When Anticipating the End of Oil, Industry Cuts Investments and Produces Less

For the first time in roughly a century, oil’s dominance as a transportation fuel is under threat. 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. It’s now plausible to consider a world where oil demand falls to zero, or at least near zero, by the end of the century. If oil producers were to anticipate such a long-run decline in demand for oil, how would they respond? A new study finds the oil industry would reduce investments even in the near term—bucking a long-held belief that they would do the reverse.

“The long time horizons of oil investments will likely prompt most producers to stop investing before demand falls—making good business sense and allowing climate policies to be successful,” says EPIC Scholar Ryan Kellogg, a professor and deputy dean for academic programs at the Harris School of Public Policy.

Many have long believed that if oil producers saw a decline in demand on the horizon they would quickly move to extract as much as they could before the demand, and prices, fall. In doing so, they would negate any reduction in emissions that could have come from climate policies and new technologies. But Kellogg finds the opposite is likely true. Producers make fewer long-term investments—reducing their initial rate of investment by 2 percent, despite no initial change in oil demand. Over time, the anticipation of a decline in oil demand pushes them to reduce oil production by 4.8 percent more than what would have been reduced if they had not anticipated the decline. Over a 75-year period in which oil demand gradually falls to zero, the oil industry would reduce its investments by 35 percent overall, reducing production by 27 percent in total. This results in fewer emissions.

OPEC+ members outside of Kuwait, Saudi Arabia and the United Arab Emirates, as well as non-OPEC producers such as those engaged in deepwater drilling reduce their investments the most because their extraction involves investments with long time horizons. The core OPEC members—Kuwait, Saudi Arabia and the United Arab Emirates—do not follow this trend. Instead, they increase their investments in response to the anticipated demand decline because their low costs and high reserve valuations induce them to extract before demand falls too far. Shale producers tend not to respond to anticipated demand changes because they exhaust their Investments have short time horizons.

Kellogg finds that producers, in aggregate, would increase their investments in response to an anticipated decline in demand only if both their investments have a short time horizon—shorter than shale oil—and the scarcity value of reserves is large throughout the globe. These conditions seem unlikely to hold individually, let alone jointly.

“This analysis suggests that policies aimed at reducing future oil demand will not be undercut by a spike in oil production and the unintended increase in near-term emissions that would cause,” Kellogg says.

This article originally appeared at EPIC at UChicago.