Projected Increases In World Oil Consumption May Require Higher Production From OPEC – Analysis

(EIA) — World benchmark crude oil prices, which reached their highest level this year at the end of April, fell by more than 10 percent by May 9 and have since moved in a relatively narrow range. A slowdown in the pace of U.S. and global economic recovery and recent increases in crude oil and gasoline inventories in the United States and elsewhere seemed to suggest softening market conditions in what is often the weakest time of the year, as have recent U.S. demand data suggesting slowing gasoline and jet fuel consumption compared to last year. Since rising close to $4 per gallon during the first half of May, the national average retail price of regular gasoline has dropped about 20 cents.

Notwithstanding the welcome break from the seemingly inexorable rise in crude oil and gasoline prices over the first four months of the year, the balance of evidence suggests that oil markets are more likely to tighten than soften over the coming months. The second quarter of the year is typically a seasonal low point in global oil consumption, a pattern reinforced this year by the unusually wide scope of refinery outages and the impact of the earthquake and tsunami in Japan. If anything, the usual third-quarter rebound in oil consumption is likely to be greater than normal this year. In Japan, electric utilities are already raising output from oil-fired generators, a trend that will likely gain momentum as air conditioning demand ramps up seasonally. In China, endemic electricity shortages will overshadow concerns about economic slowdown, with increased demand for diesel use in back-up generators in a scenario where output from coal-fired and hydroelectric power plants falls short of needs. In the Middle East, summer air-conditioning demand – and therefore oil demand for electricity generation – is expected to rise to new highs, extending a pattern of the last few years that is in line with the rapid growth of residential building in the region.

Even if one allows for lackluster economic expansion in Organisation for Economic Co-operation and Development (OECD) economies, global demand growth, which exceeded many analysts’ projections last year and earlier this year, looks set to continue at a brisk pace. The U.S. Energy Information Administration’s (EIA) Short-Term Energy Outlook (STEO), released Tuesday, forecasts world consumption of petroleum and other liquids during the third quarter of 2011 to be 1.3 million barrels per day (bbl/d) above the second quarter level and 1.7 million bbl/d above the year-ago level. Crude oil and liquid fuels consumption is expected to remain high throughout the remainder of the year, with demand for the year as a whole averaging 1.7 million bbl/d above the 2010 level.

The projected increase in global oil demand comes against the backdrop of non-Organization of Petroleum Exporting Countries (OPEC) supply that looks relatively constrained. The STEO projects non-OPEC supply (crude and non-crude liquids) to fall by more than 600 thousand bbl/d in the third quarter (primarily because of declines in northern hemisphere production for seasonal maintenance, led by relatively large and unexpected drops in the North Sea and Russia) before rising somewhat in the fourth quarter. OPEC itself has been producing above its nominal production targets for some time, but faces its own limitations as fighting in Libya took nearly all of that country’s production off line, a situation that looks unlikely to change in the short term. Output from Yemen, a less significant non-OPEC producer, has also been disrupted due to ongoing unrest.

As the balance between global supply and demand tightens, the STEO forecasts a rise in West Texas Intermediate crude oil prices, from an expected average $102 per barrel in June, to $106 per barrel by the end of the year. The Energy Price Volatility and Forecast Uncertainty supplement to the STEO, characterizes the considerable uncertainty surrounding the price outlook based on the current market valuation of energy derivatives.

Adding OPEC non-crude liquids production to non-OPEC supply leaves a gap of 31.1 million bbl/d and 30.4 million bbl/d in the third and fourth quarters of 2011 (defined as the call on OPEC crude and inventories), implying an increased call of 2.2 million bbl/d and 1.4 million bbl/d, respectively, relative to the second quarter. EIA’s forecast then assumes that the bulk of the higher call is met through increased OPEC production with global inventory draws meeting rising demand to a lesser extent. With the disruption in Libyan supplies not expected to be fully resolved by the end of 2012, much higher production from the rest of OPEC will be required to meet demand growth and replace significant amounts of Libyan supply, albeit with lower quality crude oils.

OPEC’s ministerial meeting ended Wednesday without a consensus or agreement on increasing either its target or actual production levels. On the other hand, Saudi Arabia and three other Gulf Cooperation Council countries – which have all of the available spare capacity – have indicated that they are willing and able to increase production by at least 1.5 million bbl/d over current levels.

Any increase in OPEC output does, however, result in reduced spare production capacity – a consideration that may partly offset the price calming effect of higher production. Assuming that roughly half of the lost Libyan production is restored by late 2012, EIA projects OPEC’s spare capacity to drop to about 3 million bbl/d and OECD commercial stocks to drop toward the low end of the last 5-year inventory range by the end of next year.

Should demand growth continue to outpace expectations, or should supply increases fail to materialize as projected, oil prices and volatility are likely to climb higher. Conversely, barring further disruptions, oil prices could be lower than projected if production responds more robustly than assumed or if the global economy exhibits slower economic growth. Nevertheless, in the short term, the seasonal swing in oil demand, combined with missing Libyan supplies, raises the risk of higher prices – especially if they are unaccompanied by a significant, actual increase in oil production from countries with useable spare capacity.

Gasoline and diesel retail prices continue to slide

The U.S. average retail price of regular gasoline dropped just over a penny to $3.78 per gallon. The average price is $1.06 per gallon higher than last year at this time. The biggest decrease was on the West Coast; prices there fell almost a nickel on the week to $3.93 per gallon but remain the highest among the major regions. The average price on the East Coast fell four and a half cents while in the Rocky Mountain region, gasoline prices were down two cents on average. Bucking the downward trend, the Midwest saw a price increase of almost six cents from last week.

The national average diesel price fell for the fifth consecutive week, dropping about a penny to $3.94 per gallon. The diesel price is $0.99 per gallon higher than last year at this time. The East Coast, Midwest, and Gulf Coast regional averages were also down about a penny while prices in the Rocky Mountain region fell half a cent. Like gasoline, diesel prices on the West Coast saw the largest decline, down a penny and a half, but they remain the highest in the country at $4.15 per gallon.

Propane inventories build again

Total U.S. inventories of propane continued to climb last week, adding 1.8 million barrels to end at 34.6 million barrels in total. The Gulf Coast region gained 1.1 million barrels of propane stocks. Meanwhile, the East Coast added 0.3 million barrels, the Midwest added 0.2 million barrels, and the Rocky Mountain/West Coast region’s stocks grew by 0.1 million barrels. Propylene non-fuel use inventories represented 7.1 percent of total propane inventories.