Oil Demand: A Slippery Slope

Oil output by the 11 formal and 2 linked producer states in the cartel is falling, with the largest loss by Iran, for highly obvious reasons. Not at all so obvious, Iran's large cutback in crude oil exports, due to the western embargo, will also be joined by a significant fall in Iranian imports of refined products, especially middle distillates and gasoline. For the more-than-somewhat oversupplied and nearby European market for these products, the price impact can only be downward, with the leading indicator being stocks and refinery runs in Europe.

Quota Excess Rampant
Industry data shows that oil production by Iran fell below 3 million barrels a day in the month of June. At the same time, quota-exceeding output is still rampant in the cartel's member countries, with total output from the "quota observing" 11 member states still above the 30 million barrels a day (Mbd) ceiling that has been featured in OPEC meetings for months. Total output, today, is off the highs of about 31.5 Mbd in March, but still well above 30 Mbd.
 
Put another way, Iran's significant fall in total export supply to European states, the U.S., Japan and South Korea -- but not to India and probably also not China -- may help OPEC maintain a semblance of quota-respecting discipline. But real-world supply is still chasing global oil demand down.
 
The two key figures are total world demand and the growth rate of world demand: unusually, both the cartel and the OECD's energy watchdog agency the IEA are saying the same things. Both are forecasting that world demand in 2012 may struggle to attain a year-round day average of 89.5 Mbd. Three months ago, it was possible to posit and forecast sufficient demand recovery for world demand to average 90 Mbd through 2012, in turn implying a growth of demand on a 12-month base, from late 2011 to late 2012 of close to or more than 1 Mbd.
 
Demand Growth: What Growth?
Trailing the IEA, which has been cutting its forward estimates for global demand growth since early 2012, OPEC is now forecasting that world oil demand growth will fall to only 0.8 Mbd for the full year, but that now looks like pious hope. Inside the cartel, it looks different: cutting back the growth number could put more pressure on producers to trim their production a little closer to their quota volumes. Quotas themselves may, however, need cutting, especially when we take OPEC's most recent forecast that for calendar year 2013, world oil demand will average only 89.5 Mbd. This means that through 2012-2013, we would have a perfectly flat trend line for demand, with a few ripples for winter heating and the summer-motoring and air-travel season in the northern hemisphere, eaten away by falling demand by industry worldwide. For OPEC, the polite way to talk about this outlook is “considerable uncertainties.”

Using IEA and other data we find that outside the OECD group of countries, oil-fired electric power production is still alive and taking a little more than 2 billion barrels a year, roughly 6.6% of world oil demand. This sector is most surely under threat by the shakeout in world solar and windpower, which for solar has seen 14 of the world's largest producers file for bankruptcy since the start of the year. Prices are now at giveaway levels, stocks of surplus equipment are high -- installation can be rapid and the oil impact will be sure and certain: down. Another major segment that features low in analyst reports -- global marine and shipping oil demand, which takes a little more than 2 billion barrels a year -- and was growing at a rock solid 7% a year, until 2009. Linked to world manufacturing and trade, this segment is set to flat line and then seriously shrink.

The 'Geo' Play
This only leaves geopolitical stress and uncertainty as the way to save the bull market for oil. The recent Norway oil trades union strike was feeble in its price impact, but seriois geopolitical tension can help. Outside the Middle East where Arab Spring-2 is always possible, and inside the Gulf petro-states, China is again flexing its muscles on the offshore zone around disputed islands in the East China Sea. But other offshore zones -- in East Africa -- tell a different story. This includes Anadarko's epic-sized gas find off Mozambique in 2011 and emerging, possibly large-sized oil and gas finds off Madagascar, Tanzania and Kenya. After West Africa offshore, therefore, we now have East Africa edging up as a new producer region. African oil and gas export potential is set to grow and grow.

Oil bulls can of course still flip a coin guessing that U.S. oil or refined-product stocks may have staged a recovery this week. What the bulls call "surprise builds", as U.S. gasoline supply showed last week, may unfortunately (for them) start becoming the norm. Stock trends (including strategic) in Asia are those to watch for real signs of how world demand is shaping up. And in Asia, surprise builds could be shaping up.