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The Wall Street Journal: High Prices Prod Developed World To Curb Oil Use

Data Show First Drop
In Two Decades in West;
Crude Dips Below $50
January 19, 2007; Page A1

Mild winter weather has something to do with it. So does heavy selling by financial funds. But a largely overlooked factor in the recent plunge in oil prices may portend an end to the multiyear rise in crude: For the first time in years, the developed world is burning less of it.

Fresh data from the International Energy Agency show oil consumption in the 30 member countries of the Organization for Economic Cooperation and Development fell 0.6% in 2006. Though the decline appears small, it marks the first annual drop in more than 20 years among the OECD countries, which drain close to 60% of the 84.4 million barrels of oil used globally each day. Industrialized nations’ demand tiptoed into negative territory in 2002, but the dip was so slight that it registered as flat.

Yesterday, U.S. benchmark oil for February delivery settled at $50.48 a barrel, down $1.76, or 3.4%, on the New York Mercantile Exchange. Earlier in the day, futures fell below $50 a barrel for the first time since May 2005, hitting a fresh 20-month low after the Energy Department said U.S. crude-oil stockpiles rose the most in more than four years. Oil has been sliding since peaking above $77 in July. This year, prices have fallen 17%.

The tipping point where oil prices begin to erode demand was reached last summer, several industry analysts said.

The fall in oil use by the industrialized world is a sign that the reactions to higher oil prices by businesses and consumers from the U.S. to Germany to Japan may be adding up to a cycle-turning downdraft in demand. The resulting shift in global cash flows could mean a big boost for oil consumers’ economies at the expense of producers and exporters.

Other signals, both economic and psychological, have been popping up for some time: Demand for gas-guzzling sport-utility vehicles has been falling, while investment in and sales of alternative fuels such as ethanol are booming. Even the Bush administration is vowing to reduce America’s dependence on crude.

Gasoline prices in the U.S. are also falling, both because of swelling inventories and the slide in crude-oil prices, which can take four to eight weeks to fully pass down to retail pumps.

Yesterday, the AAA automobile club reported regular-grade gasoline below $2 a gallon in Michigan, and at $2 a gallon in Missouri and Oklahoma. The Energy Information Administration of the Energy department said the national average price of a gallon of gasoline was $2.23 as of Jan. 15. The national average may continue to fall in coming weeks, the EIA said in a weekly review published yesterday; it said prices could get close to $2 a gallon by the end of this month or early in February, noting the possibility that the national average could fall below that level.

To be sure, global oil demand grew 0.9% in 2006, owing to steady growth in China and the Middle East. But that was down from growth of 3.9% in 2004 and 1.5% in 2005. And the price fluctuations highlight the role played by expectations, rather than simple supply and demand, in determining the price of oil on world markets.

Many analysts are just starting to review, and lower, their price forecasts for this year, though a fair number still expect crude to rebound to $60 a barrel or even higher. So do some investors who have placed big bets with their own money, including Texas oilman T. Boone Pickens. For some, this stems in part from a belief that $60 is the price the Organization of Petroleum Exporting Countries aims to defend, though the cartel’s de-facto leader, Saudi Oil Minister Ali Naimi, seemed to cast doubt on that notion this week when he said he saw no reason to support further output cuts. But a few analysts say oil’s four-year surge could be ending.

“The bubble is bursting,” said Frederic Lasserre, head of commodity research at Société Générale in Paris. “The sentiment has changed, and for the first time since January 2002, the hedge funds are going short at the start of the year.”

News of the oil-demand drop comes as the debate over how to curb energy consumption is reaching a fever pitch in the U.S., the world’s biggest oil consumer. Next week, President Bush is expected in his State of the Union address to expand on a call he issued last year for the country to end its “addiction” to oil. In Congress, bills are circulating to impose cap-and-trade programs, which amount to putting a price on global-warming emissions produced by the combustion of fossil fuels. While this government debate goes on, the OECD data suggest, the market itself is having an effect: When energy prices go up, people consume less energy.

A lasting downdraft in oil prices would trigger a profound redistribution of wealth around the world, putting more money in the pockets of consumers in the West and ending the bonanza enjoyed by oil-company investors and by petro-states such as Venezuela and Iran.

Currencies of some bigger oil exporters, including the Mexican peso, have faced downward pressure in line with falling oil prices. Airlines — including British Airways PLC and Cathay Pacific Airways Ltd. — have begun removing fuel surcharges imposed on passengers. Nations with significant oil industries — including Saudi Arabia, Russia and the U.S., the top-three producers — stand to take a hit to employment, profit and tax receipts in their oil sectors.

The signs of waning demand for oil began bubbling up early last year. Saudi Arabia began to quietly cut back its output in April because it couldn’t find buyers for all its crude. Iran, OPEC’s second-largest producer after Saudi Arabia, was forced to store unsold oil in tankers last summer.

Yet oil prices were sending contrary signals, peaking on July 14 at $77.03 a barrel because of fears that geopolitics or natural disasters were bound to reduce supplies. At the time, supplies were perceived to be tight, with little spare production capacity available globally to offset sudden losses. Since then, oil prices have fallen by 34% despite supply cuts by OPEC to shore up prices.

Mr. Lasserre’s take on the situation is that prices of close to $70 a barrel — they averaged $66.22 a barrel for 2006 — marked a turning point. “People wanted to know the point at which oil prices would affect demand; now they have the answer,” he said.

One factor that could insulate the world from a big price rebound, paradoxically, is OPEC’s recent output cuts. By trimming production, the cartel has swelled the world’s volume of spare oil-pumping capacity, particularly in Saudi Arabia, thus easing fears of a supply disruption in some part of the vast global oil chain.

In remarks to reporters in New Delhi this week, Mr. Naimi said the kingdom’s spare-capacity cushion would expand to three million barrels a day by Feb. 1, when the second round of output cuts agreed to by OPEC take effect. That is a half-million barrels a day more than is exported by Iran, whose nuclear-research standoff with the U.S. has stirred jitters about supply disruptions in the Persian Gulf.

Oil buyers are watching for signs of OPEC’s next move. Some OPEC members, such as Venezuela and Iran, were clamoring for further production cuts, though Mr. Naimi shot down that idea this week.

Some analysts see larger, game-changing forces in motion. One is the rise of nonoil transport fuels. “Last year was a tipping point in a lot of ways,” says Philip Verleger Jr., an oil economist who heads PK Verleger LLC. “Biofuels will take bigger and bigger bites out of petroleum demand,” Mr. Verleger said, noting climate-change and security concerns relating to the supply and use of petroleum. “Alternate fuels will take up all the growth, leaving petroleum demand static in the next two or three years.”

Forecasts by the IEA suggest biofuels output could rise to the equivalent of more than five million barrels of crude oil a day by 2011, close to triple output of such fuels in 2005. Global oil demand last year rose by 780,000 barrels a day to 84.4 million barrels a day, the latest IEA data show.

“Virtually every day, there is a new biofuels plant announced somewhere in the world,” says Lawrence Eagles, head of the IEA’s oil-industry and markets division.

Mr. Eagles said that in 2005, world output of biofuels was some 650,000 barrels a day, the equivalent of 1.95 million barrels of conventional Middle Eastern crude oil. Biofuel output could rise to as much as 1.7 million barrels a day, or the equivalent of 5.1 million barrels of conventional crude, by 2011, if capacity-expansion plans are taken into account.

According to data published yesterday by the IEA, oil demand last year fell in all three major OECD regions — North America, Europe and the Pacific. The latter two regions have from time to time had weak oil demand when economic growth was weak. But growth in U.S. oil demand had typically offset this weakness for the OECD as a whole.

But last year, the picture changed more noticeably. “Maybe they started to use less when we hit $3-a-gallon gasoline,” Adam Sieminski, an oil analyst at Deutsche Bank, said of U.S. consumers. “Perhaps, toward the middle of 2006 we hit a tipping point.”

But Mr. Sieminski questions whether people will forget the pain because oil prices have dropped — and oil use will again start to increase.

Write to Bhushan Bahree at [email protected] and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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