Demand Is Holding Back Oil Prices

A story of demand, not supply

Many view the looming supply set to flood the market in 2025 the force behind falling oil prices of late, but rather, it is demand that can foot the blame. The two are of course inextricably linked, that is, stronger oil demand in 2024 would have likely seen OPEC+ bring back voluntary supply cuts earlier. But for the most part, low demand growth is behind the weakness in oil prices this year.

The below chart summarises recent demand growth well. We are used to seeing oil demand growing at circa 1-1.5 mm b/d annually over the past decade, while in 2024, estimates put growth closer to 0.8-0.9 mm b/d.

Importantly, is not electric vehicles or renewable energy behind this weak demand growth, but rather, weakness in the global manufacturing and industrial production are to blame. Gasoil/diesel demand has contracted by around 140,000 b/d this year, with demand for such fuels primarily coming from the worlds industrial and manufacturing sectors, such as trucking and machinery. Not only is this true in China, but also true of North American and European diesel demand.

While economic growth overall has been fairly robust in most of the world, manufacturing activity has been depressed in recent times, a dynamic confirmed by global manufacturing PMIs below.

The US demand story

In terms of the US, oil demand has been robust but not outstanding. The below chart shows implied demand for the three primary refined products - gasoline, distillate (diesel) and jet fuel. Demand has more or less been in-line with 2023 levels and the five-year seasonal average, but below the highs of 2021. It is also worth noting the five-year seasonal average is being biased lower due to the lockdown-induced drop in demand during 2020.

As we saw earlier, diesel demand has been the biggest headwind to oil prices in 2024, as it is the area of the oil complex most closely associated with economic cyclicality. Manufacturing and industrial production in the US has been relatively weak in recent times, which has translated into below average diesel demand for much of 2024.

Gasoline demand on the other hand has been more robust, but like US oil demand overall, not outstanding. Perhaps the most important dynamic at play here is that despite the fact miles travelled has recently accelerated to pre-COVID highs, gasoline demand is still ~500,000 b/d below its 2019 equivalent. Weaker economic activity has certainly played a role here, and the gap should close as US manufacturing activity recovers.

The extend to which this gap does eventually close however remains to be seen, as this will likely be determined by the cyclical versus structural factors at play, and whether the relative reduction in gasoline demand is a result of EV penetration, urbanisation or other factors at play.

In terms of jet fuel demand, the picture here has been much more favourable, but again not without its flaws. Jet fuel demand has been growing again since the COVID shutdowns and is nearing 2019 levels, however, the growth in actual demand (which is a function of miles flown) has slightly lagged the number of aircraft passengers. While the latter is now above pre-COVID levels, the former is not. Clearly, airlines are managing to fit a larger number of people into a smaller number of aircraft, thus the increase in travel by consumers has not fully translated into an increase in jet fuel demand.

Again, whether the divergence between airline passengers and miles flown does eventually converge remains to be seen, but is certainly a trend worth keeping an eye on for energy investors and oil traders.

One of the best real-time ways to track US oil demand is by monitoring refining margins, or crack spreads. Crack spreads led prices higher in early 2023, and have declined in-line with prices since. Now that oil prices have fallen to the low $70s and refinery run cuts have started to take place, crack spreads have stabilised and have held up better than prices in recent weeks, suggesting the trough in US oil demand is probably behind us.

The leading indicators of the US business cycle are largely confirming this outlook. Most lead indicators are suggesting any further decline in manufacturing activity is unlikely in the short to medium-term. As such, we should expect manufacturing activity to recover in the US to some extent, which will flow through to increased diesel demand.

The China demand story

As I mentioned earlier, the real demand story here is China. After a strong demand recovery in 2023 following China exiting its extreme COVID lockdowns, demand growth has contracted once again in 2024 as the country is now mired in a property market crisis and deep recession. Most sources suggest Chinese oil demand has contracted around 0.5-1 mm b/d so far this year, though it would not surprise me if the decline was greater still.

Like in the US and Europe, most of this demand contraction has occurred through distillate and fuel oils, the consumption of which is most closely linked to manufacturing and industrial production, as discussed.

While it is true some of the decline in diesel demand has been a result of the increased sale and use of LNG trucks in the place of diesel trucks, much of this dynamic itself is a result of relatively lower LNG prices and weak economic growth reducing overall demand for trucking. Now that diesel prices have fallen, we are starting to see this trend reverse.

Either way, the key message here is that Chinese oil demand has been the primary driver of oil prices this year, with its weakness translating into lower oil prices.

Given the difficulty in actually measuring Chinese oil demand, there are a number of other ways to confirm this weakness. First, we can see China’s imports of crude oil have stagnated this year.

While Chinese crude oil inventories are also flat this year, meaning the fall in imports is not been offset by a commensurate fall in inventories.

While Singapore gasoil crack spreads - an excellent proxy for Chinese oil demand - have also been falling this year.

However, similar to the outlook in the US, there does appear to be some light at the end of the tunnel. Singapore gasoil cracks do appear to be stabilising, while economic lead indicators of China are no longer as worrisome as they were earlier this year.

Having said that, the near-term outlook for Chinese economic growth remains hazy and far from bullish. Until we see Chinese policy makers follow through on real-economy stimulus (with their latest package disappointing as policy makers focus on financial markets rather than the stimulating demand), Chinese economic growth will be stagnant, though we should see a natural rebound in Chinese oil demand in 2025, at least some extent.

Overall outlook for demand

Outside of China and the United States, we have seen demand in other major economies falter slightly this year, primarily in Europe. European diesel demand has fallen around ~110,000 b/d so far in 2024 relative to last year, though in similar fashion to the outlook for US demand, lead indicators for Europe and the global economy as a whole suggest economic activity should pick-up over the medium-term, and with it manufacturing and industrial production.

Even though there remain big question marks over Chinese economic growth, oil demand growth is set to return in 2025 and is likely to be much more in-line with recent averages. Most forecasters are calling for demand growth of around 1.1 mm b/d, led by a recovery in diesel demand (which most economic lead indicators are largely confirming). It is also worth noting the biggest demand driver remains naphtha and NGLs, with their demand being itself driven by EV and hybrid vehicles.

A rebound in demand growth in 2024 will go a long way to supporting prices, but how high the ceiling is for demand will ultimately come down to how quickly Chinese demand can rebound. Even still, OPEC+ will use 2025’s demand growth as a means to start unwinding their voluntary cuts.

Over the medium-term, a rebound in demand will put a floor under prices, while forthcoming supply increases will ultimately cap prices. As such, we should continue to see oil prices rangebound between $65-$85 over the next 12-24 months. It is beyond that time frame where I am most bullish, with stagnant US production growth central to this long-term thesis.

In the short-term, WTI crack spreads and Singapore gasoil crack spreads will provide a relatively good indication of how the demand recovery is tracking, while prices are also going to continue to be heavily dictates by speculative flows. The oil market is likely to be a trader’s market over the short to medium-term.

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