?The law of supply and demand remains intact for world energy markets. Oil-price bulls who insisted “this time it’s different” during oil’s long price run-up earlier this year would do well to remember that. Supply and demand respond to price, just as they always have, says recently retired energy analyst Bernie Picchi.


Picchi, now forming a consulting firm, was the keynote speaker at a New York Society of Security Analysts oil and gas conference recently.


Forecasting errors and macroeconomic changes abound that affect oil supply and demand projections. “Years of rapid oil-demand growth—enabled by low real oil prices in the late-1990s—led forecasters to make a fundamental, but entirely human, forecasting error: extrapolating the present.”


For example, ExxonMobil’s 25-year forecast of daily world energy demand, as of 2005, indicated that it would grow by 40 million barrels by 2030—or about one-third faster than the growth rate of the past quarter-century.


But current conditions are seeping into long-range forecasts. In its newest projection, ExxonMobil has cut its 25-year forecast from 1.4% to 1.2% per year.?


“A reduction of just two-tenths of one percent may sound like a nit, but that equates to a ‘delta’ of nearly 6 million barrels per day of consumption by 2030, or 2 billion barrels of oil,” Picchi said. “That could be the difference between surplus and scarcity in 25 years.”


A funny thing happened on the way to $200 oil, he added: demand collapsed—and so did oil prices. Households, businesses and government policy-makers can and will react to higher real prices by using oil more efficiently (or not at all), and producing more of it, he said.


“In fact, oil demand had been stumbling well before the acute economic problems of the last few months. Demand took a header because consumers and businesses in the United States …could not afford to purchase fuel when crude oil soared above $100 a barrel. Recently, of course, another factor has dealt demand a new body blow: the pandemic global credit crisis.”


Oil demand always responds to economic activity, Picchi said. That in turn has caused agencies such as OPEC and the International Energy Agency to revise downward their oil-demand estimates.


In 2007, the IEA forecast daily world oil demand would grow by 2.2 million barrels in 2008. “Had that prediction been right, 2008 would have been the best year of oil-demand growth in the last 30. But reality shredded that forecast.”


Indeed, each month in 2008, the IEA scaled back its world demand forecast to a small fraction of its year-before estimate. It forecasted 2008 daily world oil demand would grow 400,000 barrels, at the time Picchi spoke in early November. Since his talk, the IEA has further cut the number, to 300,000, thus essentially flat with 2007 demand.


Until recently, most oil consumers outside the U.S. had received two oil-price subsidies: actual price support (usually in the form of below-market prices) from their national government, and indirect subsidies from the world currency market due to the U.S. dollar’s weakness.


Now that’s been reversed. China, Indonesia, India and many other countries have reduced their oil-price support and, as the dollar has recovered, oil has suddenly become expensive in many developing countries.?
“When I visited China in August, I heard the same complaint in every city and town: ‘Last year, I bought my first car, but I haven’t taken it out of the garage in weeks—I can’t afford the petrol.”


Most forecasts of oil demand are still too high, Picchi believes. “The industry will be fortunate to see any growth in global oil demand before 2011. That is the way things played out in the 1980s; global oil demand did not exceed its old 1979 peak until 1989.”


Given this scenario, where will oil prices bottom? “In the short run, only cash operating costs would determine the true price downside, or the point below which prices cannot drop because producers would incur cash operating losses. Unfortunately, those cash costs are very low, probably $15 to $20 per barrel worldwide—even in relation to today’s ‘busted’ oil price of some $55 per barrel.?


“I don’t think oil prices will drop to that level, or, even if they did, that they could stay there for more than a few weeks or months. But, make no mistake, oil prices could stay well below their long-term trend for a while.”


That would in turn make renewable-fuel sources less attractive economically to many. “Even if renewable energy (supply) quintuples in the next 10 years, it would still constitute less than 6% of the global energy mix in 2015. For better or worse, oil, gas and coal will be the three pillars of world energy supply for years—and 80% to 82% of the mix in 2015, I believe,” Picchi said.

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