Consumer governments need to take immediate action to curb oil demand.
More Saudi oil can only give temporary respite, as non-Opec supply falls.
The oil market is in crisis. Rampant demand for one product, diesel, is driving prices up, as refinery supply is unable to keep pace. But despite the threat to the global economy, governments seem unwilling to take the necessary action to curb diesel use. More crude supply from Opec can only provide temporary relief if oil consumption continues to rise. Producers and US politicians blame oil markets for rising prices, but this distracts from the fundamental problem — chronic underinvestment in the oil supply chain.
In the short term, only consumer governments can end this oil crisis. With diesel use growing at an unsustainable rate, there is no supply-side solution that can be deployed. Refineries are already maximising diesel output in response to frantic market signals and can only boost yields with new investment in expensive upgrading capacity. Running more crude boosts diesel supply but adds to the surplus of other products that is undermining margins for simple refineries. Unless Saudi Arabia is prepared to keep widening the price discount for its heavy sour grades, it will be difficult to persuade refiners to buy much more crude.
The boom in diesel use is distorting the oil market, fuelled by price subsidies in developing countries, shortages of alternative fuels, especially for power generation, and incentives to switch from gasoline to diesel in the transport sector. Diesel demand in the 14 large oil-consuming countries monitored by Argus rose by over 6pc in the first four months of this year from a year earlier, compared with under 1pc for all oil products, making it impossible for refiners to balance their operations. In China and India, demand grew by 13pc. But consumer governments are reluctant to curb diesel demand. In developing countries, the cost of subsidies is rising sharply, but only a few governments are taking action to significantly raise domestic prices for fear of inflation and political unrest. China and India are unwilling to remove subsidies and can afford to continue with their fuel pricing policies. And in the developed world, governments are under growing pressure to cut fuel taxes and subsidise poorer consumers.
Unless governments take immediate action to curb diesel demand growth, oil prices will continue to rise. Non-Opec supply is faltering, with recent falls in output creating a gap that only Opec can fill. The global supply and demand balance is much tighter than the IEA and Opec want to believe. Their forecasts of a late-year surge in non-Opec supply are unlikely to be fulfilled and industry stocks are not rising seasonally. Non-Opec crude output fell by 600,000 b/d in the first five months of 2008 from a year earlier. There is little prospect of non-Opec supply growth this year.
If the Jeddah summit on 22 June is to have any success in defusing the price crisis, consumers and producers must take steps to reduce demand and boost supply. IEA governments should use their emergency powers to curb demand, especially for transport fuels, where relatively low-cost measures such as restrictions on car use and lower speed limits could cut fuel consumption by over 1mn b/d. And developing countries need to take concerted action to reduce price subsidies. At the same time, Opec needs to accept that more supply is urgently needed to compensate for the growing shortfall in non-Opec output. This crisis demands actions, not words.
