Global Cooling: A Cautiously Optimistic View of the Next Two Years

Global oil demand experienced some modest destruction last month (about 3.5%) and the IEA and EIA both released declining demand projections which many believe will continue through the third quarter of 2011. However, many stock analysts remain bullish on energy because of expected overall growth in demand attributable to Asia, former Soviet bloc countries (FSU), and Latin America. Projections put crude prices at around $105/bbl (Brent) at 2011 year end, $110/bbl (Brent) and gas at $5.25/mcf next year with those prices holding through 2013, so there is good reason to be optimistic.

One of the only variables in this scenario that could cause material demand destruction in the sector is taxation.

Globally, fewer countries are subsidizing gasoline now than they were five or ten years ago because the cost simply became too high and more countries are placing higher taxes on fuel. In the U.S., though unlikely this year, the looming threat of Obama-driven taxes on oil and gas as well as his proposed removal of development incentives for the industry (e.g., IDC deductions) could contribute to substantially higher prices at the pump.

What does this all mean? There are so many factors involved in the global commodities markets that it is difficult to make generalizations. However, taxation is one factor where generalization is simple:

Increased taxation will push up consumer prices and increase demand destruction.

“Taxation” of course means increased direct taxes on energy companies. It also means the removal of tax incentives for domestic development. Further, “taxation” means any legislation that has the effect of increasing costs or inhibiting development, thereby driving up prices (e.g., restrictions on U.S. offshore production, onerous anti-fracing legislation, etc.).

From an international perspective, don’t underestimate the fact that the areas with the greatest demand growth also have much higher rates of population growth and rapid urbanization and motorization. This means exponential demand on supply.

So what price is too high?

Today the economy is less sensitive to price increases than it was during the 1970s when spikes in oil prices contributed much of the inflationary pressures on consumers. Nonetheless, the stress on supply from increasing global demand (especially volatile global demand since China, while representing 11% of global production accounts for more than one third of all demand growth since 2005, and Latin America 7% of global production but 15% of demand growth) and the environmental movement (pushing increased taxation and restrictions on production) have the potential like never before to force unusually high prices.

Increased taxation could be the “tipping point” that creates a demand-destructive, high price scenario.

I would like to hear from you.

What are your perspectives on the near term?

What sorts of strategies are you, your clients, vendors and customers using based on their vision of the next few years?

Please leave a comment below.