Blind Men, Elephants And Oil Demand Forecasts
“The parable of five men attempting to describe an elephant requires imagination of what they were encountering. Oil market forecasters are being forced to imagine a future world and the energy it needs. ”
Many may be familiar with the parable, first attributed to the Buddhist text Udana, of the five blind men encountering an elephant and trying to determine what is was. Each blind man feels a different part of the elephant’s body, but only one part, such as the side or the tusk. They then describe the elephant based on their limited experience and their descriptions of the elephant are wildly different from each other. In some parable versions, each blind man suspects the others are dishonest and they come to blows. The moral of the parable is that humans have a tendency to claim absolute truth based on their limited, subjective experience as they ignore other people’s limited, subjective experiences, which may be equally true.
The parable suggests a scenario about how energy forecasters are being forced to project future oil demand scenarios. Everyone acknowledges that due to Covid-19, history provides much less of a guide to the future than normally would be the case. Behavioral patterns have been altered by both the populous response to protecting themselves from the spread of the virus, but also due to heavy-handed mandates by governments. Now forecasters have to
Exhibit 19. Examining And Describing The Unknown Source: nsjour.wordpress.com
wrestle with determining which of the emerging economic and social trends will be sustained. While many of these trends suggest radically different outlooks for the future of economic activity and energy consumption, no one can be sure which trends will be sustained versus those that fade with the setting sun. Oil market forecasters have suddenly had to become historians, amateur epidemiologists, social philosophers and futurists.
As part of their work, forecasters must offer views about megatrends such as the future of urban life and cities, social migration patterns, working from home, mobility, business and leisure travel, food consumption, and retail purchasing trends, just to name a few. Just where forecasters land on each topic can impact their future energy consumption projections, as well as which fuel will benefit or suffer the most. Understand, we are not being critical of these forecasters because we practice in the same field. Rather, to appreciate how the forecasting business has changed, we cite how much our span of reading topics has widened, as well as the webinar topics we might not have paid much attention to in another era. We have listened to many speakers from across the world offering insights to topics that we figure might have a bearing on energy consumption. Some offer insights based on very different life experiences, but others offer the same perspectives we have heard elsewhere.
In our search for additional insights, we have paid less attention to the supply side of the oil market equation, as we have plenty of it today. Maybe in a couple of years we will find the world energy-constrained, but, in our view, there is plenty of time to begin sorting that out, and any tightness will be a function of future demand.
Our shift in thinking about future oil demand began to be reshaped after listening to a presentation by economist Marie Fagen of London Economics. Her presentation was based on a paper she published in 2019 titled “Up the down staircase: What history teaches us about oil demand after a crisis.” She and her co-author examined the history of income elasticities for crude oil, gasoline, and diesel fuel, and between OECD and non-OECD countries, as well as the world overall. While we knew much of this intuitively from decades of petroleum industry involvement, there were some interesting insights. The concluding paragraph of the paper stated:
“The profile of oil demand is set to change, with demand for petrochemicals for plastics and fertilizers expected to be an increasingly important driver of oil demand. At the same time, other fundamental changes are potentially on the horizon (for example, the widespread adoption of electric vehicles) and they could result in a further decline in long-term income elasticities of oil demand. This could lead to the next downward step in global oil-intensity: though demand could continue to increase, it will struggle ‘up the down staircase.’”
Based on Dr. Fagen’s presentation, we built our first oil demand forecasting model, which left us not reaching 2019’s oil demand level until 2022. That struck us as overly pessimistic, as many forecasters were anticipating a V-shaped demand recovery from the March/April lows, and a return to 2019 oil demand levels by the end of 2020, or certainly by mid-year 2021. At the time, we, too, expected a V-shaped oil demand rebound, but then a slow recovery afterwards. We had nagging doubts that everything would return to working normally. For example, air transportation consumes roughly eight million barrels per day (mmb/d) of jet fuel, while shipping used four mmb/d of marine bunker oil. These sectors were certainly going to experience tougher times ahead in the pace of their recoveries.
With respect to marine transportation, we had already wrestled with getting our arms around the impact on the segment’s fuel consumption from the implementation of IMO 2020, which mandated ships worldwide switch from high-sulfur to low-sulfur fuel at the start of this year. Forecasters debated how much high-sulfur bunker oil would be stranded – one mmb/d, or more? There was also a fear that ship operators would be hurt by the anticipated explosion in the price of low-sulfur diesel, a preferred compliant fuel, which might also create a shortage and price spike for the global trucking industry. As it turned out, there was less of an impact on price and demand in the early months of 2020 than anticipated. When Covid-19 began shutting down global trade and the cruising industry, shipping’s fuel needs eased, along with overall global oil demand. What is the future for these businesses?
Recently, we watched the BP plc introduction of its 2020 Energy Outlook that sets out the firm’s thinking about the most important trends driving energy markets, assuming current government policies, but also in an environment with more aggressive behavioral shifts and tighter government policies. BP also put together a much more aggressive clean energy strategy and what that might mean for energy fuels.
We also recently listened as energy consultant Rystad Energy’s analysts laid out their outlook for oil demand and supply, both for the near and intermediate terms. Rystad was originally slightly more conservative about the oil demand recovery compared to many investment analysts, but their recovery outlook has pushed further into the future. We have plotted (next page) their total demand declines by month for all of 2020 and 2021 compared to 2019’s oil demand. As our chart shows, Rystad sees oil demand in December 2021 still trailing 2019’s level by 1.5 mmb/d.
Exhibit 20. How Rystad Sees The Oil Recovery SOURCE: Rystad, PPHB
Another view of the future from S&P Global Platts Analytics shows a V-shaped recovery this year and into 2021. While we only have their chart, visually it looks like by the end of 2021 oil demand would be about equal with 2019. If it is short of 2019, the gap is quite small, much like Rystad’s projection.
Exhibit 21. Platts Has Different Recovery Outlook SOURCE: S&P Global Platts
It appears from the S&P Global Platts’ chart that their analysts do not expect much of a slowdown in oil demand growth once the recovery has been completed. When we look out to the intermediate term – 2025 – it looks like the firm is forecasting a roughly 5 mmb/d increase in oil demand. That contrasts sharply with the view of Rystad that looks at oil supply in 2025 lagging due to the impact of lower oil prices and deferred exploration and development work as a result. It sees overall supply falling 3.3 mmb/d below its pre-Covid-19 projections. Assuming stable inventories, then the supply shortfall would approximate the decline in oil demand.
When we consider BP’s view of the future oil market, as shown in its 2020 Energy Outlook, we find essentially no demand change between 2019 and 2025 for its Business-as-usual scenario. They are projecting demand at 98 mmb/d in 2025, but only 94 mmb/d for both the Rapid scenario and the Net Zero scenario, or a shortfall of 4 mmb/d from the Business as usual outlook. Rapid and Net Zero are BP’s scenarios for more aggressive climate change responses that impact energy consumption patterns.
We have produced two charts based on the data from the BP report. The first shows the three oil demand scenarios out to 2050. These are the charts that have received the most press coverage, as they show a contracting oil market, a scenario about which environmentalists are cheering and investors are worrying. The second chart shows the oil demand history through 2019 (using the latest BP statistics data for oil consumption) along with the 2025 demand estimates for the three scenarios. These demand estimates are consistent with the Rystad scenario.
Exhibit 22. BP’s Oil Outlook Appears Bleak SOURCE: BP, PPHB
Exhibit 23. Near-Term Oil Outlook Isn’t That Bad SOURCE: BP, PPHB
After examining all the scenarios, we are left with a 5 mmb/d oil demand increase (S&P Global Platts), a flat outlook reflecting BP’s Business-as-usual view that global oil demand likely peaked in 2019, a potential 3.3 mmb/d decline (Rystad), or a 4 mmb/d reduction if BP’s various clean energy scenarios are adopted. To understand the ramifications of each forecast, one really must understand key demand assumptions each forecaster has made.
S&P Global Platts provided a chart showing the sectors and the issues, about which one must make a judgment in order to prepare a forecast. The calls are about how the future will compare with or differ from past trends. As the chart shows, virtually every segment of the economy and its energy demand will be impacted. The firm didn’t comment on several key trends such as migration, both from cities to suburbia and rural areas, as well as between countries. They also didn’t comment on the future of offices, especially in expensive cities.
Exhibit 24. Issues Impacting Future Oil Demand SOURCE: S&P Global Platts
The tightness of the range of oil demand estimates for the 2025 forecasts concerns us. Either all forecasters do not see any meaningful changes to demand dynamics or they just assume it will take much longer for them to impact the market. We must acknowledge that this might happen. However, as we think about the oil industry’s future, we are reminded of an observation made by Gary Burnison, Korn Ferry CEO, who recently wrote:
“Too much optimism could anchor us in the old—and threaten us with irrelevancy (and maybe extinction). We need healthy pessimism so we can wipe the board, erasing what’s no longer relevant, and give ourselves a clean slate on which to imagine tomorrow.”
No one knows the future. The exercise in making projections is that it forces us to think about what could happen and assess the probabilities. If we view things through the optimistic lens that things will return to a more normal relationship, we cannot imagine a truly alternative future. Who in the industry, even Bob Dudley, then CEO of BP, would have imagined that we would be where we are essentially six years after the great oil price boom began to unwind? Had we known then, what we know now, what would we have done differently? Would we, or the industry, be better off today? I’d like to think yes. But the more important question to ask is: What unimaginable scenarios should we be considering now, as we consider what the industry may look like in another six years?
We were intrigued reading a recent Barron’s Special Supplement to The Wall Street Journal. It asked the question: What will be the biggest financial surprise over the coming year? Three investment professional forecasters, covering various financial markets offered their views. While each surprise was addressed to the next year, the changes suggested could become permanent, with meaningful changes for the energy business.
Liz Ann Sonders, chief economist for broker Charles Schwab, offered up the prospect that “The Almighty Consumer Will Stumble.” In her view, the economy would shift away from its consumer orientation (70%) with a substantial loss of jobs. It would move toward an investment-driven model, which could be good for long-term growth. The concern is that the lost jobs would largely be lower-income ones, putting pressure on the wage scale, while also increasing structural unemployment, boost welfare rolls, and force governments to provide more money, necessitating raising taxes. Increased social discord could be an outcome, also.
Nela Richardson, investment strategist at broker Edward Jones, offered up the idea that “The Federal Reserve Will Launch a Digital Currency.” She sees that development revolutionizing the U.S. payment system and altering customer and business habits. This would be an extension of an increase in the digitization of the economy, which could lead to more layoffs and firm’s cost-cutting. While potentially good for corporate profits, it would not be good for workers with all the attendant negative fallouts.
Nicholas Colas, co-founder of DataTrek Research, described “An Unwelcome Surprise: The Debt Bomb Could Explode.” He sees the possibility that interest rates rise to 2%, or 2.5%, forcing the Federal Reserve to raise rates. This could force the cost of debt service consuming a quarter of the $4 trillion government budget, forcing out expenditures on many other things, especially on the social welfare agenda. In his view, this scenario, which would likely push up inflation rates, might also lead to another geopolitical oil shock, something being ignored by markets. It would certainly lift global commodity prices, upsetting the balance among nations of the world.
Each of these surprises would upset the current outlook for 2021, with implications for energy demand, but the more significant issue is whether they might create new economic and social trends with long-term energy demand implications. Imagining a different world than the one we have been living in requires imagination. That is often a skill we lack.