Peak Fossil Fuel Demand

By Kingsmill Bond

Fossil fuel demand in country after country and sector after sector is peaking as the cyclical downturn brings forward the looming structural peak. What has been underway for several years is now accelerating in real time. And while the human tragedy brought by the coronavirus is appalling, a peak in fossil fuel demand is necessary if we are going to have any chance of reaching the goals of the Paris Agreement. Governments now need to make sure that the collapse in prices does not set off another cycle of rising demand.

The fossil fuel sector is highly vulnerable to change at the best of times. It is low growth, has high fixed costs, is propped up by the OPEC+ cartel, and faces an environment of constantly rising regulatory pressure and falling renewable prices. The rapid deployment of new energy technologies means that a structural peak in fossil fuel demand is coming in the 2020s, which is a key reason for the remarkable underperformance of the sector over the course of the last few years.

However, the coronavirus has brought cyclicality into the equation, and total fossil fuel demand will clearly fall this year. The combination of structural change with the cyclical shift is likely to bring forward fossil fuel demand peaks by several years. By the time that demand picks up again, all of the growth may be supplied by renewable energy sources.

The classic example of this is the car sector. According to Bloomberg New Energy Finance, demand for internal combustion engine (ICE) cars peaked in 2018, at a time when electric vehicle (EV) sales were just 2 million and growing fast. By the time total car demand growth returns to its usual level of 3-4 million, EVs are likely to be providing all of the underlying growth in demand. The result is that ICE becomes a declining industry.

Something similar is now happening in the electricity sector. Global electricity generation by fossil fuels fell in 2019 according to Ember. It is almost certain to fall again this year, even as solar and wind continue to grow. By the time demand growth returns in the electricity sector, solar and wind will be large enough to supply all the growth. This incidentally is a story that we have seen play out many times before; horse demand famously peaked when cars were just 3 percent of their number, and gas lighting demand peaked when electric lighting was just 2 percent of supply.

The consequence of peaking demand for fossil fuels has been playing out for a number of years now, in sector after sector. Peak demand for coal meant lower prices for US coal and the bankruptcy of half the US coal sector. Peak demand for European fossil electricity meant falling wholesale electricity prices, $150 billion of asset write-downs and a collapse in stock prices.

And now we see the story playing out once more. Peaking demand for oil has contributed to the collapse of the OPEC+ cartel and devastated the oil price. If you want to understand how the sector is likely to react to structural demand decline for the first time in its long history, reflect on the fact that the recent 3 percent fall in oil demand has led to a 50 percent fall in the oil price.

The risk is that fossil fuel demand could bounce back as people reduce their efficiency investments, drive more and buy bigger vehicles, so the role of government now is to stop this from happening. Governments need to remove wasteful fossil fuel subsidies and implement a tax wedge between the falling price that the fossil fuel sector gets and the price that the consumer pays.

A tax wedge can accomplish three things. First, it stops us from getting addicted to cheap oil again; second, it helps to raise government revenues at a time when money will be needed to help a weak economy; and third, it taxes the fossil fuel sector for the externality cost that it imposes on the rest of society through global warming and pollution. Outside the road sector, the OECD has shown that the fossil fuel sector is very lightly taxed, at only around $3 per ton of CO2.

This crisis gives us the opportunity to bend the arc of change in the direction of hope, away from fossil fuels and to sustainable renewables. We must seize that opportunity.

Kingsmill Bond, CFA is the Energy Strategist for Carbon Tracker and a member of Energy Transition Magazine’s editorial advisory board. He has worked as a sell-side city equity analyst and strategist for 25 years, including for Deutsche Bank, Sberbank and Citibank in London, Hong Kong and Moscow, and has written research on emerging market and global themes, including the wider significance of the shale revolution and the impact of US energy independence.