2009 Oil Market Review as OPEC Meets

As OPEC members meet today Tuesday, December 22, in Angola, it is worth taking stock of why OPEC has no choice but to yet again refrain from making any production changes in order to maintain prices above the low US$70s per barrel. Compliance with the 4.2 million barrels per day (Mb/d) cuts announced by OPEC members in late 2008 is currently around 2.25Mb/d.

Oil Demand
During the 2008-2009 recession global oil demand fell by 2 Mb/d from over 86 to 84Mb/d (chart 1). Global demand is beginning to grow again. The charts in this post (click to enlarge) use monthly data and 12 month rolling averages to adjust for seasonality.  The latest point used for EIA data is November 2009.

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Almost all the global decline was concentrated in developed OECD nations (chart 2). Less developed non-OECD nations such as China and India only saw a temporary stagnation and are now exhibiting growing demand (chart 3).  Non-OECD oil demand has surpassed 2008 highs.

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Of the OECD decline, one third came from the US, one third from OECD Europe, and one third came from the remaining developed OECD countries.

The US accounts for just under 23% and Europe 18% of 2009 global oil demand. In late 2009 oil demand in the US and Europe appears to have stopped falling (see charts 4 and 5).

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Oil demand in the US was destroyed more in absolute barrels over the past few years than in any other region.

The severe demand destruction in the US had a lot to do with current US oil consumption patterns (76% of Americans get to and from work by driving alone) and infrastructure (average US vehicle fleet efficiency is less than half that of available technology). Relatively inefficient consumption allows for swift efficiency gains compared with other parts of the world which are already at or close to maximum technically available oil consumption efficiency.

Looking at total US oil demand (chart 4) one may perceive that it is in a steady decline which can perhaps be extrapolated into the future. However, delving deeper into the data provides clues as to exactly why US demand declined and why this decline has ended.

The total number of miles driven on US highways has stabilized and is increasing (chart 6-a).

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Interestingly, the pattern in which miles driven changes has defined every recession since the 1970s and defines the latest recession as V-shaped (chart 6-b).

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This stabilization and increase in highway miles driven is showing up in US gasoline demand which is no longer falling and has begun to grow again (chart 7). Gasoline demand accounts for almost half US oil consumption.

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The recovery in gasoline demand is because people are cutting back on vacation spending by driving rather than flying to holiday spots. This certainly syncs with the fall in jet fuel consumption (chart 8) and anecdotal evidence. Businesses have also been cutting back on flights.

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The decline in jet fuel consumption is more than offset by the increase in gasoline consumption. Combined, jet fuel and gasoline demand (together 57% of total US oil demand) are beginning to recover (chart 9).

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Where is the remaining weakness in US oil demand? It is in industrial oil demand. Demand for distillate (diesel and heating oil), residual fuel oil (mostly used for shipping and a little for electrical power generation) and other oils (lubes, waxes, asphalt, plastics and a bunch of other oils).

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Aggregating these three categories of US oil demand into “Industrial” demand, these industrial oils account for 43% of total US oil demand (chart 11).

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To see a strong recovery in US industrial oil demand there would have to be a recovery in consumer spending (linked to unemployment, housing and the savings rate), manufacturing activity (especially autos), and private services sector activity. Most indicators in these macroeconomic areas have begun to stabilize and improve over the past couple of months.

So why have oil prices stabilized in the US$70-80 per barrel range if the reduction in global demand is recovering such that it is now down only around 1Mb/d year/year?

Oil Supply
In the face of the oil demand collapse which began in mid-2008, OPEC members (which produce just over 40% of global supply) announced in Q408 that their new quota would be a 4.2Mb/d cut from their September 2008 output level of 31.4Mb/d. OPEC members implemented just over 3Mb/d of the cut at the beginning of 2009.

Throughout 2009 OPEC compliance slipped, with core OPEC producers such as the Saudis holding more firmly to their commitments and lesser OPEC producers cheating.

OPEC supply in December 2009 is down around 2.25Mb/d compared to September 2008. OPEC NGLs production (not counted in OPEC quotas) is up 0.8Mb/dd. So net total OPEC liquids (OPEC definition of “crude” Plus NGLs) is down 1.45Mb/d since September 2008.

Non-OPEC output (adjusting for the effects of hurricane shut-ins) is up around 0.5Mb/d year/year.

So net total liquids output (OPEC plus non-OPEC) will be down 0.95Mb/d in December 2009 compared to September 2008.

Global supply has done a masterly job of removing product from the market as demand collapsed.  The supply decline of around 1Mb/day is offsetting the current demand decline of 1Mb/day year/year with one exception: floating inventories.

The incentive to store crude oil, residual fuel oil and distillate (diesel, heating oil and jet fuel) on floating tankers has absorbed some of the supply which OPEC delivered into the market.  Due to a contango forward curve inexpensive tankers were used to store a very large amount of oil throughout the year until September 2009.  It has been this oil coming ashore since September which has capped prices at US$80 per barrel.

At the OPEC meeting today Tuesday, December 22, OPEC members have no choice but to maintain existing production cuts in order to keep the global market in balance (a balanced market has inventories neither increasing nor decreasing) and hold onto 2009 price gains.  If OPEC maintain their existing cut compliance levels of just over 2Mb/d then as soon as the drawdowns of floating inventories ends higher prices and a re-test of US$100 per barrel will be on the cards for 2010.
 
OPEC will have to wait until their next meeting to increase production if they want to defend US$70 per barrel.