IEA's Oil Market Outlook: Off the Mark

As a regular reader of IEA's reports, I can say that its demand forecasts are often off the mark, long term even more than short term. Quite often, the agency forecasts significant demand growth for oil products, sometimes creating stress in the markets, and then, over time, quietly scales those forecasts back.

• The IEA has several times downsized its global oil demand growth forecast for 2008. Its current forecast for demand growth for 2008 is lower than its supply growth forecast. Spare capacity will be three times higher by the end of 2008 than in 2005. Being usually behind the curve, it is likely that the IEA will continue to cut its demand growth forecasts for 2008. JP Morgan already estimates that global crude demand will decline in 2008.
• In the new report, the IEA says that "soaring demand for distillate fuels -- such as diesel, jet fuel and kerosene -- and a lack of sufficient refining capacity has played a key role in lifting crude oil price". That is not very logical. A lack of refining capacity suggests an expansion of refining margins. But those margins are under pressure. Refineries have problems passing trough crude oil price increases. It is also not logical to deduct an upward pressure on crude oil prices from a lack of refining capacities. The latter would suggest that crude oil supply is accumulating in front of refineries, which, without speculation, should put downward pressure on its prices. From what refineries are saying, there seems to be enough capacity to process any kind of crude.
• The IEA has reduced its demand growth forecast for the next 5 years from an average of 2.1Mb/d to 1.5Mb/d. That is quite a significant change. But it's not obvious that crude demand will increase by 1.5MB/d in each of the coming five years, mostly based on growing transportation demand in emerging markets. Those markets are not immune against price increases, especially if subsidies are gradually removed, as seems to be the case. Price-demand elasticity in such markets is higher than in OECD countries. We have seen multi-year periods in the past in which global oil demand was flat after an oil price spike, because of changes in consumer behavior, despite significant economic growth in those periods. If, for example, demand growth in the next 5 years is 1Mb/d instead of 1.5Mb/d, spare capacity will remain at comfortable levels after 2010, even with the IEA’s reduced supply growth projections.
• Following the IEA, there will be no real supply-demand problem in the next years. Spare capacity will increase in the next two years to 4.3 Mb/d. That is quite comfortable. It is supposed to decrease in the following three years. But, what really happens after 2010 is uncertain. One should for example not underestimate the ability of the Chinese government to realize its plans to significantly increase the (currently low) efficiency of energy use, manage traffic growth and diversify to alternatives like CTL. One should not underestimate the capabilities of the US to make itself less dependent from oil imports and reduce oil consumption with the implementation of a serious energy policy concerning supply and demand. The technical constraints in realizing current and new crude oil supply projects can diminish significantly in coming years, once technical capacities have been adjusted. We have seen that in past investment cycles. Moreover, the IEA doesn’t take into account the impressive potential of electric cars.
• The IEA doesn't correctly take into account speculative demand. It only admits that speculation can have a day-to-day impact on price moves. The facts presented by Masters and others in the US Senate hearings are essentially ignored. If, in the magnitude of 150B$ has been "invested" in oil via futures, indexes and other instruments over the past three years – up from close to zero before, that has had more than a day-to-day impact on prices. Such additional demand has lifted cash prices via all kind of arbitrage activities without immediately appearing in official (and only partially known) inventory data. The IEA has, by the way, only an incomplete view about what is going on in global oil inventories, as the agency has acknowledged. Following the Senate testimony of professor Greenberger, financial speculation currently accounts for 80% to 90% of trading volumes. Those who try to prove the contrary avoid looking at the unregulated markets, where the action takes place, and qualify the related activities of investment houses like Goldman Sachs as "commercial". The conclusion, that speculative demand and not consumer demand determines prices and price trends, is obvious.

If the price of oil is currently rising based on what might happen in 2013 or thereafter, the situation can only be characterized as a wild speculation.

My impression is that the IEA wants to send wake up calls. That could be useful medium term, but if prices deflate and return to more sustainable levels in the $50 to $70 per barrel area, the IEA could lose its credibility.

Comments

[junkyarddog]

Very educational article, thanks!

Truth is, NO ONE can pinpoint exactly what is going on. This whole oil business is still a bit shady. If I'm wrong, Congress would already enacted a law to arrest / sue / tax / kill whoever is responsible for such price increase (not realizing themselves Congress has quite a share of the blame).

[Tmalan]

Did the IEA predict the current demand destruction going on in the US last year? Of course not, Index investors are really putting a new twist on how to accurately predict future supplies and demand.

[buyitcheap]

Yes, Indexers are putting ina new "floor" under commodities of alltypes as the notion of commodities as an asset class permeate the investment community. This really damages the exchanges as price discovery mechanisms for true hedgers and suppliers. I'd like to see the indexers and those circumventing current trading rules removed by the CFTC.

[GH]

"I'd like to see the indexers and those circumventing current trading rules removed by the CFTC."

As would many others. Two problems:
1) The CFTC is corrupt, starting at the head placed there by Bush the Oil Pusher.
2) The CFTC is disabled, due to the Enron Loophole and other problems introduced by corrupted legislators like Phil Gramm in 2000-2001 and being actively preserved today - and prevented from being exposed via debate by Republican filibusters.

[Sophisse]

It's tough to make predictions, especially about the future. (Thanks Yogi!)

Yes they have revised their demand numbers down, based on higher oil prices which they didn't predict - but very very few predicted them to go as high as they did as quickly as they did, even energy bulls. Those that did can't post here because they are on a beach in Tahiti enjoying their fortunes.

"The IEA doesn't correctly take into account speculative demand."

But you and the Senate do?

"The IEA has, by the way, only an incomplete view about what is going on in global oil inventories"

But you and the Senate do. OK.

[Al Fin]

The US Congress is corrupt beyond imagination. It is not just Nancy Pelosi and Barbara Boxer who are restricting energy production in the US, although they are two of the most egregious examples. If the US public continues to elect such neanderthal reactionaries to Congress as these, they are doomed to perpetual high fuel costs, inflation, and recession.

[maximax]

Karl F - I don't think you got that right with your 2nd point, and I think that the IEA is spot on here. Have a look at the Argus Global Markets newsletters of the recent months, the IEA is hardly alone with this view. Refinery margins for middle distillates are high, but not for the rest, especially fuel oil. But due to a lack of upgrading & conversion capacity refiners cannot produce more middle distillates without processing more crude, thus increasing surpluses of fuel oil etc. The net refining margin is thus under pressure, and refiners need to rely on distillate rich crudes (light sweet), which tightens the WTI-type market, while heavy sour stuff (eg Iranian crudes) are in oversupply. And refinery capacity (=crude distillation capacity) is one thing, but refiners normally only refine if they can do so at a profit. And that is a problem these days, although more complex refineries are having an advantage.

[Long onAmerica]

Market speculators eventually have to meet with the law of supply and demand. High prices have to be balanced in the future by lower prices if the demand is not sufficient.
We should RAISE the price of gasoline and before that equally lower income tax so that Joe Average American will break even up and the higher price at the pump will lower demand.
Picture a $2000 1040 rebate followed by a $2.00 per gal federal use tax after the rebate. Give Joe Average American the money upfront by lowering the burden of his income tax then let him choose to buy gas for a Hummer or a Ford Focus - we'll see...

[surgcare]

Did the easter bunny and santa clause not make you happy this yare .

[sf94127]

It seems it will take wrecking the world economy to bring down the price of oil. What is the point of that?

[hyperbole]

Investment banks (IBs) are classed as "commercials"... not speculators therefore speculators are not the problem, Washington spin at its best.

(IBs) buy long oil contracts for pension funds and ETFs (who can blame them when the US dollar is the alternative) on oversees (dark market) and buy short contracts on the domestic CFTC regulated markets to protect themselves. The reported 1:1 long short ratio is actually 2:1.

KILL the IBs commercial classification NOW!!!!

The IBS feeding on the US population to recapitilize their credit crunch loss is transforming from an macroeconomic benefit to a macroeconomic cost.

Anyone got a wooden stake handy!!!!!