Oil Prices & Oil demand – Changed dynamics

It used to be that an American recession would lead to a fall in natural resource prices, but America’s dominance is no more, thanks in part to the Asian tigers in general and China in particular, which have registered GDP growth of 7-9% per annum.

In 1980, America consumed 17 million barrels of oil per day, today, 30 years later America consumes 19 million barrels per day,(in 2005 it hit 21 million, but since then higher oil prices and a rather deep recession have reduce American demand).  America’s great competitor in the 21^st century will be China -- the battle for resource has already started, as China looks to resource rich Australia (and Canada), but also forging alliances in Africa and South America; China’s goal is to find the necessary resources to support China’s continued expansion program. 

China’s challenge is important; already in 2010 China has “limited” the amount of raw rare-earth minerals available for exports.  Three years ago China started a massive nuclear power station building program:  a 10 fold increase in electricity production to 80GWe by 2020 and plans for up to 400 GWe by 2050.  So back to our oil story, while Americans were consuming 17 million barrels per day in 1980, the Chinese were consuming 2 million barrels per day.  This is where the story gets interesting; last year China consumed 8 million barrels per day, since 1995 demand growth has been around 7% p.a.

The story doesn’t end there, BP predicts that China’s oil consumption will continue to rise exponentially, as Chinese become richer they will require more energy.  BP estimates that Chinese oil demand will rise to 13 million barrels by 2015 and 19 million barrels by 2020 (equivalent to what America consumes today). 

China’s growth is slated to exceed 7% p.a. as far as they eye can see -- despite the high increase in hydro electric dams, nuclear power stations demand for oil in China is expected to grow exponentially.  Limited supply growth, near demand supply equilibrium, and demand inelasticity (at least in the short term) has to result in higher oil prices. 

Historically oil price shocks have caused recessions (obviously since it implies massive wealth redistribution).  However, if a weak recovery for America results in oil demand rising by slightly more than 2% (in 2010), than an exponential demand by China is not going to lead to a price contraction, rather it will result in American Stagflation, cause by resource price increases.

The oil production reality shows limited scope for production increases despite high oil prices over the past 18 months production has not increased dramatically.  I would suggest that long term oil prices have only one possible direction, barring some kind of major economic disaster in some part of the world, which is up. The world should expect oil prices of around $95/barrel (average over the year) within the next 2 to 4 years. 

The implication for Canada is both good and bad; first if America faces a new recession, Canada’s core export market will suffer, but a core component of Canada’s exports are energy and material which can easily find new export markets.  The good is that the nature of Canada’s economy should protect it from most of the oil price increase.  Canadian economists are increasingly talking of the Canadian dollar trading around 1.1 to the US Dollar.

We shall see