Gasoline and Natural Gas: Record Demand Growth Facing Record Supply Growth
Last month, I pointed out that U.S. gasoline demand for the first half of 2016 was the highest on record. That trend continued in July.
The U.S. Energy Information Administration keeps records on gasoline consumption dating back to 1945, when Americans consumed less than 2 million barrels per day (bpd). Demand grew pretty steadily until the Arab members of the Organization of Petroleum Exporting Countries (OPEC) imposed an embargo against the U.S. and some of our allies in 1973. By that time, average gasoline consumption had reached 7.3 million bpd, but then demand stopped growing for a couple of years amid higher prices and government measures to curb U.S. oil demand.
While this indeed slowed demand growth for gasoline, by 1978 consumption reached 7.9 million bpd. But that proved to be the peak for the next 16 years, as the Iranian revolution in 1979 and the ensuing Iran-Iraq war propelled gasoline prices to new records. Those high prices, along with the response from measures enacted following the 1973 oil embargo, sent gasoline demand into a tailspin.
A growing population and years of low gasoline prices ultimately reversed that trend, and in 1995 gasoline demand exceeded 8 million bpd for the first time. In 2001 it breached 9 million bpd, and by 2006 it exceeded 9.6 million bpd. But once more demand stalled out as oil prices headed toward $100/bbl.
Despite a history of downdrafts in gasoline demand that proved to be temporary, many insisted that this time the historic top had finally been reached. Justifications included improvements in fuel efficiency, a massive increase in biofuel consumption and a rapidly-growing electric vehicle (EV) fleet.
Yet history once more repeated itself. Since dipping to a low of 8.7 million bpd in 2012, annual gasoline demand has climbed for three years running. But the monthly record of 9.64 million bpd, set in July 2007, held until now.
Reports from both the American Petroleum Institute (API) and the EIA indicate that the past July has changed that, establishing a new gasoline demand record. The API recently reported that year-over-year gasoline demand was up 2.4% to reach 9.67 million bpd, while the EIA estimated demand at 9.75 million bpd. And for the first two weeks of August, that number has further risen to 9.77 million bpd.
What’s driving rising demand again? Lower gasoline prices. From 2002 to 2012 the average retail price of gasoline rose nearly every year, from an annual average of $1.39 per gallon in 2002 to $3.68/gal in 2012 — the year gasoline demand hit its most recent low point.
But then gasoline prices began to fall. Amid the oil price collapse that began in the second half of 2014, the average retail price of gasoline fell to $3.44/gal that year and then plunged to $2.52/gal in 2015. The average retail price fell to under $2.00/gal earlier in 2016, and is on pace be down from 2015 for the year.
The EIA recently noted that gasoline demand wasn’t the only record set in July. In its most recent Short Term Energy Outlook, the agency reported that electricity generated from natural gas also reached a record high, surpassing the previous record set a year earlier. This was the result of low natural gas prices and warmer-than-usual summer temperatures. In 2015, coal accounted for just over 33% of the U.S. power production, while natural gas was slightly under 33%. The EIA expects coal’s market share to decline to 30% this year, while natural gas will grab 34%.
Clearly with demand setting records, there should be some opportunities for investors. There are, but we have to be selective. Never forget that despite record demand, record supply can keep prices in check. That is exactly what has happened for oil and gasoline, and for natural gas. As I sometimes point out, during the previous decade government-mandated ethanol demand increased by an order of magnitude, yet many ethanol producers went bankrupt because there was just too many of them producing too much.
Despite record demand, refiners are having an abysmal year thus far. Oil producers and natural gas producers are faring better after hitting bottom earlier in the year, but they won’t be out of danger until demand begins to catch back up to supply. A similar argument can be made for solar companies. Yes, there will be record demand growth, but record supply growth poses a risk for investors.