of the price in just 24 months, kick-started a process of substitution and utilisation efficiencies that has continued, almost uninterrupted, throughout the intervening four decades.  While oil’s short-term demand inelasticity caused a significant lag for such processes to take effect, the trend towards a lower “oil-intensity” of the global economy has been inexorable since 1975 despite wide swings in the oil price, as shown in Fig. 2.  Global oil consumption in 1975 of 19.8 billion barrels corresponded to a global GDP figure of $18.58 trillion, expressed in constant 2005 $, equal to an oil/GDP ratio of 1.07 bbls/$ but by 2013, this ratio had fallen by 44% to less than 0.6 bbls/$ [2].

Figure 2 - “Global Oil Intensity”: Oil Consumption (bbls p.a.)/Global GDP US$ (constant 2005 prices)

Source: BP “Statistical Review of World Energy, 2014, Notebook”

If anything, the process of decreasing oil intensity will accelerate in the wake of price increases since 2000.  While consensus forecasts up to 2025 suggest that oil demand will grow at less than 1% annually [3], the global economy is expected to continue growing between 3.5 – 4% [4] as the “China miracle” spreads to newly industrialising economies.  Based on the median of these forecasts, the oil intensity ratio will fall by a further 30% to less than 0.43 bbls/ $ by 2025 with all economic sectors contributing to this phenomenon.

The use of oil as a fuel source for power generation has been virtually eliminated since 1970 in favour of coal, gas and renewables throughout the OECD economies while the recent advent of abundant shale gas at a fraction of the oil-equivalent price, has enabled a resurgent US petrochemical industry to regain a significant commercial advantage over Asian and European competitors.  However, it is the transport sector, accounting for 64% of global oil use [5] that has witnessed the greatest efficiency gains.  While the global vehicle population grew at a compound annual rate of 3.5% to more than 1.1 billion vehicles from 1970 – 2012 [6], oil consumption grew at only 1.6% over the same period, due mainly to technological gains in engine efficiency.

Despite an expansion of the global vehicle fleet of more than 50% by 2025 [7], technological improvements in fuel economy, increased use of vehicle hybridisation and the emergence of gas and biofuels as cheaper fuel alternatives will all serve to erode reliance on oil at the margin.  OPEC forecasts that from 2010-2035, global oil use per vehicle will decline at a compound rate of 2% p.a. and notes that markets such as China, which will account for 39% of projected growth in the global vehicle population to 2035, may emerge as trail-blazers in the drive towards wider use of gas-powered vehicles on environmental grounds.

Taken together, these limiting factors translate into consensus forecasts [8] of a marked slowdown in global demand growth to a trend rate of 0.5 – 0.8%, compared with a rate of 1.4% since 2000 and 1.65% since 1970.  Going forward, the paradigm of “smarter” global economic growth using new technologies to power an industrial transformation of the developing world is a realistic prospect for the mid-21st century and, while oil will remain an important fuel component, it will cease to be the locomotive of global economic activity.

Long-Term Trends - Rising Non-OPEC Supply

The sharp price increases of the early 1970s resulted in a deep economic contraction in the OECD industrial nations and proved to be a watershed for non-OPEC exploration and production activity as the quest for domestic supplies assumed greater strategic importance. Major initial success in areas such as the North Sea and Alaska in the 1970s led to OPEC assuming the role of “swing producer” with its share of world oil production falling from 47% in 1970 to just 28% in 1985 as non-OPEC production rose more than 60%. Moreover, the long lead times in bringing these new discoveries into production meant that OPEC’s market-share reduction coincided with steep price falls, as shown in Fig. 3, compounding the economic impact on their domestic economies. Thus a 23-fold increase in OPEC oil revenues from 1970 to a peak of $350 Bn. in 1980 was followed by a precipitous slump to less than $100 Bn. in 1986. This 1980 high point for OPEC revenues was only surpassed in 2004 with China’s emergence as a major new oil importer, which allowed OPEC to regain a 42% market share and re-establish greater pricing power.

Figure 3 - OPEC vs. non-OPEC production (MMb/d) with Oil price1970-2013(US$Bn) 

Source: BP “Statistical Review of World Energy, 2014, Notebook”

Frontier exploration in the non-OPEC area has continued to identify major new reserves such as the deep-water pre-salt reservoirs offshore Brazil but it is the development of technologies to tap unconventional resources that has provided the greatest immediate stimulus to global supply.  By far the largest contributor to production growth in the last five years has been the US, where production of oil and liquids has risen by more than 5 MMb/d due largely to the use of hydraulic fracturing of shale formations.  Although the longer term potential for similar increments from other shale-prospective countries such as Russia, Argentina and China remain uncertain at this early stage of their exploration, the productivity of North American resources appears capable of delivering further increases in production with the IEA forecasting an additional 3.8 MMb/d of non-OPEC production by 2018 [9] and BP an additional 5 MMb/d by 2030 [10] as shown in Fig 4.

Figure 4 - Projected Global Tight Oil Output (MMb/d) 

Source: BP “Energy Outlook, 2014”

Among non-OPEC producers, Brazil and Kazakhstan appear to have the greatest potential to add conventional production capacity with forecasts for Brazilian output ranging from 4.4 - 6 MMb/d by 2035 [11], while Kazakh production is expected to rise to 3.2 MMb/d [12] over the same period.  The aggregate of these capacity additions will have a material impact on OPEC output in the absence of competitive price action and it is this prospect which is prompting a policy re-appraisal by those producers with high levels of spare capacity such as Saudi Arabia and its Gulf neighbours that, historically, have shouldered the financial burden of “swing producer” status.  

Long-Term Trends - Excess OPC Supply & Capacity

Despite political disturbances, principally in Iraq and Libya, that have occasionally distorted short-term production data in recent years, overall output has remained within a narrow range of 34–37 MMb/d since 2004 due to continued investment in capacity additions, notably in Saudi Arabia, Iraq, and Angola.  However, with global demand growing at a modest 1% and North American imports falling sharply, prospective spare capacity within OPEC is expected to grow to nearly 7 MMb/d by 2018, as shown in Fig 5.  Beyond that date, however, significant capacity increases in excess of 5 MMb/d are potentially realisable if Iraq is able to overcome the challenges that confront the Oil Ministry’s plans to raise production towards Saudi levels.  While Iraqi expansion plans have had to be curtailed since 2011 in the face of logistical, bureaucratic and security concerns, medium-term increments to output are expected to result in capacity rising to 6-7 MMb/d, the bulk of which will come from the southern areas around Basra.  In this scenario, budgetary constraints bearing upon the more populous OPEC producers such as Iran, Venezuela and Nigeria are likely to conflict with the Gulf Arab producers, who appear ready to use their spare production capacity to protect their market share with higher production and/ or lower prices.  

Figure 5 - Medium Term Oil Market Balance 2004 – 2018

Source: IEA Oil Medium-Term Market Report 2013 [13]

The implication of a growing level of spare capacity within OPEC was clearly foreshadowed in its 2013 “World Oil Outlook”, where it noted that the absorption of global spare capacity by OPEC alone would result in “OPEC crude supply falling steadily throughout the rest of the current decade to below 28 MMb/d in 2021”.  Ominously, the report concluded that, in such circumstances, “alternative price paths could emerge…with more expensive oil (i.e. non-OPEC) being crowded out” – a clear portent of the looming competition in oil supplies that has contributed to the recent 30% slump in oil prices.

Supply uncertainties resulting from geopolitical disturbances in Iraq and North Africa appear likely to reverberate for the foreseeable future with Libyan production currently running at less than 25% of capacity and Iraqi Kurdish fields lying in close proximity to the ISIS security threat.  Elsewhere, however, continued capital investment in enhanced recovery programmes and new field developments, notably in Saudi Arabia, UAE, Iraq and Angola will offset declines in Algeria, Iran and elsewhere, allowing crude production capacity to increase by a net 0.4 MMb/d by 2018.  Inevitably, if the ISIS insurgency is successful in wresting control of central Iraq, including Baghdad, from the incumbent government, the potential for more damaging and large-scale supply interruptions will alter the spare capacity metrics significantly but is worth noting that the bulk of Iraqi capacity additions are in the south of the country and very distant from existing hostilities.

Given that global spare capacity equating to around 8% of total demand appears likely to be sustained for some years to come, the issue of “pain-sharing” both within OPEC and between OPEC and non-OPEC producers assumes political dimensions, as suggested in the OPEC 2013 study.  Since the budgetary needs of the respective OPEC members varies significantly, with populous countries such as Iran, Nigeria and Venezuela less able to sustain a prolonged period of lower oil prices, increasing friction within OPEC appears likely in the near-term.  Arguably, however, the greater long-term challenge arises from growing non-OPEC supplies as the US “tight oil” phenomenon proliferates internationally.  Estimates from the IEA suggest that significant volumes of shale-sourced production may be economically vulnerable if oil prices fall much beyond the current level of $78 [14], as shown in Fig. 6 but the key question is whether OPEC (or members within it) will use their low-cost productive capacity overtly to undermine the economics of unconventional or deep offshore reserves from non-OPEC sources.

Figure 6 - US Light Tight Oil Sensitivity to Oil Price ($/ bbl)  

Source: IEA Analysis of Rystad Energy. Crude and Condensate output only


The painful legacy of a 70% collapse in OPEC revenues in the early 1980s following new discoveries in the OECD illustrated the limits of the cartel’s pricing power and, in the same vein, it is debatable whether the current US “shale boom” would have happened without the sharp price rises of the early 2000s.  Moreover, the room for policy manoeuvre among OPEC’s members has narrowed as their domestic budgetary needs have grown in tandem with a 135% increase in their aggregate population since 1980 to more than 450 million [15].  Thus the combination of excess production capacity, OPEC demographics and reductions in US import requirements have coincided to exert strong downward pressure on oil prices in 2014, while the longer term potential for oil substitution in the critical transport sector raises the possibility that oil demand may be approaching a permanent plateau.  

In this environment, with all oil exporting countries seeking to minimise revenue losses, the habitual focus on Saudi Arabian policy, as the single largest holder of spare production capacity, is magnified.  While historic precedence might suggest that the Saudis will accommodate their OPEC partners with a repeat of politically-inspired, voluntary production cuts, the over-arching challenge of growing competition from non-OPEC producers may steer future policy down a more independent course.  Such a course would follow a more orthodox economic path in which oil prices are set by real demand and supply and, in this scenario, the presence of significant excess capacity could presage a prolonged period of sub-$100 oil prices.  


[1] www.tradingeconomics.com

[2] Production data sourced from IEA & EIA; GDP data sourced from World Bank: World Development Indicators, September 2014

[3] BP – 0.8% 2012-2030; OPEC – 1% 2015 – 2020; IEA – 1.07% ave. 2015 - 2025

[4] IEA 4% 2015 – 2025; OPEC 3.9% 2015 – 2020; IMF up to 4%

[5] IEA, “Key world energy statistics, 2014”

[6] Oak Ridge National Laboratory, 2014:”Transportation Energy Data Book, editions 30-33”

[7] OPEC, “World Oil Outlook, 2013”, table 2.2

[8] BP – 0.8% to 104 MMb/d; OPEC – 0.9% to 105 MMb/d; IEA – 0.5% to 102 MMb/d by 2035

[9] IEA, “Medium term Oil Market Report, 2013”, p10

[10] BP, “Energy Outlook, 2013”

[11] OPEC: 4.4 mln. b/d – “World Oil Outlook, 2013”, p131; IEA: “World Energy Outlook, 2013”

[12] OPEC, “World Oil Outlook, 2013”, table 3.5

[13] IEA: “Medium term Oil Market Report

[14] West Texas intermediate, 7.11.14

[15] 1980 – 2014: US Census Bureau: International Data Base


Have Oil Prices Passed Their All-Time Peak?

Barry Aling

Director, City of London Investment Group PLC

Barry Aling is a former Director of Gaffney Cline & Associates and continues to write for GCA on a number of topics including the geopolitics of energy.

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