After a sustained stagnation of oil prices around the $20-a-barrel mark, oil prices have spiked substantially in the last decade and now hover around $110-a-barrel. Many see the current oil prices as a new norm and possibly the base from which oil prices will continue to rise. But do the fundamentals support this view?
At Elite Mergers & Acquisitions, we believe that the oil price rise thesis is misguided and that oil prices are on the verge of sustained long term decline.
We believe that a return to $20 per barrel inflation adjusted oil prices is a distinct possibility in the next decade.
To understand future oil prices, let’s consider the key factors that determine long term oil price trends: Uses of oil, sources of oil, alternatives to oil, and geopolitical factors.
Uses of Oil
Oil has historically been the single largest driver of the world economy. Oil enables transportation, heats homes, cooks food, forms the basis of many chemicals and industrial supplies, and addresses a countless number of other world needs.
According to data from the Association of Plastic Manufacturers of Europe, approximately 85% of all the oil resources in the world are used to produce energy for the growing needs of world economy. About half of all the resources are used for transportation, a quarter for heating, a tenth for electricity generation, and the rest for plastics, chemicals and other uses. History suggests that the oil needs of all these segments combined tracks the GDP growth of the world economy. In the last several decades, oil production grew at an average of 2%; healthy but nothing spectacular. But will this trend hold going forward?
Sources of Oil
It is irrefutable that oil production at major oil fields is in a decline. In the last several decades, many industry experts using existing oil field data have consistently predicted that the world will run out of oil within the span of just a few decades. This is despite the fact that the number of known oil reserves increases every year, and the decade when we are predicted to run out of oil keeps getting pushed further out into the horizon.
The simple fact is that technological innovations are unearthing oil at a rate faster than our current growth needs. The rapidity of shale oil exploration is an excellent example of the emergence of a new source of oil that many experts failed to anticipate. At this time, only a small fraction of the world’s shale resources have been identified, and most of those that have been identified have not been tapped due to political, regulatory, access, and cost issues. Many of the barriers are artificial and can be overcome with time.
With technological advances, there is no doubt that the world will continue to find newer and more economical sources of oil. Any oil price spikes along the way will only help bring these new sources into fruition more rapidly. Some of these sources may be more expensive to unearth than traditional sources, while others may prove to be uneconomical in all but the boom times.
Alternatives to Oil
Even assuming world oil reserves do not increase meaningfully to keep pace with production, the real threats to oil’s domination are the alternatives. Let’s assume that all of the non-energy related uses for oil continue to grow at the current pace, and focus instead on oil’s use within the energy sector (which constitutes 85% of the oil market). The energy sector – transportation, heating and electricity generation – is going through some revolutionary changes.
Transportation
Tesla and Nissan Leaf are examples of a new kind of threat to oil in the transportation segment. As battery technology matures and electric automobile costs drop, the need for oil in the transportation segment will start to decline dramatically. Electric automobiles, combined with battery technologies powered by renewable resources, are well on their way to revolutionizing the transportation business.
The economic benefits of natural gas driven automobiles has also been proven, and natural gas is making a sustained push into transportation segment. With the development of shale gas distribution infrastructure, natural gas will play an increasingly larger role in the transportation segment – at the expense of oil.
Heating
Heating is a key application where natural gas has proven to be significantly more cost effective than oil. With the unearthing of shale gas resources around the world, natural gas will likely continue to make significant inroads into oil’s market share in this key segment.
Solar technology has also made significant inroads into heating applications across the world. With declining prices, it will increasingly replace oil in many heating applications. Solar power is an attractive emerging option for heating applications – especially in sunny climates.
Power Generation
It would be an understatement to say that alternative energy sources are taking off in the power generation segment. In the last decade several gigawatts of solar and wind farms have been deployed all over the world. With constant cost reductions, the Levelized Cost of Electricity (LCoE) for solar and wind farms are now below those of oil and conventional sources in many parts of the world. As the cost of these technologies declines further, energy generation from these sources will grow at an exponential pace. For countries with good solar and wind resources, oil based power generation is being marginalized at a rapid pace.
Geopolitical Factors
For the last several decades, many world politics and trade policies have been driven by oil. For many countries, the foreign exchange needs for buying oil has severely crimped their economic development. However, as alternatives to oil become more economical, many of these countries are actively investing with the aim of becoming energy independent. Given the costs and deployment flexibility in previously inaccessible areas, investment in alternative technologies is a no brainer for these countries. A look at the penetration of solar and wind projects across the world paints a startling picture of how rapidly these alternatives can be deployed, and how quickly oil can be replaced for many energy needs.
Summary
The world is witnessing the early phases of an energy revolution, which will have a significant impact on oil’s long term future. In a nutshell, oil resources continue to be found at a rate that is well beyond the needs of current global growth, putting a supply driven cap on the price of oil. Any price spikes driven by supply/demand dislocations are only temporary and work to enable longer term alternatives to oil.
The uses of oil are predicted to decline due to lower cost alternatives in transportation, heating and power generation segments. Current cost curves and deployment data suggest these trends are accelerating at an exponential pace and these alternatives will command an increasing share of global energy needs in the future. Geopolitically, reducing dependence on oil and increasing the use of renewable alternatives is a no-brainer. All of the above factors contribute to the long term decline in oil prices. We believe a return to the oil prices of the 80’s and 90’s is a distinct possibility in the next decade.
Chak Reddy is a Mergers and Acquisitions Advisor with Elite Mergers & Acquisitions, which specializes in selling businesses with revenues between $1 million and $100 million. Mr. Reddy is a business M&A and Marketing expert in the technology and energy industries, and is the chief deal maker at Elite.
Connect with Chak by emailing creddy@elitemanda.com or adding him on Google+.