Pandemic Demand Destruction No Match For Supply Shortages

Concerns about weakening demand in oil markets are real but don’t expect them to impede the bull run in prices.

Benchmark crude oil prices are back over $110 a barrel despite widespread Covid-19 lockdowns in China and evidence that oil demand elsewhere in the world, including the U.S., is not as strong as many projected.

The reason for resurgent prices is simple: markets are more concerned about the current crude supply shortage, which shows no signs of abating.

There is no question that high fuel prices and China’s “zero Covid” policy are causing some to question their demand forecasts for 2022.

The International Energy Agency (IEA) forecasts global oil demand will average 99.4 million barrels a day in 2022. That is down 800,000 barrels a day from its forecast two months ago. The agency has recently revised its demand projections lower in response to the price spike after Russia invaded Ukraine and China’s ongoing lockdowns.

The lockdown situation in China is alarming, and there’s no telling how high prices could be without it. Around 193 million people, including 25 million in Shanghai, are currently under full or partial lockdowns in China, accounting for 13.6percent of China’s popu

lation and 22percent of its GDP, according to Nomura Securities.

The situation has led some analysts to reduce their 2022 oil demand growth forecasts for China to around 2 percent from 3 percent or higher, which has significant market ramifications since China is the world’s primary engine for oil demand growth.

Meanwhile, markets are starting to consider the impact of high fuel prices on consumer behavior. Demand destruction, the phenomenon in which consumers reduce fuel use because of high prices, maybe start to bite.

In the United States, gasoline consumption has fallen for three consecutive weeks.

The U.S. Energy Information Administration reported that gasoline consumption fell to 8.61 million barrels a day in the week that ended April 8 based on a four-week moving average, the lowest since March 4. That is down 2.3 percent from the same period in 2021 and 8.1 percent from the same period in 2019 before the pandemic.

Although pump prices have dipped in recent weeks, the national average remains high at about $4.09 a gallon, about $1.25 more than a year ago.

With the arrival of warmer weather, consumers are increasing their fuel consumption, a pattern that extends through the summer months. But high prices may throw a wrench in that trend.

In its latest monthly report, the Paris-based IEA warns that prices “remain troublingly high and are a serious threat for the global economic outlook.” Still, the sample size is not large enough to say definitively that high prices will cause significant demand destruction in the United States – or anywhere else.

The safer bet is that Chinese demand will fully return when lockdowns are eased. That has been the pattern since Chinese President Xi Jinping introduced his zero Covid strategy in early 2020.

The bottom line is that any lost demand won’t be sufficient to offset the crude supply shortages anticipated this year.

The IEA expects Russian oil supply to fall by 1.5 million barrels a day in April and then drop another 1.2 million barrels a day by year-end. Russia shows no signs of easing its war efforts in Ukraine, and European Union officials have begun to draft formal sanctions targeting imports of Russian petroleum.

Production outages in Libya, another OPEC+ producer, are now increasing concerns about tightening oil supplies. Price increases tied to even minor output disruptions often become the trend in a tight market.

And not everyone is as bearish as the IEA on oil demand in 2022. OPEC’s forecast is about 1 million barrels a day higher than the IEA’s 100.5 million barrels a day prediction.

Investment bank Credit Suisse is also confident in its 100.5 million barrels a day global demand forecast, which points to a supply deficit of about 2.2 million barrels a day in the second half of this year.

With consumer nations like the United States having already tapped their strategic oil reserves in a big way, there is little to stop oil prices from rising further and eclipsing the $130 a barrel mark set shortly after Russia’s February 24 invasion of Ukraine.