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OIL DEMAND GROWTH OUTLOOK 2004-2005: THE PRICE FACTOR

by Andrew McKillop

 

Paris, 11 Sept 2004

Recent interview statements by IEA chief C. Mandil, and comments and data from some major oil corporations and certain oil analysts give growth rate forecasts for world oil demand running in the range of below 2.5% to around 3.3%-per-year, from a base of around 82 Million barrels/day (Mbd) in mid-2004. Less than one year ago, at end-2003, almost no “consensus forecast” from fit-to-print sources gave growth rate outlooks much above 2%-per-year. In particular the IEA consistently claimed in late 2003 that by end 2004 and into 2005 world oil demand growth would trend down to about 1.4% for calendar year 2005 «due to high oil prices».

 

Surprising growth

Through 2004 both the IEA and the so-called “analyst community” have consistently and continually uprated and increased their growth rate forecasts and estimates, calling this “surprising growth”. On a July-July basis for 2004-2005 it is now possible, in September 2005, to forecast that world oil demand growth is running at well above 2.5%-per-year, and is likely in the region of 2.5%-3.5% annual in many “surprising” regions and countries, outside the “growth poles” of East and South Asia, where 4.5%-7% annual is the likely figure. Prices will affect the outturn, but not as expected by the so-called “analyst community” until and unless prices move well above 60 US dollars/barrel (USD/bbl). Import demand growth worldwide is higher than demand growth for a number of factors, notably depletion loss of capacity in the vast majority of producer countries with an export surplus above domestic consumption. Capacity loss through depletion is especially strong in the OECD producer countries USA, Norway and UK, probably running at over 0.8 Mbd/year.

In final analysis it is growth of world import demand that sets the oil price environment and prices.

 

The underestimating business

Under-forecasting oil demand growth is the hallmark of conventional analysts whose professional status and job security depend on uncritical belief in the myths of (1) «price elastic» demand behavior by all consumers and users, who would (in economic myth) instantly reduce their oil burn when prices rise by even 50 US cents-a-barrel; and (2) that «high oil prices hurt economic» growth, with various percentage-point losses of GNP growth being attached to various price rises for oil — for example an 0.4% loss of GNP growth “automatically” flowing from a 5 USD/bbl increase of average oil prices. This “automatic” fall in oil demand growth will then (in economic myth) feed back to reduced oil demand and build of oil stocks, resulting in a fall of prices.

Through Jan-Aug 2004 oil prices have increased about 30%. In the same period year-on-year figures for world oil demand growth have also and consistently increased. Depending on the data and analysis, growth rate estimates through 2004 to date (September) have risen from around 1.8%-2.2%, to well above 2.75%-per-year. IEA chief Mandil, in late August, gave a forecast of around 3.2%-per-year, and expressed “surprise” at the complete absence of «price elastic» behavior by oil consumers and users, while also being “surprised” that oil majors show little or no inclination to increase exploration and development activity, especially in extreme deepwater and “frontier” environments. This inertia can easily be attributed to lack of faith in current oil prices staying that way, due to belief in a third myth, that the long-term oil price is «around 20 USD/bbl».

 

Price-levered demand growth

The reasons why a rise in oil prices feeds back, on balance and after the interaction of many different but easy-to-identify factors, to higher oil demand at the world level have been repeatedly explained by myself. One short cut is to focus two very clear, rapid-acting results of higher oil prices that soon lead to higher oil demand. First we can take increased liquidity or “more cash in circulation”, notably USD and Euros, due to fast rising values for oil transactions, and the almost automatic response of monetary authorities placing more money in circulation. This has a fast impact on world trade growth, levering it up, at present in 2004, to several times the rate of world economic growth. Another very clear pro-growth impact of higher oil prices is to lever up prices of non-oil energy-intensive commodities, that is «real resources», assuring revenue gains for generally low income exporters of raw materials. This quickly feeds back to world economic growth through increasing world solvent demand.

Increasing economic globalisation and interdependence in a context of rising «real resource» prices, for example “outplacing” or “delocalising” industrial activity from the aging, slow-growth OECD countries to lower-income, fast growing industrializing countries (that is transferring or “exporting” oil demand), results in increased economic growth for both parties. Higher oil prices can be taken as a major cause of “surprising” economic growth now observed even in the “hibernating” economies of the Eurozone, habituated to GNP growth rates of around 0.5%-1% annual. Examples of this include stronger growth outlooks for France and Germany, and the “surprising” growth of the Japanese economy through first half 2004, although internal deflationary and anti growth trends remain strong in these aging economies and societies.

We can suggest that certainly to 60 USD/bbl the overall balance of global economic impacts due to rising oil prices is pro-growth. Beyond this price level (around 60% of the real oil price of late 1979/early 1980) it is however likely that inflationary and recessionary impacts of price rises to above 75 USD/bbl will be dramatically increased by use of the «interest rate weapon» in the slow-growth, oil-intense economies and societies of the OECD countries. This is particularly the case for USA, Japan and South Korea, less so for the EU countries — due to much higher final or consumer prices for oil and energy in the EU countries, compared to the first three.

Outside the OECD group it is unlikely that prices of even 75 USD/bbl will automatically or rapidly reduce economic growth rates, as also suggested by the few “conventional” analysts and forecasters that care to treat the question of oil prices and their global economic impacts on a rational basis. One example is the recent RBS-Royal Bank of Scotland group study on potential impacts of oil prices rising to 80 USD/bbl.

 

Regional and national oil demand growth trends in 2004-2005

These are on the assumption that no economic recession results from a Kerry election, or Bush re-election in the US, and that there is no «oil shock» due to intensified and oil-targeted terror attacks by “Al Qaeda” or related organizations, focusing oil production, transport or refining installations, in the Middle East or Russia. Both of these assumptions are perhaps “heroic”. A post-election stock market crash in the US, triggering a domino set of bourse crashes outside the USA is far from impossible or unlikely; “Al Qaeda” attacks on oil infrastructures are more likely than ever, underlining the fact that US invasion and occupation of Iraq was rather certainly “oil related”.

World oil demand growth is likely running at 2.15-2.65 Mbd for mid-2004/mid-2005. In annual percent terms this gives about 2.7%-3.3% on a current demand rate (Sept 2004) of around 82.3 Mbd.

Growth outlooks by country and region can be split into 3 main groups, that is China (growth rate outlook of 0.6-0.7 Mbd); countries and regions with demand growth running at 0.4-0.6 Mbd; and “rest of world” where growth is around 0.25-0.35 Mbd.

Countries and regions with annual growth outlooks in the 0.4-0.6 Mbd region are: India and East Europe (aggregate demand growth about 0.45-0.6 Mbd); USA 0.45-0.6 Mbd; and Other Asia and West Europe (aggregate demand growth about 0.4-0.5 Mbd).

We can note that just two years continuous growth at this rate is close to the total present oil export capacity of Russia, and that less than 4 years is equivalent to total present oil export capacity of Saudi Arabia.

 

Andrew McKillop
Former Expert-Policy & programming,
Divn A-Policy, DG XVII-Energy, Euro Commission