by Ryan Kellogg
Context
For roughly a century, most global transportation has been fueled by crude oil and petroleum products. However, oil’s dominance as a transportation fuel is now, for the first time, under threat. Alternative technologies—most prominently, electric vehicles—have become cheaper and consumers are buying more of them. At the same time, climate policies are becoming more stringent and more global. While there is uncertainty about how quickly and deeply these developments will reduce crude oil demand, it is now plausible to envision scenarios in which global oil demand falls to zero, or at least near zero, by the end of the century. This paper explores how such a decrease in oil demand might affect oil producers’ behavior and global oil production during the transition.
Research Design
The study models how producers respond to an anticipated long-run decrease in global oil demand, with two possible responses. The first response (the “green paradox”) would be that producers would accelerate how much oil they are extracting in the short term because they want to extract as much as they can before demand, and prices, fall. In doing so, their increase in extraction would offset some, and possibly all, of the decrease in emissions from the drop in future demand. The green paradox therefore poses a problem for policies or new technologies that reduce future oil demand. The second response (the “disinvestment effect”) would be that producers would make fewer long-lived investments, leading to less extraction even in the near-term, and fewer emissions overall.
The model studies four main types of producers: core OPEC (Kuwait, Saudi Arabia, and the United Arab Emirates), which accounts for most of OPEC’s production and have the lowest investment costs; non-core OPEC+ (Algeria, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Lobya, Nigeria, Venezuela, Azerbaijan, Bahrain, Bruenei, Kazakhstan, Malaysia, Mexico, Oman, Russia, South Sudan, and Sudan), which includes all other OPEC+ members; conventional non-OPEC, which includes deepwater drilling; and shale oil producers.
The study does not aim to definitively predict how oil producers will respond to an anticipated long-run decrease in demand. Instead, it seeks to shed light on the factors that are most important in determining whether the green paradox or disinvestment effect will occur. For instance, if producers’ capital investments have long productive lifetimes, then the disinvestment effect will be relatively strong. On the other hand, if reserves are scarce, then the green paradox will be strengthened because the reserves’ scarcity value will prompt producers to accelerate production when they anticipate lower prices in the future. To capture these sensitivities, the study numerically calibrates its main “reference case” model using the best available evidence on producers’ costs, investment horizons, and reserves, and then extensively studies how alternative specifications affect its results.
Findings
A decline in oil demand over a 75-year period leads to a 27 percent reduction in production over time.
If demand were to not decline (baseline demand), all available oil resources would eventually be drilled, with shale resources being exhausted first. In the reference case model, all undrilled resources outside of core OPEC are exhausted by 2070, and core OPEC drilling ceases in 2087. Production then declines as global oil reserves are fully exhausted.
If demand for oil were to decline over a 75-year period, the oil industry would reduce its investments by 35.2 percent overall, reducing production by 27.1 percent in total. The production decrease would be the greatest for shale oil (41.5 percent) because shale wells are relatively high-cost, and because shale producers exhaust their resources so rapidly that they are able to respond more quickly to demand. OPEC producers decrease production the least because they have relatively low costs and investments with long time horizons.
The anticipation of a decline in oil demand reduces cumulative oil production by 4.8 percent more than what would be reduced if the decline was not anticipated.
Producers’ anticipation of the fall in demand lead them, in aggregate, to reduce their initial rates of capital investment by 2.0 percent, even though oil demand is unchanged in the initial period. Thus, the disinvestment effect outweighs the green paradox. Over time, the net effect of disinvestment over the green paradox causes an anticipated decline in demand to reduce cumulative, long-run oil production by 4.8 percent more than what would be reduced from an unanticipated decline.
The disinvestment effect is strongest for non-core OPEC+ and non-OPEC conventional producers because their extraction involves investments with long time-horizons. Shale wells exhibit neither disinvestment nor a green paradox, since their investments are short-cycle and their reserves are not scarce. In contrast, core OPEC producers increase near-term production, in line with a green paradox, because these producers plausibly have high scarcity values for their reserves.
Producers increase their investments in response to an anticipated decline in demand only when both investments have a short time horizons and scarcity values are large.
While the study’s reference case model shows that disinvestment outweighs the green paradox (oil producers invest and produce less in the near-term as a reaction to an anticipated decline in demand), it also identifies two conditions that would need to be present for the reverse to hold. First, investments would need to have very short time horizons, even shorter than those associated with shale drilling.
Second, the initial scarcity value of reserves would need to be large not just for core OPEC, but for all resources throughout the globe. High scarcity values would occur if all producers made reserve valuations using interest rates similar to those associated with “riskless” assets like U.S. treasury bills.
These two conditions seem unlikely to hold individually, let alone jointly, suggesting that the green paradox is unlikely to be a significant problem for climate policies or low- or no-carbon technologies that will reduce future oil demand.
Closing Take-Away
If the oil industry were to anticipate a decline in demand for oil—driven by stricter climate policies and cheaper low- or no-carbon technologies such as electric vehicles—they would most likely respond by investing less in exploration and drilling. This reduction in investment would lead to reduced oil extraction, and hence reduced greenhouse gas emissions, even in the near-term. The opposite result—a green paradox that leads to a substantial increase in near-term extraction and emissions—is possible but unlikely. The lack of a meaningful green paradox implies that policies aimed at reducing future oil demand will not be undercut by an unintended increase in near-term emissions.