The Last Oil Cycle is Now Behind Us

If you wanted to make a case that US oil demand was threatening a new, upside breakout, a good place to begin would be the year 2000, the beginning of the new millenium. The country was using 6% more oil that year than it is today. More tellingly, the population was 12% lower. Since that time, the US has added over 40 million people. If US oil demand growth is so noteworthy, so enduring, so healthy, then why isn’t demand back at least to the levels of 17 years ago?

(The chart shown here is from Datawrapper and is useful because it’s responsive. Go ahead, move your mouse over the chart.)

The reason oil’s vulnerability begins now—why the oil industry is no longer protected from further downside price risk—is that the market is already in a weakened price-position as it heads into a series of major, demand growth challenges. Interestingly, some believe another one to two oil cycles still lie ahead of us. The problem with this view is that oil has finally run out of time.

For example, it’s no longer likely that sales of internal-combustion engine (ICE) vehicles will return to growth in the United States. There will still be many ICE vehicles driven in the US for a long time. But already, EV sales are growing and ICE sales are declining. By the time US sales of ICE vehicles are ready to mount a recovery, say by 2020, EV will have been taking market share for several years, and will be ready to compete head to head with ICE, on price.

More broadly, it’s now possible to ask where, in what large markets, will ICE vehicles enjoy further growth compared to EV? China—leaving aside its recent plan to ban ICE cars by 2040—is already set to roll out new restrictions on ICE vehicles in 2019. As the world’s largest car market, and largest EV market, one could make the argument that ICE cars still have a few years left of growth in China. But EV sales growth trends, and policy initiatives, are already underway right now, in China.

The problem is that the number of domains where the oil industry can find new growth is shrinking. India was the standout last year, growing demand at 8.3%. But China’s demand growth, at 2.7%, was doubly concerning. A high rate of ICE adoption would imply a much, much higher rate of demand growth in the world’s most populous nation. More revealing was a research note just published from IEA in Paris, pointing out that in 2016, more than a half-million bpd of China’s demand was likely due to stockpiling. Here is the key quote from IEA, “Therefore, China effectively acted as a price setter from 3Q15 to 1Q17, when it stored away much of the global oil overhang.” In other words, even at flat global production rates, there was still oversupply in the market and China took up that overhang and stored it.

A new oil cycle globally would imply a brand new phase of oil user adoption, concurrent with a new round of supply growth–and firmer prices. But global oil supply, after lifting off (crazily enough, on the back of lower prices) starting in 2015, has been roughly flat. At the current 80.5 mbpd of production, the market has been able to satisfy the lower rate of demand growth at a fairly stable $50 price level. If you believe in a new oil cycle, you would have to believe the current equilibrium must be disrupted in order to bring new oil supplies forth, at higher prices to the world economy.

The global oil industry and the global auto industry now face the same challenge: not the current level of demand, but finding a new, higher level of demand. Tediously, those who want to argue about future demand growth often, erroneously, point to current levels of market penetration. That misses the point. For global oil demand to go higher, global sales of ICE vehicles need to go higher from here. When you look at all the changes taking place at the margins of both industries, it becomes quickly apparent that the next growth leg isn’t coming, and neither is another, new oil cycle.

–Gregor Macdonald

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