September 24, 2014 / 12:05 AM / 5 years ago

COLUMN-Energy efficiency - bigger than shale: Kemp

(John Kemp is a Reuters market analyst. The views expressed are his own)

By John Kemp

LONDON, Sept 24 (Reuters) - The United States is experiencing the largest and most sustained drop in oil demand since the start of the petroleum era in 1859 thanks to improvements in efficiency and the switch to alternative fuels.

Quietly and almost unnoticed by most commentators, efficiency and fuel switching are making an even bigger contribution to the North American energy revolution than hydraulic fracturing and horizontal drilling.

Fuel savings have contributed more barrels to the supply/demand balance than the combined output from North Dakota’s Bakken and Texas’ Eagle Ford.

Efficiency gains and the switch from crude oil to natural gas and biofuels have cut the consumption of petroleum products in the United States by more than 2 million barrels per day since 2005, according to the Energy Information Administration.

If consumption is adjusted for the rise in population and economic output, oil use has actually fallen by between 3 and 4 million barrels per day compared with the previous trend (link.reuters.com/cyd92w).

The plunge is a delayed response to the quadrupling of real oil prices since 1998 and especially after 2004, which sharpened the incentive for households, businesses and federal, state and local governments to change behaviour, enact conservation laws, and invest heavily in capital equipment designed to reduce oil consumption.

Many of the regulations and investments made in response to rising prices are still reducing oil demand today, even though prices have been steady for the last three years, and the efficiency drive is not over yet.

Vehicle efficiency standards and biofuel mandates will continue cutting petroleum consumption throughout the rest of the decade and into the 2020s even without a further rise in prices because they have been hardcoded into legislation and regulations.

Businesses have also become smarter at reducing fuel bills by optimising delivery and logistics systems, and those changes are unlikely to be reversed.

Similar lagged demand reductions are evident in Europe, leading many observers to conclude oil demand has peaked in the advanced industrial economies and that all future growth will come from the emerging economies.

Even bigger falls in consumption are possible in future if the gap between crude and natural gas prices in North America remains wide and encourages substantial switching from diesel to gas in road, rail and maritime transport.

LONG CYCLES

Demand reductions as much as increases in supply explain stable oil prices over the last four years and the evaporation of volatility.

However, this is not the first time demand has dropped; consumption fell after both the first and second oil shocks in 1973 and 1979.

Previous periods of demand destruction were followed by a drop in prices and a gradual recovery in consumption as memories faded and consumers reverted to more oil-intensive behaviour.

The question is whether this cycle is about to repeat itself. Will oil prices decline over the next few years, at least in real terms, sending the efficiency revolution into reverse?

Benchmark Brent prices have already slipped below $100 per barrel, a level some analysts thought would prove to be a floor, amid signs demand is anaemic and the market is oversupplied.

In theory, lower prices are the means to rebalance the market by slowing the pace of demand destruction, and perhaps even buying back some of the consumption that has been lost, as well as curbing rising supply.

Past experience suggests a period of weaker prices will be needed to stem the loss of demand and curtail the enormous amount of investment in new production which has been taking place in recent years (and is still occurring in many areas such as Russia, China and Argentina).

But prices might have to remain lower for longer than most producers have dared to admit if the market is to rebalance fully.

There are substantial amounts of extra shale oil that could be brought into production profitably at prices well under $100 per barrel which will keep supplies ample.

On the demand side, oil will continue to face stiff competition from cleaner burning and cheaper (at least in North America) natural gas.

Crucially, much of the demand destruction has been hardwired into the system in the form of efficiency regulations and mandates that will not easily be reversed.

Even if oil prices drift lower, governments in the advanced economies are unlikely to relax the push for because it is central to their climate change strategies.

In fact, advanced countries would likely oppose any resurgence in oil demand with additional taxes and regulations.

If some demand is bought back, it will have to be in developing economies rather than in North America and Western Europe, and even there prices may need to be lower for longer than many forecasters currently expect. (Editing by William Hardy)

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