Demand Destruction In Progress

Jim Brown
 
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The knowledge consumers around the globe are cutting back on fuel consumption because of high prices should not be a surprise to anyone. OPEC, the IEA and EIA have all narrowed their demand estimates and Saudi Arabia actually cut production because of lack of demand.

This may seem like an episode from the Twilight Zone where oil prices continue to spiral higher while demand for that oil is dropping like a rock. What is wrong with this picture?

It is all in the "expectations" for future demand rather than actual demand at present. The actual demand has declined for the last six weeks according to the MasterCard Spending Pulse report. Gasoline demand last week declined by -1.8% week to week and -3.0% year over year. Of course that is just in America and not a worldwide picture.

The IEA published their latest outlook for demand but warned preliminary data from January and February already suggests rising prices slowed demand and that was a fairly inexpensive period compared to prices today.

The IEA said "there are real risks that a sustained $100 per barrel price will prove incompatible with the currently expected pace of recovery."

OPEC cut its world oil demand forecast for 2011 by 50,000 bpd this week. That was the first downgrade in expectations in a year. OPEC had been raising estimates almost monthly but they said the higher prices were slowing demand for their crude. They still expect demand to grow by 1.39 mbpd in 2011.

To emphasize that point we found out that Saudi Arabia has cut production back to pre-Libya levels of 8.6 mbpd after temporarily raising production to 9.2 mbpd. Saudi said there were no buyers for the extra oil.

The IMF cut global growth rate estimates for 2011 on Monday from +5.0% to 4.4% because of high oil prices and the EU austerity crisis threatening the recovery. They warned a major price spike in crude prices would knock a full percentage point off of growth in many nations.

Goldman, Barclays and JP Morgan all made comments this week warning that signs of slowing demand had already appeared. Barclays said high oil prices have yet to show any "considerable" impact on demand but we are at a dangerous period.

Societe General said U.S. demand growth had "faded to zero" in March from a projected 600,000 bpd in January.

In an alternate view to the current demand destruction thesis the U.S. EIA warned that oil markets will continue to tighten over the next two years. The EIA said slowing production in non-OPEC nations will require OPEC to produce more oil as inventories are depleted by the global economic recovery. The EIA projected the average price of WTI crude in 2011 to be $106.38 and rise to $113.50 in 2012. Those were increases of $5 and $9 per barrel respectively.

The EIA expects demand in 2011 to be 88.2 mbpd and 89.76 mbpd in 2012. That is up from 86.68 mbpd in 2010. (Several estimates are over 90.0 mbpd for 2012)

The EIA is projecting an average price for gasoline in 2011 will be $3.86 this summer, an increase of $1 per gallon over the same period in 2010. They expect U.S gasoline to sell for more than $4 by July with diesel even higher.

I think it is easy to see that despite the claimed demand destruction currently underway the outlook for crude oil prices will continue higher. The slight drop in consumer demand, assuming prices don't accelerate much past the $3.75 today for gasoline, will eventually be overcome by the increase in business activity around the globe. We need to get used to paying $4 per gallon because that will be the new normal by the end of 2012.

Jim Brown

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