Price trajectories and sensitivities

The oil price is the intermediary between supply and demand: it ensures that new sources of oil supply steadily come online at the right time to meet changes in oil demand and to keep the system in equilibrium. The upward drift in oil prices in the STEPS reflects the large requirement for new resource development, while the steady fall in oil demand in the SDS limits the call on higher-cost oil to balance the market and so the price is lower.

Projections of future prices are of course subject to a high degree of uncertainty and this report’s trajectories do not attempt to anticipate the fluctuations that characterise commodity markets in practice. Price levels in the scenarios reflect a dynamic, cyclical relationship between the oil price and the cost of oil and gas extraction, along with other factors such as depletion and technology learning.

As discussed above, another important assumption is that investment and production in major low-cost resource holders is limited in a way that maintains a floor under oil prices, e.g. by major resource-holders maintaining a strategy of market management. This means that the marginal project required to meet demand is more expensive than would be implied only by the global supply-cost curve.

However, faced with rapidly falling demand, major resource holders could choose an alternative strategy and look to ramp up production in an attempt to gain market share while there is still scope to do so. In this event, the combination of falling demand and increased availability of low-cost oil would undoubtedly lead to even lower prices.

This situation is modelled here in the Low Oil Price – SDS Case (LOPSDS). In the early 2020s, large resource holders rapidly increase production by fully utilising all of their spare production capacity: this leads to an overhang of supply and a sudden drop in the oil price.

Thereafter, these resource holders continue to grow production to force out higher-cost sources of supply and so increase their overall market share. In this case, the oil price suddenly drops to below USD 25/barrel and thereafter remains in a relatively tight band between USD 25/barrel and USD 35/barrel. (This case focuses on oil markets because demand trends, the more regional nature of natural gas markets and the absence of large levels of spare natural gas capacity make a similar case for gas somewhat less likely).

Despite the drop in the oil price, for the purposes of this case this report assumes that global oil demand remains identical to the levels projected in the SDS to ensure that emissions fall in line with the Paris Agreement. Keeping end-user prices the same as in the SDS would require even stronger policies and taxation on oil use to avoid any rebound in demand. The implications of this case are examined directly below.

Another possibility examined in this report is a Disjointed Transition Case. In this case, energy policies and markets initially follow the trends of the STEPS to 2025. This is followed by a sudden strengthening of energy policies, with oil and gas demand then dropping abruptly to the level of the SDS over the five-year period to 2030. Prior to 2025, operators invest on the assumption that prices and demand will continue to rise as in the STEPS, only to be faced with a sharp break in the trend.

The precipitous drop in oil demand in this case leads to a large surplus of supply and so there is again a sudden drop in the oil price. After 2030, oil demand follows the trend of the SDS and, as the surplus is slowly worked off, the oil price slowly recovers. Results from this case are examined in more detail in Section III.

Dollars per barrel (2018)

140

120

Stated Policies Scenario

Historical

100

80

Sustainable Development Scenario

60

Billion dollars (2018)

1 600

1200

800

400