Oil demand plunges

Thursday, 27 August 2009 07:43

IEA Medium-Term forecast shows a 6.6 mmb/d drop in demand

he International Energy Agency (IEA) recently released its 2009 Medium-Term Oil Market Report showing a sharply reduced projection for oil demand growth.

In the material used by the IEA economist charged with announcing the study’s results, it states that the projected oil demand for 2013 is now 3.3 million barrels per day (mmb/d), below the agency’s December forecast.

What is more telling, however, is to examine the change between this forecast and the agency’s 2008 medium-term forecast that shows almost a 6.6 mmb/d drop in demand.

In fact, if we go back to the 2007 demand forecast – although not all future years were forecast – the drop in projected oil consumption is even greater.

The challenging aspect of the IEA’s new forecast is its reliance on the highly optimistic global gross domestic product (GDP) growth projections of the International Monetary Fund (IMF).

Its projections suggest that global economic growth, once we recover from the current recession, should average close to 5% a year.

The IMF expects the world’s GDP to post negative growth of about 1.5% in 2009, but then show positive real growth of nearly 2% in 2010.

In subsequent years, real GDP growth is expected to exceed 4% in 2011 followed by nearly 5% growth in each of 2012 and 2013, before slowing slightly to 4.6% growth in 2014.

This global economic growth will reportedly be driven by strong gains in non-OECD countries as the Organisation for Economic Co-operation and Development countries will experience growth barely over 3% at its peak in 2012.

Figure 1: IEA oil demand forecast has fallen significantly (Source: EIA, PPHB)

The economic growth scenarios employed by the IEA in preparation of last year’s medium-term oil market forecast called for 3.8% growth in 2009, followed by 4.8%, 5.0%, 5.0% and 4.95% in 2010-2013.

Clearly, the IEA forecast was made well before the economic and credit market problems of 2008 materialised, but that alone points out how questionable relying on very high global economic growth projections may be.

The economic growth rates utilised in the 2008 study produced annual oil demand growth forecasts ranging from a low of 1% to a high of 1.9% in 2013, with an average growth over the period of slightly over 1.6% per year.

The latest IEA oil demand forecast was made before the passage by the United States House of Representatives of its historic cap-and-trade energy and climate change bill, now touted as a “jobs” bill.

In the government’s projection of the impact of this bill on oil demand due to the increased use of renewable fuels, US demand is projected to fall by over 1.8 billion barrels over 2012-2016. That demand decline equates to a 1.232 mmb/d per year on average.

This could be a significant depressant on global oil demand growth, particularly if global economic growth is actually lower than assumed by the IEA and IMF.

The significance of this oil demand erosion in the US is meaningful when relative growth rates in demand are taken into account. If world oil demand grows 0.6% per year, then based on 2014’s estimated demand of 88 mmb/d, annual growth would be 528 000 b/d. The annual average demand decline in the US alone would be 2.3 times that overall annual growth projection.

Even if one assumes that some US oil demand erosion was factored in by the IEA, we are still looking at substantial headwinds for global oil demand growth.

In its analysis, the IEA points out that if oil demand growth is stronger or weaker than its modeling assumption, then there can be a wide divergence in the amount of oil needed in future years.

If oil demand grows at only 0.4% per year on the low side versus 1.4% annually on the high side, there will be a 4.1 mmb/d demand difference in 2014, from 89.0 mmb/d to 84.9 mmb/d. (Talk about ranges through which one can drive a fleet of 18-wheelers!)

Figure 2: GDP growth will determine oil needs (Source: IEA)

The more ominous take-away from the IEA medium-term oil demand forecast is its implications for global oil demand over the longer term.

Under its economic and oil demand growth assumptions, it will be 2012 before oil demand exceeds 2008’s consumption, or a four-year period of weak demand.

One need only remember 1979 to 1989, when oil demand fell for four consecutive years before recovering, however, it was not until 1989 that oil consumption surpassed the level of 1979. Are we in for the same possibility today?

In the 1980s there were two forces at work in the global oil market which magnified the fall in demand and inhibited the speed of its recovery: the deep economic recession of 1982-1983, and the increased use of nuclear power in the US and Europe to generate electricity at the expense of petroleum.

The shift in fuel sources for electric power generation, a one-time event, changed the US and global energy fuel mix.

Today, most people would point out that we employ petroleum fuel to generate only about 1% of electricity output. The potential impact from the increased mandate to use ethanol in gasoline and diesel fuels could be construed as a similar step-change in oil demand usage.

Given the likelihood that renewable fuel blending mandates will be increased in the future, ethanol may hit petroleum consumption in the same way that increased nuclear power impacted oil demand in the 1980s.

Equally, and maybe more importantly, will be the impact on global oil demand from reduced fuel subsidies by governments in developing economies.

China, for instance, just announced its third gasoline and diesel fuel price hike so far this year. While the price hikes have been done to attempt to restore profitability to state-owned oil company refining operations, the hikes will impact the high consumption growth rates of gasoline and diesel fuel.

So far this year, China has increased gasoline prices by CNY 1 290 (US$ 187) per ton and diesel prices by CNY 1 180 (US$ 171) per ton. Those increases represent roughly 18% to 20% price increases at the pump and bring some gasoline prices to over US$3.00 per gallon, which in the US has been the threshold for meaningful driving reductions by Americans.

Anecdotal reports in the Chinese media suggest that many drivers there anticipate driving less with the higher fuel prices.

What the impact will be on new vehicle sales is uncertain, but the higher operating cost will figure into some buying decisions.

At the same time, China is gearing up to be a world leader in electric vehicle sales that may begin by capturing a larger share of the local market due to higher gasoline and diesel fuel prices.

There is another consideration about the future compared to the 1980s history.

During part of the 1980s, when oil demand was falling and then only slowly recovering, real global GDP growth was at levels currently projected to be experienced during the next five years by the IMF and utilised by the IEA in its oil demand forecasts.

If, as we fear, economic growth is not as strong as the IMF calls for, then oil demand cannot possibly grow as much as the
IEA projects.

Figure 3: Falling oil demand despite high economic growth (Source: IMF, IEA, PPHB)

The turmoil in the global economy will have an impact on oil demand. How the cross-currents play out, as during the 1980s, will depend upon a number of factors – credit markets, US consumer spending patterns, automobile fuel efficiency, market penetration by alternative-fuel vehicles and government regulations, to name only a few.

We understand the argument that more people in the world will mean more energy consumption, but what we do not know is how much more demand, what particular fuels will be favoured and whether there are other forces that could impact the demand equation.

The world has been very focused on Peak Oil. We, on the other hand, have been, and remain, concerned about the fate of global oil demand. The new IEA forecast is a sign for concern.

G. Allen Brooks

Eskom Power Gauge