Global oil demand takes hit from unrest

The rapidly rising price of crude has forced many oil importers to reduce usage.

A drop in global oil demand could set the stage for future volatility.

Global oil demand has fallen in response to sharply higher oil prices, and the stage may be set for a structural drop in crude demand and more price volatility.

The European benchmark Brent crude has climbed almost 30 per cent so far this year, recently surpassing US$126 per barrel, and has risen 50 per cent since September, the International Energy Agency (IEA), which advises industrialised countries on energy, noted in its latest monthly oil market report. In intraday trading in London yesterday Brent was priced at $124.38 per barrel, up 0.49 per cent.

"The sharp rise in oil prices may already be sowing the seeds of future demand destruction," it warned. "There is a clear potential, if prices remain above $100 per barrel, of adverse economic impacts and slower oil demand growth becoming firmly entrenched in late 2011 and 2012."

The IEA said a formal response by Opec to uncertainty over supplies linked to unrest in the Middle East and North Africa region was unlikely and suggested economic slow-down and weakening growth in oil demand as the most probable route to more moderate crude prices.

"Our projections already incorporate an expected halving in 2011 from the heady 3 million barrels per day [bpd] growth of 2010," the agency said. "Preliminary data for early 2011 already show signs of oil demand slow-down. Unfortunately, the surest remedy for high prices may ultimately prove to be high prices themselves."

By referring to price moderation, the IEA signalled that a soft landing from the current bout of "inflated" oil prices might be possible, avoiding the long-term oil supply uncertainty that another collapse in prices could inflict. Nevertheless, it also drew parallels with the market in early 2008, as crude rose towards the record $147 per barrel set in July of that year, subsequently falling by about 80 per cent.

"Global [oil demand] growth slowed from December to January and February in a manner reminiscent of 2008 when prices were last scaling to such heady levels," the agency said.

Ominously for the world's economy, the pullback in oil demand was strongest in emerging markets such as China and India, the expected engines of continued global economic recovery. The IEA has stuck, for now, with its previous forecast for oil demand this year, but only because it expects Japan to need more oil for power generation and reconstruction after the earthquake and tsunami.

"This has offset downward adjustments elsewhere," it said. "If confirmed, these trends could signal that high oil prices may already have started to bite."

But before oil prices retreat, they could still rise higher.

Recent attacks on eastern Libyan oilfields by forces loyal to Muammar Qaddafi "may be a game-changer", the IEA said, prompting "memories of a scorched-earth policy seen in Kuwait 20 years ago". That was when a retreating Iraqi invasion force set fire to the Kuwait's 700 oil wells, causing them to gush uncontrollably, seriously damaging the emirate's biggest oilfields.

"Libyan output could take months to reinstate once conflict ends," the agency said. "Had the Libyan crisis emerged at a time other than during peak European refinery maintenance, $125 per barrel might already be a distant speck in the rear-view mirror."

The Libyan conflict has curtailed virtually all the country's previous crude output of 1.2 million bpd, according to recent estimates.

Global oil supply fell by 700,000 bpd last month, and Opec output dropped by 890,000 bpd because of lower Libyan production, the IEA reported.

It noted that a number of countries outside Opec in the Middle East and Africa were also facing political turmoil, potentially putting another 3 million bpd of oil production at risk.