Business | Oil & Gas
Opec in a bind as demand falls
For the last two years, analysts have argued about how far oil demand would respond to the rise in prices.
- Agencies
- Published: 23:47 October 16, 2008
London: For the last two years, analysts have argued about how far oil demand would respond to the rise in prices.
But in the past few weeks, evidence of a sharp decline in demand has become incontrovertible, resulting in big cuts in forecast oil demand, and posing a sharp dilemma for the Organisation of Petroleum Exporting Countries (Opec) about how to respond when ministers meet on November 18.
The International Energy Agency (IEA) has been steadily dropping its demand forecasts for more than a year, as surging prices have forced conservation measures and substitution for cheaper fuels, while a slowing economy, especially in the US, bites further into demand.
In July 2007, the agency forecast global crude consumption would hit 89.8 million barrels per day (bpd) in the fourth quarter of 2008. Fifteen months later, the forecast had been cut by a massive 2.2 million bpd (2.4 per cent) to just 87.6 million bpd. Most of the reduction has been concentrated in North America, where the IEA has cut its prediction by 1.6 million bpd (6.1 per cent).
The IEA still believes crude consumption will be higher than in the same period last year (400,000 bpd) - but it would be the slowest rate of growth in more than five years, and the forecast increase relies on continued growth in China (500,000 bpd) and the Middle East (400,000 bpd) to offset projected declines in North America (900,000 bpd).
It is not clear how well emerging market demand will hold up if the advanced economies tip into recession.
Opec therefore faces an awkward choice over how to respond. It is under pressure to allow prices to settle at lower levels as its own contribution to stabilising financial markets in consumer countries and averting a deep and prolonged worldwide recession.
Unless it begins to rein in supply now, the market could emerge from the winter heating season with higher stocks than normal, requiring even larger cuts in February 2009 or a vertiginous drop in prices reminiscent of 1998.
The difficulty is judging how much to cut supply to avoid a massive stock-build, while at the same time allowing prices to fall to buy back some of the demand that has been lost.
Despite its reputation as a profligate energy user, the US achieved a real and lasting reduction in crude oil use following the oil shocks of the 1970s and early 1980s. Oil was substituted by natural gas for power generation, while motor manufacturers achieved significant and durable improvements in engine technology.
Between 1973 and 2008, US output rose 172 per cent. The resident population rose 44 per cent. Oil consumption was up just 14 per cent. Per capita consumption was cut almost a third, from 34 barrels in 1976 to 23 barrels in 2008. Consumption per $1,000 of GDP (2000 prices) fell two-thirds from 1.6 barrels to 0.6.
Some of the decline is more apparent than real. "Contained" fuel use has fallen by less than the raw figures suggest, and natural gas consumption has risen sharply.
Manufacturing activity has shifted overseas to emerging markets such as China, and the attendant crude use moved with it.
Nevertheless, the oil shocks were followed by a significant structural decline in oil demand that has never been fully reversed.
Fuel economy of new vehicles in the US improved from 26.9 miles per gallon in 1975 to 43.1 miles per gallon in 2008 (60 per cent). But automakers used the improvements to build bigger and more powerful cars. Thus, the achieved fuel efficiency of new US vehicles has fallen from a peak of 22 miles per gallon in 1987 to 20.8 in 2008.
Outlook
The US economy looks set to slow further in the next six months as the credit crisis spreads to the real economy. Oil consumption is almost certain to soften further unless there is a very harsh winter.
In the run up to the ministerial meeting, Opec's task is to remove enough surplus barrels to avoid a destabilising inventory overhang when the winter is over, while not encouraging a renewed spike in prices that would intensify the recession in consumer countries.
But in stabilising inventories and prices, ministers will also have to estimate how much demand is being lost due to long-term factors linked to escalation in prices, and how much is being lost from a short-term cyclical downturn.
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