Power Shortages Push Oil Demand Upward

Oil Price Forecasts Raised

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Even with the decline in crude oil prices from recent highs we remain bullish on the energy sector. We think investors are grossly underestimating the impact the shut-in Libyan sweet crude oil production will have on energy markets this summer and fall. Additionally Yemen is moving toward a possible civil war with escalating violence - the country shares a lengthy border with Saudi Arabia. And we think investors are overlooking the ongoing electrical power shortage in China and elsewhere in the developing economies – the worst seen in years - which will create additional demand for oil products to fuel electrical generators.

The following developments last month in our opinion are bullish for the energy sector:

China’s April Oil Demand

Platt’s reported that China's oil demand in April increased 8.3% from the same month last year. The apparent oil demand reached 9.4 million barrels per day, the third highest figure ever. Since the Chinese government does not release official data Platt’s calculates the demand through domestic refinery volume and net oil product imports.

Ken Rapoza at Forbes notes in a column that “higher oil prices did not deter China’s hunger for crude. April imports totaled 5.25 million barrels of oil a day compared with an average of 4.8 million barrels a day in 2010. April oil imports rose from 5.1 million barrels a day recorded in March. . . .” The concern in the market is that the Chinese demand will experience “a fairly sharp slowdown in Chinese oil demand for the remainder of the year”, but Rapoza concludes “the balance of risks currently points to significant upside” to estimated demand levels.

Estimates of the increase in Chinese demand for 2011 are all over the map: Barclays Capital’s (growth of 790,000 barrels per day), International Energy Agency (610,000 barrels per day), US Energy Information Agency (580,000 barrels per day) and OPEC (560,000 barrels per day).

electricity consumption china and usChina Power Shortage

China ordered the operator of the Three Gorges Dam to begin discharging additional water to replenish the Yangtze River and counter the Hubei region’s lowest rainfall in half a century.

Bloomberg notes that lower water levels in the 3,915 mile river may increase China’s oil demand by 300,000 barrels a day as diesel and refined products make up for lost hydropower generation.  Diesel’s usage as the swing fuel for power could easily translate into “an additional 200,000 to 300,000 barrels a day of potential oil demand” according to analysts at Barclays Capital.

Increased use of diesel generators has driven oil demand upward by 400,000 to 600,000 barrels per day in previous summers when electrical shortages have occurred. We expect a similar response this summer.

The explosive growth of China’s demand for electricity is apparent from an excellent chart prepared for an article recently published in the New York Times—electricity consumption and economic growth are highly correlated.

Pakistan Power Shortage

 The Financial Times reports that nationwide power shortages have brought protesters to the streets of Pakistan. Many parts of the country are suffering from power rationing. The result is that as the summer temperature rises many households are lucky to receive eight hours of electricity a day. The article notes that the power cuts are more acute this year because of underinvestment in power stations, unreliable distribution and gas shortages. The government has also cut funding for the electricity sector as it struggles to reduce its fiscal deficit.

China Crude Imports RisingAs with China, industry and wealthier households are using oil powered generators to generate power when the main grid goes black. “The power cuts are terrible. I have a generator so I’m okay. But poorer people don’t” one Islamabad resident noted. Like China, this incremental demand for oil to power generators should be apparent this summer and fall – and add to the supply/demand imbalance. 

Oman Power Shortage

Oman’s electricity demand reached a record earlier this week with demand exceeding the country’s power-generating capacity. Domestic demand in the Arab Peninsula nation was 10 per cent higher than last year. The country is meeting the additional demand partly by using reserve diesel powered generators and may seek to import power this summer. Again, additional incremental diesel demand is being created to meet electrical power demands.

Frank Holmes on China

Frank Holmes, CEO of US Global Investors, discussed the robust demand growth from China in a column last month:

…Emerging markets, driven by China, are the main source of the increase in [global crude oil] demand. You can see from this next chart how China’s demand for crude oil imports has grown over the past decade or so. China imported an average of just under 1.4 million barrels a day of oil in 2002 when prices were hovering around $20 per barrel.

In the years since, China’s crude oil imports have increased more than 260 percent despite per barrel oil prices jumping nearly four-fold. This is indicative of the insatiable demand that emerging markets have for oil.

UAE May Output Cut

The IEA announced that the UAE experienced an “unexpected shut down of the Upper Zakum field at end April. As much as 50 per cent of the field's 550,000 bpd capacity will be shut for the next several months”. Not a huge amount of oil production, but it adds to the developing supply and demand imbalance.

Oil Price Forecasts Raised

As long term investors tracking long term trends we don’t place a lot of weight in forecasts by the major investment banks, but we like to read their research for their analysis and reasoning. Last month Goldman Sachs raised their forecast for Brent crude oil to $120 a barrel by the end of 2011 from $107. And they forecast $130 in 12 months.

Morgan Stanley also raised its forecast for the average Brent price by 20% to $120 a barrel for this year and $130 for next. They cited a sustained loss of Libyan crude oil production and disappointing output by non-OPEC nations. The oil market will tighten to critical levels in early 2012 they assert, and “spare [production] capacity continues its fall to untenable levels.”

JP Morgan also predicted crude oil will lead to a rally in raw materials as production fails to keep pace with rising demand. Oil supply will trail consumption in the second half as OPEC and other producers won’t be able to increase output fast enough according to the JP Morgan analysts.

Gulf of Mexico Hurricane Season

atlantic hurricane seasonThe Gulf of Mexico and US coastline contain a significant number of oil and gas wells and refineries. Any hurricane activity can disrupt operations. With regard to the upcoming hurricane season the National Oceanic and Atmospheric Administration predicts that the Atlantic hurricane season will be “above normal” this year with 12 to 18 named storms. The storm season begins June 1st.

2011 hurricane season forecastClimate conditions that developed in 1995 remain in place in the Atlantic Ocean and will contribute to a higher-than- average storm total and more powerful hurricanes according to NOAA. Ocean temperatures are 2 degrees Fahrenheit above normal this year, compared with 4 degrees in 2010, and the heat tends to add additional energy to developing storms.

Accuweather also issued their 2011 hurricane forecast. They similarly forecast an active hurricane season (charts courtesy Accuweather.com, Paul Pastelok).

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About Joseph Dancy