Oil Outlook- Part 2: Demand Side

By Yaser Anwar, CSC of Equity Investment Ideas

Last week I talked about Oil Outlook- Part 1: Supply Side. This week, I’ll be talking about the ‘Demand Side’ and issues affecting it.

• To understand the future demand of Oil, it is important to understand the underlying factors that spur demand, two key ones being: Production & Global economic growth.

• Prior to 1995, oil demand remained in the 66-68 million b/d range for eight years, which lead to the belief that prices will not rise any further. Just then, global oil demand crossed 70 million B/D in 95 and since then, global oil demand has grown from 70 to 83 million b/d over a period of eleven years. OECD oil use from 95 to 06 rose almost 5 million bpd.
• Non-OECD use grew even faster, expanding by 7.7 million bpd. China was a big contributor but represented only 39% of this non-OECD growth. The story of how demand outgrew supply did not originate in 2004 and did not involve only China, as the graph below will indicate.
• IMF has marked up the forecast for global growth to 4.9% in 07. Growth in the US is expected to slow to 2.9% (from 3.4%, 06) in 07. In the Euro area, the growth is projected to sustain its momentum this year (German growth will decelerate if the planned tax increases go through). Among emerging markets and developing countries, growth is expected to remain very strong, with the Chinese economy continuing its rapid expansion.

• In emerging market and developing economies, policymakers must adjust to the more challenging global environment by continuing to reduce vulnerabilities and by putting in place reforms that will help sustain the current growth momentum. The market has also adjusted to political hubris coming out of Iran, Venezuela about oil production cuts.
• In my opinion, there will be no significant cuts, especially not at these prices. Oil is primary income for these countries, and at $58 a barrel it will significantly reduce their GNP. This is evident by Saudi Oil minister lambasting about how Saudis will cut production by 1.2 million barrels, well they just cut by 300K. At $70 a barrel, more cuts would have made sense for them, as the dollar per barrel was significantly higher, just not at these levels.
• According to CAPP: Total Canadian production will approach 4 million bpd by 2015, as it grows from 2.6 million b/d to 3.9 million b/d. For more one Canadian Crude Oil Production, read this.
• Just last month, the IEA raised its 07 demand forecast by 273K b/d, to a total of 86 million b/d. According to them, despite a milder-than-normal start to the winter, 4th Q world demand was up 1.3 million b/d from a year earlier.
• Global economic growth has remained resilient, even in light of $70 barrel of oil. However, beyond this price level it is likely that inflationary and recessionary impacts of price rises to above $80 will be dramatically increased, in the slow growth, oil-centric economies of the OECD countries. The effects would be less pronounced for EU countries, as the prices are already much higher for consumers vs. US, Japan & S. Korea.
• Having analyzed 100s of scenarios at during my JPM internship, I’ve come to believe that global oil demand is a lot more inflexible today than it was in the past. The price spikes of the 1970s triggered worldwide efforts to reduce consumption. From ’78-’83, global oil demand plunged 8.5%, despite cumulative world GDP growth of 11.6%.
• Energy prices started to slightly increase in ’99, with a sharp rise since 03. This surge has been driven by growing demand in advanced and emerging economies, as well as by expectations of future market tightness. However, current and expected future real oil prices are still significantly below their value in the late ’70s and ’80s.

• There is a chance that mild weather could depress winter demand. Summer weather could become so mild that it hampers air condition usage. Global economies could also weaken, leading to oil demand being flat or stagnating. China could experience a hard landing or endure social chaos (doesn’t seem likely, given China’s economic growth outlook, its appetite for oil is likely to remain huge).
• Either of these scenarios, and more, are possible, but unless they occur it is hard to see how supply will outstrip demand in 07.

**Also, I would strongly suggest a quick glance over these charts, which pertain to ‘The World’s Petroleum Life-Cycle’.

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