Stronger-than-expected demand to drive oil prices, experts say

Nick Snow
OGJ Washington Editor

WASHINGTON, DC, Jan. 7 -- Stronger-than-anticipated global demand apparently is the main reason crude oil prices began to rise late in 2010, four experts suggested. Growth in China has been particularly robust, they agreed.

More details will emerge when the US Energy Information Administration issues its latest Short-Term Energy Outlook on Jan. 11 and the International Energy Agency publishes its next Monthly Oil Report on Jan. 18. But IEA Chief Economist Fatih Birol warned on Jan. 5 that a recovering global economy faces a threat from rising crude prices.

“Oil prices are entering a dangerous zone for the global economy,” Birol said. “The oil import bills are becoming a threat to the economic recovery. This is a wake-up call to the oil-consuming countries and to the oil producers.”

Birol’s observation followed a recent IEA analysis that found that oil import prices for Organization for Economic Cooperation and Development member countries climbed by $200 billion to $790 billion by yearend 2010. The trend toward higher prices emphasizes the need for consuming countries to increase efforts to reduce the amount of oil they use, particularly for transportation, he suggested.

That would need to take place amid oil demand that was surprisingly strong last year, experts told OGJ. “Contributing factors include a cold winter in the United States, and increased demand in China from diesel use restricting grid generation,” American Petroleum Institute Senior Economist Sara Banaszak said. “Economies also are recovering worldwide, and demand also has been strong domestically.”

‘More pressure’
Lost production from the Gulf of Mexico following the Apr. 20 Macondo well accident and subsequent oil spill also may have contributed to higher prices, but other factors were more important, Banaszak said. “[US President Barack] Obama came into office with prices around $70/bbl, and his years in office gave us a break from oil price pressure. Certainly, we all want the economy to recover, but it will put more pressure on oil prices,” she said.

David Pumphrey, energy and national security deputy director at the Center for Strategic and International Studies, said, “Certainly, on the fundamentals side, there’s been a strong economic recovery from a couple of years ago. China’s economy barely stumbled before starting to recover. But there also is a pretty big surplus capacity within [the Organization of Petroleum Exporting Countries], particularly in Saudi Arabia. So in fundamental terms, prices should be more stable.”

They have climbed, however, which Pumphrey said makes him wonder if investors are putting more money into oil. “There’s still a sense of trying to separate supply/demand fundamentals from the role oil plays as a longer-term investment. That’s still uncertain,” he said, adding, “On balance, I think what we’re seeing is a kind of perception that oil is a good place to put money because the supply-demand fundamentals are exerting a lot of upward pressure.”

Adam Sieminski, chief energy economist at Deutsche Bank’s global markets and commodities research department, said that group’s analyst who follows China says that demand grew there by just over 1 million b/d in 2010, compared with IEA’s 880,000 b/d estimate. “We think demand in China is likely to be up 880,000 b/d in 2011, while the IEA is only looking for 450,000 b/d. It’s key because it’s so big. There were internal policies there which encouraged more consumption,” he said.

“The good news, from the consumer’s standpoint, is that there‘s plenty of spare capacity in OPEC and spare inventory,” Sieminski continued. “That said, demand was higher in 2010 than expected and is fairly robust at the beginning of 2011. OPEC’s supply, while solid, looks as if it’s going to be plateauing in the next 3-5 years.” That perception could be affecting global crude markets, which respond more to what could lie ahead than what’s happening now, he said. “I think it’s reasonable to assume that markets will be tighter. They don’t wait for supplies to tighten; they react now, and this economic reality always seems to surprise politicians,” Sieminski said.

Weakening US dollar
Christopher Guith, vice-president for policy at the US Chamber of Commerce’s Institute for 21st Century Energy, also noted that China did not feel the recession as much as the rest of the world did and it began to recover sooner. But he also suggested that the US has used monetary policy to make the dollar more liquid, which has reduced its global purchasing power.

“China, which is not tied to the US dollar, could buy the same amount of oil for less. My economist friends tell me the dollar is becoming more stable and it should be less of an issue,” he told OGJ. “They also seem to generally believe we won’t see the kind of oil-price spikes we saw in 2008 because we’re in better supply shape and OPEC is more likely to keep incremental production at its marginal sweet spot.”

Sieminski also did not consider the current situation similar to 2008. “There was no spare production capacity then. Most of it had been used up between 2004 and 2008, and there also was very little spare refining capacity,” he explained. “To be more precise, there was spare production capacity but it was largely heavy oil and there were no refineries to take it. In the first half, everyone seemed to think we were in a new era of no recession and demand was growing.

“That seems to contradict charges of rampant speculation,” he maintained. “With everybody thinking that demand would move up continually, the markets responded accordingly. Then the recession solved the problem of spare capacity—in a very nasty way.”

Sieminski said OPEC may need to be careful now to not let the global oil market get too carried away. “The Saudis can turn the spare production on now, but people may be thinking that in 3 more years, we’ll be back in the same boat we were in back in 2008,” he said, adding, “Even though speculators may have had something to do with the forward momentum, other major forces, essentially the economy driving demand and investment cycles driving supply, are much more significant.”

Overseas production
The production growth outlook outside North America appears mixed, the experts said. “Russian production has been coming back up. It recently set a record for the post-Soviet period. It hasn’t been below expectations,” Pumphrey observed. “Venezuelan expectations have been written down for a while. It seems to be producing as much as it can. The Saudis seem to be very strong. OPEC behavior matters as well. Most statements, particularly from the Saudis, say they don’t benefit from a price runup. How quickly they can accommodate increased demand is another issue.”

Sieminski surmised, “Venezuela and Nigeria have obvious internal political problems. As far as Russia is concerned, they’ve actually been an up-side surprise in 2010, starting at the beginning of the year, and could continue that way in 2011. EIA has Russian production down 150,000 b/d in 2011. We believe it will be flat-to-up.”

Guith told OGJ: “Over the long run, Venezuela, Russia, and Nigeria always pose production risks because of their reliability. On the other hand, countries like Brazil are making their production grow, and there’s much more exploration off Southeast Asia as well. They’re more expensive to produce, but as North America grows more and more inaccessible, that’s where companies are going.”

That trend has accelerated since US Interior Sec. Ken Salazar removed most of the US Outer Continental Shelf from the next 5-year program because of concerns emerging from the Macondo accident, Guith said. “Ultimately, it could become a political issue, but if you look at what America spent on imports last year, it rose by $72 billion,” he said. “The more we take domestic supplies off-line, make them inaccessible, or delay their production for decades, the more we have to import at a time when we can least afford it from an economic standpoint.”

The question of what resources actually will be available onshore as well as offshore may have a long-term effect on prices, Pumphrey said. “Investors may hesitate, especially since the presidential commission report indicates there are still issues with regulatory processes,” he said.

The Iraq question
Oil markets also aren’t certain about Iraq’s production prospects, particularly since production there hasn’t changed much in the last 5 years, Pumphrey told OGJ, while Sieminski separately observed, “We need stability in Iraq to have stability in the oil markets.”

Sieminski maintained that if any single force was responsible for oil prices rising so much in 2010, the simplest explanation is that global oil demand grew by more than 2.5 million b/d—“a huge climb.” He said, “No one was talking about an oil shortage, but the growth was about twice the level of what people were talking about a year ago.”

He added that the seemingly inexorable rise in OPEC’s market power is also closer. “People who thought things would be tight around 2015 at the beginning of 2010 now see a year’s faster-than-expected growth in demand, so now it seems more like 3 years instead of the 4 years it would have been if demand hadn’t been so strong,” Sieminski said. “OPEC can produce the oil, but in the next 5 years, the world will need Iraq’s capacity to grow to keep OPEC’s spare capacity from shrinking.”

Contact Nick Snow at

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