By Ryan M. Couture and John Auers
We hope y’all had a great (and safe) Fourth of July. For many of you, it likely involved getting into your cars for some serious driving, whether for weekend trips or as part of extended family vacations. The good news was, despite the increases in prices since February, you paid less for that gasoline here in the U.S. than during any other 4th of July weekend since at least 2005. These low prices also resulted in gasoline consumption levels approaching or exceeding last year’s record for the Independence Day weekend. Unless there is a significant change in the second half of the year, 2016 will likely smash the record for annual gasoline consumption set in 2007 (which came in at just under 9.3 million BPD). This would have been considered “dreaming” just a few short years ago, with almost all industry analysts forecasting that 2007 was the high-water mark, and the U.S. demand for gasoline would steadily decline as a result of increasing efficiencies, negative demographic trends and competition from alternatives. This isn’t the first time we have gotten it wrong. These same predictions were being made back in the late 1970’s and early 1980’s, with 1978 the first supposed peak (at a mere 7.4 million BPD). While high prices, economic recession and the move to smaller cars did cause a slump for a few years, a sharp drop in petroleum prices (sound familiar?) caused a resumption in gasoline demand growth, which continued over the next two decades. Will this happen again, or will 2016 actually be the real peak demand year? We’ll explore this in today’s blog, and certainly feel free to hum Billy Ocean’s 1988 hit while doing so – it might create some good karma for the gasoline markets.
“What’s the score?”
The post-World War II economic boom really solidified the American love affair with the automobile. Cheap gasoline, supported by the massive oil discoveries in the Middle East, fueled this revolution, resulting in truly spectacular and very consistent growth in U.S. gasoline demand. It averaged over 5% annually and almost quintupled from less than 1.6 million BPD in 1945 to over 7.4 million BPD by 1978. The only significant down year in that whole time came in 1974 as a result of the Arab Oil Embargo, and although it rebounded in the subsequent few years to peak in 1978, hints of a new era had begun.
The Iranian revolution in 1979, followed soon after by the Iran-Iraq war in 1980, led to decreases in oil supply and what many thought would be a new period of scarcity. Oil prices rose to record highs, the economy went into recession and gasoline demand fell. In September 1979, The New York Times published an article, “The End of an Era: Gas Consumption Peaking.” In the article, experts predicted that demand in 1979 would fall below the levels in 1977 and 1978 (both consecutive record years). They were right, as 1979 demand fell to just over 7 million BPD, and 1980 demand plummeted to just over 6.5 million BPD. At the time, a technical director for the Ethyl Corporation said, “It may be that we have seen our peak in gasoline last year [1978].” Ethyl Corporation was not alone in their prediction. A senior economist with the Petroleum Industry Research Foundation said, “I’d say 1978 will probably turn out to be the peak year.”
These predictions were based not only on the shocks delivered by events in the Middle East, but also on what looked like a fundamental change from the era of “gas guzzlers” to one of “economy cars.” Between 1973 and 1977, average fuel efficiency increased 30% as U.S. drivers reacted to higher prices caused by the 1973-1974 embargo. Government-mandated fuel economy standards, which were legislated because of the embargo, went into effect in 1978, and codified this move to greater efficiencies. The NYT article closed by summarizing the prevailing view at the time, “Thus, even if every American had ignored both the rapidly rising prices at the pump and the repeated requests to conserve, choosing to drive as much as ever, gasoline consumption was destined to level off anyway.” Although it appeared the experts had it right at first, looking back now (see Figure 1), the late 1970’s and early 1980’s turned out not to be the beginning of a new era of conservation, but rather a short-term blip in the longer-term growth story for U.S. gasoline demand.
While demand fell sharply through 1982, the world soon realized we really weren’t running out of cheap oil. With the development of vast new deposits in the North Sea, Alaska, Latin America and Africa, the Saudi’s realized they couldn’t control the market and opened their spigots. Prices dropped dramatically and stayed low for the next two decades. Drivers responded to the lower prices by driving more and switching away from the economy cars they never really liked. 1982 turned out to be the bottom, demand began a slow but steady climb, and by 1993, had passed the 1978 peak. Although the mandated fuel efficiency standards stayed in place, consumers overrode their effects by driving more, as shown in Figure 2, a graph of vehicle miles traveled (VMT).
But nothing goes up forever and by the summer of 2007, it appeared that (quoting that great philosopher Yogi Berra), “It was déjà vu all over again.” Non-OPEC production growth had declined, oil prices were soaring, and the era of “cheap oil” again looked to be drawing to a close. While U.S. gasoline demand reached a peak of 9.64 million BPD in July 2007, falling levels of VMT as a result of the rising prices and weakening economy led to a reversal in demand growth similar to what was seen in the late 1970’s and early 1980’s. Demand dropped by over a million BPD in the coming years, along with a drop in VMT to 2003 levels by 2011. The downward trend in the wake of the recession, the higher price environment and a variety of other demographic factors were enough for ExxonMobil CEO Rex Tillerson to proclaim in October 2009 that U.S. gasoline demand had peaked in 2007, never to be breached again. Other analysts echoed those remarks, sounding much as they had back in 1979.
“Hey let’s make a deal, Make it real”
There were certainly many reasons to support the pessimistic view regarding gasoline demand beyond the short-term impacts of the 2008 recession. Among these are the government mandated fuel efficiency measures, known as Corporate Average Fuel Efficiency (CAFE) standards (different from, and higher than the EPA fuel economy numbers posted on car window stickers). The initial government standards set in the 1970s mandated that new vehicles sold in the U.S. (on a company average basis) would need to average 18 MPG in 1978, 20 MPG in 1980 and 27.5 MPG by 1985. Despite the fuel efficiency improvements after the oil embargo (cars had improved from 14 MPG in 1973 to 18.6 MPG in 1977, beating the initial mandates) the incremental improvements were an increasing challenge to meet, and the deadlines were stretched. With continued low prices in the mid- to late-1980s, consumers became increasingly less concerned with fuel economy. In 1990, Ford introduced the Explorer, which was classified as a light truck along with many other SUVs, and was not subject to the same fuel economy regulations cars were, ultimately reducing the effective fuel economy in the U.S. The love affair with trucks and SUVs had begun.
Government fuel efficiency standards continued unchanged through the 1990s and early 2000s. Persistent low fuel prices left little incentive. After oil prices rose rapidly in the mid-2000s, the government responded with legislation revising fuel economy numbers based upon vehicle size and classification. While it has prompted introduction of some fuel-saving technologies, the program ultimately increases the costs to manufacturers for producing less efficient vehicles by introducing penalties.
In addition to the ever stricter CAFE standards, there have been a variety of other fundamental factors that provide a “headwind” to gasoline demand. In 2005, the Renewable Fuel Standard (RFS) was implemented, which mandated blending increasing amounts of ethanol into gasoline, displacing petroleum derived volumes. Since then, total ethanol volumes in the gasoline pool have increased from just over 200 MBPD to exceeding 900 MBPD today. The growth in ethanol consumption has slowed as we have approached and reached the 10% “blendwall,” with refiners, ethanol proponents and the EPA hashing out the challenges of moving to E15 (15% ethanol in gasoline blends).
Demographics have been another hurdle to demand. While the prospect of a car is still a necessity for most people, the demand to drive every day has been diminished. As many cities “reurbanize,” more people live closer to work, opting to take public transportation (or walk) to the office. Additionally, telecommuting has reduced the need for millions of others to drive anywhere at all to get to their jobs. These trends show no signs of slowing, regardless of the gasoline price. Combined with slowing overall population growth and maturing U.S. economy, demographics could be a continuing impediment to gasoline demand growth.
“Hey (hey), You (you), Get into my car”
Despite these hurdles, U.S. gasoline demand has again surprised, and it appears that just like 1978 wasn’t the peak, neither was 2007. The U.S. shale boom, which drove crude and gasoline prices lower, has incentivized more driving, with VMT reaching a new record of 3.15 trillion miles in 2015. Although the increased efficiency standards kept overall demand from exceeding the 2007 record, 2015 still saw the third highest level of consumption in history and the largest year-over-year growth since 1976. With low prices continuing, 2016 has started off even stronger than last year as monthly figures for the first three months of the year all set records and April was just 2 MBPD below the all-time record for that month. If EIA weekly data is to be believed, demand over the last two months has accelerated, reaching a record of almost 10.3 million BPD during the week ending June 17 and up by almost 4% on a YTD basis through June 24th. Unless something changes drastically in the second half of the year, you can kiss the 2007 record goodbye.
There are also some trends that might lead us to believe that “structural’ demand could be increasing as well, particularly as it relates to the type of vehicles the public is buying. Facing $4+/gal gasoline a few years ago, consumers flocked to smaller, more efficient vehicles, including hybrids. But low prices have drastically changed that dynamic. Not only are drivers buying more vehicles, most of what they are buying are gas-guzzling trucks and SUV’s. Halfway through 2016, the U.S. auto industry is on track for a second consecutive year of record sales. Sales are up 1.5% for the first half of 2016 versus last year, with growth of trucks, SUVs and crossovers accounting for 58% of sales, up 4% on the year, while passenger car sales are down 7.5%. America’s love affair with gas guzzlers is back, at least for a while, and this will tend to support gasoline demand even as prices rise.
Conclusion
So what’s next? As with diesel, there are both headwinds and tailwinds that will impact U.S. gasoline demand over the next few years. Prices could serve as either, as U.S consumers have shown a high degree of responsiveness to what they pay at the pump. If they remain low, drivers will continue to respond by “getting into their cars” and pushing demand up, while an increase in prices will act in the opposite direction. Government policies will be important, and with a very uncertain election year in progress and candidates with polar opposite views regarding oil competing for the top job, what happens to CAFE, RFS and other key programs will be critical to gasoline demand. Demographics, world geopolitical and economic developments, technological breakthroughs on electric cars and other alternatives and any number of other factors will also play important roles. Because of these many uncertainties, while we believe it is an easy thing to forecast that 2016 will assume first place with regards to U.S. gasoline demand, what happens next is very difficult to predict and only time will tell (as it always does).
Notwithstanding those “weasily” qualifications, we are developing a specific gasoline demand forecast as part of our 2016 Crude and Refined Products Outlook Mid-Year Update. This study will be released in the next two weeks, and will include a comprehensive demand forecast for all petroleum products. The changing dynamics impacting the gasoline markets are a key part and we will provide a deep dive into the issues discussed in this blog which will determine what happens to gasoline demand in the coming years. More importantly, using this demand outlook, the study will include a detailed, region-by-region forecast of where prices and margins for all grades of gasoline are headed. This forecast will include an assessment of the ability of refiners to supply the necessary demand, taking into consideration growing refinery capacities and capabilities. For more information on this product or on specific consulting engagements, please send us an email or give us a call.