Oil's Demand Destruction

Keith Kohl

Written By Keith Kohl

Posted January 12, 2009

What was your breaking point last summer?

There must have been a point in 2008 when you snapped and changed your habits to cater to record gasoline prices.

Remember the public outrage when gasoline prices hit $4-5 per gallon? My sympathies go out to my readers outside the U.S. who were paying more than double those prices. Naturally, there has been a good deal of reasons for oil falling more than $100 per barrel since. Today, oil is once again trading below $40 per barrel.

Which leads me to one phrase in particular that I’ve heard being tossed around too often… 

Demand Destruction

Demand destruction simply refers to the lower demand of a commodity due to a period of tight supply and/or higher prices.

In other words, prices reached consumers’ breaking point. Habits changed. I even recall several specific readers that completely altered their lifestyle in the face of $147/bbl oil.

Once prices began to collapse, the go-to excuse was demand destruction. At first, it was hard not to fall into that belief. After all, just look at how oil prices plunged in such a short period of time:

Oil price chart 1-12-09

Personally, I’m not buying it.

Taking Advantage of a Demand Slump

Let’s take a closer look at our demand slump.

Take a second and look at the numbers from the Energy Information Administration. As expected, our petroleum consumption levels fell to 18.61 million barrels per day during the second week of October. That comes out to a decline of about 8.6%. For some, this decline justified the destruction claim.

The problem is that consumption has been on the rise since those October lows. During the first week of January, consumption was back over 20.1 million barrels per day. Although we’re still 5% below levels compared to year ago, I’m not the only person who’s become bullish on oil. Both the U.S. and China announced they were refilling strategic reserves, clearly taking advantage of the cheap crude prices.

Can you blame them?

World Oil Demand

Even if global oil consumption falls by one million barrels per day in 2009. our outlook remains bullish.

Consider these points:

  • Approximately 86% of the world’s energy is derived from fossil fuels. Don’t get me wrong, dear reader, I have my own hopes for alternative fuels in the future. Sadly, I don’t see renewables making up that share for decades to come.

  • Aging fields that are in depletion, particularly the giant oil fields, means we’re going to have to make up that production from somewhere. Producers are forced to drill deeper and in remote regions around the world.

  • Lower oil prices has delayed new projects and forced companies to drastically slash exploration budgets. Without that development, how can we ever expect to make up for the depleting fields around the world.

  • These problems will add up to some serious supply problems over the next few years.

We also can’t make the mistake of solely focusing on U.S. consumption.

I’ve been asked what would signal a return to higher oil prices. My answer is always the same: Keep a eye on China’s consumption levels.

When Chinese demand turns around, you can bank on higher oil prices. I mentioned earlier how China is taking the time to refill their crude stockpiles. If they’re comfortable taking advantage of bottoming crude prices, there’s no reason we can’t do the same.

Looking Forward for Profit

As I was sifting through a mass of Energy and Capital columns recently, one in particular gave me pause. It was a quote from my colleague Chris Nelder. Several months ago, "When the world is upside down, buy!"

I believe that statement is even more true in today’s market, especially once an end to this recession is in sight.

Believe me, there’s only one way those energy stocks will move in the next two years. Next week, I’m going to show you why many of those energy companies may have bottomed out already.

Until next time,

keith Kohl

Keith Kohl

Energy and Capital

P.S. I know what you’re thinking. If we can’t pin the blame on demand destruction, why have the markets been this volatile? I agree whole-heartedly. Well, dear reader, not only should you know who the real Criminals of the Financial Crisis are, but also how you can defend your portfolio from their corruption.

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