(EnergyAsia, August 25 2017, Friday) — More than three years into the global energy price collapse, complacent consumers could be ripe for another shock from “substantially higher oil prices” in the next few years, according to two economists at the Federal Reserve Bank of San Francisco.


In a research paper, Deepa D. Datta and Robert J. Vigfusson predicts China’s strong oil appetite will be the market’s main driver that will override current expectations for stable prices from a protracted global energy supply glut, weak demand growth, and the growing popularity of electric vehicles.

“Although China’s growth has slowed recently, the country’s demand for oil could be entering a period of faster growth that could result in substantially higher oil prices,” the economists wrote.

The oil market has seen two major surprises in the 21st century, according to their paper, “Forecasting China’s Role in World Oil Demand.”

The world was sucker-punched in 2008 when crude prices surged to a record US$147 a barrel on the back of years of strong consumption growth in China and other developing countries.

It was caught out again when the US successfully exploited its massive shale reserves to unleash new supplies of oil and gas that led to crude prices crashing from more than US$100 a barrel in early 2014 to less than US$50 today.

In their paper, Datta and Vigfusson raised the possibility of a third surprise lurking in the shadows. The world is at risk of being lulled into complacency by the “resilience of US shale oil production” in the face of sustained lower oil prices and challenges from the Organisation of Petroleum-Exporting Countries (OPEC) in recent years.

While most studies suggest that oil prices will remain subdued, the two economists contend that energy demand growth in China and other emerging economies are once again being under-estimated.

They said the world could be set up for “a similar surprise in the coming years” in the same manner “that Chinese demand helped boost world oil prices in the early 2000s.”

Chinese oil demand could double by 2025 on a combination of sustained economic growth at current rate and further expansion of energy-intensive activities. Even in a scenario with more moderate growth and less energy-intensive choices, the economists said China’s oil demand would still grow by over 30% by 2025.

They concluded that “prices would have to rise, perhaps dramatically” if US and other oil producers do not anticipate this demand increase.

 

Why focus on China?

Datta and Vigfusson said they chose to focus on China because its size and rapid economic growth gave it “primary importance in determining the path of global oil demand.”

Between 2005 and 2015, China’s oil consumption increased by 4.8 million b/d. To put this in perspective, world oil consumption grew by 9.8 million b/d over the same period.

Although China accounted for only 12.2% of global oil demand in 2015, it accounted for almost one-half of the increase in demand between 2005 and 2015.

“These increases more than offset decreases elsewhere over the same period, as the US reduced its oil consumption by 1.3 million b/d, and other advanced economies reduced their oil consumption by 2.9 million b/d,” they wrote.

“(While) China won’t match the level of per capita demand among developed nations anytime soon, its large population implies that even modest increases in per capita consumption may have dramatic effects on global energy markets.”

In a slow growth scenario, Datta and Vigfusson project China’s oil demand to increase from 11.5 million b/d in 2015 to 15.2 million b/d in 2025. In a fast-track scenario, they said China’s oil demand could reach 20.8 million b/d in 2025.

The economists acknowledge that their projections could be derailed if China implemented policies to greatly discourage oil consumption and adopted technologies that are energy-efficient and reduce carbon emissions.

 

The case for higher oil prices

In both scenarios, the economists noted that they have taken a more bullish outlook on China’s oil market than the US Energy Information Administration (EIA) which expects Chinese demand to reach 13.8 million b/d by 2025.

As a result, the EIA expects the crude price to rise only gradually from about $55 per barrel in 2015 to $90 per barrel in 2025.

Citing scholar James Hamilton who studied the link between oil prices and demand growth in the 2008 run-up, Datta and Vigfusson concluded that crude prices would have to reach to US$172 per barrel by 2025 for the market to balance out in a high-demand scenario.

“Although this represents an extreme and less likely outcome, it does highlight the risk of unexpectedly strong demand growth,” they wrote.