Oil: Demand Destruction Overdone?

Much ado has been made of ‘demand destruction’, an economic term that refers to declining demand for a good due to high prices. The past month or so the mainstream US press has latched onto demand destruction as a reason for the decline in oil prices much in the same way they blamed speculators for high oil prices just a few weeks earlier. 

Also, when talking about demand destruction, they will refer to US numbers only; conveniently forgetting the rest of the world. The mindset here is still that the US is the top dog and the rest of the globe is irrelevant. So let’s indulge them in their narrow-mindedness for a minute and look only at US consumption as presented by the Energy Information Administration. 

Overall oil consumption in the United States has actually been on the rise for the past 3 weeks during this period of unprecedented ‘demand destruction’. This is supported by the EIA’s own numbers. (See chart below).

click to enlarge images

From the high of 5/23/2008 at 20.807 million barrels per day (bpd), there was a drop of 4.34% to 19.903 million bpd on 07/18/2008. Since mid-July, usage has risen 2.36% to 20.372 million bpd.

While it will take some examination of the price and usage trends going forward, the data at this time point to demand destruction occurring somewhere in the $145/bbl range with usage picking up as prices fell back from those levels. If this is truly the correct analysis, deduction would tell us we should soon see usage return to spring levels. However, there are seasonal components involved as well. Gasoline usage typically falls as summer comes to an end. There are one or two ‘shoulder’ months (August/September), then usage starts to switch over to heating. I would opine that much of Americans’ driving is discretionary, in that we can willfully choose to cut back. I would counter that heating tends to be more non-discretionary. Sure, people can turn the thermostats back a few degrees, but traditionally heating demand has been more price inelastic than driving demand. This winter will prove interesting in terms of usage.

To look at a more long-term picture, I am including a chart that lists usage in the United States from the beginning of 2000. Since then, oil has risen nearly 10-fold, yet there has never been a sustained period of contraction in oil usage here in the US. This while overseas usage has literally exploded. Notice that the only two real decreases in oil consumption occurred at times when the US was either in or near a recession; NOT when the price of oil was spiking. This argues that petroleum usage is more a function of economic growth than of price; an assertion I have made for some time.

One must understand that there are many factors other than price and supply which drive demand. If we were seeing this price spike in a time of low debt load and overall economic prosperity, $4 gas wouldn’t matter as much to people. Note the prior observation that usage appears to be more a function of growth than price. However, when people are relying on credit cards and other types of debt to make ends meet, and their wages lose ground each year to inflation, then $4 gas is suddenly more significant.

Much like the recent action in the Dollar, oil bears have feasted on the notion that the rest of the world will follow the US into a recession. (A recession that, by the way, our leaders still refuse to acknowledge exists). It is pretty telling that we’re in such dire straits that we have to rely on bad things happening to others to continue our own fallacy of prosperity.

Changing of the guard?

In looking at the lines of demarcation, it is worth noting that it is the OECD countries that appear headed for recession and theoretical reduced oil consumption while the rest of the world appears to be relatively unscathed so far. Granted, with the credit infection that overspreads the globe, this could certainly change. From the International Energy Agency’s numbers, we see the following with regard to world oil demand and supply:

2007 featured a 500,000 bpd shortfall or a yearly shortfall of 182.5 million barrels. Interestingly enough, 2008 shows a small surplus so far, but the size of that surplus dropped in the second quarter despite record high oil prices and the demand destruction parroted by the mainstream press.

Lastly, the engines of oil consumption, China and OPEC are shown. While their petroleum usage is dwarfed by that of the US (for now), the trends are solid and distinct.

In conclusion, demand destruction certainly occurred here in the US earlier this summer. I argue this is more due to economic malaise as opposed to high prices. However, over the course of the past month, usage has increased as prices fell off their recent highs and Americans received stimulus checks. The reality of increased usage has been almost totally ignored by the press as they stick to ‘demand destruction’. In truth, nothing could be worse than the recent decline in oil prices coupled with economic ‘stimulus’. It will encourage people who had been conserving to return to life as usual. Political and economic incentives to develop alternative energy sources will disappear. Once again our energy independence could be delayed and we’ll continue to rely on foreign oil. Real change is more than a political slogan; it is a long, painful process and I fear that our long term well-being has been sacrificed once again at the altar of political convenience.

Disclosures: none

Comments

[Ishortyou:]

Well I guess consumers around the world are realizing that dark age fossil fuel is too much of headache, conflictive, polluting, etc. Looks like they prefer new age technology electricity, hydrogen-water at least to drive a car to work.

2008 Aug 17 06:25 AM

[User 244491:]

Nice graphs,thanks.
Are you short/long energies or you are one of those smart contribiutors who know it all but themselves lost money long time ago on things they are experts on.
I am at the moment short calls 130$ and puts 100$ for October Crude Oil,long Natural Gas October at 8.20$.
This is where my money is,if each of us would say more about our real life trading SA would be more serious space for traders as I see many writers here with nice flash websites who know shit about real trading ( it is not about the author).
Let's trade folks and open our cards,as it is easy to be cool on the internet.
I am up 20% since August day trading futures/options like CL,NG,ZB,YM,GEC,PL,GC (Crude Oil.Nat Gas,T-Bonds,mini-Dow,E...

2008 Aug 17 06:45 AM

[mangolfer:]

I'm not hearing anything about people using more. Everybody is cutting back anyway they can. I'm in DUG since early July and making a fortune. It will be a long time before people worldwide get comfortable with these prices. Yes, overall demand may be increasing in China, India, etc, but the demand increase rates are slowing the right now too....

2008 Aug 17 08:38 AM

[Bill James:]

Thanks for the insight and graphics. Demand destruction equals economic destruction.

2008 Aug 17 09:05 AM

[pachanguero:]

I would never hold DUG you are asking to get robbed.
At some point that trade wiil turn and cut your head off.

2008 Aug 17 09:39 AM

[freefall51:]

I think the steep gradient of the recent oil price increases was as important as the absolute level, shocking a lot of people and letting them pull their horns in. Now the public is conditioned to these prices and with some price relief the shock effect is fading out. We are coming closer to the next round of price increases. Gas prices are still only half of what the Europeans pay. I would agree however that the Americans of all folks in the world have the biggest potential to save energy and make a difference to the oil price.

2008 Aug 17 10:11 AM

[dhavis:]

Nice analysis. I think when you look back and even at current numbers you might come to the conclusion that oil/gas demand is not being destroyed. But when you factor in that SUV sales have all but stopped and that small car sales have ramped up so much that manufacturers can't keep up with demand, then extraolate that out, you might get a better understanding of what is to come. This happened in the late 70's and early 80's, it takes many months or years to truly show up in the numbers. Also, a lot of the cutbacks airlines have made in routes and planes have not taken effect. It is a phasing out approach, not an axe it now approach. As for global demand, I have not studied it, but I would assume they are less likely to be able to absorb the impact of high oil/gas than those in the US. Subsadies of foreign nations have only been in effect for a month or two, give it time to take effect. Demand will fall.

2008 Aug 17 11:34 AM

[bowman711:]

Isn't this the 'conventional wisdom' that oil goes up and, along with it, gasoline price goes up? Then, oil goes down A BIT, and gasoline goes down PART of the way to its previous level. The 'relief' of gasoline price going down is observed by North American drivers by going back to their previous levels of driving or other usage of oil. I'd wager that nine out of ten Americans believe this is the standard procedure of oil companies raising prices and getting drivers to accept it. [Whether it is standard procedure for oil companies to raise gasoline prices I'll leave for you to decide.]

2008 Aug 17 12:01 PM

[Tony Daltorio:]

Brilliant article! Anyone who is hanging their hat on 'demand destruction' does not understand American consumers and is probably a clueless short-term trader.

2008 Aug 17 12:09 PM

[Ax:]

Nobody wants to hear about fossil fuel anymore. People just don't wanna hear about being kidnapped by the Arabs and paying them their mansions in the deserts.

What the oil markets showed is that there is no real benefit of having this sort of energy if the price of it can sky rocket at any explosion of a pipeline in some Mumbojumboland in the middle of nothing.

There is a radical shift in the way people think. Maybe it's not the Americans, but the technology societies of the future are doing something about the problem right now.

So you can put your charts from the past as much as you like... the money is pouring in alternative energy and all the oil rich countries know this century policies are coming to a brutal end.

Demand destruction? Wait and see. No one wants to hear about oil anymore except for the ones who made billions. Oil is out of fashion... and anyone who thinks about buying a SUV is now regarded as an idiot, a mere egotistical moron who should be shoot. That's what people in Europe think. So demand destruction? Of course... not only destruction, but complete elimination of this old, expensive, geopolitically dangerous addiction altogether.

This is going to be an alternative energy century. More expensive than a 100 USD for a barrel of oil, but sustainable and clean.

2008 Aug 17 03:02 PM

[January Thaw:]

I think Bill James is right. Demand destruction = economic destruction.

2008 Aug 17 04:22 PM

[Tim Miles:]

Thanks, Andy. Good, well-reasoned analysis. No one should believe that the latest drop in price at the gas pumps is a long-term trend. Get rid of your gas guzzling SUVs and support the development of alternative energy resources. Drilling for more domestic oil is not a viable, long-term solution to our problems when it will take ten years for that supply to come online. Moreover, the new oil will be just as expensive (if not more) and will be sold on the international marketplace, not secured for U.S. consumption.

2008 Aug 18 07:45 AM

[scfranklin94:]

Andy is confirming what I'm experiencing on my commute to work; for awhile it seemed to be slackening off, but now people seem to think $3.50 gasoline is 'cheap', and the traffic seems to be picking up again....

2008 Aug 18 09:02 AM

[erniem:]

No doubt alternative energy is on the way. Shortly after the expenditure of $1-3 trillion, we will have a fairly viable alternative to petroleum. Probably this century. Maybe as soon as 40 years.

2008 Aug 18 10:43 AM

[Old Wizard:]

It is wearisome to keep hearing that if we drill for new oil it will take ten years to get it. Does anyonne really believe that a country that could go to the moon in the 60's in 8 years, can't with technology that is already developed get new oil from known deposits in less than 10 years?This kind of assertion, is what keeps us from having a comprehensive energy plan. The necessity to stop the negative cash flow of over 800b DOLLARS /YR. out of this country as measured by the current account, most of it due to importation of oil, should drive our plan. Short term, drilling for 2m barrels of oil/day from our off-shore supply and crash programs in wind, solar and nuclear to achieve 5m barrels of oil/day less import of oil from undesirable sources in 5 years and a goal of 10m barrels/day in 10 years will serve 3 positive factors; 1]cash flow2] growth and 3]new job creation. Those of you who cling to the ten year number should look in to the timetable the CHinese have for getting oil 70miles off the coast of Florida. New car sales and conservation methods will not by themseves have enough near term impact, because of underlying structural factors inherent in our current state;i.e. the number of cars that must turnover,the population distribution around our urban centers and the availability of conveniient and affordable mass transportation. No doubt a deep worldwide depression might create the near-term demand destruction to severely reduce the price of energy which would probably require a world war to reverse as did 1929. I vote for a comprehensive energy plan that has significant short and long term permenant impact on our country's well-being.

2008 Aug 20 12:06 PM