The Energy Report

Demand is back and we are going to be in trouble, hey la de da demand is back. All right based on the Department of Energy it is clear that demand is far from being back in the US but just you wait according to Goldman Sachs as they say that demand is going to be back to pre-recession levels by the third quarter of this year. What?? That is right. Peak demand fears may give way back to peak oil fears as Goldman says that strong demand from emerging markets will increasingly offset the lagging recovery in OECD demand. Are they right?

Goldman Sachs analysts Arjun Murti, Kevin Koh and Michele Della Vigna, authors of the “Super Spike”, say the fact that the increase in Chinese oil imports has exceeded the decline in US oil imports seem to support their conclusion that demand will return to those lofty unquenchable levels. China this week reported that oil exports rose by 1.6 million barrels per day which exceeded the drop of US imports of 1.5 million barrels per day.

Yet the question is whether or not we see this continue in a straight line. We have already seen China raise reserve requirements on banks to slow speculative growth. China has also been storing oil. The speed of demand growth will also be slowed by more efficiencies and energy alternatives so I think that it may be years before we get back to global demand levels. On the other hand, if Chinese growth continues in a straight line the way it has, it is possible that Goldman may be right. And if that happens at that point it would be in an expanded bubble.

When Goldman came out in 2005 with their $100 a barrel prediction there was no doubt they were right on. I agreed with their call at the time as long term readers of “The Energy Report” (the original, accept no Johnny come lately) know that we had held a very bullish long term outlook from 1999. We held at that time and did for almost the entire decade, that demand from China would drive the price of oil. Believe it or not that was not a popular view as the markets fascination with dot com’s and memories of the Asian financial crisis raised skepticism that China could sustain an oil consumption marathon or even a sprint. In the “year ahead” surveys during those years my price projections were always the highest or at the high end of all the firms on the street. We embraced the Goldman call in 2005 and kept pretty much in agreement with Goldman until last year when they were saying that oil could go as high as $200 a barrel. Obviously we felt at that time that the financial crisis created an unnatural price for oil that ultimately could not be sustained. That proved to be correct as global demand had the largest drop in history eventually created the largest peak to valley drop in the history of Nymex oil trading.

Not to take away anything from Goldman for their correct calls, but I feel that they are wrong on this one. I do not feel that this stimulus fueled oil demand surge will go in a straight line. In fact once again I feel that this China demand trajectory is unsustainable and will be slowed by the Chinese government. Demand growth in the US and other countries will be slowed by alternatives. The record US corn crop bodes well for the ethanol market and we may see a move globally for the use of what will be cheaper ethanol. The other factor will be raising interest rates that should also temper global demand. The ECB is not expected to raise rates but comments about the outlook and how the ECB plans to extract itself from extraordinary liquidity measures may move oil. Watch the dollar and listen to Jean-Claude Trichet just in case he says something crazy. We might want a little crazy!

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Phil Flynn

Senior Market Analyst

800-935-6487

312-563-8344

pflynn@pfgbest.com