(image: Nicholas Whitaker for HeatingOil.com)

News of robust export activity in China and an optimistic report on future oil demand from the IEA boosted crude and heating oil prices on Thursday. Overall exports from China jumped 48.5 percent in May, stoking hopes of a global economic recovery as evidenced by increasing demand for consumer goods. Such a recovery would provide a long-awaited boost to global oil demand and send prices higher. The International Energy Agency also helped lift oil prices on Thursday when it made an upward revision to its 2010 global oil demand forecast. The twin supports to prices made for crude oil closing about 2 percent higher on the day, which brought a moderate increase in heating oil prices. The upward trend appears to be reversing on Friday morning, as oil prices took an early dive.

Today’s average retail heating oil in the Northeast is 3 cents higher than Thursday’s average price.

The IEA reduced its forecast for 2010 oil demand due to tepid demand in many countries in Asia and the Middle East. (image: internationalenergyworkshop.org)

One day after OPEC and the Energy Information Agency (EIA) raised their forecasts for oil demand in 2010, the International Energy Agency (IEA) bucked the trend and cut its prediction for oil demand this year. The IEA’s revision lowered their demand forecast by 220,000 barrels per day (bpd) compared to their April forecast, reported the Wall Street Journal.

Sluggish demand in emerging markets in Asia and the Middle East, which many analysts expect to drive growth in oil demand for years to come, led the IEA to revise its forecast. The agency singled out Iran and Malaysia as showing lower demand than previously expected, though the IEA does not expect any slowdown in China’s oil demand. Uncertainty in the global economy added to the IEA’s cautious revision. Europe is working to bail Greece out of its debt crisis and prevent instability from spreading to the similarly debt-ridden nations of Spain and Portugal, but if Europe’s economy struggles that could disrupt fuel demand not only on the continent and reduce global oil demand.

While demand concerns guided the IEA’s forecast, the agency also noted that oil supply remained plentiful. The IEA raised its estimate of non-OPEC crude oil production in 2010 by 200,000 bpd to 52.3 million bpd.

Even after cutting its demand forecast, the IEA remains more optimistic about oil demand than OPEC. OPEC, after hiking their forecast for oil demand on Tuesday, expects demand to be 950,000 bpd higher than demand in 2009. The IEA, though it trimmed its prediction, thinks demand will exceed 2009 levels by 1.6 million bpd.

Because the IEA still expects significant year-on-year growth in oil demand, though slightly less growth than foreseen in April, the agency’s revision has had a muted impact on oil prices. Fuel demand is still expected to recover this year as the economy recovers and that has kept oil prices on an upward trajectory, even as that demand has been more than adequately covered by existing supplies.

Oil spills, debt crises, and volatile prices have not dampened OPEC’s optimism on oil demand in 2010. (image: wikimedia.org)

While oil traders evince jitters over the debt crisis in Europe and the oil industry tries to withstand the negative publicity of the BP oil spill in the Gulf of Mexico, OPEC remains unruffled and has even raised its forecast for global oil demand in 2010. Their confidence influenced oil markets, and pushed up the price of crude and heating oil on Tuesday morning.

As Reuters reports, this the third consecutive month in which OPEC has raised its forecast for oil demand. In its latest monthly report, the oil cartel said that 2010 oil demand would rise by 950,000 barrels per day (bpd) from 2009 levels. That prediction is 50,000 bpd higher than OPEC’s previous forecast.

“The recent signs of improvement in the global economy have been encouraging,” said OPEC, affirming the conventional wisdom that economic recovery will lift oil demand in 2010. But OPEC also stated that rising oil demand could be reversed if oil prices, and especially the price of gasoline, moved too high:

“Any strong and lasting increase in pump prices will certainly dent demand, not only in the United States, but also across the globe.”

Despite OPEC’s concern in its monthly report about the prospects of demand destruction, as recently as April representatives of OPEC member states indicated that they wouldn’t take any action to halt rising oil prices until crude oil hit $100 per barrel.

OPEC’s forecast gave some support to oil prices on the NYMEX, and other reports by major oil forecasters could also move the markets this week. The Energy Information Administration (EIA) will release a report on Tuesday, and the International Energy Agency (IEA) will release its report on Wednesday. If these agencies follow OPEC’s lead and increase their 2010 oil demand forecast, it will bolster optimism among oil traders and could drive up the price of crude oil and refined products such as heating oil, gasoline, and diesel.

A representative of the Energy Department told Le Monde that oil production could start to fall next year, but new investment could prevent that. (image: richardmasoner via flickr.com)

The Department of Energy’s leading analyst of global oil markets told a blogger for the French newspaper Le Monde that world oil production could decline from 2011 to 2015 “if the investment is not there.”

This forecast comes from Glen Sweetnam, the director of the International Economic and Greenhouse Gas Division at the Energy Information Administration (EIA), the statistical branch of the DOE. Sweetnam oversees the publication of the EIA’s yearly International Energy Outlook, one of the most authoritative sources on forecasting global oil supply and demand.

While Sweetnam says that global oil production could fall as early as next year, he—like the DOE at large—does not fully subscribe to peak oil theory, which states that world oil production will at some point peak and irrevocably decline as oil, a finite resource, is exhausted. Instead, Sweetnam believes that oil production will reach an “undulating plateau” at which production will dip but then be restored through investment in new oil production capacity. In 2008 Sweetnam gave a presentation for the DOE that said oil production could remain at its undulating plateau until 2090, when production would begin to fall.

Sweetnam believes that any drop-offs in oil production will be met with renewed investment, but acknowledges that the recession has interrupted such investment. Without that investment, 2011 could be the year that global oil production begins to decline.

According to Le Monde, Sweetnam’s recent comments reflect a growing pessimism within the DOE about the future of global oil supply. A leading figure in what was once one of the most optimistic of oil forecasters has now said that the world could be entering an extended phase of uncertain oil production in less than one year’s time. Le Monde puts Sweetnam’s comments alongside other ominous pronouncements about the eventual decline of world oil production made by the CEO of Petrobras, the chief economist of the International Energy Agency, and a host of others to imply that Sweetnam bolsters the case for peak oil whether he wants to or not.

Yet Sweetnam’s statements highlight other causes—“above ground factors,” rather than the dwindling amount of oil in the ground—of a potential decline in global oil production:

If the investment is not there, a chance exists that we may experience a decline. If we do, I would expect investment in new capacity to increase if there is still demand for oil.

As Sweetnam sees it, if people want oil they will be able to get it. As long as there is demand for oil there will be investment to produce it, even if it comes from unconventional sources that are harder to refine into the oil products that we use, such as heating oil and gasoline. Yet as alternative sources of energy are developed, people may not want oil, or at least not as much of it. The possibility of peak oil demand—not peak oil supply—will shape our energy future.

This transition toward lower oil demand can be seen in the heating oil industry itself, which—through a combination of industry leadership and legislative mandate—is adopting blends of biodiesel and heating oil. Biodiesel blends will lower overall oil demand while supplying consumers with a more efficient and cleaner-burning heating fuel. As with Sweetnam’s forecast that declining oil production could happen next year, many heating oil users will see changes by next heating season—in Massachusetts all heating oil will have to contain 2 percent biodiesel by July 1, 2010, and pending legislation in Connecticut and Pennsylvania would have a similar effect on heating oil users in those states in the next three to four years.

(image: opec.org)

Arguably, few institutions know more about oil pricing than OPEC—after all, scratch an OPEC member state and crude, not blood, wells out. And further, OPEC, or its membership, has a vested emotional interest in attributing any increases in price to sustainable fundamentals. When your economy depends on selling one and only one commodity, you want to believe that the market for it is robust.

Given that expertise, and also the natural inclination to interpret oil-related news in the most favorable light, it’s striking that OPEC does not believe that economic fundamentals are behind oil’s price increase. Instead, as reported by MarketNews.com Tuesday, OPEC’s Monthly Oil Market Report for January 2010 attributes oil price increases to speculation.

OPEC is referring specifically to the December 2009 surge in crude prices, which rose more than $10 to above $80 per barrel. OPEC stated the case for speculation being behind this market movement quite succinctly:

• While the organization is very modestly bullish on economic recovery in 2010, there was no sudden revival of economic fortunes in December. As the Monthly Report notes, for example, even though “[t]he US economy showed improvement supported by government policies. . . unemployment continued high while retail sales weakened.” (U.S. economic performance is significant because OPEC believes that the United States is a key country in determining global oil demand.)

• There was a cold snap across nearly all of the Northern Hemisphere; however, inventories of crude and distillates were high enough to deal with any short-term winter demand spike. While the cold led to some drawdown in inventories, as of the writing of the report, crude and heating oil inventories remained 6 percent and 23 percent, respectively, above their five-year averages. Furthermore, floating (i.e. supertanker) storage remains very high, with 140 million barrels, most of it distillates like heating oil, still at sea.

• However, while the economy did not improve markedly in December, and the cold weather was insufficient to significantly move the dial on oil prices, what did happen was that there a huge influx of investment dollars into the commodities markets. Money managers boosted their net positions by 70 percent.

So, no significant change in economic fundamentals, and not enough impact from the cold snap, but speculation in oil rose sharply at the same time that prices rose. By simple deductive reasoning, once you eliminate other factors as possible reasons for the price increase, only speculation is left as the cause.

What does OPEC forecast for the future (2010) of oil demand and pricing? The organization sees a very modest upswing in demand, from 84.3 mb/d (or million barrels per day) to 85.1 md/d. This will be a gain of only 0.8 mb/d, or nine-tenths of 1 percent, in terms of oil demand. Most of the actual gain will be from the non-OECD (Organization for Economic Cooperation and Development; more-or-less synonymous with the developed world) states, led in particular by China. OPEC sees Chinese oil demand growing by 5.4 percent in 2010, leading the non-OECD nations to a combined demand growth of 1.0 mb/d.

The non-OECD growth will be offset by continued OECD weakness. While OPEC believes that the developed world will experience some economic recovery and make good part of its decline in oil demand, demand in OECD countries will still be down from 2008. Netting out OECD and non-OECD oil demand for 2010 leads to the predicted composite gain of 0.8 mb/d.

What does this mean for heating oil users? To the degree that economic fundamentals drive prices, it’s good news: modest demand increases, cushioned by large inventories, would be expected to lead to more-or-less flat pricing.

Of course, there’s always speculation as a driver. To the degree that financial investors influence oil prices, it’s almost anyone’s guess as to what will happen. As we’ve seen time and again since the turn of the millennium, when price is driven by investment, you get modestly long periods of price inflation—bubbles—followed by sudden, sharp price deflation. The tech bubble, the housing bubble, and the 2008 oil bubble (where prices fell by almost three-quarters from their unprecedented, unsustainable peak) all show that the more speculation drives the market, the less predictable and the more volatile it is.

Balancing fundamentals versus speculation, one might with a modest degree of confidence predict fairly stable heating oil prices, while noting that there’s still a significant chance of abrupt price swings.

(image: chrisjordan.com)

Right now the price of crude is $83 on NYMEX. Global daily demand for oil, assuming no change from the 2009 average, is 84.9 million barrels a day (mb/d) according to the IEA’s December Oil Market Report.

The global economy is in flux and it’s anyone’s guess which factors will exert the most influence over demand for crude oil in 2010. The question for many has been whether growth in China and other non-OECD countries like India and Brazil will be enough to offset declining demand from North America and the United Kingdom. An added factor that has received little attention is the historic levels of global crude and distillate supplies currently in storage—a massive overhang of 159 million barrels—the likes of which have not been seen for 26 years.

U.S. distillate supplies, long view. Based on data up to September 2009, when distillate inventories were at 171 million barrels, the highest level in 26 years. According to EIA data, the decline in distillate inventories over the next few months, including the reported “surprise drop” in the last few weeks, have had negligible effect on the historic situation, shifting the 26 year record by less than one year. (image: tonto.eia.doe.gov)

The U.S. oil glut, close-up. DOE Fuel Oil Total Inventory, past five years. (image: doe.gov)

Demand Rebound

The majority of analysts covered on this site, including Goldman Sachs, the IEA, and the EIA, declared it likely that oil demand will improve in 2010. Despite the economic slowdown felt most acutely by mature economies, these analysts find the surprising growth of developing nations, particularly China, in the same period as reason to expect a broader market recovery this year.

The most optimistic within this pack is the world’s largest energy trader, Goldman Sachs, who has predicted global demand to accelerate to 86.4 million barrels a day (mb/d) from 2009’s 84.9 mb/d due to growing consumption in China, India, and Brazil. Citing dwindling production levels in the world’s largest oilfields, Goldman Sachs projects that supply will fail to meet needed levels of demand in 2010, which will bring about a price hike to $90/barrel this year and $110 in 2011.

That demand will outpace supply is a perspective found in the results of a November Reuters poll of “ten prominent oil-tracking organizations,” and in Saudi Arabia’s oil minister Ali al-Naimi, who said in September that a demand rebound would quickly make the massive stockpiles of the commodity irrelevant. Despite vacillating positions on this issue in every report since October, the International Energy Administration has also most recently come out in favor of a short-term demand spike, predicting that 2010 demand will rise to 86.3 mb/d, and crude prices upwards of $100.

Table of 2010 oil demand predictions.

A Long Bottom

Other agencies, though agreeing that global oil usage is poised to rise, place this event farther off in the future. Relatively weaker demand estimates from OPEC, JP Morgan and the EIA reflect greater weight attributed to the economic recession and floating oil stockpiles.

OPEC said demand would rise only later in the year, and in the first part of 2010 would drop further. In its December report, it predicted a daily global consumption of 85.13 million barrels in 2010, a mere 0.82 mb/d increase over 2009 levels. As explanation, OPEC noted the extremity of the global oil glut. JP Morgan also cited the record supply glut in its demand forecast, which predicted a 1.1 mb/d increase.

In early December, the U.S.-based EIA lowered its national 2010 demand predictions at the same time that OPEC and the IEA were upping predictions for worldwide demand. While those other organizations were responding to new data from China and other non-OECD countries, the EIA was responding to a weaker-than-expected US economy, though the source of this newer wariness was not shared its Report Summary. Even without this minor adjustment, the EIA prediction would still be on the low end of the spectrum, at 85.22 mb/d, a 1.1 mb/d increase. The agency attributed “almost all” of expected 2010 oil demand growth to developing countries, underscoring the major shift in oil demand from wealthier to poorer nations.

In contrast to a Reuters poll mentioned earlier, a BDO Seidman survey of 100 American small and medium oil and natural gas companies predicted that 2010 oil demand will not rise at all. 

Demand Downturn as Market Correction

Only a handful of voices covered on HeatingOil.com believed oil demand could fall in 2010. These were motivated not by a belief that another economic downturn is imminent, but by skepticism for the “realness” of current oil market figures. A December Economic Times article and European oil trader Trafigura have posited that a price bubble is in the works, similar to the one that grew in the housing market a few years ago and caused the mortgage crisis of 2007 and subsequent credit crunch when it finally burst. Both pointed to the world’s massive oversupply of oil as reason for concern over the market’s high prices.

What’s curious is that establishment agencies such as the IEA have also repeatedly voiced strong concerns about the high price of oil, but have done so while neglecting to mention the supply overhang. In November, Goldman Sachs confessed in a report that it had “underestimated” the impact of the distillate oil glut, but made no adjustments to its 2010 demand predictions.

Price hedging activities by the Mexican finance ministry and oil traders as observed by analyst Phillip Verleger support the idea that the possibility of a coming bubble burst is more widely accepted than the highest-ranking analysts would have one believe. However, other competing theories such as peak oil complicate the picture and make it difficult to reject optimistic demand predictions.

In Short

The near-unanimous consensus is that oil consumption will rise this year as long as world economic conditions improve. Key in this “if” is the economic growth of non-OECD countries (developing countries), which has taken place at nearly the same rate in the last few years as the economic slowdown of OECD countries (developed countries). Optimistic analysts believe that non-OECD demand growth will continue even as demand from developed countries remains flat. Very optimistic analysts believe that non-OECD demand will rise sharply, and/or that OECD demand will improve moderately.

Global daily oil demand by year, broken into contributions by OECD and non-OECD countries. Based on the IEA Oil Market Report data of each year’s quarterly average, available here: http://omrpublic.iea.org/balances.asp.

However, the degree to which any nominal demand growth actually registers as real growth will depend on the speed at which countries absorb the distillate supply overhang, and to a lesser extent the crude overhang. If this does not happen quickly, then it forms another factor encouraging flat demand.

Widely anticipated as a year of transition by optimists, it will take time to see how each factor affects the others.

Note: This summary excluded discussion of oil prices, which are heavily affected by factors outside of real demand such as inflation, the strength of the U.S. dollar, and speculation in the oil futures market.