A demand-supply tug of war and $100 – $200 oil prices in 2012?
In an earlier Sep 2011 article by the author, he wrote that a tug of war ensued between the elasticities of demand and supply to create range bound oil prices. The year 2012 started in earnest with dichotomous forecasts on the oil price. This is due to ongoing market uncertainties – with the Euro crisis damping potential demand and supply disruptions from the ongoing Iranian crisis. The author is convinced though this tug of war is increasingly won by the supply factors and the oil price will hinge on the upside.
Demand destruction and the Euro crisis:
During the financial crisis of 2008, OECD oil demand fell from 47.9 mb/d in 2Q 2008 to 44.2 mb/d in 2Q 2009 (IEA OMR data). Most of the demand loss came from the USA (1.8 mb/d). A look at the main demand figures from Europe during the financial crisis revealed important consumption patterns:
kd/b (product demand) |
2008 Jun |
2009 Jun |
Change |
France |
1870 |
1930 |
+70 |
Germany |
2430 |
2360 |
-70 |
Greece1 |
331 |
320 |
-11 |
Italy |
1870 |
1610 |
-260 |
Portugal1 |
274 |
255 |
-19 |
Spain |
1500 |
1470 |
-30 |
UK |
1740 |
1670 |
-70 |
Ireland1 |
166 |
136 |
-30 |
TOTAL |
-420 |
The consumption demand2 has actually decreased only a marginal 350 kb/d in continental Europe with the major powerhouses France, UK and Germany having minimal impact. A key reason for the relatively low demand destruction is the use of natural gas and other alternative sources of energy in Europe (for eg nuclear in France) as a primary form of energy. The peripheral countries – Italy, Portugal, Greece and Spain in the epicenter of the crisis lost 350 kb/d of demand.
The latest economic data3 indicated that the US and China are likely to weather the contagion from Europe. More importantly central banks have learnt an important past lesson – it was the constriction of bank credit that led to the contagion in 2008 and in this respect, the European central bank (ECB) has offered low interest rate loans to banks to shore up liquidity.
A further base on the prices – $100 was cited by Saudi Oil minister Ali al-Naimi on 16 Jan ’12 as a level to be ‘stabilised’ at. This was the first time a price level was hinted at 3 years after $75 was cited in Nov ’08. It is an acknowledgement of the growing fiscal spending by the Kingdom in social welfare and wages in its public sector to balance the government budget. A recent IMF report in Oct ’11 indicated that the break-even oil price for the Kingdom has grown by almost $30 since these 3 years.
Demand never fully restored in US post crisis:
Importantly, the US has seen a dramatic fall in oil demand from 20.24 mb/d in Jun 2008 to 18.7 mb/d in Oct 2011. Most of it is due to higher vehicle fuel efficiency and the higher average price of gasoline experienced in 2011 (even more than 2008) slashing gasoline demand by 0.7 mb/d. The USA never fully recovered its oil demand post financial crisis.
USA demand (mb/d)4 |
2008 Jun |
2009 Jun |
2011 Oct |
Change Jun08 – Oct11 |
Gasoline |
9.24 |
8.96 |
8.56 |
-0.68 |
Jet |
1.59 |
1.4 |
1.45 |
-0.14 |
Diesel |
3.85 |
2.87 |
3.76 |
-0.09 |
Others |
4.67 |
3.7 |
4.08 |
-0.59 |
RFO |
0.57 |
0.89 |
0.67 |
0.1 |
Total |
20.24 |
18.04 |
18.69 |
-1.55 |
Supply disruption and geopolitical instability:
A list of existent supply disruptions issues is below. The list is not extensive with other disruptions in Libya and potential unrest in Iraq and Kazakhstan. However, these longstanding issues appear to have been ‘factored’ into market prices. A geopolitical theme permeates through the list with the Straits of Hormuz having the greatest impact.
Region | Remarks |
Iran (through Straits of Hormuz) | Ongoing nuclear crisis could see the blockage of the Straits of Hormuz where 17 mb/d of crude flows. Mitigating factors include the 5mb/d Petroline to Yanbu and a 1.7 mb/d Fujairah pipeline ready from UAE ready only in 2H 2012. Still, up to 11 mb/d immediate supply could be lost in a worst case scenario. Iran itself exports 2.3 mb/d of crude. Comparatively, the OECD has oil stocks of 2630mb (IEA Dec ’11 OMR). An excellent article on the cruciality of the Straits of Hormuz is found here. |
Nigeria | Removal of fuel subsidies has triggered a strike among oil workers potentially disrupting its 2.4 mb/d of exports. On 16 Jan, the Nigerian president reinstated partial subsidy. |
South Sudan | Landlocked South Sudan seceded from Sudan but its oil exports of 350kb/d through Port Sudan appeared to have been routed for Sudan domestic consumption. |
An observation is a relatively ‘minor’ supply disruption (in South Sudan or Nigeria) is expected to have the same order of impact as demand destruction in Europe. The author therefore postulates the supply elasticity of oil price to win this tug of war against demand, and consequently the oil price to surprise on the upside this year.
Footnote:
1 – Greece, Ireland and Portugal data are import data from EIA and not consumption data, but given that their own production is minimal, import and consumption figures should be similar.
2 – The dates were chosen as covering the period of the Lehman collapse – a defining moment of the crisis and to reflect the summer driving season in the USA.
3 – The labour market in USA is improving whilst the PMI data in China improved to 50.3 in Dec from 49 in Nov 2011.
4 – From IEA oil market reports in Aug 2008, 2009 and Dec 2011.