Efficiency Mandates to Cap Recovery in Oil Demand

Lower prices should help stimulate oil consumption in advanced economies, restoring some of the demand lost over the last decade, as the cost of crude soared from less than $50 to more than $100 per barrel.

In the late 1980s and through the 1990s, strong growth in demand played a crucial role in rebalancing the market after the slump caused by the two oil shocks in the 1970s.

Investments in energy efficiency and policies to encourage conservation ebbed as memories of the oil shocks receded and a long period of relatively low prices encouraged complacency.

But it could prove much harder to stimulate increased oil consumption this time around because policies to encourage further reductions in fuel demand for years ahead are now entrenched in legislation.

In the 1970s and 1980s, fuel efficiency mandates were enacted in response to concerns about energy prices and the security of oil supplies.

In the 2000s, efficiency mandates were enacted in response to both concerns about energy prices and climate change, which will give them much more stickiness.

Even if prices remain low, it is unlikely policymakers will roll back efficiency mandates set to take effect over the next decade as long as climate concerns persist.


Demand Softens
Between 2005 and 2014, oil demand in the rich countries of the Organisation for Economic Cooperation and Development (OECD) fell in seven of the 10 years (http://link.reuters.com/nef55w).

OECD consumption dropped by almost 5 million barrels per day (bpd), about 10 percent, according to the U.S. Energy Information Administration (EIA).

In the United States alone, consumption fell by around 1.75 million bpd, almost 9 percent, with demand declining for every type of fuel from gasoline to diesel and jet fuel.

But over the same period, consumption in developing economies grew by more than 12 million bpd, with China alone up 4 million bpd, ensuring global consumption continued to rise.

However, in 2013 and 2014, demand in non-OECD countries rose more slowly, while shale output from the United States surged, pushing the market into surplus and making a sharp price correction inevitable.

Part of the necessary rebalancing in the oil market must come through slower output growth, though members of OPEC, shale drillers and other producers are resisting pressure to cut production.

But much of the adjustment will have to come through faster growth in oil demand, particularly in the advanced economies.


Traffic Volumes
There is already evidence of increasing demand in the OECD, with traffic volumes and fuel consumption rising in the United States and Europe, as a result of economic growth and cheaper fuel.

Traffic volumes across the United States were 3 percent higher in the 12 months to June compared with a year earlier, according to the Federal Highway Administration.

Gasoline consumption in the United States is running as much as 500,000 bpd ahead of last year's level, weekly data published by the EIA shows (http://link.reuters.com/qef55w).

And there has been a similar pick-up in Britain, where traffic volumes have risen by 2.7 percent in the last year, according to the UK Department for Transport (http://link.reuters.com/tef55w).

OECD consumption will increase almost 500,000 bpd this year and another 300,000 bpd in 2016, according to the EIA ("Short-Term Energy Outlook", August 2015).


Efficiency Gains
Transportation accounts for two-thirds of all petroleum consumption in the OECD, so oil demand is strongly influenced by traffic volumes and vehicle fuel efficiency.

The U.S. government raised the average fuel economy standard for new passenger cars from 18 miles per gallon (mpg) to 27.5 mpg between 1978 and 1985, in response to the oil shocks.

But the fuel economy standard was cut to 26 mpg in the late 1980s, and left unchanged at 27.5 mpg between 1990 and 2010, as concerns about energy security waned.

In response to soaring oil prices and climate concerns in the 2000s, however, the federal government has implemented regulations raising the standard to 34.1 mpg in 2014 and will increase it to 56 mpg by 2025.

Fuel standards for light-duty trucks are set to rise from 21 mpg in 2005 and 26.3 mpg in 2014 to as much as 40.3 mpg by 2025 (http://link.reuters.com/wef55w).

Given persistent concerns about climate change, it is unlikely these standards will be softened significantly, even if oil prices remain low. The impact on future oil demand is substantial.

Traffic volumes attributable to cars and light trucks are projected to increase by 16 percent between 2014 and 2025, according to the EIA ("Annual Energy Outlook", April 2015).

But the average fuel economy of cars and light trucks on U.S. roads is projected to rise from 22.3 mpg in 2014 to 28.5 mpg in 2025.

The combined effect of more traffic but greater efficiency is that fuel consumption is predicted to drop from the equivalent of 8.05 million bpd of oil equivalent to 7.31 million bpd between 2014 and 2025 (http://link.reuters.com/zef55w).

Similar improvements in fuel economy and reductions in fuel demand are under way in most other OECD economies in a lagged response to the rise in prices as well as fears over global warming.

Oil demand in the advanced economies should benefit from a cyclical economic recovery coupled with lower prices over the next two to three years.

But unlike the 1980s and 1990s, oil demand will have to struggle against structural policy changes, which are likely to cap consumption in the medium term.

The lagged effect of conservation measures, coupled with climate concerns, will act as a strong headwind limiting demand growth and any increase in oil prices before 2020.

(By John Kemp)