BRIC Demand in 2011 Could Be Trouble

Jim Brown
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Oil demand in the U.S. may be increasing at a snails pace but demand from Brazil, China and India could push consumption to the second highest level on record in 2011.

The rising demand from the BRIC nations could push prices much higher in 2011 and endanger the global recovery. In a Bloomberg survey of 23 analysts the average price for crude in 2011 is expected to be $85. That compares to the $77.70 average so far in 2010. The 2008 average was $99.75 and a global recession resulted.

Goldman Sachs is aiming a little higher. They claim oil prices in 2011 will average over $100. Bloomberg correctly calls this a undeclared tax on global consumers. If it was just the U.S. or some other affluent country passing a tax to curb consumption the results would not be so drastic. When oil prices are high it affects everyone on the planet and not just in one country.

OPEC does not have a lot of excess capacity left. We already know they are producing two million barrels per day over their current quotas. What we don't know is how much demand has increased inside OPEC nations over the last two years. If you have been reading my recent commentary you know that demand inside a producing nation expands more rapidly than an importing nation. If aggregate OPEC demand has risen by a million barrels per day over the last two years then excess capacity could be as little as 1.5 to 2.0 mbpd total.

OPEC, the IEA and the EIA all agree that global demand should grow over 1.1 mbpd in 2011. They adjust that number monthly. If the rest of the planet started to recover just half as strongly as the BRIC nations that number could rise to 1.5 mbpd in 2011.

China's GDP is expected to grow by 8.9% in 2011. India should grow around an 8.8% rate and Brazil is expanding at close to 5%. There are a dozen Asian countries also growing well over 5%. The U.S. will do good to add 2.5% and Europe will struggle to grow 1.5%. If the U.S. finds some traction our oil demand will explode. We already consume 21 mbpd so even a small percentage increase would be dramatic in terms of its impact on world consumption.

If global economic growth suddenly improves, the demand for oil could easily push 2011 to the second highest level of consumption in history and 2012 could be the highest assuming the oil is actually available. The problem is the rising price. The current price at $83 is well over the level of prices back in 2006-2007 when demand was at the same level. Prices then averaged in the low $60 range.

What is the difference today? Why does equivalent demand command a $20 higher per barrel price? First the cost of equipment is higher today. The cost to drill a well is nearly double the 2006 rate. Wells are being drilled under more difficult conditions and are more costly to maintain once into production. The marginal cost of a barrel of oil today is $65. In 2006 it was around $40.

The cost to explore and produce will continue to climb as well as the tax drain from the host country. Nationalism is alive and well and even in democratic countries like the USA lawmakers want a bigger piece of the royalty pie.

Going back to the original thought, we don't know how much spare capacity OPEC has today. In theory it is roughly 2.5 mbpd to as much as 4.0 mbpd if you believe the OPEC claims. Very few analysts actually believe they have that much capacity left. Even if they do it may not be a grade of oil that we can use. This has been a favorite tactic of OPEC in the past. They can claim millions of barrels of excess capacity but that capacity is mostly heavy, sour crude that nobody wants. There is limited excess capacity of light sweet crude that is needed for low sulfur gasoline and diesel.

I project crude will reach $120 by the end of 2011 and that will touch off a new wave of economic weakness. The majority of the globe is poor. They can't afford gasoline at twice today's prices. This will depress the recovery and weaken demand. This scenario will be repeated over and over until it is proven that global production has begun its final and terminal decline then it will no longer be a matter of price but one of availability.

Jim Brown

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