What's Driving Future Price of Crude Oil

 |  Includes: CRUD, DBO, OIL, USO
by: Edgar Ambartsoumian

At the beginning of the 20th century, crude oil supplied only 4% of the world’s energy; decades later, it became the most important energy source. Today oil supplies about 40% of the world’s energy and 96% of its transportation energy. Per EIA (Energy Information Administration), since the partial shift from coal to oil, the world has consumed over 875 billion barrels. From now to 2020, world oil consumption is expected to rise by about 60%.

Transportation will be the fastest growing oil-consuming sector. By year 2020, the number of cars will increase to well over 1.25 billion from approximately 700 million today. Before you jump the gun by snapping up shares in value names like Chevron Corp. (NYSE: CVX), Exxon Mobil Corp. (NYSE: XOM), Hess Corp. (NYSE: HES) and Royal Dutch Shell (NYSE: RDS.A), let us analyze the next question with a longer term horizon in perspective.

Should one continue to invest aggressively in crude after year 2020? Currently, Select Sector Spdr Fund (NYSE: XLE) still remains one of my favorite commodity ETF plays right after Spider Gold Trust (NYSE: GLD). Nonetheless, I would like to bring out several important key points that investors often overlook regarding crude oil going forward.

  • US Energy Independence and Security Act (EISA) and the European Union (EU) climate and energy legislative packages are the main energy policies that will impact crude oil. Their main agenda is to rapidly increase car fleet efficiencies, move the United States towards a greater energy independence and security, increase the production of clean renewable fuels, increase efficiency of products, building, and vehicles, to promote research and deploy greenhouse gas capture and storage options, in hopes of reducing gasoline consumption by 20% in 10 years.
  • Furthermore, CAFE (Corporate Average Fuel Economy) standards are projected to reduce demand by 1.1 million barrels per day by year 2020, and 2.1 million barrels per day by 2030 in United States.

Now, whether these figures will be significant enough to put downward pressure on the price of crude in the future, will largely depend on several components: including, but not limited to, transportation expansion, increased jet fuel consumption, demographics, population growth trends, urbanization factors, increased use of alternative energy, etc.

Let us first look at a regular barrel of crude oil and its segment breakdown by demand before diving into the demographic analysis.

What does a barrel of oil break down to?

World oil demand is expected to sustain a growth of 1.05 mb/d (million barrels per day) to average 86.4 mb/d by the end of 2011. According to the organization of the Petroleum Exporting Countries, the products that will be showing the most growth in world oil demand will be gasoline, diesel and naphtha, given the fact that the industrial sector will be the area that is projected to recover first. With moderate global recovery, jet fuel, which is linked to transportation, will lead to an increase in consumption as well.

Population Growth Decline: The world’s population currently stands at 6.8 billion people. The population boom that we experienced since 1970’s with an average growth of 2% per year will not be seen for quite some time. The population growth rate has been steadily declining in almost all the world regions and by World Oil Outlook estimates, it will continue to decline due to even lower fertility rates.

World Demographics: Various pools of working age groups could have negative effects on the labor force, expansion rates, and can have a host of implications towards healthcare costs, state pension expenditures as well as savings rates. Demographics are an imperative link between expected population growth trends and future interest rates. Interest rates will adjust accordingly due to these shifts in demographics. In addition, a too robust of a population growth can be a hindrance towards a sustainable development.

Urbanization Trends: As the city grows, it experiences a shift in greater mobility requirements, and needs increased access to electricity. Urbanization is a critical trend that will have future effects on energy demand. According to WOO (World Oil Outlook) estimates, there is to be a strong shift in the population distribution between rural and urban areas. In a current state, half of the world lives in cities and towns, but by 2030, urban populations are expected to rise more than 60%. Africa and South Asia will see growth in both urban and rural populations. With globalization and modern technological advancement, there is an increased need in skilled human capital, and it takes years for the working age group to retrain themselves out of manufacturing jobs into service jobs, and relocate accordingly if needed. This transition is projected to occur faster in OECD (Organization for Economic Co-operation and Development) countries than the emerging market economies.

The two countries with the highest rate of growth in oil use are China and India, whose combined populations account for a third of humanity. In the next two decades, China's oil consumption is expected to grow at a rate of 7.5% per year and India’s 5.5%. (Compared to a 1% growth for the developing countries). It will be strategically imperative for these countries to secure their access to oil in the long term.

The bottom line is that there are multiple variables driving the future price of oil and pulling it in different directions, and I barely scratched the surface in listing the aforementioned components. 10 to 15 years from now, the rate of change of our nano-technological advancement will influence the price of crude in ways one cannot comprehend at the present time. 30 years from now, having your own personal jetpack might become a reality, and who knows how that trend will affect the amount of miles a typical American family will drive. At this point it is just too early to tell.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.