Oil Demand Surprises To The Downside: What This May Mean For Prices

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EIA reported another volatile oil storage report today showing a sizable total liquids draw of 12.8 million bbls. All of it came from crude oil which showed a sizable drop of 12.7 million bbls. As we noted last week, the large build we saw last week would be reversed due to bad data, and the reverse came all in this week’s report.

A report of this size would have, in the past, sent prices soaring. But oil prices are flat as a pancake today because the underlying data is not bullish.

4-week average U.S. product supplied of petroleum products

EIA, HFIR

Implied oil demand on a 4-week average basis is now below 2021. This is alarming because last year still had some COVID-related restrictions. In addition to weakening overall demand, the big 3 demand variables we track (gasoline, distillate, and jet fuel) are all below the 2021 level.

Oil Demand

EIA, HFIR

This is extremely disturbing and suggests that the recent spike in oil prices is already having a significant impact on consumer behaviors. In combination with other commodity prices spiking, we are already seeing a wave of slowing demand taking hold.

Now it’s important to note that we’ve only had 6 weeks of triple-digit oil prices, so some of this demand drop could be related to consumer spending shifts. But if we go back to the 2008 implied demand chart, there are some similarities taking hold.

2008 demand

EIA, HFIR

While the similarities of 2008’s economy versus today are like comparing apples to steaks, it is important to keep watching the implied demand chart as it could form the basis for where oil prices are headed going forward.

What happens if…

Here’s a good way to think about the recent demand weakness. If we assume that demand surprises to the downside and in line with IEA’s oil demand assumption, then this is what happens to global oil market balances if Russia doesn’t lose any production.

BALANCE

HFIR

The above balance also includes the following:

  • ~12.5 million b/d from US oil production in Q4 2022
  • OPEC+ continues to increase production with Saudi pumping ~10.75 million b/d by Q4
  • Iran sanctions are lifted by July 2022

Essentially, if demand surprises to the downside and Russia lose no production, the oil market will tip into a surplus.

But that’s not realistic given that we are already seeing Russian oil production fall. Here’s the math assuming ~1 million b/d decline.

balance

HFIR

Now take all the above assumptions but add the caveat that Russia loses ~1 million b/d, and the oil market is now back in balance.

If we now assume that Russia ends up losing ~2 million b/d and Iran sanctions are never lifted, this is what global oil market balances will look like.

balance

HFIR

The oil market deficit steepens.

In essence, this is what’s happening. If Russian oil production losses steepen, oil prices will go higher than today to induce more demand destruction. If $100/bbl is already starting to hit demand, then we can assume that price will have to keep going up in order to hit demand further. How much? We don’t know. But it appears to be in $20/bbl increments.

The magical number appears to be ~1 million b/d of Russian production loss to get the oil market back to balance. This is assuming Iran’s production is at full by H2 2022. If Iran doesn’t come back, then Russia could lose no production and we would be balanced:

(If Iran doesn’t come back, and Russia loses no production.)

balance

HFIR

For now, the oil demand surprise to the downside is just a chink in the oil bulls’ armor. It’s a vulnerability we must pay close attention to, but it’s nowhere near fatal.

Oil markets are likely to keep staying in the deficit going forward as our scenario analysis has demonstrated. If Russia loses at least ~1 million b/d of production and Iran doesn’t come back, oil prices will have to keep going up to induce more demand destruction. SPR releases will help tame some of that price increase, but the only way to fight this deficit is for prices to increase to reduce demand. There’s no other way around it and we are starting to see some of that take hold.

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