Singapore, 30 August As oil traders weigh up the rising risk of a weaker US economy, some analysts warn that the varied impact on global demand for refined fuels may not follow the precedent set in previous downturns.
Europe’s growing diesel addiction could mute the typically sharp hit to middle-distillate consumption; and gasoline use -- least affected by economic activity in the past -- could be the first to succumb this time if US consumers feel the pinch.
And Asia’s rise may insulate it from the worst of the impact.
“At the end of the day, the run-up in price and demand was not what we’d seen in the past -- sharp demand growth and high prices,” says Jeff Brown, managing director of FACTS Global Energy. “It stands to reason that the way back down might also be quite unusual, demand might not behave as in the past.”
For the banks, oil companies and traders who place heavy bets on derivatives measuring the price spreads between regions or types of fuel, rather than the absolute price of crude, that raises additional risks to their fundamentals-based strategies.
While the current credit squeeze triggered by a meltdown in the US subprime mortgages has yet to visibly spill from financial markets into the real economy, the risk has grown.
The US consumer sentiment took its sharpest plunge in nearly two years during August, data showed on , the same day OPEC’s Secretary-General said the subprime fallout had clouded the outlook for oil demand.
“This really has us worried,” said one senior oil trader with a major company. “We’re spending a lot of time talking about it.”
Should the US economy stall or even move into reverse, most analysts agree it would brake total oil demand growth in a country that accounts for nearly a quarter of the world’s use; that in turn would weigh heavily on high absolute prices.
Whether that would spill over to others is an open question. Many economists say the economies of China, India and Japan are less reliant on US growth than in the past.
“My feeling is that Asian demand growth would stand up better than elsewhere in the world, especially if prices fell,” says independent analyst Geoff Pyne of enerpyltd.com.
Working out the more nuanced implications may prove more difficult, but just as important for oil traders who prefer to bet on relative prices rather than a rise or fall in crude.
Many believe that their insight into physical oil flows gives them a better chance to predict spreads than “outright” prices, which are whipsawed daily by unpredictable factors such as Iranian politics, hurricanes or OPEC policies.
But that does not mean they’re immune to sudden volatility.
Just ask Bank of America, which lost $89 million in jet fuel trading when the Severe Acute Respiratory Syndrome (SARS) epidemic struck Asia in 2003. At the time traders said its position was in the so-called regrade spread, the premium of jet fuel to diesel, which suddenly turned negative as air travel weakened.
“Traditionally in the case of an economic slowdown, diesel would be the product to react strongest as it is used for industrial uses. Yet with the increase in its use as a transportation fuel, this correlation is waning,” said PVM Vienna, a consultancy and brokerage.
European drivers are leading a gradual global shift towards diesel engines, which now power more than half the continent’s cars. They are also not facing the cash squeeze of some motorists in the US and have gained from the weakening US dollar.
Middle-distillate demand in Europe has risen by 15% or over 1 million barrels per day (bpd) since 2000, while demand for most other fuels has fallen, BP data show.
But US diesel use could be even more vulnerable than in the past, as it has been stoked by the shift in manufacturing to China. If a slowdown means less demand for imported Chinese goods to the US, West Coast, inland trucking demand would be hit.
In the US, history shows a weaker correlation between gasoline demand and economic performance, a relationship some analysts expect to continue given drivers’ apparent willingness to continue paying $3-plus pump prices.
In 1991, the last economic bad patch and the last time that total US annual fuel demand contracted, motor diesel and jet fuel demand fell by 4% each while gasoline sales fell about 0.6%, US government data showed.
The International Energy Agency expects North American gasoline demand, about one-eighth of global oil use, to grow by 1.4% this year, according to its latest monthly report.
But others say the fact that the current troubles originate in the US mortgage sector may upend that assumption.
Michelle Foss, head of the Center for Energy Economics at the University of Texas, Austin, says the growing strain on US household spending for homeowners facing late mortgage payments or foreclosures threatens dampen growth.
“Demand is not necessarily dropping, but fuel costs are competing with other purchases,” she says.
For fuel oil, two counter effects will be in play. A possible reduction in global trade caused by lower US demand for Chinese goods would hurt demand for the fuel used to power ships and generate electricity. But supplies could also be curbed if OPEC reduced supplies of its cheaper, heavier crudes.
“Its (fuel oil’s) discount to crude ought to contract as a higher proportion of refinery throughput (worldwide) would be light/sweet crude,” says Enerpy’s Pyne. REUTERS