The International Energy Agency (IEA) confirmed the blog's worst fears this week, with its announcement that crude oil demand actually fell by 300kbd in Q4. Not only is this "quite rare" as the IEA noted, but they went on to warn:
"We're flagging that there are clearly downside risks to the global economy and to oil demand: the world could see zero demand growth if there were further downgrades to global GDP estimates".
The issue is simple. The world has never before had to live with Brent prices at over $100/bbl ($2012) for so long. Demand destruction is clearly taking place on a wider and wider scale. Even if prices fell sharply tomorrow, demand would now still take a long time to recover.
The IEA data shows that Western demand fell very sharply in Q4, by 700kbd. And Asia, despite all the bullish analyst talk about decoupling and perpetual demand growth, saw just a 400kbd increase. China's slowing economy meant its demand rose only 1.7% in November versus 2010.
Yet for the moment, prices remain at their record levels. They are supported not only by Iran's threat to block the Strait of Hormuz, but also by Saudi Arabia's comment that its "wish and hope is we can stabilize this oil price and keep it at a level around $100/bbl".
As a former feedstocks and oil product trader, the blog well remembers that the basic rule in oil markets has always been to assume Saudi will achieve its objectives:
• It has the largest reserves, and plenty of spare capacity (Oil Minister Naimi suggested in his interview it could easily produce an extra 2mbd)
• And usually Saudi prefers relatively low prices, as it is keen to be seen as a reliable supplier, helping to promote global growth
• It is equally dangerous to bet against Saudi when it wants higher prices
• It cut production between 1980 - 1985 from 10.3mbd to just 3.6mbd, in its effort to keep prices at ~$30/bbl ($65/bbl in $2012)
But today's position is less clear-cut. Saudi needs high prices, at least $80/bbl, to balance its budget, following its decision to increase subsidies and handouts following the Arab Spring. But it also (unlike the 1980s) needs high volumes. 3.6mbd at $100/bbl wouldn't provide enough income.
It is thus hard to see how both its objectives can be achieved:
• US demand is down 1.5mbd since 2007, and its domestic production is increasing rapidly, whilst European and Japanese demand is also reducing
• 2012 seems a bad year to try the experiment, with demand growth under threat from European austerity programmes
• Equally, China imports only 5mbd, so even a major new stimulus programme would not really create much extra global oil demand
• The outlook is even less promising. Spare capacity today is 4mbd, and this volume is already set to rise to 8mbd by 2015
And finally, of course, there is the growth of gas supply. The arrival of shale gas has pushed US prices down to $2.35/MMBTU. As the chart shows, this has led to a record ratio for crude oil prices versus gas of 34 today, when the energy equivalent ratio is only ~6.
This will further reduce oil demand in favour of gas, probably permanently. Whilst today's record prices mean that other major consumers including the UK, Poland and China, are all hurriedly jumping on the bandwagon.
The blog cannot remember a time in the past 30 years when oil markets have been so uncertain.
History suggests it would be extremely unwise to bet against Saudi, at least in the short-term. The Iranian situation makes this doubly risky. Yet building inventory would also be very risky, if prices did begin to fall. And it is also very expensive at today's prices.
Thus low inventories and increasing nervousness create the potential for continued price volatility, further adding to the uncertainty.