The Other Side of The Equation: Oil Growth now Depends on Consumer Choice more than Industry Demand
Car as Device, Gasoline as Consumer Good
Reviewing US gasoline consumption in detail reveals the emergence of a deeper trend for crude oil demand: it’s future growth depends increasingly on its capability as a consumer good, not as an industrial commodity.
In its major markets – the US, EU and China – crude oil’s major growth component, motor gasoline, now has to compete with non-gasoline technologies in its core market, road transportation.
OPEC and other oil producers may still calculate consumer demand for gasoline is a given – but that is no longer a safe assumption. They need to consider how to compete as providers of a consumer product, rather than act as suppliers of an irreplaceable commodity.
Oil demand may soon start to be dominated by choosy individual consumers, rather than more predictable industrial buyers.
The Different Worlds of Supply & Demand
Whilst we noted in an end-year piece here, that 2017 would be a year in which oil watchers would be intrigued and obsessed with the actions of OPEC, we also suggested more attention should be paid to the other side of the equation: demand.
Where supply junkies are prone to narratives about Middle Eastern politics, nervous about pipeline outages and ever more amazed by oil shale’s economic resilience, demand observers tend to play with spreadsheets, and sometimes subtle shifts in trends.
Different worlds.
A recent post from Bloomberg by Liam Denning – America’s Gas Pump Puzzle – belongs clearly to the Demand School.
In it he revisits a theme he has covered several times – the future of US gasoline consumption.
Why is this so important?
Although oil companies and the IEA often point to aviation or marine fuel as a potential source of oil demand advance, gasoline and diesel make up almost 60% of the crude oil barrel, and their growth, or decline, will determine the future course of oil demand. (Those other components contribute a lot less, or have mature growth profiles already.)
Best, therefore, for industry participants to get ahead of any new gasoline trends, rather than behind them.
The US Gasoline Demand Puzzle
As the US consumes almost 50% of global gasoline, at over 9.3 mb/d in 2016, it pays to analyse its demand in some detail.
This is true despite many demand analysts focusing on – potentially – high growth areas such as China and India.
For a start, those two countries together only consume about a third of the gasoline that the US does.
In addition, robust demand growth in these countries is also far from certain.
So, if the demand pattern in the US changes, the world oil demand pattern may closely follow.
What, therefore, is the US gas-pump puzzle?
As the Bloomberg note points out, although American drivers drove more miles in January 2017 – 242 billion in total, more than in any January previously, gasoline demand was actually lower than in the previous year.
At just under 8.5 million b/d, motor fuel consumption was down by 167,000 barrels a day, despite an extra 5 billion miles being driven.
That did solve one puzzle though: most other metrics suggested the US economy was in reasonable health – so a downturn in driving activity would have run to counter to those. As it was, driving was up as expected – but gasoline intake went the other way.
How so?
Here are three possible reasons:
First, fuel economy is becoming more effective. Over the past 40 years US fuel economy on a miles per gallon basis has improved by about 2% pa (see more details in this post). This number goes in fits and starts, often prompted by changes in the oil price, causing consumers to demand more fuel efficiency that then locks in technology improvements.
Although the US consumer has increased their taste for bigger and more powerful truck / SUV options, fuel efficiency standards and technology competition have meant that even these vehicles consume lower amounts of gasoline per mile than earlier models of smaller cars.
See chart below:
source: Baker Institute Working Paper
However, in January 2017, a year on year 2% efficiency gain would only have kept demand flat, as total miles driven increased by about the same. Something else must have been at work.
Second, the shape of driving patterns may have changed. It may be that the miles driven are different from before, increasing efficiency. This could be due to high mileage vehicles, eg taxis, taking advantage of the most fuel efficient models, or the increase in vehicle sales causing newer engines to enter the fleet more rapidly than before.
For example, see the chart below from a Platt’s Oil analysis. In Texas, driving miles are increasing as is consumption due to demographic factors and relatively low retail gasoline prices. In contrast, consumption in California is slowing as urbanization density, high gasoline costs and high adoption rates of EVs combine.
Third, the emergence of new vehicle technologies may be making an impact at the margins. Although electric vehicles and hybrid versions only make up 3% of vehicle sales, and about 1% of the total US vehicle fleet, the impact of high fuel efficiency vehicles can have a noticeable impact on overall fuel efficiency.
This nice diagram from visual capitalist.com indicates the impact on the US fleet from new technology models.
As many entrepreneurs will tell you it’s getting to the 1% that counts – to get there an awful lot of development and effort has gone right.
It’s unlikely that the high mpg vehicles will have caused the full differential in January. But simple maths will tell you that when 1% of the fleet can achieve say an average of 60-70mpg or more, a wider effect will start to be felt quite quickly.
An indication of the impact is shown in the simple model below – where you can rationalise a higher overall fuel economy from the marginal influence new technology vehicles.
To be sure this would need the rapid emergence of the 1% of new entrants: but it indicates what such a swift rise would do.
So, of the 167,000 missing barrels a fair chunk might well be attributable to new technology vehicles entering the fleet. And as recent sales of Tesla and other EVs testify to, this impact on overall fleet mpg is only going to get larger, and do so rapidly – the growth in EV sales in February 2017 was up 50% on February 2016.
In reality, though, the gas sales dip is more likely due to a combination of the above issues.
US demand is therefore likely to play as out as the net outcome between two opposing forces: the growth of travel miles in larger vehicles, offset by efficiency improvements and alternative automotive technologies.
Gasoline Becomes just another Consumer Good
Whatever the actual outcome of US gasoline consumption in the months ahead, the emergence of new automotive technologies leads to a deeper trend for crude oil demand: it’s future growth depends increasingly on its capability as a consumer good, not as an industrial commodity.
In its major markets – the US, EU and China – crude oil’s major growth component, motor gasoline, now has to compete with non-gasoline technologies in its core market, road transportation.
In all these markets, there has been an historic monopoly of demand for gasoline and diesel as the economies grew through an energy-intensive investment phase.
As they now emerge into a lower energy consumption phase, diesel demand declines and gasoline is left on its own to service a largely consumer market.
And consumer tastes are more fickle than that of industry. For the first time in over a century, the general consumer is being offered a genuine choice in terms of automotive transport: gasoline, electric or a bit of both.
As the chart below shows, as battery costs drop quickly, the car is becoming more inclined toward personal transportation device, than just a stand-alone vehicle.
This fact itself will remove demand from gasoline-only vehicles, which now sit as only one preference in a wider spectrum of transport options and technologies.
This is an important shift.
With the individual consumer now having personal choices regarding transport technology, gasoline now has to compete over the long-term with hybrid and all-electric alternatives.
As the US EPA indicates in its web literature, new electric vehicles and hybrids can save consumers over $3,500-$4,000 in fuel costs over a 5 year period – possibly more, depending on how pump prices and general gasoline fuel efficiency progresses.
With a new viable competition establishing itself, any OPEC policy to maintain higher crude and hence pump prices, or government rules aimed at slowing all-gasoline vehicle efficiency may not turn out to be winning strategies for the incumbents.
Any motor manufacturer content to focus purely on gasoline-only, high consumption vehicles runs the risk of pushing consumers into the grasp of partly or fully-electrified alternatives. Over time, this should force oil producers and car firms to reduce fuel and consumption costs to compete in a sailing-ship type response.
Demand Becomes More Uncertain: The End of the Gasoline-Only Era
All this makes the future of oil demand much more volatile and uncertain. And whilst the debate around peak oil and peak gasoline demand continues to rage on, one element is definite: the era of gasoline-only car transport is over.
OPEC and other oil producers may still calculate consumer demand for gasoline is a given – but that is no longer a safe assumption. They need to consider how to compete as providers of a consumer product, rather than act as suppliers of an irreplaceable commodity.
Of course we may be reading far too much into one strain of monthly fuel demand data.
But studying America’s gas pump puzzle in detail might be allowing us an early glimpse into how the world of oil demand – the other side of the equation – may soon start to be dominated by choosy individual consumers, rather than more predictable industrial buyers.