Sunday, January 16, 2011

The Price of Oil: What does the future hold?

The mainstream media has been all abuzz the past month, moaning about the mounting price of oil.  United Kingdom-based newspapers are already touting the hundred dollar a barrel mark for North Sea Brent crude and United States-based newspapers are lamenting the rapid increase of prices at gas station pumps.  For those of us who have been watching the world's oil supply-demand situation for the past three decades, none of this is particularly surprising.

The Energy Information Administration (EIA), a branch of the United States Department of Energy puts together a forecast called the "Short-Term Energy Outlook" that outlines the world's supply and demand situation for oil and associated products.  In their January 2011 release, for the first time they have added forecasts that run to the end of 2012.  In this posting, I'll hit the high points.

In 2011, the EIA expects that the price of oil will average $93 per barrel, up $14 from 2010.  They forecast an average price of $99 per barrel by the fourth quarter of 2012.  All of this assumes that the United States' real gross domestic product grows by 2.2 percent in 2011 and 2.9 percent in 2012, something that is far from certain.  Here's a chart showing historical prices along with the EIA's price projections for the next two years and don't forget to notice the very broad ranging "price confidence interval in blue:

World Demand and Supply

The EIA expects that the world's oil markets will tighten over the next two years.  The EIA is predicting growth in consumption of 1.4 million BOPD for 2011 and 1.6 million BOPD for 2012 which will bring consumption to approximately 89.6 million BOPD.  World consumption grew by an estimated 2.2 million BOPD in 2010 to 86.6 million BOPD.  World consumption in 2010 exceeded the decreases of the past two years and has surpassed the 2007 consumption level of 86.3 million BOPD.  This compares to average annual consumption growth of 1.3 million BOPD between 2000 and 2007.  Here is a chart showing changes in the annual consumption of oil since 2004 and the EIA's projected consumption for the next two years:

On the supply side of the equation, the EIA expects non-OPEC oil production to grow in Canada, China and Brazil with each country showing production increases of 120,000 BOPD in 2011 and 150,000 BOPD in 2012.  Mexico's production is expected to fall by 200,000 BOPD in 2011 and an additional 80,000 BOPD in 2012 and the United Kingdom is expected to experience production declines of 120,000 BOPD in both 2011 and 2012 as their fields mature.  OPEC is expected to increase production to meet world demand with projected increases of 0.7 million BOPD in 2011 and 0.4 million BOPD in 2012.  The most interesting part of the projection is that OPEC's surplus production capacity will fall from 4.7 million BOPD at the end of 2010 to 4.3 million BOPD at the end of 2012.  Here's a chart showing the drop in OPEC's surplus production:

United States Demand and Supply:

On the demand side of the equation, the EIA projects that the United States will increase its consumption of liquid fuels by 160,000 BOPD in 2011 and 170,000 BOPD in 2010, bringing total daily consumption to 19.4 million BOPD in 2012 with gasoline and distillate accounting for much of the increase.  Here is a chart showing the increase in domestic consumption:

On the supply side of the equation, United States domestic oil production which increased by 150,000 BOPD in 2010 to 5.51 million BOPD will decline by 20,000 BOPD in 2011 and a further 130,000 BOPD in 2012.  Here's a chart showing the projected production statistics for the United States:

Of the most interest to American consumers is the EIA's projection of gasoline price.  Regular-grade gasoline prices are expected to rise from an average of $2.78 per gallon in 2010 to $3.17 per gallon in 2011 and $3.29 per gallon in 2012.  The EIA calculates that there is a 7 percent chance that the retail price of gasoline will exceed $4.00 per gallon in July 2011.  Here's a chart showing the projected and historical gasoline prices:

The EIA projects that natural gas in storage will remain at or very close to the 2009 record-setting levels through most of 2011 with some market tightening in 2012.  Natural gas prices are predicted to average $4.02 per million BTU in 2011, down $0.37 per million BTU from 2010 levels and rising to $4.50 per million BTU in 2012.

While none of these numbers is terribly surprising, my personal suspicion is that, if the economy remains in even a modest growth mode, the EIA's estimate of $93 per barrel for 2011 is low by about $10 per barrel.  I base my projection on increased demand from both China and India; China's consumption over the past 5 years alone has increased an average of just over 5 percent annually or about 400,000 BOPD per year and 6.7 percent in 2009 alone.  India's demand has increased 3.7 percent or about 100,000 BOPD from 2008 to 2009 alone.  In the next two years, that increase in demand from those two nations alone could put a strain on supplies, especially in light of the fact that both countries showed increased consumption in 2009 despite the downturn in the world's economy.  As well, the world's reserve life index or reserves-to-production index has not changed substantially in the last 20 years as shown in this chart from BP's Statistical Review of World Energy 2010 despite massive exploration efforts in the most hostile of environments:

Of course, if the economy tanks, then I'm wrong!


  1. I'd agree with your assessment, particularly in China, where their economy grew by 9% or something this year. Whatever it was, it was not bad for a recession! The point being that there have to be quite a few people in China now able to afford a car, and a few more people in China able to afford trips in their already purchased car. But the world demand graph you have there shows China's demand growth estimated at less than the rest of the world. I don't see how that's realistic.

  2. That's where I think the EIA's estimates are off. I would agree with your analysis but if you look at the chart, it looks like China (with 1/5th of the world's population) is going to increase their consumption by 1/3rd of the world's total increased consumption. I'll see if I can find the data to back up what I think I'm seeing

  3. Less than 10% of Chinese own cars. China's social compact basically guarantees 8% to 11% growth for next decade or so to its citizens - and it has a couple of trillion US greenbacks to throw at their economy to achieve this.

    The US is no longer driving the bus - the US is barely ON the bus - home prices have another 20% to 30% to fall, hundreds of US municipalities, and several states will start the process of defaulting on their issued debt in June 2011 as their fiscal year ends and their dramatic loss of income become apparent - even to morons (that would exclude all readers of this excellent blog).

    Most projections for oil use seem seriously low to me. Most projections for the price of oil seem seriously low to me. Also, factor in Saudi LIES about their existing in ground oil.

    Gonna be - as the Chinese philosopher said - Interesting times ahead.

  4. $10/barrel low sounds about right. Of course that is an average . . . it will probably creep up high ($120s perhaps) and then get slapped back down as the economy again collapses.

    Tough times ahead.

  5. The price of oil will increase only if the stock exchange will be in the green...once it dips to the red like it did in 2008 oil prices will fall as well.

    As you predict in this excellent blog, the US, EU and Japan are on the brink of a debt spiral. 110 dollars per barrel will remain....
    the question is what the dollar will be worth after the fall???

  6. I would agree with your analysis but if you look at the chart, it looks like China (with 1/5th of the world's population) is going to increase their consumption by 1/3rd of the world's total increased consumption.