‘DEMAND DESTRUCTION’ AT PLAY?

Samantha Amerasinghe evaluates the reasons for the waning demand for oil in recent times

Two key factors are impacting the demand for oil: tensions in the Middle East and weaker than expected oil consumption in China due to the growing demand for electric vehicles (EVs).

Weak demand from China amid rapid electrification of its car fleets has weighed heavily on oil prices. China’s demand for oil continues to undershoot expectations and has been the principal drag on overall growth.

Saudi Arabia’s stance on unwinding production cuts is another important consideration. The question is whether a major disruption to oil supplies will cause prices to rise – or whether the current supply is sufficient given that demand is slowing.

A major factor supporting oil prices in recent times has been the conflict in the Middle East and concerns about the potential for supply disruptions have kept prices elevated.

Iran, which is a key player in global oil production and member of the Organization of the Petroleum Exporting Countries (OPEC), is central to these fears as the potential for wider regional conflict could see interruptions to crude supplies.

Efforts by the US to broker a ceasefire in Gaza temporarily eased supply concerns and led to a brief dip in prices. However, the lack of a clear resolution, coupled with uncertainty about future regional developments, has kept a floor under oil prices.

Any further escalation in the conflict could cause prices to spike.

The International Energy Agency (IEA) has affirmed that it’s ready to act in the case of supply shocks. But for now, it appears to be satisfied that supply is under control in the absence of a major disruption with the market facing a sizeable surplus in the new year amid ample supply and slowing demand.

Global oil demand is set to increase by only 862,000 barrels per day (bpd) this year, amid decelerating consumption growth in China, according to the IEA.

Both OPEC and the International Energy Agency trimmed their forecasts for oil demand next year after witnessing continuing weakness in the Chinese market. The IEA expects oil demand in China to increase by only 150,000 bpd in 2025.

China, which accounted for almost 70 percent of the world’s oil demand growth in 2023, will account for only a fifth of this year’s increase and underline a rapid slowdown, as the economy has weakened and the country’s shift to electric vehicles accelerates.

OPEC is projecting a much stronger outcome of 1.93 million barrels per day despite also cutting its forecast for oil demand growth. The IEA predicts that the demand for oil will rise by about one million bpd in 2025.

Some analysts believe that we might have already seen the low point in Chinese demand. Beijing’s recent efforts to reinvigorate its slowing economy – with the Bank of China announcing cuts to benchmark lending rates – has led to raised expectations for oil demand in the world’s largest crude importing nation.

Any improvement in economic growth should boost fuel consumption but it may take some time for the stimulus efforts to filter through to oil demand.

Saudi Arabia recently signalled that it’s resigned to a prolonged period of lower oil prices due to renewed demand fears and a weak Chinese economy. It was committed to bringing back production as planned on 1 December, regardless of market conditions and oil prices at the time.

Some experts argue that Riyadh is doing its utmost to avoid losing market share to non-OPEC producers including the US. However, other commentators have taken a more nuanced view and opined that Saudi Arabia’s intention to increase output by 84,000 barrels per day starting in December does not mean that it is aiming for market share.

Instead, the country appears to be sending a warning that it will accelerate the phasing out of voluntary cuts unless all partners involved fulfil their pledges. Compliance with OPEC+ output cut pledges will be key in determining whether oil markets remain tight or not.

It’s unlikely that Riyadh will be too brash with its pace of unwinding given that the country is already facing a substantial budget deficit at current oil prices. According to the IMF, Saudi Arabia – which is the Gulf Cooperation Council’s (GCC) biggest economy – needs an oil price of US$ 96.20 a barrel to balance its books.

The dilemma facing the Saudi government is that it can neither raise production and exports to compensate for lower prices nor can it expect prices to rise above 96.20 dollars anytime soon.

This situation is not helped by the fact that over the past few years, Saudi Arabia has borne the lion’s share of OPEC+ production cuts. That said, Riyadh can still afford to inflict some pain on oil markets.

World oil demand looks set to grow at a slower pace in 2025. And in the words of the IEA, “demand destruction” is still at play.