Will Market Demand Correct the Negative Oil Shock?

CEIC WorldTrend Data Talk - December 18, 2014 At its meeting on November 27, 2014, OPEC saw a streak of discord within its ranks and what seemed to be a tougher stance from the Gulf States against their competitors in the oil market. Fiscally-troubled OPEC countries, such as Venezuela and Algeria, requested a cut in oil output in an effort to put a stop to plummeting oil prices. However, the wealthier oil producers blocked such attempts, rolling over their output quota in a move designed to keep their market shares, suppress shale oil production in the USA and stay in a position to benefit from increasing price-driven demand. This resembles the way of thinking during the late 1980s oil glut, but the question is: will this work in the present climate with governments backing ambitious environmental programmes and consumer sentiment shifting away from oil? Oil prices have been affected negatively since weakened demand in the advanced economies met with slowing Chinese GDP growth after 2008. The latter amounted to 14.2% in 2007 but has slackened to 7.7% in 2013, and is forecast to fall below 7% this year. Falling demand has led to considerable market over-supply, exacerbated by the development of shale oil extraction in the USA, where oil exports quadrupled between January 2008 and July 2014 to reach USD 12.4 bn. Crude oil prices have fallen sharply by USD 39.7 between July 2014 and mid-December 2014 to USD 67.1/barrel, which compares to an all-time high of USD 132.6/barrel in June 2008. OPEC countries with larger foreign exchange (FX) reserves, such as Saudi Arabia (measuring USD 736.2 bn in October 2014), can withstand long periods of low prices without seeing public spending cuts or their wealth depleting. However, their smaller partners, such as Venezuela and Iran, have high hopes that global demand will pick up soon. Annual oil exports growth of the group of oil exports earning countries has increased only marginally since the beginning of 2014, while year-on-year growth of USA’s exports has been quite unstable, turning negative for two consecutive months in September and October this year. It can also be observed in the chart above that the sudden drop in oil prices in 2008 affected even major oil producers’ FX reserves, so an indefinite period of low oil prices poses risks to all oil producers, and it is no wonder they are all in need of higher energy demand. However, China’s response to the low prices, namely raising oil reserves, and introducing an energy plan to curb coal consumption, offers little hope for reviving market demand. Furthermore, the advanced economies seem to be on course for a limp recovery, while hopes of counterbalancing growth inform the emerging markets look increasingly dim. Another factor affecting oil demand which should be considered is consumption efficiency, measured as fossil fuel use per unit of real GDP. The logic that low prices will decrease efficiency and vice versa was only slightly visible in North America and the EU during the fossil fuels price surge in the 1970s and 1980s, and the trend has been positive regardless of price movements afterwards. The East Asia and the Pacific regions are prominent examples of price-affected efficiency in the 1970s, but the results afterwards do not support any such expectations. It seems that only South Asia’s efficiency has followed fuel prices and the market can expect a rise in oil demand there, but alas, the region’s consumption comprises only 6% of the world’s total. Oil prices were traditionally deemed to have low elasticity to demand, but still affect the latter over time. However, the world is changing in terms of fossil fuel usage. China has joined advanced economies’ efforts in combating pollution and the latter have pushed their environmental programmes even further to lessen the reliance in favour of renewables. Greenhouse gas emissions from the energy, industry and transport sectors have been decreasing and protected areas have increased by around 20% globally between 2002 and 2012. This engagement with environmental protection can keep demand for oil lower than the price-driven expectations, and force even the largest suppliers to reduce output amounts. By Hristo Nikodimov - CEIC Analyst Discuss this post and many other topics in our LinkedIn Group (you must be a LinkedIn member to participate). Request a Free Trial Subscription. Back to Blog
18th December 2014 Will Market Demand Correct the Negative Oil Shock?