By Tim Gould, Head of Division, and Tae-Yoon Kim, WEO Energy Analyst at the International Energy Agency
The recent attacks in Saudi Arabia were a sharp reminder that the world can’t take oil security for granted, even when markets are well supplied. But there have also been suggestions that this kind of disruption to oil supply could have less impact in the future, either because of changes in oil markets or because oil itself is set to be side-lined by accelerated transitions to other energy sources.
The International Energy Agency’s World Energy Outlook (WEO), which will be released on 13 November, addresses this question directly: do changing energy dynamics to 2040 mean that the world can afford to become more relaxed about oil security?
The short answer is that there’s little room for complacency. The market and policy environment may be changing, rapidly in some areas, but oil security concerns don’t disappear in any of the scenarios examined in the report. Whether we like it or not, what happens in oil markets will still matter for all of us – for decades to come.
Oil is under pressure, but is it resistant to change?
Oil is not the force in the global economy and energy mix that it once was. It is still the largest fuel in the global energy mix, but its share is 31 per cent today down from 45 per cent in 1974, when the IEA was founded. The amount of oil consumed per unit of economic output has also fallen by one-third since 2000. This means that economic growth doesn’t drive oil consumption growth as much as it did in the past.
These trends are set to continue as oil is used more efficiently and consumers and policy makers seek cleaner alternatives for transport. In the WEO-2019, a scenario based on today’s policy settings and ambitions sees a marked slowdown in oil demand growth from the late 2020s, mainly because of dramatic changes in the passenger car sector that accounts for one-quarter of global oil demand. More concerted efforts to tackle climate change and air pollution would further accelerate these changes.
Changes on the supply side are also easing some concerns. The remarkable rise of US shale oil production has brought greater diversity to global supplies and reduced dependence on some traditional producers and exporters. The short investment and production cycle of US shale oil also makes it more responsive to price movements, offering something of a safety net for markets in the event of an imbalance between global demand and supply.
These shifts in oil markets are profound, but their effects need to be kept in context. A peak in oil use for passenger cars is clearly visible on the horizon, but this is not yet the case for many other areas of oil demand such as shipping, aviation, freight trucks and the petrochemicals sector.
Even in a scenario where a shared determination to meet the goals of the 2015 Paris Agreement on climate change in full leads to a sharp reduction in oil consumption worldwide, there would still be an oil market of 67 million barrels per day (mb/d) in 2040. That is comparable in size to the market of the early 1990s.
On the supply side, traditional oil producers are being challenged by the shale boom in the United States, but not eclipsed. The Middle East remains by far the largest net provider of crude oil to international markets. And as the US position in global markets evolves, new potential vulnerabilities emerge.
For example, oil analysts had typically watched the hurricane season in the Gulf of Mexico for its implications for US domestic supply, as with Hurricanes Katrina and Rita in 2005. Now, extreme weather in this region also cuts across one of the world’s main oil export routes.
Import dependence and chokepoints
Our projections suggest that dependence on oil, particularly imported oil, is unlikely to disappear quickly. In a scenario based on today’s policy settings and ambitions – which include some ambitious goals for making transport more efficient and more reliant on electricity – oil use continues to grow across much of the developing world. Demand shifts markedly towards Asia, where leading economies’ imports and import bills rise significantly.
In this scenario, Asian importers tap into a wider variety of supply sources, and there is a major increase in flows from North and South America to Asia. However, despite the major changes in oil markets over the period to 2040 and the rise in US output, seaborne crude oil trade from the Middle East to Asia remains critical.
This means that the Strait of Hormuz – the narrow stretch of water that connects oil producers around the Gulf with global markets – remains a vital artery of global oil trade. At present, the strait carries some 16 mb/d of crude oil and 4 mb/d of oil products (around one-third of global seaborne oil trade), largely to consumers in Asia. In 2018, around 80 per cent of crude oil imports to Japan came through the strait, as did 40 per cent of China’s oil imports and more than one-quarter of global LNG trade. Any impediment to shipments through the Strait of Hormuz would materially tighten markets.
The Strait of Hormuz is not the only potential chokepoint: the Strait of Malacca between Malaysia and Indonesia connects exporters in the Middle East and Africa with Asian importers. Around 19 mb/d of crude oil and oil products pass through the Strait of Malacca today. It is also a crucial location for fuel storage, blending and ship refuelling. Growing traffic through the narrow strait increases the risks of congestion, collision or attacks, which could have major implications for global oil and LNG markets. As in the case of Hormuz, finding alternative routes is not a straightforward task.
Some barrels are more equal than others
Crude quality is another important consideration. Crude oil exported from the Middle East consists mainly of light and medium sour crude. Asian refiners have been importing Middle Eastern oil for many years and many of their refineries are configured precisely to process these grades. For example, over 70 per cent of the crude oil processed in refineries in Japan and Korea is light and medium sour crude. There is also a large appetite for these grades from refiners in China and India, although they process a slightly more diverse range of different grades. A potential supply disruption either in the Middle East or in one of the major chokepoints would have a particularly large impact on the global supply of the oil most in demand by Asian refiners.
In such a situation, these supplies could in theory be replaced by increased output from other regions. A key candidate would be the United States where shale production could likely ramp up relatively quickly in the event of a prolonged disruption. But because of differences in crude quality, using US production to offset a sudden drop in the supply of medium sour grades would come with additional challenges. It would take time and could well incur additional costs as refiners adjusted.
Producer economies matter for consumers
A changing energy system is also posing critical questions for many of the world’s traditional oil producers and exporters, raising the prospect of sustained pressure on economies that rely heavily on hydrocarbon revenues. As we highlighted in a WEO special report last year, fundamental changes to the prevailing development model in resource-rich countries look unavoidable.
The rollercoaster ride in oil prices in recent years has brought into sharp relief some structural weaknesses in many producer countries, prompting a number of governments to renew a commitment to reform and diversify their economies. How these producers respond to a changing policy and market environment is critical not only for their own future prospects, but also for oil markets and security.
Inaction or unsuccessful reform efforts would compound future risks, particularly given the need to create employment opportunities for growing, youthful populations in many cases. These risks would multiply in an environment where global demand and prices are lower. Indeed, in the absence of reforms, the risks of disruption and volatility may be significantly greater in scenarios in which major producers have to cope with sustained pressure on hydrocarbon revenues.
No country is an energy island
There are plenty of reasons for policy makers to continue to pay close attention to oil market security, even as they pursue a range of other important energy and environmental goals. A marked slowdown in the pace of overall oil demand growth is seen from the mid-2020s, but demand continues to grow briskly in much of Asia. And these supplies flow through major chokepoints. Rising output from the United States offers Asian importers opportunities for supplier diversification. But it also increases the pressure on producer economies, some of whom are in regions facing escalating geopolitical tensions.
No country is immune from these developments. The risks associated with a physical disruption to supply may change over time, but all are affected by price movements in an interconnected global market.
Against this backdrop, the role of emergency oil stocks to help cope with sudden supply disruptions remains vital, and the effectiveness of such stocks will be greater with broader participation and with increased attention to changes in crude quality and product demand.
It will also be important for refiners to improve the flexibility of their operations; for importing countries to remove fossil fuel consumption subsidies and promote energy efficiency and alternative technologies to moderate their vulnerabilities; and for producer economies to expedite their efforts to reform and diversify their economies.
Founded 45 years ago, the IEA was initially designed to help countries coordinate a collective response to major disruptions in the supply of oil. The IEA’s work has evolved and expanded significantly since then and its expertise across the full spectrum of energy issues puts it at the heart of global dialogue on energy security and sustainability. But the founding mission remains as relevant as ever, and oil security continues to be a core issue for the IEA.
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