The recent jump in oil prices to $80 per barrel raised a lot of questions about whether or not the heady demand growth projections for this year would hold up. In fact, signs of strain quickly popped up in disparate parts of the world. But as governments move to protect their citizens from high fuel prices (and to protect their political positions), demand might not be as price sensitive as analysts tend to think.
The history of oil price cycles show demand is highly sensitive to sharp increases in prices – demand took a hit in 1973, the early 1980s, the extraordinary 2005-2008 price increase, and the 2011-2014 period, when prices routinely topped $100 per barrel.
That record provides some guidance about what we should expect. Brent hit $80 per barrel for the first time in more than three years in May, a price level that would start to test the durability of demand growth. The run up in prices coincided with some early signs that consumers were losing their patience.
For example, U.S. President Donald Trump complained to OPEC in April about “artificially” high prices, and reportedly sent a request to the Saudis for higher output recently. Crippling protests in Brazil brought the economy to a standstill and led to the ouster of the CEO of Petrobras. The International Energy Agency revised down its forecast for demand growth this year by 100,000 bpd, citing high prices.
Just as prices started to become painful, the OPEC+ coalition felt compelled to change course, and are on the verge of increasing output. Even with the recent price correction, demand threats still loom. The U.S. Federal Reserve continues to hike interest rates, which is strengthening the U.S. dollar and making dollar-denominated debt more painful to service. That is putting a strain on emerging market demand. The currencies of Argentina and Turkey have been slammed in the past few months.
That is important because oil demand growth is coming almost entirely from developing countries, not the OECD.
However, even as emerging markets groan at high oil prices, governments are feeling the pressure, and in some cases are stepping in to subsidize fuels.
A combination of price caps, fuel subsidies, tax cuts and monetary policy intervention to blunt the damaging effects of a strong greenback are proliferating in a variety of countries. While Brent prices have jumped more than 40 percent since the beginning of 2017, for instance, diesel prices (in local currencies) have increased less than 20 percent in China and India, and by less than 10 percent in Thailand, Malaysia and the Eurozone, according to Bank of America Merrill Lynch.
In India, for example, rising fuel prices are becoming politically dangerous, particularly with national elections just a year away. As such, the government has started to remove some fuel taxes to cushion the impact of higher global oil prices. “Should fuel price regimes become more accommodative for the consumer, it would set the stage for increased government borrowing and a deteriorating debt profile,” Bank of America Merrill Lynch said in a note. “But it would not allow for a natural reduction in local oil demand.”
In Brazil, the worker protests that temporarily shut down the economy have pushed the extremely unpopular government into lowering fuel prices, potentially ending the market-based fuel pricing policy that was introduced a few years ago. That could prove costly for Petrobras and for public coffers, but pressure from the populace is forcing the government’s hand.
Argentina has also frozen fuel prices temporarily. Indonesia and Mexico are considering similar measures. In fact, the upcoming election in Mexico could result in a significant change in policy, with subsidized fuel a possibility, although that remains to be seen.
Higher oil prices should cut into global oil demand. That’s the theory at least. But policy responses from governments around the world, fearful of political damage from rising fuel prices, could keep demand growth on track, defying expectations. These “rigidities,” as BofA Merrill Lynch puts it, “will not allow for a natural price-driven adjustment in oil demand.”
Meanwhile, the bank says that the prospect of a trade war could be damaging to global growth, but the negative fallout has yet to show up in the data. Manufacturing activity, measured in PMIs, is expanding in “all major economies,” BofA Merrill Lynch says. “The risk of trade wars or an outright policy mistake has clearly grown after the announcement of steel and aluminum tariffs, but the market has yet to take notice.”
The overall conclusion, then, is that oil demand remains solid, and is not as price sensitive as some might think. An oil price averaging $80 per barrel instead of $70 could shave off 200,000 bpd, BofA Merrill Lynch estimates, which is ultimately not a dramatic decline.
By Nick Cunningham of Oilprice.com