Oil prices won't recover without significant increase in demand

In the past, such an increase would have been seen as inevitable in the wake of cheap prices and falling supply, but that may no longer be the case. The demand destruction caused by years of high prices will be far harder to reverse than in the past thanks to a mix of technological advancements and government mandates limiting oil consumption. And, even if consumers wanted to use more oil, they may not be able to do so.

National initiatives in many countries aimed at reducing oil consumption could increasingly cap any potential increase in demand. Take the steady increase in fuel economy standards in the US. In 2013, vehicles in the US achieved an all-time record for fuel economy at 24.1 miles per gallon, which is five miles per gallon more than a decade ago. This increase is set to continue in the decade to come and is projected to save nearly 12 billion barrels of oil by 2025. By then, standards will hit 54.5 miles per gallon.

Next comes oil indexation to GDP. Generally, as an economy has grown, so has its consumption of oil. But the connection between oil consumption and economic growth has grown tenuous over the last few years as the Western economies have transitioned from industrial to informational and service centricity. For example, while US GDP grew 8.9% since 2007, demand for finished petroleum products dropped by 10.5%, according to Bloomberg New Energy Finance. The overall oil-consumption-to-world-GDP ratio declined by 60 percent between 1980 and 2013, with most of the decline accounted for by the advanced economies, says the IMF. In fact, the US is consuming a third less oil per dollar of GDP than it was back in 1976, and it will just go lower from here.

But not all economies are as oil efficient as the US. Developing nations, such as China, along with its fellow BRIC (Brazil, Russia, India and China) nations, are more dependent on oil to drive their economies than those in the West. Unfortunately, the BRICs economies aren’t doing so hot economically at the moment, which has direct consequences for world oil consumption as they are the main drivers of oil demand growth globally.  The emerging markets will hit their sixth straight year of reduced growth rates, according to the latest IMF economic forecast. China’s economy grew at a measly 7.4% last year and isn’t expected to do much better this year. Russia’s economy is also suffering due to weak European demand as well as the sanctions levied on the back of their Crimean escapades. And Brazil is getting hit from all sides as investment dollars flow out of the country. The result is an anemic increase in world oil demand projected to be at around one million barrels a day in 2015, according to the EIA, which is weaker than in the past.

This could go from bad to worse in the months to come. The recent loose monetary policies implemented by the central banks of Japan and the Eurozone have led to a sharp appreciation of the US dollar vis-à-vis the Yen and the Euro. The IMF warned last week that this appreciation could not only threaten the US economy, but could also deepen China’s economic slowdown as the Yuan is informally pegged to the dollar. The cumulative impact could see oil demand stall, or even fall.

Then there is technology. Sustained high oil prices paired with environmental concerns have not only led to changes in government regulations, but they have also ushered in a whole new area of science bent on replacing oil as the world’s transportation fuel. Take electric vehicles. Changes in battery and storage technology are expected to bring the price of electric vehicles down to more affordable levels in the coming years. As such, electric vehicle penetration in the US vehicle market will rise from its current level of 1% to 6% by 2020, even if oil prices average $2.09 a gallon, according to a new study by Bloomberg New Energy Finance. If it averages around $3.34 a gallon, then they should rise to 9%, the study says.

Along with research into new and more exciting battery technology, we are also seeing new ways to utilize existing battery technology that could encourage electric vehicle penetration. The Chinese government planning agency said this week that they would like to use the batteries in electric vehicles as storage to help stabilize the output of their rapidly unfolding wind and solar business. An electric car with a range of 250 km can store 40 kWh of electricity.  Multiply that by the five million EVs that are supposed to hit the road in China by the end of year and that’s a whole lot of power.

There are also exciting things happening in the realm of green electricity generation, but that will have a more muted impact on oil demand as the vast majority of the planet uses oil only as a transportation fuel. Saudi Arabia is an exception. It burns 900,000 barrels of oil a day, around 1 percent of total world production to supply 50% of its power needs. But even the Saudis are going green. Advances in solar technology and battery storage are allowing the Kingdom to harness the sun for most of its energy needs. They plan on spending a whopping $109 billion to install 41GW of solar power by 2032, and replacing much of the rest of its oil burning fleet with natural gas plants in the next few years as well.

It is unclear when or even if oil demand will respond to the recent drop in oil prices. While there are reports of SUV sales on the rise, it isn’t like we’re seeing Hummer dealerships opening up at the mall. Indeed, the IMF said last week that the fall in oil prices hasn’t boosted growth as much as they originally believed as many countries are negating the drop in prices by raising taxes or cutting fuel subsidies. They now say that the initial collapse in the oil price from $110 to $82, which occurred from late July to mid-October, was 96% due to a collapse in demand, not an increased supply. The drop seen later in the year, when prices fell below $50 a barrel was due half because of supply and half because of demand. Now that oil has recovered to around $60 a barrel, it will need demand to perk up if it wants to go any higher. But given all these headwinds, and barring any geo-political dust-up, it is hard to imagine a big, sustained run up in prices in the near future.

http://www.forbes.com/sites/chipregister1/2015/04/23/oil-prices-wont-recover-without-significant-increase-in-demand-and-thats-not-likely-anytime-soon/?ss=energy