SPECIAL REPORT: Energy demand takes diverse paths in 2008

July 14, 2008
While US energy demand this year will be limited by weak economic growth and improved fuel-use efficiency, China, Latin America, and the Middle East will sustain worldwide oil demand growth despite high global prices and keep pressure on supply.

While US energy demand this year will be limited by weak economic growth and improved fuel-use efficiency, China, Latin America, and the Middle East will sustain worldwide oil demand growth despite high global prices and keep pressure on supply.

The extent to which producers can respond to the need for more oil in the short run is inadequate to relieve prices.

US oil demand will contract this year, and demand for natural gas and coal will get a lift from increased power consumption. Hydroelectric power and other renewable sources of energy will also be in higher demand in the US, although they still represent a small share of the energy market.

Production of crude, condensate, and liquids in the US will climb faintly, but with demand waning, imports will decline. US gas production will also increase this year.

Worldwide outlook

Worldwide oil demand will increase 800,000 b/d this year, according to estimates by the International Energy Agency, and all of the growth will take place in countries outside the Organization for Economic Cooperation and Development.

Demand in the OECD will contract 500,000 b/d from last year, as North American consumption shrinks on economic weakness and demand in Europe and Asia/Pacific holds steady.

China, with demand rising to 8 million b/d from 7.5 million b/d last year, will lead demand growth outside the OECD. Meanwhile, IEA expects demand to rise 300,000 b/d in both Latin America and the Middle East.

Declining OECD oil output will be offset this year by a small increase in non-OECD oil production outside the Organization of Petroleum Exporting Countries, processing gain, and biofuels production. This will leave total non-OPEC supply at an average 50 million b/d for 2008.

OGJ forecasts that following first-quarter 2008 OPEC supply of 32.3 million b/d, oil output by the organization averaged 32.2 million b/d in the second quarter and will rise to average 32.4 million b/d in the second half of the year.

Although Saudi Arabia pledged last month to increase output, any gain will be negated by production declines in Nigeria brought about by militant attacks on production facilities and the possibility of production cuts in other OPEC countries.

With 5.1 million b/d of OPEC natural gas liquids, worldwide oil supply will average 87.4 million b/d this year, resulting in a stockbuild of 600,000 b/d.

Oil prices

“As oil prices rose to $50, $70, and $90/bbl, analysts often pointed out that these prices hadn’t yet breached the all-time high in real, or inflation-adjusted, terms,” said Stephen Brown, director of energy economics and microeconomic policy at the Federal Reserve Bank of Dallas. “That barrier finally fell in early March, when prices topped the real 1980 peak.”

Escalating worldwide oil demand, propelled by climbing consumption in developing countries, strengthened competition for crude supplies. Limited spare crude production capacity combined with supply disruptions and declining output in some key exporting countries to strain the amount of available crude.

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In addition, a weakening US dollar drew investment funds to oil and other commodities as a hedge against inflation. Geopolitical tensions, including the possibility of conflict between Israel and Iran, continued to add upward pressure to oil prices through the first half of 2008.

In March, the closing price of the front-month futures price of crude on the New York Mercantile Exchange surpassed $110/bbl. The futures price closed at another record high of $145.29/bbl on July 3. This compares to a closing price of $71.41/bbl a year earlier.

In June some countries, including India, Indonesia, Malaysia, Sri Lanka, and Taiwan, relaxed subsidies on fuels, which had shielded their consumers from the pain of high prices and blunted incentives to conserve. Easing subsidies might suppress demand this year but will have little, if any, impact on world prices.

Also in June the world’s largest crude supplier, Saudi Arabia, announced plans to increase production. This news had little impact on prices, though, as the incremental supply not only reduced spare production capacity but also put a greater volume of heavy, less-desirable crude on the market.

OGJ forecasts that the 2008 US wellhead price of crude will average $110/bbl, up from an average of $66.52/bbl last year. Similarly, US refiner acquisition costs of domestic and imported crude will climb to an average $108/bbl from $67.93/bbl last year.

Product prices

Average retail gasoline and heating oil prices in 2008 will reach record levels for the 6th year in a row. Strong worldwide demand propelled diesel prices in the first quarter of this year $1/gal higher than in the first quarter of 2007 in the US.

Excluding taxes, the US refiner price of highway diesel fuel climbed to average $3.255/gal this March from $2.055/gal a year earlier, according to the latest figures available from US Energy Information Administration.

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Pump prices for motor gasoline have followed crude prices upward as high costs have depressed refining margins, and refinery utilization rates held below 90% through the first half of this year. Inventories of motor gasoline finished the first half near the midpoint of the 5-year range.

OGJ forecasts that the pump price for all types of gasoline in the US will average $3.67/gal this year, including taxes of 43.6¢/gal. Retail prices were $2.849/gal on average last year, according to EIA.

The price of residential heating oil excluding taxes will average $3.60/gal this year, up from $2.59/gal last year, OGJ forecasts. The price in the first 4 months of 2008 was 39% higher than during the same 2007 period, EIA estimates show.

Natural gas prices

The average wellhead price of US natural gas will surge to $10/Mcf from $6.39/Mcf last year. The US is more dependent on domestic supplies this year as imports of LNG and pipeline gas from Canada and Mexico are limited.

Strong electric power demand and the potential for an active Atlantic hurricane season will keep a floor under gas prices through the third quarter of 2008.

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EIA preliminary estimates show that for the first 5 moths of this year, the wellhead gas price averaged $8.32/Mcf.

At the end of trading on July 3, 2008, the price of gas for August delivery was $13.577/MMbtu, the highest recent closing price since a late-2005 rally, when gas settled as high as $15.378/MMbtu on Dec. 13, 2005.

US economy

OGJ forecasts that US gross domestic product will grow 1% this year. The final report from the Bureau of Economic Analysis revealed that first-quarter 2008 GDP grew 1% from the preceding quarter.

The federal government’s stimulus payments to US taxpayers, intended to boost consumer spending, will stave off economic contraction in the second and third quarters of 2008.

Although inflation is a threat, largely due to the run-up in oil prices, the Federal Open Market Committee at its latest meeting decided to keep its target for the federal funds rate, which banks charge each other for overnight loans, at 2%.

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The Fed said overall economic activity continues to expand, partly reflecting some firming in household spending. But labor markets have softened, and financial markets remain under stress. Also, tight credit, the housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters, the Fed stated.

Last year’s GDP growth was 2.2%, down from 2.9% a year earlier, slowed by a meltdown in the housing and credit markets. GDP growth in 2005 was 3.1%.

US energy use will grow slower than the economy. Total energy demand in the US this year will grow just 0.4%, and energy efficiency will improve to 8,735 btu/dollar of GDP from last year’s rate of 8,784 btu/dollar.

Energy by source

US energy demand this year will total 102.052 quadrillion btu (quads). Although total demand is nearly unchanged from last year, there is a shift in use among the sources.

Petroleum demand will decline, but consumption of gas, coal, and renewable energy sources will climb. Demand for nuclear energy will retreat from last year’s record high.

Oil will still command the largest share of the US energy mix, accounting for 38.2% of the market. Total use will be 38.942 quads, a decline of 2.2% from last year. Demand for all major petroleum products will slump this year as a result of high prices.

With demand at 24.47 quads, natural gas will account for 24% of the energy mix this year. In 2007, US demand for gas totaled 23.64 quads. Rising demand for gas in electric power generation and by industrial users will drive this year’s climb in gas use.

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Coal demand will also increase, though by only 1% to 23 quads, and represent 22.5% of this year’s energy consumption. Preliminary estimates show that demand for coal by industrial customers and electric power producers grew sharply in the first half of 2008 from a year ago.

Nuclear energy’s share of electricity net generation has been nearly flat for the past few years and will remain so this year. OGJ forecasts that total demand for nuclear energy will be 8.4 quads this year vs. 8.415 quads last year, and nuclear’s share of the energy market will be 8.2%.

All forms of renewable energy used in the US this year, including hydroelectric power, will meet 7.1% of total energy demand, up from 6.9% last year. In the first quarter of this year, EIA estimates that hydroelectric power generation was down year-on-year from 2007 by almost 9%.

The renewable energy category also includes solar, wind, geothermal, and biomass. The use of biofuels and wind energy increased in the first quarter of this year, according to early EIA estimates, but the use of solar thermal and photovoltaic electricity net generation was unchanged from first-quarter 2007.

US oil product demand

Oil product consumption in the US this year will decline more than 2% as high prices for transportation fuels and heating oil curb demand.

Motor gasoline demand will average 9.2 million b/d this year, down from the 2007 average of 9.29 million b/d.

The US Department of Transportation recently announced that in April of this year, Americans drove less for the 6th month in a row, and mass transit ridership climbed as a result of rising fuel prices. The number of highway miles traveled was down 1.4 billion from April 2007 and down 400 million miles from March of this year.

In search of savings at the pump, drivers are not only taking fewer trips and traveling shorter distances when possible but also seeking more fuel-efficient automobiles in lieu of large sport utility vehicles, as indicated by auto sales trends.

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Demand for gasoline began showing weakness in October 2007, when pump prices rose counterseasonally toward $3/gal. Since then, the average price of gasoline has continued to climb. Motor gasoline demand in the first half of 2008 averaged 9.125 million b/d, down from 9.209 million b/d in the 2007 first half.

Meanwhile, rising jet fuel prices have cut into airline profits, resulting not only in higher passenger fares but also in cuts in the numbers of flights and routes. OGJ forecasts that jet fuel demand will decline 2.5% to 1.583 million b/d this year due to fewer flights.

Strong diesel fuel consumption will limit the decline in distillate demand this year. Because of heavy trucking and rail use, including that used to move ethanol to distribution centers for blending with gasoline, distillate demand will average 4.18 million b/d, down from 4.22 million b/d last year.

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Residual fuel oil demand has declined over time as less is used in electricity generation and by industrial customers. This year, OGJ expects an 18% decline in demand for resid to average 600,000 b/d.

Demand for LPG, including propylene, will decline 5% this year across industrial, residential, commercial, and transportation users, averaging 1.977 million b/d.

Demand for all other petroleum products will average 2.71 million b/d this year, down about 1.5%. These products include asphalt and road oil, petroleum coke, lubricants, pentanes plus, petrochemical feedstocks, waxes, and others.

US oil production

As it has each year since 2002, oil production in Alaska will decline this year. Last year Alaskan crude output averaged 719,000 b/d, and EIA’s estimates for the first 5 months of 2008 show average production of 705,000 b/d, a nearly 7% reduction from the corresponding 2007 period.

Oil production from the Lower 48 is getting a small boost from higher output in Colorado, Louisiana, and Texas.

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OGJ forecasts that US crude and condensate production this year will average 5.12 million b/d, up from 5.103 million b/d last year. Production of NGL and LRG will climb almost 4% to average 1.85 million b/d.

Imports, exports

Because of declining demand for oil in the US, imports will fall off last year’s levels. Imports of oil products will decline 5%, averaging 3.25 million b/d, and crude imports will contract 3.1% to 9.7 million b/d.

US net imports will drop to 56.3% of domestic demand for 2008, down from 58.1% last year.

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The source of the most US gross imports of crude and products last year was Canada, followed by Mexico, then Saudi Arabia, Venezuela, and Nigeria.

The US will export 1.55 million b/d of crude and products this year, OGJ forecasts, with most of this being oil products. In 2007, the US exported an average 23,000 b/d of crude and 1.37 million b/d of products.

Oil inventories

Crude and product stocks in the US will be able to build by only a small margin this year after closing 2007 at uncomfortably low levels.

OGJ expects commercial oil stocks to build less than 2%, putting inventories of crude at 290 million bbl and product stocks at 690 million bbl at yearend 2008.

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Industry stocks of crude at the midyear point stood at 300 million bbl, down from 354 million after the first half of 2007. Crude in the Strategic Petroleum Reserve (SPR) totaled 706 million bbl, up 2% from the end of the first half of 2007.

The Department of Energy will defer about 2.1 million bbl of royalty-in-kind exchange crude oil that had been scheduled for delivery to the SPR this summer in accordance with the Energy Policy Act of 2005, which directs the SPR to fill to its 1 billion bbl capacity.

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The crude will be deferred until March-May 2009, after the heating season. Deliveries of about 2.8 million bbl were not deferred and will continue through this month, as shipment of these barrels was under way and could not be practicably deferred, DOE announced.

At the close of the first half of 2008, distillate stocks were down almost 3 million bbl from a year earlier to 120.7 million bbl, as inventories of heating oil were below their 5-year range, and diesel stocks were higher than their 5-year range. Meanwhile, total gasoline stocks were up more than 6 million bbl from mid-2007 to 210.9 million bbl.

Refining

Refinery utilization will average 86.4% this year on operable capacity of 17.65 million b/d, OGJ forecasts.

A combination of factors is holding utilization relatively low this year, including heavy maintenance during the first half and weak refining margins in the face of high input costs and weakening demand for gasoline.

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Last year, US refinery utilization averaged 88.5%, and in 2006, refineries ran at 89.7% of capacity on average, down from 90.6% in 2005.

Following a stretch of healthy margins, refining margins took a turn downward after peaking in the second quarter of 2007. Cash refining margins were down sharply for the first 5 months of 2008 compared with the same 2007 period.

Especially hard hit were margins on the US East Coast, where cash refining margins averaged 73% lower than a year earlier, according to Muse, Stancil, & Co. Meanwhile, the average East Coast cash margin for January 2008 was 82¢/bbl vs. a $10.04/bbl margin for refiners on the West Coast that month.

For the first 5 months of this year, the West Coast cash refining margin averaged $14.99/bbl, down 46% from a year earlier. And Gulf Coast margins averaged $9.46/bbl, down 37% from the first 5 months of last year.

US gas market

Natural gas production and imports this year will outpace demand growth, even though demand for gas by power producers will be robust. OGJ forecasts that US gas demand will increase 3.5% following last year’s 6.5% growth.

The National Oceanic and Atmospheric Administration’s Climate Prediction Center announced in May that projected climate conditions point to a near-normal or above-normal hurricane season in the Atlantic Basin this year. If so, the storms have the potential to affect offshore gas production, but OGJ forecasts that total US production of gas will climb 5% this year.

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Last year total US gas production increased 4%, with output moving higher in Texas and some other key producing states but lower in Louisiana and in the federal Gulf of Mexico.

Declining gas production in Canada and the demand for gas in the production of oil sands, domestic demand in Mexico, and crashing LNG imports will drag down US gas imports 9% from last year.

Cold winter weather early this year increased residential gas use, leaving storage levels low during the spring. After a stockbuild during April and May, injections to storage slowed in June due to hot weather as cooling season drove electricity demand.

At the end of the first half of this year, working gas in storage stood at 2.1 tcf, down from 2.5 tcf a year earlier and just below the midpoint of the 5-year range.

Production in the second half of this year from some major projects, including Anadarko’s Independence Hub, will keep a floor under gas inventories. US gas exports will increase this year nearly 10% to 900 bcf.