As the U.S. economy enters a period of sustained recovery—political rows aside—it's worth considering how developments in the country's energy industry and other forces will affect future demand for oil and oil products.

Certainly, the global energy basket has changed significantly in the past five decades, with cleaner energy looking increasingly likely to displace conventional sources—albeit gradually. According to BP data, oil and coal (the dominant sources of energy since industrialization) have seen their share of energy production drop from a rate of 40.4% and 38.1%, respectively, in 1965, to 33% and 30% today.

Offsetting this decline has been a rise in cleaner fuels such as natural gas, renewable fuels and nuclear energy. Indeed, in the past 50 years the share of natural gas in the global energy basket has increased eight percentage points, to 24%. Meanwhile, nuclear energy and renewable fuels—which were almost nonexistent in the early 1960s—have risen to 4.5% and 2% shares, respectively.

Of course, oil's domination in the energy sector is likely to remain unchanged for at least another decade. There is potential, however, for it to be displaced as the world's primary energy resource in the longer term, particularly if current demand trends are any indicator.

Macroeconomic outlook

To assess the potential strength of global demand for oil, oil products and natural gas in the longer term, let's first consider the macroeconomic picture of the U.S. After all, growth in oil consumption and in gross domestic product (GDP) are closely correlated. Following rapid GDP growth in the decade leading up to 2007, the global economy suffered from a real estate sector crash in the U.S. and a series of fiscal crises across Europe.

Five years on, a much healthier economic scenario is taking shape in the U.S. The Federal Reserve's third round of quantitative easing, which targeted the mortgage market, has led to a revival of the U.S. housing market and a boost in economic recovery. House prices have risen by an average of 16% since their March 2012 lows, which has in turn encouraged higher volumes of new home construction and improved access to credit for households that were previously struggling with their mortgages. Meanwhile, new household formation has

boosted consumption of consumer durables such as white goods and cars.

Another sector significantly contributing to U.S. economic growth is the energy industry. Huge investment in energy infrastructure has enhanced growth by adding jobs and economic activity in those areas closely associated with extraction, transportation and processing of energy products. In 2013, U.S. oil and gas capex (capital expenditure) is expected to reach $348 billion, more than 2% of GDP for 2012. There is increased business investment in other sectors as well.

Furthermore, new supplies of oil and gas have brought down energy prices, in turn improving the position of U.S. industrial (and service sector) companies against overseas competitors.

U.S. fuel demand

The energy industry is experiencing a radical shift in the use of different fuels, particularly in the U.S. transport sector, which comprises more than 68% of current demand for U.S. oil products. This applies not only to heavy trucks, but also to light trucks and automobiles. The transport industry faces higher Corporate Aver-

CAFE Requirements age Fuel Economy (CAFE) requirements, increased bioethanol consumption and stringent emission laws that are likely to lead to significant changes in patterns of fuel demand.

In its drive toward energy self-sufficiency, the U.S. has already expanded the use of biofuels (especially corn-based ethanol), to the detriment of gasoline consumption. Yet, while ethanol production peaked at the end of 2011, it has since plateaued, due to withdrawal of tax incentives and implementation of the “blend-wall” (a 10% cap on the proportion of ethanol blended into regular gasoline). This appears likely to remain a near-term roadblock to higher ethanol usage—at least until second-generation bioethanol, such as cellulosic, becomes commercially available. There is a huge drive for dieselization of US passenger cars, which could compensate for some drop in demand for gasoline in the future.

The outlook for gasoline

U.S. demand for gasoline dropped sharply in 2011 and 2012, falling from more than 9 million barrels per day to a little more than 8.6 million per day. This decline was due to two developments: higher bioethanol blending and weak consumer demand. But, with ethanol hitting the blend-wall, coupled with the economic recovery, U.S. gasoline demand has remained stable at around 8.6 million barrels per day for the past year.

Nevertheless, tighter CAFE standards seem inherently to favor reduced gasoline consumption. As tighter rules gradually bite into new vehicles' fuel usage, we should expect to see demand for gasoline return to a gradual year-on-year decline at some point in 2014.

Annual declines of 1% to 2% in U.S. gasoline demand should then become the norm. And, the decline could be more significant if bioethanol producers achieve a commercial breakthrough, or there is a significant shift away from gasoline toward diesel among new vehicle sales.

U.S. CAFE standards currently languish far behind not only Japan and Europe standards, but also those of most developing countries. This helps to explain the disproportionately large demand for gasoline in the U.S. At present, 47% of US oil product demand is made up of gasoline.

In addition, a drop in U.S. demand for gasoline to as little as 5 million barrels per day by 2025 would be driven not just by regulatory constraints but also by changing consumer tastes. Evidence since 2008 suggests that U.S. household demand for gasoline is increasingly price sensitive. For instance, in both 2008 and 2011, a fall in vehicle miles was associated with sharp increases in gasoline prices, particularly for passenger cars.

Distillates demand

U.S. demand for distillates in the short term will increase, thanks to the economic recovery. We expect distillates demand to expand by 100,000 to 200,000 barrels per day. Dieselization of cars will help support this rise to a small extent. Although liquefied natural gas (LNG) could displace distillates fuel in the trucking sector in particular, our base-case scenario expects the volume displaced to be about 21,000 barrels per day by 2019.

Another significant trend to consider is the high level of drilling activity in the U.S. from the shale oil and gas boom. There has been a rapid increase in distillates demand from refineries, from 8% to 15% year-over-year growth prior to 2006 to 20% to 45% year-over-year growth in the post-2006 period. Although this sector is also at risk for substitution by natural gas, the lack of infrastructure means that the industry may need to wait until LNG is more accessible to drilling sites before any significant changes become obvious.

Over the past decade, U.S. refineries have increased distillates production capacity, supported by strong demand for distillates within and outside of the country. Average annual distillates production rose from 3.98 million barrels per day in 2005 to 4.54 million per day in 2012, up 14%. This compares with an increase of only 3.8% for gasoline production over the same period. U.S. export of distillates rose by 28% year over year in 2012 alone.

Crude consumption

Demand for U.S. crude oil peaked in 2005 at around 20.8 million barrels per day. However, after sharp declines in 2008 and 2009 in response to high oil prices and severe economic weakness, demand recovered in 2010, only to subside once more in 2011 and 2012.

For 2014, the U.S. economic recovery offers the prospect of another year of growth. In 2013, year-to-date consumption was up almost 1% from 2012 at about 18.8 million per day, and is expected to reach 18.85 million per day for the year overall as seasonal demand strengthens in the second half. Crude demand seems to be led by higher distillates demand. In addition, the blend-wall has temporarily halted the decline in U.S. gasoline demand—a development worth watching.

When considering the possibility of U.S. crude oil exports on a global level, it's worth remembering that US law bans exporting crude to any country except Canada. Certainly, there is huge potential for Canadian imports of U.S. oil in the future, as Canada currently imports only 100,000 barrels per day for a refining capacity of more than 500,000 per day in Eastern Canada. But as far as crude exports outside of the U.S. and Canada are concerned, it will be very difficult to justify energy independence while exporting U.S. domestic crude—after all, securing energy needs was the very reason why the ban on U.S. crude exports was put in place.

As for U.S. energy independence, it has become a subject much commented on, whichever way you may define it. But if energy independence means U.S. oil imports dropping to zero, then it is highly unlikely, even 10 years out. This is because the U.S. will continue to import the heavy crude that it cannot produce for its complex refineries off the Gulf Coast, due to the heavier grade of oil products production elsewhere.

In addition, arbitrage will play a significant role in assisting refiners and other consumer sources of cheaper crude from elsewhere in the world, if the economics make sense.

Macroeconomic indicators

Industry health is tied to economic stability, which is why it's important to consider US macroeconomic indicators in conjunction with demand trends.

Since early May, when the Fed first mooted the idea of scaling back some of its $85 billion of monthly purchases via QE3, interest rates have risen. Ten-year swap rates have increased from 1.80% to 2.80%, and concern about tightening of monetary conditions has been reflected in the sharp decline in applications for remortgages, in line with the 100-basis-point rise in 30-year mortgage rates. This trend may constrain growth through 2013, particularly if Fed tapering and/or stronger employment data push interest rates higher.

Meanwhile, U.S. growth in 2013 has also run directly into the headwinds of fiscal austerity. At the end of 2012, tax rates were increased by 2 percentage points, followed at the end of February by the automatic sequester. The government shutdown in October further highlighted the political risk posed by the US Congress.

Collectively, these factors will have subtracted about 1 percentage point from U.S. growth this year, although they also have reduced the budget deficit, which is expected to fall from 6.9% in 2012 to just 4% this year and to 3.4% in 2014—a positive. We forecast US growth of 1.5% in 2013, followed by a small improvement to 2.2% in 2014.

We expect oil prices to remain either unchanged or slightly bullish in 2014. Oil prices will be sustained by the recovery in the global economy, as well as ongoing geopolitical tensions in coming years. Meanwhile, the oversupply of crude from non-OPEC countries will help slow—or stop—the growth in oil prices.

Generally speaking, the robust supports for oil prices will be the higher fiscal breakevens of the OPEC members, the rising cost of crude oil production and increasing demand for crude. WTI will edge higher as the arbitrage/discount to Brent will be narrowed to close to $4 to $5 per barrel and, potentially, even lower. With all of this in mind, we expect oil prices to remain range bound at $100 to $110 per barrel in the short term.

An improved economic outlook (as indicated by strong rises in the jobs market and business investments) offers the prospect of a modest rise in US oil demand. In 2014, demand could increase to as much as 19 million barrels per day, based on a 100,000-barrel-per-day rise in diesel demand and broadly unchanged demand for other oil products.

Beyond that, however, we would expect to see the longer-term downtrend in U.S. oil demand begin to reassert itself, particularly as tighter CAFE rules exert a growing negative effect on demand for gasoline, and a commercial breakthrough for cleaner energy becomes a possibility.

Abhishek Deshpande, Ph.D, leads oil and oil products research at Natixis, providing price forecasts and analysis of developments across the global oil and oil product markets. He has a doctorate in chemical engineering from Cambridge University and Chartered Engineer status with the Institute of Engineers, UK.

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