An Oil-less Recovery

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In the last two years, US oil consumption has fallen some 9%, down nearly 2 million barrels per day (mbpd) from 20.7 mbpd in mid 2007, to about 18.8 mbpd in October 2009. The comedown has been painful, marked by severe recession and high unemployment. As we look to the future and recovery, what should we expect? Will US oil consumption recover, or is the country fated to make do with permanently lower levels of oil consumption?

As ever, understanding the future begins with a look at the past. The seeds of the collapse in oil demand were sown in late 2004, when the oil supply stalled. Thereafter, no extra supply was forthcoming until 2008. Notwithstanding, global GDP growth continued strong, and oil prices rose as demand from China and other emerging countries increased competition for existing supplies. As prices increased, demand in the developed countries stalled, and after 2006, turned down. Thus, peak oil consumption for the US was and remains 21.7 mbpd in August 2005, nearly 3 mbpd above current levels.

The oil supply started improving modestly in early 2008, as new capacity in Saudi Arabia came on line. But it was far too little, too late. Prices spiked in July 2008, contributing to a crash of the global economy two months later. Oil demand collapsed with the global economy, with US consumption bottoming at 18.2 mbpd in May 2009. A month later, it had risen to 18.8 mbpd and has remained in that range since, reaching 18.9 mbpd in October.

For those in the peak oil school, this comes as no surprise. If the oil supply cannot accommodate demand growth, then the existing supplies will be re-allocated from the slow growing countries—EU, the US and Japan—to the fast growing emerging economies.

But what should we expect from the future? Will the US recover earlier consumption levels, or is the erosion of share likely to continue?

The EIA, in its November Short Term Energy Outlook (STEO), sees US oil consumption recovering modestly to 19 mbpd on average in 2010, up 1.4% from 18.8 mbpd on average in 2009. This implies a stronger recovery than any of the other OECD countries, better than the EU, Canada or the ever-disastrous Japan. This would be the first time that US consumption had increased since 2005.This growth is plausible, although not assured.

The US has been losing market share in oil consumption since 2005; therefore 2010 would see an uncharacteristic reversal of trend. Moreover, it is not clear why the US, still struggling from a massive financial crisis, would outdraw the EU or Canada. Still, the US could potentially hold market share, as the EIA outlook in the chart below suggests. As we project out future US oil consumption, which is more important, supply or demand? Are we seeing the much-touted ‘peak demand’?

Additional supply is available. The EIA shows about 4 mbpd of spare crude oil production capacity in late 2009, and another 0.5 mbpd in natural gas liquids capacity on a barrel of oil equivalent basis. The vast majority of this spare capacity is in OPEC. Could this spare capacity be made available to the US? In principle, the answer is ‘yes’. However, the US has not shown great appetite for additional oil at recent prices. Consumption is not much changed since the end of the recession. And before the recession, demand in the United States was falling at around $75 / barrel. Therefore, based on the most recent observed period, we would expect US consumption to stagnate around recent prices approaching $80.

At the same time, the carrying capacity of the US economy may be increasing. Historically, the United States has been able to shed oil consumption at the rate of 0.8% of GDP per year, equaling about $16 per barrel of oil. If we allow that the lock out price for US consumption was $75 before the recession, it could be as high as $90 as the country emerges from the recession. So conceivably, US consumption could increase modestly.

How much could it increase? If the US were able to hold market share, and all of the approximately 5 mbpd of spare capacity were committed, then US consumption might increase by about 1 mbpd. However, the last two mbpd of capacity is likely to be committed well north of $100 / barrel, and it is unlikely that the US would increase its consumption above that price for some time. Moreover, were longer term trends to continue, we would expect US share of consumption to continue to decline, which in turn would suggest that US consumption would tend to stagnate at current levels through at least 2010. In the worst case scenario, oil could rise above $90, and consumption could again begin to fall.

Overall, then, US consumption is unlikely to ever recover levels seen in 2007. In the best of cases, consumption could close half the last years’ decline and increase by about 5%, or 1 mbpd. As likely is the possibility that consumption will stagnate at or near current levels, and may be significantly sensitive to prices at or near those seen recently. US consumption is perhaps most likely to increase modestly by perhaps 0.5 mbpd, reaching approximately 19.0-19.5 mbpd.

As the country looks to recovery, policy makers must face the very real possibility that economic growth cannot depend on very much extra oil, and perhaps none at all. It may well prove an oil-less recovery, with all the implications that brings for employment and the economic outlook.

Mr. Kopits manages the New York office of Douglas Westwood, providing market research, strategic advisory and transactions support to companies, investors and investment banks active in the oil and gas business.

(Note: Commentaries do not necessarily represent ASPO-USA’s positions; they are personal statements and observations by informed commentators.)