Balancing Oil Supply and Demand: Oil Price Looks Like It's Bottoming

This article by Evan Smith is adapted from Commodities: Reasons to be a Bull When Everyone’s a Bear, a recent webcast presentation by U.S. Global Investors.

We’ve seen huge volatility for oil prices the last nine months, but it now looks like oil is starting to bottom out after hitting lows in late 2008 and the first part of this year.

While prices have improved, there hasn’t been much data in the United States to indicate we’re out of the woods just yet. But there is hope, as incremental buying from China and other Asian countries has started to pick up.

The above chart shows projected annual growth in oil demand over the next 10 years. The largest block—representing 1 million barrels a day—comes from China, Southeast Asia and the Middle East.

The next largest source of demand growth—about 400,000 barrels a day—will come from Russia and other developing markets.

Historically, as GDP per capita rises to a certain threshold between $5,000 and $10,000 per person per year on a purchasing-power-parity basis, you start to see a really accelerated demand in oil use per person. Many Southeast Asian and developing countries are at this point right now so we can expect a considerable increase in demand from those areas in the years to come.

In contrast, OECD countries are expected to see their oil demand shrink by a couple hundred thousand barrels per day. This decrease is mostly a result of aging populations and becoming more efficient in their energy use.

Oil Supply

There are several factors that can disrupt supply. Spare capacity and concentrated production are two things we’re keeping an eye on.

We’re seeing a spike in spare capacity in 2009 above the historical average (marked by the horizontal yellow line) after four or five years of running well below that average. That spike is likely a result of a steep decline in demand. However, a lack of investment by OPEC producers and a recovery in demand will slip us back into the long-term trend which is supportive for oil prices.

We also see the concentration of oil supply in the Middle East as a potential threat to supply because of its susceptibility to disruptions. This has always been a big issue, but we’re starting to see more market share of the global oil industry in the hands of the Middle Eastern producers.

The Middle East is currently home to about two-thirds of the world’s crude oil reserves and about a third of global crude oil production. If there are geopolitical issues or supply problems, it’s possible we could see severe supply disruption up to a million barrels a day or more.

Comments

[Prudent Man...:]

This is certainly not good news for the U.S. economy. Combined with creeping upward interest rates we are seeing prices rising while employment is decreasing.

There is a word for this: Stagflation and governments piling on more debt is part of the problem not the cure, unfortunately. This "change".

May 20 09:49 AM

[HardwoodFlo...:]

Kind of like the housing market is bottoming?

May 20 09:56 AM

[fxmaven:]

nice, but two months too late.

May 20 10:16 AM

[mattupp:]

Agree w/fxmaven above, a bit late on the uptake, and with Asian markets starting to develop their own internal demand, this will continue upward pressure through year-end ($75+ bl) and beyond, especially since China is desperately working on developing consumers in non-US markets to find new buyers for their goods.

PS - I'm looking for US/Int'l service co's that cater to/aid in market development in those countries, that will grow with those countries as they develop internal consumer markets.

May 20 10:52 AM

[Respirate:]

I like the correlation with spare capacity. Nicely done.

Agree w/ mattupp on the $75/bbl toward years end.

Aside from the fundamentals, you never know when news (fear) headlines will give oil a bump. (And investors *love* fear and panic.) This week we had violence in Nigeria aimed at oil interests, and a refinery fire in Pennsylvania. Next week it could be one of any number of things, such as Iran acting up. (Today Iran announced the successful test of a missile 1200 mile range. What does it have to do w/ oil prices? Nothing, but it stirs the fear.) Since we're probably at the bottom end of the consumption decline, oil will likely edge up from here.
--R

May 20 12:05 PM

[Allen Fuller:]

Invested in DXO about two months ago. Nearly doubled my money.

May 20 12:48 PM

[TheHague:]

I have decided to buy into a hedge against oil price inflation! I am buying OIL ETF! That way I get some of my money back that I am pumping into my gas tank! It has worked out since my money has grown about 20% since April 1! I am buying some more Tomorrow!

May 20 04:32 PM

[Ferdinand E...:]

Interesting and useful article. It's nice to see the rise in quality of articles today as compared to a few years ago, when some energy experts seemed to have taken leave of their senses.

May 21 12:43 PM