Falling oil demand puts OPEC in a bind

-- John Kemp is a Reuters columnist. The opinions expressed are his own --

By John Kemp

LONDON (Reuters) - For the last two years, analysts have argued about how far oil demand would respond to the rise in prices.

But in the past few weeks evidence of a sharp decline in demand has become incontrovertible, resulting in big cuts in forecast oil demand, and posing a sharp dilemma for OPEC about how to respond when ministers meet on Nov 18.

The International Energy Agency (IEA) has been steadily dropping its demand forecasts for more than a year, as surging prices have forced conservation measures and substitution for cheaper fuels, while a slowing economy, especially in the United States, bites further into demand.

Back in July 2007, the agency forecast global crude consumption would hit 89.8 million barrels per day (bpd) in Q4 2008. Fifteen months later, the forecast had been cut by a massive -2.2 million bpd (-2.4 percent) to just 87.6 million bpd. Most of the reduction has been concentrated in North America, where the IEA has cut its prediction by -1.6 million b/d (-6.1 percent).

The IEA still believes crude consumption will be higher than in the same period last year (+400,000 bpd) -- but it would be the slowest rate of growth in more than five years, and the forecast increase relies on continued growth in China (+500,000 bpd) and the Middle East (+400,000 bpd) to offset projected declines in North America (-900,000 bpd).

It is not clear how well emerging market demand will hold up if the advanced economies tip into recession.

OPEC therefore faces an awkward choice over how to respond. It is under pressure to allow prices to settle at lower levels as its own contribution to stabilizing financial markets in consumer countries and averting a deep and prolonged worldwide recession.

Unless it begins to rein in supply now, the market could emerge from the winter heating season with higher stocks than normal, requiring even larger cuts in Feb 2009 or a vertiginous drop in prices reminiscent of 1998.

The difficulty is judging how much to cut supply to avoid a massive stock-build, while at the same time allowing prices to fall to buy back some of the demand that has been lost.

Despite its reputation as a profligate energy user, the United States achieved a real and lasting reduction in crude oil use following the oil shocks of the 1970s and early 1980s. Oil was substituted by natural gas for power generation, while much-maligned motor manufacturers achieved significant and durable improvements in engine technology.

Between 1973 and 2008, U.S. output rose +172 percent. The resident population rose +44 percent. Oil consumption was up just +14 percent. Per capita consumption was cut almost a third, from 34 bbls in 1976 to 23 bbls in 2008. Consumption per $1000 of GDP (2000 prices) fell two-thirds from 1.6 barrels to 0.6.

Some of the decline is more apparent than real. "Contained" petroleum consumption has fallen by less than the raw figures suggest, and natural gas consumption has risen sharply.

Manufacturing activity has shifted overseas to emerging markets such as China, and the attendant crude consumption moved with it.

Nevertheless, the oil shocks were followed by a significant structural decline in oil demand that has never been fully reversed.