Peter Jones: North Sea at risk from global forces

FEARS of declining demand, a burst carbon bubble and investment jitters cloud oil’s long-term future, writes Peter Jones
Greater fuel efficiency and a switch to electric or hydrogen-powered cars will reduce demand for oil. Picture: GettyGreater fuel efficiency and a switch to electric or hydrogen-powered cars will reduce demand for oil. Picture: Getty
Greater fuel efficiency and a switch to electric or hydrogen-powered cars will reduce demand for oil. Picture: Getty

Is the North Sea oil and gas industry now entering a period of long, slow, decline? Sir Ian Wood, who has spent a lifetime in the offshore business and therefore deserves a respectful hearing, thinks it may well be. If it is, this may not be just peculiar to the North Sea, but simply part of a worldwide trend.

Of course, in the current political climate, Sir Ian’s words are highly charged. They go against what the SNP ruling administration would like all Scots to believe – that there are 24 billion barrels of oil remaining, that all that will be extracted, giving the industry at least another 40 years of profitable life, that the price will average more than $100 per barrel over the long term, and that this will yield billions in tax revenues which could yet persuade people to vote for independence in some future referendum.

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Lots of Scots, and not just the paid-up nationalists, appear to believe that. The conventional wisdom is that the developing world – China, India, Brazil, Indonesia, etc – will buy millions of motor vehicles they don’t have just now, so consumption of oil will rise and rise, pushing up the price.

Actually, there is growing evidence to suggest this is not how things are going to pan out. Two groups of people, for very different reasons, believe that global trends are turning against the oil industry. And these trends, rather than local North Sea problems, are why I think Sir Ian is right.

I have mentioned the first group of people in a previous column. They are environmentalists who point out that if scientists are right about the causes of climate change, and their projections for global warming are also right, then we need to drastically cut back on the amount of fossil fuel we are burning.

The campaigning organisation Scottish Environment Link has produced a useful report –Scotland and the Carbon Bubble – summarising the argument. Grossly simplifying, it contends that if the world is to avoid a global temperature rise of more than 2°C, we need to avoid burning any more than a third of the world’s known fossil fuel reserves of oil, gas, and coal.

Because these reserves exist as assets on the books of extractive industry companies, it means that these companies are over-valued, which the environmentalists call a carbon bubble. If it bursts like a house price bubble, there will be severe economic repercussions, ranging from lots of lost jobs to pension funds having a lot less money in them, akin to a financial crisis.

Some may think this is just scaremongering. But in fact, serious people in the financial world think there may be something in it. Some pension funds, particularly in Norway and Sweden, but also in the UK, have begun to sell shareholdings in fossil fuel companies. These are among the second group of people I referred to above, but their motivations may be slightly different.

The environmental theorists reckon that co-ordinated global action by governments aiming to reduce carbon emissions could cause the carbon bubble to burst.

Such action, which involves taxes to increase the price of carbon-based fuels, I think, is unlikely as governments of oil-consuming countries are currently cheering the economic boost created by cheap oil.

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The environmentalists can also be criticised for laying too much stress on the asset valuation of companies. Pension funds are interested in the likely long-term value of companies but markets, by and large, are more interested in a firm’s earnings capacity.

The current oil price slump obviously reduces an oil company’s earnings and that, rather than any worries about a carbon bubble, is why the value of oil firms has fallen in the last six months. From the middle of 2014, Shell’s market capitalisation has fallen from $238 billion to $210bn; BP from $156bn to $118bn; even non-western firms such as PetroChina’s value is down from $287bn to $210bn.

Another factor has begun to trouble the markets. Is the demand for oil about to peak and then start declining?

At first sight, that doesn’t seem to be happening. According to BP’s annual energy statistics, world consumption in 2003 was 80,216 thousand barrels per day (b/d) and in 2013 it was 91,331 thousand b/d.

Inside those big numbers, however, are some very different trends. North America, Europe, and Japan consume almost half of the world’s oil production. In 2003, these regions consumed 45,699 thousand b/d, but by 2013 their consumption had fallen to 41,929 thousand b/d, an 8 per cent reduction.

Some of that has been caused by recession and high oil prices, but much has been caused by greater vehicle fuel efficiency and switching, particularly by bus and trucking fleets, to liquefied gas fuels.

This fuel efficiency will also apply to the additional new vehicles the developing world will buy, slowing their consumption increase. Switching to zero-carbon and cheaper fuels, such as hydrogen, may well cause global oil consumption to hit a peak and start declining.

Toyota, who were first in the field with the petrol/electric hybrid, have just put a hydrogen-powered car on sale in Japan and it will hit the US market later this year with expressions of interest greatly exciting the company. European sales may also come later this year.

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Analysts at Citi, a global bank, think that demand for oil will peak at 92,000 – 95,000 thousand b/d some time before 2020. Others have come to broadly similar conclusions. This is bad news for the North Sea because it needs investment to stay in business and extract the remaining resources. But the markets are asking whether the big sums involved in opening a new offshore field, anything between £2-4 billion, are really justified, when a conventional field needs 25 years of production to earn back that investment and declining demand may depress oil prices in the last half of that period.

More sensibly, they think to invest in shale oil wells, which cost relatively little and have a brief life of 3-6 years.

That kind of thinking is a big risk for the North Sea because it may deter the investment it needs. New investment allowances and reduced tax may make it a sunnier prospect in the short-term, but peak demand is a dark cloud that doesn’t look like going away.