The myth of declining oil demand

You all understand well, perhaps better than I, the oil supply/demand issue, but since there has been some loose talk among the attractive people with nice voices on Bloomberg and Fox Business about "collapsing" oil demand, I could not resist the urge to comment.

As the chart below shows, world demand each quarter has consistently exceeded demand in the same quarter of the previous year. Demand continues to grow along its accustomed trajectory. It's almost like a law of nature. The problem, then, is supply.

And we are not talking about a lot of excess supply. What we have is a small amount of excess supply persisting consistently over time. If, for example, one left the faucet dripping and the sink were plugged, then the drips would, in time, flood the house. So the oil market is being flooded in a sort of Chinese water torture.

In this case, however, supply will have to keep increasing to maintain an oversupply, because demand keeps growing. In the second chart below, you can see the biggest oversupply was in the second quarter of 2015. Nonetheless, demand in that quarter was still greater than supply in the corresponding quarter of the previous year.

This is an interesting and important time. For the first time since OPEC was formed in the 1960s were are seeing a free market in oil. In a free market, the high cost producers drop out as the price drops and equilibrium is maintained. In the cartel world, this was upside down. The low cost producer used to drop its production to maintain the production of higher cost producers. It will take some time to find the equilibrium price because the low cost producer is now going all out many high cost producers still have a low marginal cost, but equilibrium will eventually appear. In the meantime, the price can go anywhere.