Forces Driving Oil and Gas Demand Cycles

Abstract Oil and gas prices have historically been very volatile taking the demand for oil through wild cycles and have taken the economy of the world through the cycles with them. Oil producers and consumers tried to dampen the cycles and establish a market with softer fluctuations; however, their efforts were largely unsuccessful. OPEC strategy for dealing with the possibility of declining oil prices in the future appears to be the same old one that failed to stem the price fluctuations of the past. OPEC appears to be setting themselves up for yet another failure and the old cliché "history repeats itself" seems to be in order. Indeed every steep price increase results in a steep decline and we appear to be due for one, will it actually happen? If the past is any indicator, nobody knows. This implies that the forces that drive the oil and gas demand are not all understood and certainly not easily predictable. Perhaps the cyclical nature of supply, demand and prices of energy is a lasting phenomenon, and therefore both producers and consumers should be prepared to live with this reality. In our paper we looked at the fundamentals, we examined the forces that drive oil and gas prices, we point out the changes that are occurring in the world socio-economic systems that may affect the oil and gas supply patterns in the future. Our method breaks the barrel of oil into segments, namely industrial plus, transportation, Commercial & public services, Residential and electrical generation. Then we predict the demand level for each segment based on the projected growth in the segment, incorporating uncertainty factors. Population growth and the expected standard of living improvements, particularly in the developed nations, are the main causes for increases in energy requirements. In our conclusions, we have found that structural changes are occurring in the energy market. The large consumers of yesterday may not be the same ones tomorrow, and hence we may have new players on both sides; the producing and the consuming sides. We believe that oil and gas prices are going to be more stable and more in tone with the market forces. Introduction What sets the price of a barrel of oil? If we can answer this question, we will go a long way in forecasting future prices. In any period, market forces must set the price level of a barrel of oil and hence, for every equilibrium price, there exists an equilibrium demand level. This hypothesis seems to be holding as evidenced by the fact that over the long term, the average price of a barrel of oil is largely set by the market in real monetary terms. For example, over the past four decades, oil prices did not depart from the average, except for short-term fluctuations that occur now and then. The price in real terms has not increased except for this past year (2006) indicating that we may have a pattern change, and that we may see the current prices stay for an extended period. The reasons for the pattern change are related to the social, political and economical changes that occurred during the last two decades; the world experienced a relatively stagnant pattern during the cold war years (1945–1990). North America had its own pattern of socio-economic system easily distinguishable from that of Western Europe and vastly different from that of the soviet block and other developing nations. Despite the obvious differences, the patterns were predictable and tended to be cyclical in nature and independent to some extent. Following the collapse of the Soviet Block, the 1991 Gulf war, the integration of Western Europe into the European Union, and the events of September 11, 2001, the world socio- economic system has moved toward integration. This phenomenon accelerated due to the rapid development of global communication systems that essentially made the world a small one indeed. We believe that in spite of the current instabilities, the world will eventually adjust to more stable system in which economic growth will be the target for the majority of world population. South Korea, China, India, Indonesia and Malaysia will be the role model for countries. Nations will be striving for better standards of living to satisfy increasingly informed populations. This translates into higher energy consumption in the transportation and residential sectors, and therefore, the demand for oil and gas will be higher.