Oil demand surprises on the downside: what it may mean for prices

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The EIA today released another volatile oil storage report showing a significant total liquids draw of 12.8 million barrels. All of this came from crude oil which recorded a significant decline of 12.7 million barrels. As we noted last week, the big build we saw last week would be reversed due to bad data, and the reverse happened in this week’s report.

A report of this size would have, in the past, sent prices soaring. But oil prices are flat as a pancake today because the underlying data is not bullish.

4-Week Average U.S. Product Supplied in Petroleum Products

EIA, HFIR

Implied demand for oil on a 4 week average basis is now below 2021. This is alarming as last year there were still COVID related restrictions. In addition to weaker aggregate demand, the three major demand variables we track (gasoline, distillate and jet fuel) are all below 2021 levels.

oil demand

EIA, HFIR

This is extremely worrying and suggests that the recent oil price spike is already having a significant impact on consumer behavior. Combined with soaring prices for other commodities, we are already seeing a wave of demand slowdown.

Now, it’s important to note that we’ve only had 6 weeks of triple-digit oil prices, so some of this drop in demand could be related to changes in consumer spending. But if we go back to the 2008 implicit demand chart, some similarities stand out.

request 2008

EIA, HFIR

Although the similarities between the economy of 2008 and today look like apples and steaks, it is important to keep watching the implied demand chart as it could form the basis for the direction future oil prices.

What happens if…

Here’s a good way to think about the recent weakness in demand. If we assume that demand surprises on the downside and in line with the IEA’s oil demand hypothesis, then this is what happens to global oil market equilibriums if Russia does not lose any production.

BALANCE

HFIR

The balance above also includes the following:

  • ~12.5 million bpd of US oil production in Q4 2022
  • OPEC+ continues to increase production with Saudi pumping around 10.75m bpd by Q4
  • Iran sanctions lifted by July 2022

Essentially, if demand surprises lower and Russia does not lose any production, the oil market will swing into surplus.

But this is not realistic given that we are already witnessing a drop in Russian oil production. Here is the calculation assuming a drop of about 1 million bpd.

balance

HFIR

Now take all of the above assumptions, but add the caveat that Russia is losing around 1m bpd, and the oil market is now balanced again.

If we now assume that Russia ends up losing about 2 million barrels a day and the sanctions against Iran are never lifted, this is what the global oil market balances will look like.

balance

HFIR

The oil market deficit is widening.

Basically, that’s what happens. If Russian oil production losses continue, oil prices will go higher than today to induce further demand destruction. If $100/bbl is already starting to hit demand, then we can assume that the price will have to keep rising to hit demand further. How much? We do not know. But it seems to be in $20/bbl increments.

The magic number seems to be around 1 million b/d of lost Russian production to restore balance to the oil market. This assumes that Iran’s production is complete by the second half of 2022. If Iran does not return, Russia could not lose any production and we would be balanced:

(If Iran doesn’t come back and Russia doesn’t lose any production.)

balance

HFIR

For now, the downside surprise in oil demand is just a chink in the armor of the oil bulls. It’s a vulnerability we need to pay close attention to, but it’s far from fatal.

Oil markets are likely to remain in deficit going forward, as our scenario analysis has demonstrated. If Russia loses at least ~1m bpd of production and Iran doesn’t come back, oil prices will have to keep rising to induce further demand destruction. SPR builds will help tame some of this price increase, but the only way to combat this shortfall is for prices to rise to reduce demand. There’s no other way around it and we’re starting to see some of it taking hold.


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Felix J. Dixon