The continued fall in the price of oil due to stock market crashes worldwide leads most analysts to wonder how far down it can go? To understand the depths of oil’s potential price we have to first understand the potential imbalance of demand and supply that can send prices lower than $80 per barrel. This blog will focus on the demand side and probe US demand specifically.
At ~20 million barrels per day (Mbd), the United States consumes more than double the amount of the world’s #2 consumer, China (~8.3 Mbd). US consumption equals almost 24% of world consumption. Thus, fluctuations in US demand have a strong impact on the supply/demand balance of oil markets. US oil demand is currently falling, the main factor behind the oil price plunge of the last three months. US demand peaked in 2005, at 20.8 Mbd, but have since fallen 130,000 barrels per day (bd) in 2006 and another 70,000 bd in 2007 due to higher oil prices. In 2008, consumption decline has accelerated due to pump prices passing a tipping point above $3.50 per gallon and the economic downturn. Current estimates have demand falling ~4.5% or almost one million barrels per day this year! And with many economic analysts predicting a deep recession, consumption could fall further in 2009 and 2010.
I took a look at the recession of the early 1980s to get an idea of how much our oil consumption could fall. I knew consumption went down a significant amount, but what I found was dramatic…
From a peak in 1978, oil consumption fell for five straight years to a level 19.2% below the peak. What would it mean for a similar drop to take place this time around?
Well, our demand would fall to 16.8 Mbd, about three Mbd below the 2008 level. The good news: this would negate the need for imports from declining producers Mexico, Venezuela, Norway and the UK. And it would send our greenhouse gas emissions from oil below their 1990 level. But an issue I have discussed in previous blogs is that many of the shifts in consumption in the early 1980s are not available to us today. We substituted oil use to heat our homes and generate electricity during that time with natural gas. But thanks to that substitution in the past, today only ~1% of electricity comes from oil-fired generation and 7% of homes are heated with oil. So, a further 15% cut in oil demand may be more painful today, since it would have to come mostly from our transportation sector. Luckily, we have the technology to ramp up telecommuting and carpooling. And we can shift lines on our roads to accelerate safe bicycle routes to major destinations. American transportation would have to shift toward the European model, including some difficult changes in such a short time frame.
A three Mbd fall in US consumption could send oil prices back down below $60 per barrel unless Saudi Arabia and other OPEC producers cut their production commensurately to preserve a higher price level. I think such a cut would be likely even from non-OPEC producers since current prices are close to the marginal cost of discovery and production for new fields.
In sum, a deep recession in the US has the potential to send prices lower than today’s level ~$80 per barrel due to demand falling as much as 15% further. Due to the substitution that has already taken place in heating and electricity generation, such demand reduction could cut more than the fat (tourism travel and joy-rides) that we became used to during the cheap oil 1990s. On the bright side, such demand reduction would lower our carbon dioxide pollution quickly and increase our oil security by lowering our import demand from declining producers. But clearly any recession is a difficult time for our nation and its people. We will have to learn the lessons of economic growth through energy efficiency for us to successfully get out of the recession in 2010 or (hopefully) soon afterward.
Tags: 1980s, oil demand, oil prices, OPEC, recession