The global economy has a lot of uncertain variables, and either a recession or long-term stagnation would cushion against any price spike.
With current trends of strong demand and cuts to investment on supply, the oil market could be heading toward tighter fundamentals and a price spike at some point. There are, however, mitigating factors on the supply side that could keep prices in check, explored in the first part of this series. This piece will look at what could occur on the demand side to keep another long-term bull market from taking place.
Economic downturn, or ‘secular stagnation’
A global recession is the biggest threat to a substantial run-up in prices.
The global economy has a lot of uncertain variables, and either a recession or long-term stagnation would cushion against any price spike. Although the fallout from the “Brexit” vote appears contained for now, it may shave off economic growth in the UK, the world’s fifth largest economy, and the EU, crimping global demand growth and slowing the path to rebalancing. The next economic shock could be fiercer, and a contraction in demand could rival 2008-9, when it fell by 1.4 mbd over the two years. The world economy hasn’t fully rebounded from that recession—the International Monetary Fund (IMF) says growth has been “too slow for too long.” The World Bank sliced its forecast of global GDP growth in 2016 to 2.4 percent from 2.9 percent last month, before the Brexit vote took place (see below).
Even if a full-blown economic recession doesn’t occur, a stagnant economy could bring about anemic growth and reduce the outlook for oil demand. The idea that the global economy is in a period of secular stagnation, essentially being stuck in neutral, was highlighted earlier this year by economist Larry Summers.
If secular stagnation has outsized effects in emerging markets, the key areas of growth, oil demand growth could tail off.
Despite unprecedented action taken by central banks in the wake of the 2008 crisis and stimulus measures from policy makers globally, growth has been relatively weak ever since. Current economic headwinds could portend even softer growth. If secular stagnation has outsized effects in emerging markets, the key areas of growth, oil demand growth could tail off. “It now appears likely that more capital will flow out of emerging markets and less will flow in than has been the case in recent years,” wrote Summers. “These capital outflows and the consequent increases in net exports will further reduce demand and neutral real rates in the developed world, thereby exacerbating secular stagnation.”
If oil demand, which grew by 1.8 mbd last year and is performing better than expected because of lower prices, takes a hit from either a recession or simply lackluster growth, it will be difficult for oil prices to have a sustained sharp rally. “Limited growth would keep the world in surplus longer than expected,” Jeff Quigley of Stratas Advisors told The Fuse.
Peak demand moves forward
Projections about peak demand can be as controversial as peak supply. Talk about demand reaching a plateau and subsequently declining has materialized every now and again for the past decade or so, but it’s always proved premature. The Energy Information Administration (EIA), in its latest long-term outlook, projects liquid fuel consumption to grow by a third over the next two and a half decades. Still, a number of forces—including shifts in the economy, penetration of alternative vehicles, and increased fuel efficiency—could come together to reach a peak in consumption sooner than some might suggest, helping put a cap on prices.
It’s important to note that demand growth for gasoil/diesel, kerosene, and fuel oil has already slowed, or even turned negative, in some areas, perhaps portending how weakening economic growth and greater fuel economy will shape oil demand moving forward. Most of the boost in the past couple of years has come from consumer-fueled demand for gasoline. For instance, so far in 2016, U.S gasoline is up 2.6 percent year-on-year, but diesel is down by more than 7 percent. In the U.S., despite all the talk of gasoline consumption rising, overall oil demand is still 1.3 mbd lower than its record in 2007.
China’s massive growth seen since the early 2000s will not be replicated elsewhere, JBC argues. “There will be no new China,” the analysts say.
JBC analysts in Vienna, in a report earlier this year, argued that global demand would peak during the second part of next decade and 2016 would be the last year with growth above 1 mbd. One main reason is that the world’s main growth center, China, has slowed and will not return to previous blistering levels, as the country undergoes structural changes, moving from a manufacturing-based economy to being led by consumers. China’s oil demand grew by 470,000 b/d from 2003-15, but is forecast to slow to 300,000 b/d in 2016 and remain near this level the rest of this decade, before falling some more.
China’s massive growth seen since the early 2000s will not be replicated elsewhere, JBC argues. “There will be no new China,” the analysts say. While India will see high growth rates on a percentage basis, the increases in volumes will be relatively modest (see graphic below from JBC).
In the next two and half decades, the IEA says, India will boost oil demand by 6 mbd, making it the largest grower globally. But growth will average a modest 240,000 b/d per year, which could simply be offset by contractions in the OECD. By contrast, in the past 25 years, China’ demand has grown by 9.1 mbd, with 2004’s increase at a massive 860,000 b/d. Beyond India, the next largest countries in emerging markets, even when population growth is taken into account, are not big enough to produce hefty volumetric increases in demand.
There’s also the growing likelihood that alternative vehicles will become more compelling, particularly with large number of small-size electric vehicles now more popular and affordable as battery capability improves and charging infrastructure expands. “On top of all of these developments, there is the simple fact that the average gasoline and diesel vehicle efficiency continues to improve,” says JBC.
Not yet a foregone conclusion
A price spike down the road, whether later this decade or in the early 2020s, is indeed a strong possibility. However, there’s plenty of upside for supply while ongoing changes in the global economy and the penetration of alternative vehicles could bring profound changes on the demand side. An extended period of investment cuts and the fact that petroleum products still fuel more than 90 percent of the transportation sector could mean we’re headed for another boom—but it’s not yet a foregone conclusion.