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Tuesday, November 13, 2018

Widespread demand destruction?

The Paris-based International Energy Agency (IEA) says that, although it seems unlikely at this point that sustained high oil prices will trigger a recession across the OECD, they may delay the recovery of the U.S. economy well beyond 2010. In most non-OECD countries, meanwhile, high oil prices are becoming unbearable and are also fuelling inflation.


On the one hand, the cost of imported oil is becoming prohibitive. Only a few oil importing countries have to a certain extent been able to cushion the price rise: those that export other, higher-priced commodities or that have seen their exchange rates appreciate (several central and western African currencies, for example, are indexed to the Euro). But for the vast majority – generally the poorest countries – higher oil prices will in effect have a dramatic effect upon income and development levels.

 On the other hand, many countries where end-user prices are capped or subsidised are being obliged to make significant adjustments to their price regimes as these become unaffordable, with all the economic, political and social consequences that this entails.


In those regions where consumers are largely exposed to international oil prices – namely OECD countries and most of the world’s poorest nations – oil demand is already stagnating or even falling, according to available data. In particular, as noted in this report, demand in the U.S. – the traditional driver of oil demand growth in the OECD – is poised to contract markedly in 2008 as a result of the double squeeze provided by the slowing economy and higher prices.


In the short term, discretionary driving is likely to contract further, while the use of public transport (whenever it is available) should continue to increase. More significantly, in the medium to long term, as consumers realise that high prices are not due to temporary spikes and are therefore bound to remain at high levels, the structure of the vehicle fleet will arguably change gradually in favour of smaller cars and away from SUVs and light trucks. Such a trend would be further compounded by more stringent federal mandates on fuel efficiency and by the adoption of diesel-fuelled passenger cars, unthinkable in the recent past but now gaining attention given technological advances.


The IEA has been continuously revising world oil demand downward this year. In January its forecast was a 1.98 mbd increase; now the forecast in the June report is for a 0.80 mbd increase.  Yet at the same time the tanker market has been extremely strong. How does this add up?


Firstly, the supply of ships has been reduced by conversions, by the reduced productivity of single hull (SH) tankers, and by talk of floating storage - Iran Daily publishes speculation that the Iranians are storing oil in 14 VLCCs. Keeping these VLCCs out of the market I slikely to have a positive effect on international tanker freight rates, both in the VLCC range and in other size ranges as charterers may be forced to cargo-split into suezmaxes and even aframaxes owing to a current general scarcity of VLCCs.


Secondly, OPEC continues to dominate global supply growth, as non-OPEC production languishes at or below levels of a year ago for the past three quarters. OPEC’s May crude supply averaged 32.3 mbd, a gain of 0.395 mbd versus April. Increases were widespread, with Saudi Arabia, Iraq, Nigeria and Angola prominent. Iraqi output hit a six and a half year high at 2.5 mbd, as Basrah exports increased further. Saudi Arabia signalled its intention to boost supplies in response to higher refiner demand.


This increased Middle East oil production has a direct effect on VLCC demand and rates. Middle East oil production in May 2008 was 23.31 mbd compared to 21.98 mbd in May 2007.  The increase of 1.33 mbd of Middle East oil production will mean additional one million barrels per day extra export, which if exported to China would generate an extra demand for some 21 VLCCs.


According to the U.S. Energy Information Administration (EIA) world oil consumption is projected to grow by one million barrels per day in 2008.  However U.S. consumption of liquid fuels and other petroleum is expected to decline by about 0.29 mbd in 2008 because of higher petroleum product prices and slower economic growth. Adjusting for increased ethanol use, U.S. petroleum consumption is projected to fall by 0.44 mbd in 2008.


The EIA emphasises that non-OPEC supply growth remains weak despite 6 years of rising prices.  Non-OPEC production is according to EIA expected to rise by 0.31 mbd in 2008, down sharply from EIA’s last month’s Outlook. Actual production data from Russia, Norway, and Mexico, along with lowered expectations for Brazil, are the principal reasons for the downward revision.  Non-OPEC supply during the first quarter of the year was 0.24 mbd lower than the first quarter of 2007, and the second quarter of 2008 is expected to be 0.20 mbd lower than last year.  Virtually all of the growth in non-OPEC supply is expected in the second half of the year, with an expected year-over-year increase of 0.82 mbd in the second half, driven by growth in Brazil and Azerbaijan.


A third reason why tanker freight rates are beating fundamentals may be that high oil prices and tight refining capacity are causing a great deal of trading of both crude oil and products. The high oil prices also mean that producer countries are pumping as much oil as they can.


If oil demand keeps falling, then the Vienna-headquartered oil prodiucers’ cartel will need to slash production to keep prices up, claims oil analyst Leo Drollas, deputy director and chief economist at the Centre for Global Energy Studies (CGES). Prices have been rising almost continuously since early February this year, reports Drollas, driven by a greater demand for OPEC oil than the cartel has produced. However the picture for Q308 looks different since, in his view, by Q409, world demand for OPEC oil will have dropped dramatically. In one scenario, the CGES is forecasting that the world will only want about 29M bpd of OPEC oil, which will mean a slump in production volumes to match. Prices are predicted to fall to about $60 for a barrel of Brent.


Contact: Erik Ranheim