Traditionally,
demand levels would determine the overall condition of the oil market.
Supply (and the investment required for that supply) would be based
upon what demand told us.
Actually, oil never reflected the demand-supply relationship as
well as other sectors of the market. Oil has an irritating habit of not
reflecting what it should in the dynamics of market play. Until
recently, petroleum economists would comment (or lament) about the
demand inelasticity of oil. That means, due to the lack of available
alternatives (especially in transportation), demand for oil products would not decline as the price rose.
Such a relationship has certainly been tested over the last
several years. The New York market price for West Texas Intermediate
benchmark crude (WTI) moved from a $147.27-per-barrel high in July of
2008 to below $33 by the end of that year, only to rise again to almost
$114 by the end of April of this year. It's moved back down to the
$85-$90 range since then.
We did witness some demand destruction in the summer of 2008, and
then (to a much lesser extent) in the spring of this year, with the
rise of prices at the pump to well over $4 a gallon.
Yet what must be remembered is the simple fact that developed countries no longer call the shots in oil demand.
This is now – officially – a global market.
On the production side, of course, it has been a global
market – for more than 50 years. The primary reserves are located in the
Middle East, the former Soviet Union and offshore in places stretching
from Vietnam and Australia to the Arctic basin. The supply side,
therefore, has been global for some time.
But now the demand component is also global in scope.
This changes everything, as you'll see. And there's even a way to track
this new (and more accurate) demand for oil.
Three "Crude" Shifts
By fixating on U.S. demand, analysts exhibit an out-of-date
tendency. The description of the American market as "having less than 5%
of the world's population yet consuming 25% of the world's energy" no
longer has the impact it once did.
Yes, the U.S. remains one of the two largest end users
internationally (the other being China). But the spike in demand is
coming from developing parts of the world. As demand figures move
latterly in North America and Western Europe, they are accelerating
elsewhere.
Three elements are leading to this rise.
1. The industrial and production advances in
China and India, along with the East Asian recovery and the more recent
moves in Indonesia, have resulted in substantial increases in energy
demand. That translates primarily into an increase in the need for oil.
2. OPEC members such as Saudi Arabia and Kuwait,
as well as main non-OPEC producers like Russia, have been withholding
more of their crude from the global market to advance their own
refining and petrochemical sector. The move is not simply to supply
rising domestic demand, but also to provide a larger value-added oil
product export stream to improve return.
3. Regions usually ignored by analysts are registering accelerating demand. One of the most pronounced is West Africa…
Nigeria is certainly a major international oil producer (and one
of the last sources for prized light sweet crude, which requires less
processing). However, the country has insufficient refinery capacity,
resulting in most of the crude being exported.
On the other hand, Nigeria produces only about 15% of the
electricity needed daily. That means 85% of the power comes from private
generators. Those generators run on diesel. And the vast majority of
that diesel must be imported.
Similar trade cycles are emerging in other areas of Asia and Africa. They are likely to become more pronounced.
The combination of these three factors completely overwhelms any
sluggishness in U.S. demand figures. This offset is continuing.
So what does this tell us about the overall picture?
Demand Is Hitting An All-Time Record
Global demand will come in this year at an average 88.2 million
barrels per day, an all-time record. That level will extend to 89.4
million barrels per day by mid-2012.
Yet, the headlines today speak of OPEC decreasing demand
forecasts. The OPEC projection had been at 88.7 million barrels for
this year. That higher figure, however, had been more political than
anything else. It was advanced before the last OPEC meeting, in which
Saudi Arabia failed to entice a production increase.
That was followed by Riyadh unilaterally increasing production
some 500,000 to 700,000 barrels per day (nicely matching the difference
between the two estimates, by the way) along with the poorly-conceived
International Energy Agency (IEA)/U.S. move to release 60 million
barrels from strategic reserves (half of that U.S.).
The reserve release accounted for only 18 hours of international demand.
It was never a factor.
The important point to remember is this:
The global demand rise between June and the end of the year is
poised to absorb all of the additional Saudi volume… and would have
swallowed up continued IEA monthly releases as well.
The demand picture has not changed. In fact, as the market has
revealed a number of times before, any short-term reductions in the
price will merely result in an additional encouragement to demand.
The global picture is one of the primary reasons why Brent, the
London benchmark used more often to determine prices in other regions,
has a price more than $20-a-barrel higher than WTI traded in New York.
That has been the case now for a year, despite WTI being a slightly
better grade of oil than Brent.
The vast majority of oil traded on a daily basis globally is
inferior in quality to both of these benchmarks. But Brent is employed
more as the standard against which oil is bought and sold at discount.
You can track the price of Brent right here. There's an ETF that tracks it, too – the United States Brent Oil Fund (NYSEArca:BNO).
Keep an eye on it, because it will tell you what is really happening worldwide.
Sincerely,
