Countering climate change is creating unprecedented uncertainty over the long-term outlook for fossil fuels. Energy users are making changes, but not yet enough for the world to meet the Paris Agreement’s aim of limiting global average temperatures.

The goal is to limit the increase to well-below 2°C above pre-industrial levels. However, a growing body of opinion believes this will not be sufficient and that the rise needs to be limited to 1.5°C. The UN’s climate science body reckons that carbon emissions in 2050 should be 40 per cent-70 per cent below 2010 levels for 2°C but must be at net-zero carbon emissions to ensure an increase of 1.5° isn’t exceeded.

Now the International Energy Agency has published its first detailed net-zero 2050 scenario. On its net-zero pathway, renewables would need to contribute about half of the primary energy mix by 2040 and nearer 60 per cent by mid-century. Demand for oil would need to fall 75 per cent by 2050.

Business-as-usual scenarios typically imply that oil demand shrink only gradually from around a third of the world energy mix today, to about 25 per cent by 2050. Achieving net-zero by 2070 could require a reduction to 15 per cent-20 per cent. However, for net-zero in 2050, the IEA sees oil falling below 10 per cent, with renewables at around 60 per cent and supplanting hydrocarbons across a wide range of activities.

There is thus significant uncertainty over global oil demand. It could be little changed in the next two decades if climate policies don’t accelerate, but could halve by 2040 if the world successfully moves on a path towards net-zero emissions by 2050.

Based on an HSBC scenario that is reasonably progressive but which does not meet the Paris goals, global oil demand could plateau in the second half of this decade at no more than 1 million to 2 million barrels a day above 2019 levels, then gradually decline through the 2030s.

Changes in consumer behaviour due to COVID-19 add to the uncertainty, especially for jet fuel and gasoline, but the overall trend seems downward. Our base case assumes electric vehicles could comprise over 55 per cent of new light vehicle sales by 2035, rising to 73 per cent by 2040.

But while global oil demand looks likely to be lower in 20 years than today, supply will also fall without substantial new investment. How quickly depends on price and a host of other factors, but the climate debate is now having a negative effect on the prospects for longer term oil supply.

Rising uncertainty over the energy transition coupled with investor pressure are impacting long-term decision making. Under the IEA’s net-zero pathway, no major new oil or gas developments would be needed beyond those already approved. In practice, this looks extremely unlikely to happen, but investors may increasingly use the IEA pathway to question companies’ development plans.

The risk is that this uncertainty leads to a scarcity of supply before global demand turns decisively downwards. Unless the world acts quickly on climate initiatives, considerably more oil supply may be needed as soon as the late 2020s, with prices needing to be high enough to incentivise this production.

However, the longer the world remains on a path inconsistent with the Paris Agreement goals, the more political impetus to act in time will likely grow, intensifying investor pressure on the hydrocarbon producers, especially in the developed world.

First published 24 May 2021.

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