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Factors that could make $5 a Gallon Gas the Norm

By Dave Summers | Tue, 06 March 2012 16:57 | 0

It is hard to miss the recent rise in gasoline (gas) prices in the United States, and the rumblings that it has generated in the national press. It is a concern that has already entered the on-going political debate with one Republican candidate promising that, once elected, he will bring the price of gas down to $2.00. (The unreality of that prediction has been explained earlier.) As a result there have been a number of reasons projected (for example here) as to why, in contrast with most seasons, gas prices are rising at the present, in the season of the year when demand is generally lower than normal. Today (Thurs the 1st March) they have risen for the 23nd straight day with prices about $0.30 above what they were a month ago. The Administration does not seem, however, concerned.

US Retail Gasoline Price
Changes in the price of gasoline (EIA TWIP)

US Gasoline Demand
Changes in US demand for gasoline (EIA TWIP)

Even though the economy is somewhat stronger than it was a year ago, the demand for gas is still down around 400 kbd. (8.746 against 9.101 mbd). In a more conventional market decreasing demand, against constant supply would lead to a fall in prices. That is not likely to happen, and in part this is because the USA only provides a part of the global market where the demand from the developing countries (as Stuart Staniford has noted) is steadily increasing. China, for example, is growing its oil demand at slightly more than 5% p.a. (0.51 mbd y-o-y for December growth) and has reached a total consumption of 9.3 mbd. It is also slowly starting to build its own reserve of oil and has been buying additional oil for that reason. How long that will continue this year is one of those questions to which there is no clear answer, although, since it is apparently buying heavier and higher sulphur crude and it may be acquiring those crudes that Saudi Arabia has previously had problems selling.

However I continue to have a concern that in the face of this growing demand there continues to be a question over the stability of supply during the next year. (And also thereafter, but that is less likely to affect current gas prices). Consider, if you will, that during the height of the summer US demand will, following the pattern shown above, rise about 1 mbd. Similarly with the driving season in Europe and elsewhere, demand in general can be anticipated to increase over the next four months. OPEC, in its February Monthly Oil Market Report, has lowered its projection of demand growth this year overall to 0.9 mbd, (for a peak of 89.95 mbd on average in the fourth quarter of 2012) having recently lowered the estimate based on doubts over the growth of the US economy, but nevertheless that additional supply has to be found from somewhere.

Projections of Oil Demand Growth
Projections of oil demand growth from OPEC (OPEC February 2012 MOMR)

And this is where the troubles that continue after the beginning of the “Arab Spring” may have consequences in meeting those targets, together with questions on the nature of the continued status of oil shipments from Iran. OPEC anticipates that, in total, it will (plus minus 100 kbd) continue to supply 30 mbd into the global market. For, as the EIA TWIP notes:

EIA estimates that the world oil market has become increasingly tight over the first two months of this year. Oil prices have risen since the beginning of the year and are currently at a high level. Global liquid fuels consumption is at historically high levels. While the economic outlook, especially in Europe, remains uncertain, continued growth is expected. . . . . With respect to supply, the world has experienced a number of supply interruptions in the last two months, including production drops in South Sudan, Syria, Yemen, and the North Sea. Both the United States and the European Union (EU) have acted to tighten sanctions against Iran, including measures with both immediate and future effective dates. There is some evidence that these measures may already be causing some adjustments in oil supply patterns. For example, there is emerging evidence that some shipments of Iranian crude oil under existing contracts are being curtailed . . . .

One should also remember, that, in discussing oil supply, price is set by that which is available on the market, and this usually discounts the volumes that are consumed domestically. Thus, if Saudi Arabia, for example, increases domestic demand by 100 kbd and the FSU increases demand by 100 kbd, both against a constant overall output, then the rest of the world has to find that additional 200 kbd from somewhere else. In the short term that might be the United States, since production overall rose some 360 kbd in 2011, largely credited to growth in production from the Bakken in North Dakota, and from Eagle Ford shale in Texas. OPEC anticipates that growth to continue, estimating a total gain of 260 kbd from North America this year, though only half of that will come from the United States (the rest will come from Canada).

Non-OPEC growth is, in total, expected to continue in 2012, with an overall production gain to 53.34 mbd by the fourth quarter.

But it is the volumes from the countries involved in continued conflict that raise concern. Libya is making considerable strides to return to pre-conflict levels of 1.6 mbd, having reached 1.4 mbd this month, with exports at 1.1 mbd but Iraq has yet to reach 3 mbd – being at 2.75 mbd in January. (It remains hard to be optimistic over claims that this will rise significantly in the near term.) The EIA are more concerned than OPEC. They note that in order to balance demand against supply Saudi Arabia was producing at 9.9 mbd in January and they consider that the country has only 2 mbd in additional production that it can bring to the market at present (and most of that is heavy sour crude). Further they see domestic demand rising to 3.2 mbd in the middle of the summer, cutting exports significantly. Some of this might be needed to offset supply from Syria, which has been shipping over 150 kbd into the market, but which has already had to cut back that amount as sanctions from Turkey have cut the market.

But it is Iranian production, which normally runs at around 3.5 mbd that raises the real concerns. If this all disappears from the market, the fear is that this cannot all be made up even if Saudi Arabia went into emergency production, and thus that there may be a shortfall of around 1.4 mbd in global supply. The ban will take full effect in July, but as sanctions continue to bite and nibble away at what is still being sold, so the flexibility of the market to adjust is going to be tested. And that may have already begun. Predictions of increases in production and thus global supply, appear somewhat more tenuous than one can be comfortable with, as oil – and thus gas – prices continue their rise.

By. Dave Summers

David (Dave) Summers is a Curators' Professor Emeritus of Mining Engineering at Missouri University of Science and Technology (he retired in 2010). He directed the Rock Mechanics and Explosives Research Centre at MO S&T off and on from 1976 to 2008, leading research teams that developed new mining and extraction technologies, mainly developing the use of high-pressure waterjets into a broad range of industrial uses. While one of the founders of The Oil Drum, back in 2005, he now also writes separately at Bit Tooth Energy.

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