Is oil industry surviving on borrowed time?

By Dick Taremwa

Oil prices have been in steep decline due to combination of weaker demand and rising supply that caused oil prices to start dropping from their June peak of $115 per barrel down to around $58 a barrel, its lowest prices since July 2009 and the US crude fell below $56 a barrel; its weakest since May 2009.

The oil price crash is now upsetting the global economy, with ramifications for every country in the world.

As prices slid, many observers waited to see whether OPEC (Organisation of the Petroleum Exporting Countries), the world's largest oil cartel, would cut back on its production to prop prices up. (Many OPEC states, like Saudi Arabia and Iran, need high prices to balance their budgets.) But at its big meeting in November, OPEC did nothing. Saudi Arabia didn't want to give up market share and it hoped that lower prices would help throttle the US oil boom. That was a surprise. So oil went into free-fall.

These countries need high prices in order to "break even" on their budgets and to pay for all the government spending. For example, the “break even” price for Russia is $100 per barrel, Saudi Arabia $97, Emirates $89, Iraq $108, Bahrain and Algeria $120 per barrel.

The clinching shift in solar power has come with battery storage becoming cheaper and lasting long enough for users to draw down their suplus generated during the day to cover needs at night.

The world energy markets are entering a period of "extreme flux", with oil caught in triple encirclement by cheap natural gas, much more efficient vehicles and breathtaking advances in solar power as scientists crack the secrets.

The combined effect is to "bend" to the curve of global oil use over coming years, eroding the assumptions that have underpinned a threefold rise in Western oil industry debt to $600bn since 2005, much of it to hunt for crude in prohibitively expensive places. Costs rose 9 percent in 2012 and 11 percent in 2013 and, according to the US Energy Department.

The "oil intensity" of global GDP has already halved since 1980s. We are becoming more frugal. Gasoline demand in the Organisation for Economic Co-operation and Development (OECD) rich states has been sliding in absolute terms since 2007, punctuated by ups and downs, but dropping overall from 15.5m barrels a day (b/d) of crude to 14m b/d.

The average efficiency of new cars in the US has risen by 4.6 miles per gallon (mpg) since 2008 under fuel economy mandates. It is still rising at a steeper rate. Gasoline demand will slide by 900,000 b/d in the US alone by 2020.

China has even more draconian curbs coming into force, with a 50mpg fuel economy mandate by 2020. Its output of electric cars is up 177pc in a year, and hybrids are up 567pc. India will reach 50mpg by 2021, Mexico by 2025.

In the end, oil must converge towards gas prices since vehicles can be designed to use either source, or both. Natural gas Lorries are expected to take around 4pc of the US market as new taxes and pollution laws come to bear.  A large portion of the freight market could utilise Liquefied natural gas (LNG) and penetration rates could ultimately top 40pc.

It is possible that gas and LNG prices will converge upwards, rather than oil coming down. That seems unlikely. America's gas output has risen from 440 to 720bn cubic metres (bcm) in six years - 20pc of global production - and is still rising. The US Energy Department expects it to reach 960bcm by the end of the decade. These are huge volumes.

There is now speculation that the US will surpass Qatar to become the world's top exporter of LNG by 2020. Australia is catching up - albeit at high cost - and it too is expected to triple LNG exports and overtake Qatar by 2020.

Even if global gas fails to deliver as expected, this will merely accelerate the powerful shift towards solar power already under way, eroding the demand for oil more slowly by a different means.

Solar already competes in the growing regions of the world on "pure economics" without subsidies. It has reached grid parity with residential electricity prices in Germany, Italy, Spain, Portugal, Australia and the US southwest. Japan will cross this year, Korea in 2018. It forecast that even Britain will achieve grid parity by 2020, a remarkable thought for this wet isle at 51 or 52 degrees latitude.

The industry can at last tap a "large investor universe" through the market for asset-backed securities. It priced debt below 5pc last year. Some US electric companies are starting to build solar farms for hard-headed commercial reasons as a hedge against future shifts in the gas price.

Roughly 29pc of all electricity capacity added in America last year came from solar. The story is by now well-known. Studies show the average cost of installed solar power in the US across all sectors has dropped to $2.59 from more than $6 a watt in 2010. It expects this fall to $2.30 by next year and $1.60 by 2020, largely due to the collapse in the cost of solar cells.

The clinching shift will come when the battery storage is cheap enough and lasts long enough for users to draw down their suplus generated during the day to cover needs at night, opening the way for mass exodus from the grid, unless utilities harness it first to their own advantage.

There are at least 220 research projects into energy storage currently under way in the US, many funded by the US Advanced Research Projects Agency and other arms of the world's scientific superpower. We can now see that the oil price shock of 2008 was traumatic enough to draw an emergency response, bringing forward oil's nemesis.

There is hope to cut battery costs by two-thirds within three years and eventually slash the cost by 90pc below today's lithium-ion batteries.

It is a fair bet that scientists will have conquered intermittency by the end of the decade, at which point the switch to renewables becomes a stampede. It is the new order of "global energy deflation".

Technology momentum is unstoppable and one-way only.

The writer is a financial markets strategist