The Price of Oil this summer

Devin, over at Bleakonomy had posted a comment this morning on the future of gas prices which got me to thinking a little about where they might go this year. Trying to get some sense for where we stand on this needs some information, which I can get from, for example, the Department of Transportation as well as the EIA. Let me see if I can go through the logic of my answer with a series of questions and replies.

Firstly we recognize that in order to stabilize prices OPEC has cut production, so that there is not as much oil available. For the sake of this example I am going to make some very crude approximations. Let us say that the world is producing 80 mbd, half of which comes from OPEC, and half not (it’s actually about 43% OPEC). The non-OPEC portion has stayed at the same level (they are slightly past peak production), while the reduction in supply to balance demand has come from OPEC. OPEC has cut production 4 mbd to soak up the un-needed demand over the past few months as the economies of the world have sunk. We are now back in balance between supply and demand at a price of $40 a barrel. America uses about a quarter of the world’s oil, which for our discussion we can therefore assume is normally some 20 mbd of oil. We will further assume that 45% of a barrel of oil is made into gasoline and that the rest of the barrel can be consumed as a variety of products that don’t influence the argument. America thus uses about 9 mbd of gasoline.

To keep the argument simple I am now going to assume that all this is used in cars. If the world is now in balance with these numbers, what can we expect in the next year. The first thing to understand is that demand is not constant during the year. Thus when we plot demand it fluctuates, with most driving being done in the summer. You can see this in two sets of graphs. The first (and I referred to this last week) is the refinery production to meet demand.
US Gasoline Demand
We can compare this with the amount of driving that the general public are doing. This is broken down into rural and urban driving, and shown, by month (the tables are from last November).
Rural driving
Urban driving

The figures show that actual driving has dropped between 4 & 5% from the 2006/2007 average to 2008. But it also shows that right now we are at the time of year when demand is least. We can go back and look at the composite figures from the FHWA over the past four decades and the shape of the curve is the same.
Vehicle miles travelled by month averaged 1970 – 2007. (FHWA)
Vehicle miles travelled per year 1970 – 2007 (FHWA).

What the curves show is that we can expect an increase in demand for the next six months of somewhere around 13%, or a little over 1 mbd. (Looking at the normal gas demand change in 2007 it went from 8.8 to 9.6 mbd – see top graph). Now converting that back to crude would increase it to 2.2 mbd. However, there is a slight change in the blending strategy to change the mix, so let us simplify that to drop the need for crude down to 2 mbd.

If the US demand maintains its quarter of the world demand proportion, that would take the global increase as we move into summer up some 8 mbd. Some countries won’t see that since they have other constraints, and other countries are going into winter not summer, so let us cut that number in half. And we get to 4 mbd, as the increase in demand between now and summer.

How much did OPEC cut production down to meet a decline in demand, about 4 mbd. So what we may well see over the next six months could well be a slackening of the OPEC restrictions on production, to meet the increasing seasonal needs, but as that slackening occurs, so it will be at a price that OPEC controls.

So if I were to make a prediction for oil prices this summer I would suspect that they would be around $65 a barrel. Of course the economies of the world are still somewhat in the tank, but if they do not get much worse (and thus drop demand further), then (having left a loophole a battleship could sail through) this would be my prediction.