Black Friday came and went. Consumers fought over cheap shoes, televisions and toasters. This chaotic ritual is a living economics lab that every year validates Alfred Marshall's basic principle: Consumers will buy more stuff when prices are cut.
And so too it is with oil. Buyers of petroleum products are being offered a Black Friday of cheap black gold that will last well beyond the holiday season. And like anything else that goes into the bargain basement, consumers will inevitably load up with more gasoline, diesel, and jet fuel, as they have in the past, as they have every time the price of oil has gone on sale.
Low oil prices will last until the market comes back into "balance" as the Organization of Petroleum Exporting Countries ministers like to always say in their public narratives (Note to self: Oil markets have never been in balance, so what are they talking about?) Let's be honest about the events of last week: Had the 12-ring OPEC circus agreed to cut their production quotas, the price of oil would have jumped a few dollars a barrel. And then the price would have proceeded to quickly drift down after the market realized that half of this tattered cartel is a collection of unstable or stateless (or both) governments that have little ability to collectively control their output. It wouldn't have mattered what OPEC decided; either way the price of oil would have still ended up being sub-$70 (U.S.).
So the free market has to sort this out. As it should. As it will. As Alfred Marshall prescribed in his formative 1890, two-volume book, Principles of Economics. The intuitive calculus is simple: When price goes down, supply goes down and consumption goes up. For a commodity like oil, it's just a matter of timing.
Although the recent fixation has been on oil supply, demand is the variable to watch, especially in the United States. American use of oil has fallen by over 1.5 million barrels a day since peaking in 2005, but a partial rebound is looking likely now that the economy is picking up and gasoline prices are doing a limbo under $3.00 a gallon. When summer 2015 comes, the era of stay-close-to-home vacations, or "stay-cations" as they were called, should be over. As well, recent sales data shows that heavier SUVs and pickup trucks have returned as the vehicles of choice – a trend that will start bucking improvements in average fuel economy (as was the case throughout the 1990s). Already there are signs that overall oil consumption is perking up – American petroleum demand is up almost 1 per cent or 150,000 b/d from last year. That doesn't sound like much, but the trend has mostly been negative since the Financial Crisis.
There is another demand side factor that will come into play soon. Oil is a major input into the global economy, so any price cut translates into a consumer stimulus that can be spent on other Black Friday items. What is bought typically consumes more energy, as well as takes more energy to produce and deliver. In short, lower oil prices should lubricate the global economy in 2015, potentially more than most expect. Consider that a barrel of oil has dropped in price by about $30 – an average for the smorgasbord of all grades, light, medium, and heavy. On 93 million barrels a day of world consumption, this $30 price cut will translate into an annual $1-trillion stimulus package for the global economy. Going forward that will make every Friday black, assuming today's prices last through next year.
Current projections for oil consumption growth into 2015 run around 1.1 million barrels a day; a level of growth that has been viewed as optimistic, especially considering that 2014 demand is anticipated to rise just 0.7 million barrels a day. However, a lower oil price boosts the odds of achieving next year's projection. Much still hinges on the Chinese economy, but note that car sales there are running at a record high. In addition, China imports six million barrels a day, so the $30 cut translates into a $65-billion trade balance windfall for next year, all else being equal.
Over the past few years the arithmetic of estimating oil consumption has been one of addition and subtraction: Add up the expected growth from emerging economies like China, then subtract the expected decline in North American, Japanese and European oil consumption. At today's low prices, this deduction is likely to flip into an addition.
How oil suppliers will respond to lower price is more complex, but the production side of the equation often takes longer to respond to changes in price than consumption. It's looking likely that demand will grow by another 1.1 million barrels a day next year and possibly even more, which is far more tangible than the promise of an OPEC cut.
In other words, it's the deal-seeking consumers that are going to "balance" the oil markets faster than the producers.
Peter Tertzakian is chief energy economist at ARC Financial Corp. in Calgary and the author of two best-selling books, A Thousand Barrels a Second and The End of Energy Obesity.
Peter Tertzakian