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5 "Tells" that the Stock Markets Are About to Reverse

IEA Report Shows We Are Already In A 'Peak Oil' Context

Commodities / Crude Oil Mar 20, 2012 - 12:54 PM GMT

By: Andrew_McKillop


Best Financial Markets Analysis ArticleThe most recent IEA Oil Market Report, for February, could be interpreted as bringing some good news to oil importer countries of the OECD group, for which the IEA is the "energy watchdog agency". Its report said that oil demand in the OECD group, at about 46.25 million barrels per day (Mbd) was still 1.25 Mbd below the 5-year average for oil consumption by the 30-nation developed economy group.

The OECD group has a total population of about 1.05 billion, 14% of world population, and consumes slightly more than 50% of world total oil supplies - but nonOECD consumption is progressing fast.

The report pointed out that reduced oil demand was almost exclusively due to recession, led by sharp oil demand declines in some OECD Europe countries since 2008 and by declining US oil demand since 2008. OECD Pacific countries, including Japan and South Korea have already renewed their growth of oil demand, and the outlook for US oil demand is for an end to decline, as the US economy's industrial output recovers.

The report treats the demand side, before the oil supply side highlighting that oil prices, at least since 2000-2005, are heavily and more affected by demand changes, than by supply changes. Not referring anywhere in its report to Peak Oil, this report like others in the same series however highlights the changing fundamentals of world oil, which show there is a "megashift" in progress towards Peak Oil.

The main findings of the latest Oil Market Report can be summarized this way:

*Oil demand can easily "bounce" in OECD countries, including Europe, and demand remains very strong in non OECD countries led by China, India, other Asian, many African, and Latin American countries;
*Oil supply is tight, as witnessed by the impact of slowly growing and small-sized embargoes on Iranian supply, and net additions of global supply capacity, due to depletion and high development costs, that are now vanishingly low;
*Oil inventories are declining, low or very low in nearly all world regions;
*Market prices are high and converging at a high level, pulled up not down by continuing high demand and anticipations of supply shortage in 2012;
*Refinery runs in major global regions, and oil product imports also underline a supply/demand context of tight supply but strong demand, that is "Peak Oil".

This report cut back the IEA's forecast for global oil demand growth, from its previous of 1.1 Mbd in 2012, to 0.8 Mbd, for an 0.9% growth on the IEA's forecast of year average global demand through 2012, of 89.9 Mbd. This demand level, we can note, is considered by several major figures of the oil industry, such as Total Oil's CEO C. de Margerie as very close to the maximum possible sustainable extraction and production of oil at the world level, of perhaps 90 - 95 Mbd. After that peak is attained, supply will decline.

The role of economic type or structure and economic growth, for each country, has major impacts on how much that country's oil demand will grow for a 1% growth of its GDP, as the IEA shows with several charts and tables in this report.

Economic growth in China and India, for example, is a lot "thirstier" for oil, than the lower levels of economic growth in the slow-growing OECD economies. However, given the structure of global economic growth now strongly led by China, India, other Asian, many African and Latin American countries and the OPEC states (the non OECD group), the IEA's forecast that world total oil demand will only grow by 0.9% in 2012 is neither rational nor likely.

China's GDP forecast, given by the IEA, is of 8.2% growth, and India's forecast GDP growth is 7.5% implying their oil demand growth for 2012 will attain at least 5% for China and 4% for India. This alone would raise global demand, in the absence of declining OECD oil demand, by about 0.675 Mbd, while the IEA forecasts that world total oil demand growth will only be 0.8 Mbd in 2012. Taking a rational analysis of world oil demand and strong economic growth not only in China and India but in most other non OECD countries, global oil demand can easily grow by 1.8% - 2% in 2012. 

On the supply side the IEA is forced to note that declines and losses of production in many countries, including North Sea producers, Syria, Yemen, Oman, Nigeria, Sudan, Kazakhstan, Azerbaijan, Malaysia and others are only just compensated by rising production in producer and consumer countries including Canada, USA, Colombia, Saudi Arabia, Russia and others, for an overall net addition to world production capacity in year 2011, using IEA data, of 0.1 Mbd (net change through January 2011-January 2012).

The US Energy Department's (EIA) briefing, in February, to American federal agencies and political deciders on the possible impact of Iran oil embargoes, with the probable loss of Iranian supply to July 2012 attaining about 0.6 - 0.8 Mbd (on Iran's total oil export supply capacity of about 2.3 Mbd), was that the current global supply/demand outlook is of world supplies running at least 0.3 Mbd behind demand, even with Iranian supply. This in turn explains the major impact on oil market sentiment, and higher prices, due to the gradual application of oil embargoes against Iran, at present only by the US and EU27 countries, and not by China or India.

Using IEA data, OECD demand at about 46.25 Mbd in early 2012 remains at more than 50% of world total demand, but the OECD group has been expanded, especially by adding Mexico, South Korea and Poland since the mid or late 1990s. Relative to the "core OECD countries", not including these most-recent major additions (other smaller countries have also recently joined the OECD), non OECD countries have consumed more oil than the "core group" OECD since 2010-2011. This trend will continue, due to much higher linkage of oil demand with economic growth in non OECD countries, and due to their much higher rates of economic growth.

This in turn will tend to raise, not lower, the expected growth of world oil demand for a 1% growth in world GDP, at a time when net annual additions to world oil supply capacity are extremely low, and costly to attain, and the probable maximum possible sustained output of 90 - 95 Mbd approaches rapidly.

This change of demand trends is economy-driven, but even for the slow-growing OECD group its oil demand performance in the recession years since 2008 is more intensive than in the recession years of 1980-1983, when in dollars of today's value oil prices attained a high of about $213 a barrel, in 1980. Charts and diagrams in the IEA report show that only in 2009 did the OECD group show as high contraction of oil demand as it did in 1980-83 and since 2009 is more oil-intensive. In the OECD Pacific region, Japan's relatively strong growth of oil demand in 2011 despite very slow economic growth can be explained by the impacts of the tsunami and the Fukushima disaster, raising the country's need to import refined oil products, but with no surprise Chinese and Indian oil demand show the most intense growth.

For China, which in 2001 consumed 3.67 Mbd but at end 2011 was consuming 9.3 Mbd the average annual growth on a 10-year basis was 9.74%, while India's annual growth of oil demand was more than 6%.

This focuses attention to the actual capacity, and theoretical spare capacity of the OPEC states, which according to the IEA report had either unused or potential spare capacity of 3.6 Mbd as of February 2012, but for many analysts this figure is heavily overestimated. These estimates place OPEC's real spare and quickly available (under 90 days) capacity as about 2.5 Mbd, mostly Saudi. Total current export supply capacity of the OPEC states, including Iraq (3 Mbd), is set by the IEA at 34.6 Mbd, with several scenarios for OPEC export capacity through 2012. This capacity has in recent years shown very low net growth mainly due to slow additions to production, and domestic oil demand growing in several OPEC states at well above 5% per year.

Outside OPEC, in the "NOPEC" group headed by Russia, actual production and export capacity increases through 2011, according to the IEA, have been very low in percentage terms, except in Canada, exclusively due to tarsand oil and Canada's slow growing domestic oil demand. Net export capacity by Russia and the FSU producers of Central Asia declined by 0.35 Mbd in 2011, mainly due to domestic oil demand increases.

Conversely, depletion losses in the NOPEC group of exporter countries (and former exporters such as the UK) are often impressive. Taking the North Sea producers of Norway, UK, Demark and Germany, their peak total output was in 1999 at 5.9 Mbd, but 2011 production was 3 Mbd. This is a 50% loss of capacity in 11 years.

The IEA report is resolutely bullish on Brazil's rising output from deepwater reserves, and on US shale oil output growth, but unlike some observers, the IEA does not forecast these can become NOPEC exporters, some day. Using IEA data on current trends for US shale oil production increase, the US would require some 25 - 35 years of output growth, at current rates, to attain self-sufficiency in oil.

Falling stocks worldwide are reported by the IEA. While for US and Canada these declines are only small, in Europe they are very large and come during a period of normal build, not decline. This in turn probably signals that European oil demand is set to "turn around", and cease declining, but the IEA does not draw that conclusion. Stock declines have also been large in 2011, for special reasons, in Japan.

The IEA interprets Europe's very large inventory falls as due to refiners and traders expecting backwardated prices to continue and because of this, are running down crude oil stocks. This is in fact not entirely logical in a pricing context either likely, or very likely moving to contango, with higher future prices. A more logical interpretation is that European refiners were expecting, or hoping for a fall in global crude prices, especially Brent prices in the present January-March quarter, and will now increase their purchases of crude, further driving the trend to higher prices.

Another interpretation (not given by IEA) is that European refiners and traders overestimated the decline of oil demand in Europe, which was in fact turned around by cold winter conditions. Also supporting that argument, European diesel fuel demand, as well as heating oil demand, has been sustained since late 2011 even in debt-wracked Italy and Spain.

The IEA gives major attention to the Chinese oil inventory puzzle, the question as to why Chinese stocks have very recently been rising. The IEA attributes this to flattening demand due to slowed economic growth, and due to variations in the rate of build of the Chinese SPR (strategic oil reserve), while also suggesting that if the build of SPR stocks resumes, or accelerates in 2012, this could further raise China's oil demand. The IEA does not interpret the  recent and current large increases in refined product and crude oil exports by China to Japan as being operated through drawing down China's SPR stocks, rather than regular commercial oil stocks. If this is the case, Chinese oil import demand will rather strongly increase later this year, due to rebuilding of both.

Relative to 5-year average stocks, the world picture is that they are quite low. For the non OECD group this has special significance because their oil demand, over 5 years, has in several cases increased by more than 30%, making a comparison of today's stocks and today's demand, relative to 5-year averages a considerable underestimation of the real fall in stock levels relative to present day demand.

The IEA attributes global oil price rises, led by Brent grade prices in January-February more to winter conditions in Europe, than to Iran. That is the demand side was more important than the supply side. Another indicator of recovering demand (OECD) and strong demand (nonOECD) was the general growth of crack spreads of refined products against crude in nearly all world markets. Why WTI prices trail Brent prices is also considered in some detail in the IEA report, covering a range of factors extending to proposed or possible changes by the US CFTC and European regulators on oil trading accountability.

More significant concerning demand fundamentals and how they impact prices, Dubai grade oil is now trading close to or above Brent prices, with large physical shipments moving from Europe and Middle East to Asia, that is West-East. Formerly heavily discounted, cheaper crudes like ESPO grade Russian oil have risen in price as Brent, Dubai and ESPO prices move towards convergence, especially in the 5 months since October 2011. This demand-driven convergence of prices at a high level is a major signal of very tight supplies, fundamentally driven by Peak Oil.

This demand-driven pricing context is explained by the IEA in this way: "Fuel oil markets continued to show unusual strength, and in Asia HSFO (heating and fuel oil) cracks were at record‐highs with positive differentials to Dubai for January. Continued tightness in the bunker fuel market, with refiners still adjusting to the new global sulphur regulations, (also) explains much of the strength".

The IMCO (now IMO) has mandated a global shift to low sulfur marine fuel, creating a large number of impacts for world bunker fuel demand. This a complex subject with major implications for world oil. Bunker demand stands at about 1.75 billion barrels per year, or 4.75 Mbd, with typical demand growth rates, except in the recession years 2009-2010, of around 7% per year. The shift to low sulphur marine fuel, for technical reasons, will itself raise global shipping oil demand and increase pressure on prices.

As already noted, oil demand as shown by refinery runs in Italy and Spain has ceased to decline since July 2011, and IEA global refining data perhaps surprisingly shows the US, with historically low refinery runs in January (14.6 Mbd average) is trailing Europe in its recovery of oil demand, which was also caused by very warm winter conditions in the US, unlike Europe. The high capacity utilization but increasing number of outages for US refining also suggests that US crude and/or refined product imports may soon rise, as refining runs recover from their present remarkable lows.

In January 2012, China's refineries had crude throughputs estimated by the IEA at a record-high of 9.3 Mbd, rising from 9.28 Mbd in December. This was at least 2.5 Mbd up on the 2008 year average run, for a growth of more than 25% in less than 4 years.

Due to the IEA's "Other Asia" category including not only India, but also countries such as Malaysia, Singapore, Thailand, Taiwan, Pakistan, Bangladesh, this large group is a major oil consumer (over 9 Mbd). Early 2012 refinery runs for this Other Asia group were estimated at 8.9 Mbd, with the IEA giving the likely true value for India's oil demand, 4.3 Mbd, based on the balance of crude + products imports, exports and trade. We can note that elsewhere, the IEA gives much lower figures for India's net total demand.

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2012 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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