Oil Demand May Decline Next Year

The global economic slowdown and the lingering effects of high prices are likely to crimp consumption, while the credit crunch may curb production

The oil industry has been rolling in dough in recent years as fast-rising prices lifted just about all boats. The next couple of years, however, are likely to be a lot tougher as the credit crunch bites, according to the well-known Edinburgh consultancy Wood Mackenzie. John Waterlow, an analyst with the group, is expecting oil demand actually to fall in 2009—by 250,000 barrels per day—for the first time since 1983 as the world economic slowdown and the lingering effects of high prices crimp consumption. At the same time, supply is expected to rise only slightly, by about 100,000 barrels per day, as oil companies pare back spending and struggle to find financing.

Prices have collapsed in recent months from a high of $147 per barrel in mid-July to about $63 at present. Will there be a further nosedive? Ann-Louise Hittle, an oil analyst at Wood Mackenzie, doesn't think so. The key question will be whether OPEC, which is adding capacity, will be willing to maintain spare capacity at high levels. She believes OPEC will rein in output enough to prevent "out of control" stock builds next year and "a market collapse to $30 to $40 per barrel." She is expecting prices to average around $75 per barrel next year and in 2010.

Impact on Oil Supply

The credit crunch is having a dramatic effect on supply as well as demand. To take one example, Hittle now expects Russian production to fall by 60,000 barrels per day in 2009, to 9.78 million barrels per day, and then decline further to 9.6 million barrels per day in 2010. The main reasons: Russian fields require constant investment to maintain and increase supply. Now, with Russian banks feeling credit strains, highly indebted Russian oil companies are likely to reduce capital expenditures. Because Russia's fields are mostly old and in need of work, these cutbacks are likely to show up quickly in their performance.

Russia isn't the only place where the credit crunch is likely to bite into production. Onshore North American fields, which are often in the hands of financially stretched companies, likely will come under pressure as well. Overall production outside of OPEC likely will rise by a skimpy 400,000 barrels per day next year and may actually fall in 2010, Wood Mackenzie predicts.

With demand growth low or nonexistent and non-OPEC supply increases modest, OPEC's behavior will be key to determining prices. The organization recently announced a cut of 1.5 million barrels per day (BusinessWeek.com, 10/24/08), and some members are already saying that more reductions may be necessary. Hittle is skeptical about how much OPEC will really cut, but she does expect Saudi Arabia to curb its production to around 8.7 million barrels per day. That's well below its peak of 9.7 million barrels per day this past summer but about the same as what it produced in 2007. The Saudis are privately saying that they were unable to sell about 300,000 barrels per day in September and had to put it in storage. Overall, Hittle thinks OPEC will cut production by about 300,000 barrels per day next year.

Growing Refining Capacity

Fears that OPEC has inadequate spare capacity to cover emergencies also are likely to ease. OPEC's margin, which declined to as low as the 1 million barrel per day range in recent years, could rise to roughly 5 million barrels per day next year—giving markets a lot more comfort.

While the oil industry contends with lower crude prices, it will also have to cope with what could turn out to be an excess of refining capacity. High prices have triggered a host of announcements of new refineries. Wood Mackenzie analyst Alan Gelder figures that about 30 of these installations with a total capacity of 11 million barrels per day will be built in the next few years. Most are likely to be either in Asia or the Middle East and will be built by national oil companies such as Saudi Aramco and Sinopec (SNP) rather than the major international oil companies such as ExxonMobil (XOM) and Royal Dutch Shell (RDSA). "For the next six to seven years, refining supply is going to outpace demand growth," Gelder says. He says the climate for European refiners is going to be particularly tough. It looks like the oil industry, like others, is entering a very different world.

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