Oil price increase

Objective
Purpose of this paper is to study the cause of increase in crude oil price. In this paper I will highlight the change in demand drivers and supply dynamics of oil since 1985. Indian and China have been the biggest demand drivers in the last 10 years hence I will also draw correlations between the GDP growth and energy consumption of these two fast growing countries to predict the future growth of oil consumption. On the supply side I will discuss why OPEC has gained power over time and why it has a higher pricing power than it had in the past.
Demand drivers of crude oil
Crude oil consumption has been consistently going up since 1985. Oil consumption has increased from 19,956 Mbbls/ year in 1985 to 27,932 Mbbls/year in 2007, an increase of 7,795 Mbbls/ year (exhibit 1). China and India together contributed 2688 Mbbls/year, 33% of the increase. In the first 12 years till 1997 they contributed only to 23% total increase in oil consumption, however, in the last 10 years two countries have contributed to 44% of overall increase.
Both the countries have a strong correlation in energy consumption with increase in GDP. For every USD 1 M increase in GDP at 2007 prices China needs 3108 barrels (exhibit 2) equivalent energy while India needs 2897 barrels (exhibit 3) equivalent energy. Not all the additional energy is comes from Oil, 30% of all energy consumed by India is in the form of oil while 20% of all the energy consumed by China is in the form of Oil. Assuming current 10% growth rate for the two countries they need 336 Mbbls of oil with a compounded growth rate of 10% to fund their growth. This is already more than double the rate of growth of their consumption in the last 22 years. OPEC countries have also increased their consumption as they are rapidly industrializing their countries.
Hence I expect oil demand to increase by 700 Mbbls per year or 2 Mbpd per year in the recent future. Although oil is now a significant expenditure for non OPEC countries, still demand continues to be inelastic.
Supply dynamics of crude oil
In 1985 OPEC countries produced 30.55% of the total crude oil in the world, this has increased to 45.3% (exhibit 4) in 2007. Known oil reserves across the world are reducing and almost all countries are beyond their peak oil production. Assuming the current reserves of oil, OPEC countries share in the production of oil will keep increasing. With the higher share, inelastic demand (probably to a limit, that they would like to test) OPEC countries will continue to have higher monopolistic pricing power.
It is in their best interest to get the maximum price of their resources today because:
• Currently there is no viable alternative to oil and alternatives will continue to be developed irrespective of the price of oil. There is a possibility of faster development of alternatives with increase in price of crude oil but environment is a bigger driver for their development and hence price of crude oil will not majorly affect the time line of development of non conventional resources.
• Even if non conventional resources get developed penny today is worth more than the penny tomorrow. Hence extracting better price of their resources today is more beneficial to them.
Conclusion
With the continuous growth in the demand of oil from the world’s two most populous nations (that does not seem to be going down in recent future) , growth in the OPEC share in oil production and OPEC having clear incentives to increase the oil price I believe that oil price will remain in the high zone and will not fall drastically.

Data sources:
Global market information database

Apeendices:
Exhibit 1 : Overall crude oil consumption of the world in Mbbls
Exhibit 2: China’s GDP in USD at 2007 prices, Mn barrels equivalent energy consumption, and their correlation
Exhibit 3: India’s GDP in USD at 2007 prices, Mn barrels equivalent energy consumption, and their correlation
Exhibit 4: Share of OPEC countries in global crude oil supply










Exhibit 1: World crude oil consumption in Mn barrels
Year World crude oil consumption in Mn barrels
1985 19956.13
1986 20598.73
1987 21013.02
1988 21654.11
1989 22023.79
1990 22405.57
1991 22488.73
1992 22741.24
1993 22532.58
1994 22913.6
1995 23238.68
1996 23818.54
1997 24415.78
1998 24504.23
1999 25003.19
2000 25263.25
2001 25347.17
2002 25533.9
2003 26034.37
2004 27033.8
2005 27349.06
2006 27511.6
2007 27931.93









Exhibit 2: China’s GDP in USD at 2007 prices, Mn barrels equivalent energy consumption, and their correlation
Year GDP in Mn USD at 2007 prices Total energy in Mn barrels
1979 250803 3341.52
1980 270616 3138.156
1981 283335 3101.868
1982 309119 3245.508
1983 342812 3414.852
1984 394920 3721.032
1985 448234 4028.724
1986 487679 4283.496
1987 544250 4563.972
1988 605750 4883.76
1989 630585 5091.66
1990 654548 5177.844
1991 714766 5439.42
1992 816263 5667.732
1993 930540 6094.116
1994 1052440 6447.924
1995 1167156 6927.984
1996 1283872 7295.4
1997 1403272 7265.16
1998 1512727 6931.764
1999 1627695 7061.796
2000 1764421 7307.496
2001 1910868 7560.756
2002 2084757 7996.968
2003 2293233 9288.972
2004 2524849 10761.66
2005 2787433 11845.01
2006 3096839 12834.61
2007 3452975 13807.58




Regression Statistics
Multiple R 0.983124228
R Square 0.966533248
Adjusted R Square 0.965293739
Standard Error 542.8151018
Observations 29


Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
Intercept 2681.149161 169.9169305 15.77917605 3.75402E-15 2332.508422 3029.7899
Slope 0.003107531 0.000111284 27.92437734 1.86808E-21 0.002879196 0.003335867

Hence we clearly have statistically significant high correlation value.



Exhibit 3: India’s GDP in USD at 2007 prices, Mn barrels equivalent energy consumption, and their correlation
Year GDP in Mn USD at 2007 prices Total energy in Mn Barrels
1979 233251 750.708
1980 241648 777.924
1981 257114 850.5
1982 268170 860.328
1983 284796 909.468
1984 298466 954.072
1985 314285 1034.964
1986 329999 1109.808
1987 344519 1170.288
1988 373804 1262.52
1989 400717 1394.064
1990 423158 1461.348
1991 432044 1551.312
1992 450190 1636.74
1993 472699 1681.344
1994 504842.8 1780.38
1995 543210.9 1922.508
1996 583951.7 2052.54
1997 612565.3 2159.136
1998 648706.7 2237.76
1999 693467.4 2298.24
2000 730914.7 2422.224
2001 759420.4 2450.952
2002 793594.3 2561.328
2003 848352.3 2632.392
2004 915372.1 2874.312
2005 997755.6 3036.096
2006 1094538 3199.392
2007 1191952 3410.316



Regression Statistics
Multiple R 0.98944761
R Square 0.979006573
Adjusted R Square 0.978229039
Standard Error 116.7510991
Observations 29

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
Intercept 205.4566736 50.10619496 4.100425 0.000339145 102.6472549 308.2660923
Slope 0.002897417 8.16541E-05 35.48404 3.42491E-24 0.002729877 0.003064957

Hence we clearly have statistically significant high correlation value.






Exhibit 4: Share of OPEC countries in global crude oil supply
Production in Mn Barrels
Year World production OPEC production Share of OPEC
1985 20715.912 6328 30.55%
1986 21803.04 7332 33.63%
1987 21899.052 7246 33.09%
1988 22831.956 8110 35.52%
1989 23099.58 8665 37.51%
1990 23626.512 9308 39.40%
1991 23549.4 9393 39.89%
1992 23794.344 9945 41.80%
1993 23791.32 10183 42.80%
1994 24154.956 10392 43.02%
1995 24578.316 10524 42.82%
1996 25234.524 10868 43.07%
1997 25996.572 11351 43.66%
1998 26503.092 11816 44.58%
1999 26013.96 11335 43.57%
2000 27028.512 11933 44.15%
2001 26918.892 11645 43.26%
2002 26720.064 11026 41.26%
2003 27648.432 11684 42.26%
2004 28879.956 12622 43.71%
2005 29154.384 12990 44.56%
2006 29288.196 13077 44.65%
2007 29677.536 13444 45.30%