1. Prices and consumption

Even a major supply disruption due to a pipeline bombing in Turkey and the fighting in Georgia was not enough to stem the drop in oil prices which has been underway for nearly a month. The markets are seized with the notion that worsening economic conditions around the world will result in a significant decline in the demand for oil. Announcements that China’s crude imports in July fell by 7 percent on-year and that a new high was established for OPEC production, plus a rapidly strengthening US dollar, all contributed to the steepest price decline in 26 years.

Prices rebounded, at least temporarily, on Wednesday when the EIA reported an unexpectedly large drop of 6.4 million barrels in US gasoline stocks. Oil closed at $116 a barrel on Wednesday, up $3 a barrel from Tuesday’s close.

There appears to be a consensus among oil traders that Wednesday’s bounce will be a short lived affair and that prices still have further to decline. For now, they cite technical factors in the oil market, their conviction that demand will continue to fall, and brush off falling stockpiles and supply disruptions.

Demand destruction

In recent weeks the press has been filled with stories that high gasoline prices have led to greatly reduced US demand. Every month the Federal Highway Administration puts out a report which talks about billions of fewer miles being driven by US motorists. Indeed the EIA reports that so far this year US oil consumption is down by 3.6 percent. The drop in oil product consumption, however, is not uniform. In its most recent report, the EIA says average gasoline consumption during the last four weeks is down by 182,000 b/d on year while distillate consumption, which includes exports, is up by 172,000 b/d. Not a lot of demand destruction going on when you net the two together. Jet fuel demand, however, is down by 142,000 b/d.

The American Petroleum Institute, using different methodologies and time periods, says US demand for gasoline was down 4.2 percent in July vs. the EIA’s 2.3 percent for the last four weeks. The API however has distillate fuels production, including jet fuel, increasing by 13.5 percent during July. All this suggests that demand for gasoline and diesel in the US may not be as low as widely believed. There is also the issue of how much of the recent decline in driving is related to fewer or shorter vacation trips so that the numbers might not be so low after Labor Day.

China and to a lesser extent India are important to the demand question. Beijing stockpiled a lot of crude and products during the spring in preparation for the Olympics and then curtailed imports drastically during July and August. Despite signs that China’s economy is starting to slip, it is still growing rapidly. The IEA recently suggested there could be a surge in Beijing’s imports in the fall.
Unlike US vacation driving, most of the world’s oil consumption is not for discretionary activities. World-wide demand destruction may not be as steep as the conventional wisdom among oil traders suggests.