Whatever happened to oil demand destruction?

Tom Traill - 10 July 2019

Why didn’t the surge in oil prices in 2017-18 result in a noticeable cutback in oil consumption? The Brent price surged from US$45 in June 2017 to US$85 in early October last year, but world oil consumption rose 1.3 per cent in 2017 and 1.2 per cent in 2018. Small decreases in European, EMEA and Latin American demand were offset by strong growth in Asia Pacific and North America last year. A recent empirical study found that the price elasticity of demand for oil is just -0.1 and that oil supply shocks are responsible for roughly half of the volatility in oil prices. More volatile temperatures have also contributed to the unresponsiveness of oil consumption.  

If presented only with BP’s time series charts of crude oil production and consumption, shown in figure 1, it would be impossible to deduce the erratic behaviour oil prices over the past 25 years. Such is our continued dependence on fossil fuels for the bulk of energy use, that little more than 2bn of the almost 14bn tonnes of oil equivalent consumption was represented by renewables, hydroelectricity and nuclear energy in 2018. Indeed, global energy consumption increased by 2.9 per cent in 2018, the strongest since 2010.

Figure 1

Source: BP Statistical Review of World Energy, 2019 

In an insightful 2016 paper entitled “Oil price elasticities and oil price fluctuations”, by Dario Caldara, Michele Cavallo and Matteo Iacoviello for the US Fed, the impacts of demand and supply shocks were distinguished using a structural vector autoregressive model for the oil market. They estimated the short-run oil supply elasticity as about 0.1 and the oil demand elasticity about −0.1. Based on these elasticities, oil supply shocks are the main driving force of oil market movements, accounting for 50 and 40 percent of the volatility of oil prices and oil production, respectively. Shocks to global economic conditions also play an important role, explaining about 35 percent of the volatility of oil prices, and 25 percent of the volatility of oil production.  A drop in oil prices driven by oil market shocks, regardless of whether the shock originates from supply or demand, depresses economic activity in emerging economies, while a decline in oil prices boosts economic activity in advanced economies only if it is supply-driven. Given the historical realization of these oil shocks, these findings help rationalize the muted effects of changes in oil prices on global economic activity.

The increased variability of temperatures, and other aspects of extreme weather, may also be responsible for the resilience of energy consumption. Spencer Dale, group chief economist at BP and a former chief economist at the Bank of England, comments that a simple model using oil prices and GDP growth goes a long way towards explaining oil demand. However, when they account for unusual weather – 2018 saw a larger than normal incidence of both hot and cold days leading to more demand for both heating and air conditioning – this improved their model forecasts (figure 2).

Figure 2: Global energy consumption growth (annual change, %)

Source: BP Statistical Review of World Energy, 2019

While developments like electric cars and solar technology capture the headlines, the falling demand for oil-thirsty products at the high-tech end of the market is seemingly outweighed by the demand for more energy-intensive products at the other end of the scale. It might seem that China's energy demand would be largely industrial, and thus not significantly impacted by the weather, but the rapidly growing Chinese middle class has dramatically increased the number of air conditioning units to more than fifty per cent greater than that of the US (figure 3). A report from the International Energy Agency suggests that global cooling use in buildings doubled between 2000 and 2016 and was likely to double again by 2040. This could be mitigated by improvements to the efficiency of air conditioners but represents a major ongoing source of demand for energy.

The recent strength in global energy demand last year might have been partly attributable to increased variability in the weather.  However, this is a reality that is likely to persist.  We have yet to reach an oil price range that triggers sufficient demand destruction to stabilise global energy consumption. 

Figure 3

Data source: International Energy Agency

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