By John Auers and Brian Mason
There certainly has been a lot of big (and in some cases) very surprising developments in the petroleum industry over the past week. While hints that the Saudi’s and Russians were preparing to increase production sent the oil markets in a “tizzy,” the big surprise was Canada’s “nationalization” of Kinder Morgan’s TransMountain pipeline project. Much has already been written about these developments, and we will address them in the coming weeks; however, in today’s blog, we will focus instead on a situation that has been developing for several months now. As oil prices have risen to levels not seen since before the crash in late 2014, worries about what this will do to product demand are beginning to surface. The low price environment which has prevailed over the past three years has certainly been beneficial for demand globally, with annual average increases averaging almost 1.7 million BPD. This compares with an average of less than 1 million BPD which prevailed over the previous ten years. Demand in the U.S. and Europe has especially benefited, with the low prices reversing a decade-long trend of declining petroleum consumption. The robust demand has been great for refiners, even throwing a life line to plants in many places, particularly Europe, which were headed for potential shutdown. The strong demand growth itself has been a major factor leading to higher crude prices, helping to work off the “oil glut” and leading to a balanced market quicker than many thought. So will this be the “End of the Line” for the revival in product demand as the 1980s Supergroup, The Traveling Wilbury’s, might have sung? In today’s blog, we examine the trends and look at some of the factors which will help determine the answer to that question.
“Well it’s all right, doing the best you can”
The term “Peak Demand” has become a growing fear for refiners, but the fact is we likely have already seen this event in most of the developed countries (the U.S., Europe and Japan/Oceania). This peak was reached by the mid-2000’s in all of those regions (2005 in the U.S., 2006 in Western Europe, and as early as 1996 in Japan). Despite the recent strong growth discussed above, total petroleum demand in the U.S. was still lower by almost 1 million BPD in 2017 than in 2005, while European demand was almost 2 million BPD below peak levels over 10 years ago.
A variety of factors combined to lead to the decline in petroleum consumption in the developed countries for the decade from 2005 to 2015. Some of these are structural and demographic in nature (maturing economies, stagnant populations, energy efficiency improvements, changing lifestyles, etc.). These will continue to impact demand during the foreseeable future. Another major factor was the global recession caused by the financial collapse in 2007/08. A final factor was the high price environment which prevailed during most of this period; which, due to price elasticity and the negative impacts high energy prices have on economic activity, are always a major dynamic impacting petroleum consumption.
Back in the mid-2000s, “Peak Oil” was the fear of the day, not “Peak Demand.” Crude prices increased from the $20s at the beginning of the millennium to levels exceeding triple digits (and approaching $140 per barrel) by mid-2008. Driving these dramatic increases and feeding the Peak Oil worries was slowing production growth, which really began showing up between 2005 and 2007. Up until this time, producers had been rapidly expanding their operations but they had reached a tipping point based on viable extraction methods and field availability at the time.
In the mid-2000s, production finally started to slow for the first time in decades and demand continued to go up in developing countries. And to make matters worse, demand was also going up globally. China, who was once an exporter of oil was now a large importer. All of this combined to cause high prices, which in turn, caused notable demand declines in both Europe and North America. The 2008 Global Financial Crisis then accelerated these demand declines, causing crude prices to fall by over 50%. The price decline, however, was short lived, as the global recovery and continued demand growth in the developing world sent Brent crude prices back above $100/barrel by late 2010. As a result, North American demand stagnated while European demand continued its decline. This trend led most analysts to forecast ever-shrinking petroleum demand in the developed world.
“Well it’s all right, sometimes you gotta be strong”
Then the supply “glut,” brought on in late 2014 by the rapid growth of U.S. LTO, caused Brent prices to briefly fall below $30 by early 2016. This price decline caused strong product demand growth in both Europe in North America for each year from 2015 through 2017. Furthermore, average annual global demand growth accelerated from 930 MBPD for the 2005-2014 period, to 1,650 MBPD for the 2014-2017 period. The graph below shows the annual average Brent crude oil price and North American and European product demand for the 2000-2017 time period. 
Further, this demand growth, coupled with a lack of global refinery capacity additions, led to notable increase in global refining margins since 2014. While U.S. margins generally peaked during the 2011-2014 period as a result of logistical constraints across various producing basins around the country, international margins have grown significantly over the last three years, but have stayed well below those for most U.S. refiners. The chart below shows Global refining margins dating back to 2002 along with annual global refinery capacity growth.
“Sit around and wonder what tomorrow will bring”
This leaves us with the question as to what will happen to demand over the next few years and to what extent this demand growth will be tied to crude prices. With increasing global demand and shrinking supply from the OPEC/Russia cuts, the Venezuelan political crisis, and renewed Iran sanctions, global crude prices have risen dramatically over the past nine months. If these high prices persist, they could potentially affect demand growth negatively in the coming years. Still, as U.S. LTO continues its relentless growth and Saudi Arabia and Russia discuss the potential of adding crude back to the market, the current crude “shortage” that has caused the run-up in prices may be short-lived. Additionally, other factors in the near future will weigh on crude pricing, including the IMO regulations coming in to effect in 2020, which will leave some refiners scrambling to make changes to meet the new standards. This could heavily impact the market as producers pass these cost on to the consumer and drive up pricing for clean fuels and light sweet crudes (like Brent), while simultaneously causing a drop in the price of high sulfur fuel oil and heavy sour crudes. Only time will tell what the next few years will bring, but history shows us that oil demand growth is heavily dependent on prices as well as global economic growth.
At Turner, Mason & Company, we continually evaluate the effects of changing dynamics on petroleum demand (and other aspects of supply/demand balances). We use these analyses to forecast impacts on refiners and other industry participants. These analyses and forecasts are discussed in detail in our Crude and Refined Products Outlook, the most recent edition of which was released in February. We are currently in the process of preparing our next issue of this publication (due out in early August) and the changing absolute price environment will certainly play a major role in our updated demand forecast. Please feel free call or email us at 214-754-0898 or visit our website if we can answer any questions or assist you in any way.