Demand Fears Crush Crude

Jim Brown
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Crude oil prices declined by $3 on Wednesday as new economic reports created new fears about falling demand. Does demand really rise and fall so quickly or is this simply a renewed bout of volatility fueled by sagging economics?

Demand does not decline on a daily or weekly basis. Gasoline prices do not go from $3.50 to $4.00 overnight or even over a week or two. We all know it is a long slow process where every fill-up seems to be a nickel per gallon higher than the prior visit to the pump.

Prices never seem to go down as fast as they go up or return to their original starting point. In the USA we pay a relatively small amount in gasoline taxes so the bulk of the price is related to the price of oil. If oil jumps +10% we can see a 7% rise in gasoline prices. In Europe where fuel taxes and the total cost per gallon is much higher a 10% jump in oil prices is almost invisible. Translating European prices per liter to the U.S. gallon price and you will get something in the $8 range. Where a 25-cent hike in our $3.50 price per gallon is very noticeable the same hike to an $8 price is nominal at best. You are not going to get a lot of demand change in Europe because of a 25-cent hike.

In many Asian, African and Middle Eastern countries the price of fuel is set by the government and subsidized heavily. Short term price fluctuations are absorbed by the government and the retail price remains the same. Definitely no demand decline in those countries.

In China, where lines at service stations can be blocks long they are just happy to get the gasoline at any price and that price is set below market by the state. Some drivers pay street people to sit in their cars in the gas line while they go tend to other business or shop. Definitely no demand decline in China.

The only real country with close to real time demand decline is the USA. Because we consume nearly 25% of the world's oil a 25-cent per gallon change is significant. A 50-cent change is a source of concern and a $1.00 change forces drivers to conserve. U.S. gasoline prices are $1.07 over year ago levels.

As a result of the recession gasoline demand and prices were extra low. Those prices were growing normally with the economic recovery until WTI abandoned its average of $85 in November and began its assault on the $115 high in April. That $30 price increase in five months DID pressure demand in the USA.

I have reported on the demand numbers for several months. After rising slightly in the spring we saw demand levels for gasoline decline over the last two months. (dotted red line on chart) The dotted blue line is the normal demand curve over the last two years. As you can see we are significantly below normal for May. Of course "significantly" is also a relative term. Gasoline demand for the week ended May 20th was 9.025 million barrels per day compared to 9.099 mbpd in 2010. Demand over the prior weeks had dipped into the high 8.8 mbpd range but still immaterial in the greater scheme of things.

EIA Gasoline Demand Chart

Yes, demand slowed slightly in the USA. The MasterCard Spending Pulse report showed retail gasoline purchases declined for eleven straight weeks leading into early May. According to MasterCard it was down -2% over April 2010 levels.

Did demand slow around the world? No. Demand did not slow in the countries with subsidized fuel or China where buying gasoline is a lot harder than in the USA.

Did our minor -2% decline in demand alter the world consumption rate? No. Everything is a matter of perception. Because of the U.S. mindset and active financial community we fixate on every little thing that affects our lives and our retirement accounts. How many people in a Chinese or Indian market know how much a barrel of oil costs today? I suspect it is very, very few.

The negative economic reports we saw on Wednesday provoke a knee jerk reaction from traders. With the market already weak throughout May and everyone pondering a June swoon it made that knee jerk reaction even more severe.

Jane Doe may be making one trip to Wal-Mart per week instead of two because gasoline has cut into her budget but it will pass. As long as gasoline remains under $4 the consuming public will eventually grow accustomed to $56 fill-ups instead of $50 fill-ups. That $10 is the difference between $3.50 gasoline and $3.75 assuming a 15-gallon fill-up. SUV drivers are looking at $80 instead of $70 so everything is relative.

Did that $6-$10 extra per tank dramatically alter our driving patterns forever? No, but it did force millions of Americans to think about those extra trips. Once they become used to the slightly higher price those trips will return. If you go back before the 2008 price spike when gasoline was $1.85 to $2.25 the amount of demand was lower than it is today. Our gasoline is nearly double what it was five years ago but overall demand is higher because we become immune to the sticker shock at the pump.

Demand will continue to rise as long as the rise in oil prices is orderly. Spikes over $4 gasoline will temporarily alter demand patterns and could quickly cause a fuel price recession. However, at current price levels and oil prices this will not be "the" fuel price recession I expect in late 2012. As global demand increases and oil production fails to keep pace we will enter an entirely different demand destruction cycle similar to the 2008 price hike and recession. Only this fuel price recession will be long lasting and long term driving habits will be changed forever.

Jim Brown

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