BP AMOCO’s Magic Curve

Andrew McKillop

BP Amoco like other consumer nation players in the world oil market necessarily has to provide logical seeming rationales for a downside view on prices. On the supply side, agencies such as the OECD´s IEA and the US EIA present a possible return of ‘structural oversupply´ by about 2006. The underlying credo is that world oil supply will always tend to increase faster than demand. On the demand side, BP Amoco has created what can be called its ‘Magic Curve´. This purports to show that world oil demand growth is always trending downwards. Complete zero growth would be attained in about the year 2007. In other words, from about 2007, according to  BP Amoco, all net demand growth for oil at the world level will shrink to zero – as if by magic !

Both on the supply side, and on the demand side, any temporary ‘oversupply´ of the market will be precisely that – temporary – for a number of reasons. While oil discoveries, replacement to lost capacity from both economic and geological depletion, and net energy available from the overall effort to produce and deliver oil will and can only fall, world oil demand can only rise. Conversely, and underlying the BP Amoco Magic Curve, which can be called petroleum´s answer to the Laffer Curve, is the preconception of ‘price elastic´ responses to what, in real terms, have been only limited increases in oil prices since the most recent low – about USD 10/bbl in dollars of 2003 – which was briefly attained in 1998-99.

 

BP Amoco´s approach is fundamentally flawed through overbelief in the so-called price elastic response of oil consumers, who are in no way homogenous anyplace in the world. BP Amoco totally ignores the observed and real fact of reverse elasticity. That is, in very simple terms, oil demand growth increases as oil prices increase, up to very high price levels relative to the still-depressed oil price levels of today (about USD 30/bbl). This is for many reasons, notably that much oil demand is inelastic, but also because of global macroeconomic changes induced or triggered whenever oil prices break out of their recent, artificially low levels.

 

It is likely that BP Amoco´s Magic Curve integrates or takes account of possible or likely reductions in oil and gas burn by Kyoto Treaty compliant countries (EU countries, Japan, Canada and others). This effort – which in certain cases will need heroic 50% reductions in oil and gas burn, and coal burning where it is significant, in the 4-year period of 2008-2012 – may or could start being applied in the immediate and very short-term future, but its impact on global, composite oil demand growth will be swamped by long-term growth trends in many emerging economies. Energy conservation and efficiency raising can be completely discarded as any kind of supporting rationale in favour of BP Amoco´s claimed ´ trend rate º of falling oil demand growth (a claimed figure of about 65% in 9 years, see below). All OECD countries, notably, have rising average car engine sizes, number of vehicles, and annual kilometres run per car, and thermal electric power production is on the rise in many countries, some new plants even using fuel oil !

 

Real world trends

 

The BP Amoco Magic Curve (see Figure, below) has a no doubt agreeable scientific look to it, through showing a sinusoidal downtrending pattern of annual increases of world oil demand. What is more important is that reality shows little or no compliance with the required ‘long term trend´, shown by the straight line. The ‘surprising´ growth of world oil – and energy – demand through the period since 1999 to now has even been referred to even by BP Amoco, in the ‘Introduction´ to its 2003 edition of the Statistical Review.

Figure 1 BP Amoco Magic Curve

 

Red line/ Bp Amoco claimed ‘trend rate of annual demand growth fall’

Black line/ Logarithmic trend (fitted by McKillop)

The predictive value of this curve is not zero, but close to that low figure. Using data from various editions of the BP Amoco Statistical Review in the 1994-2002 period, completed with data for 2002-2003, and comparing the two we get the Table, below

 

Table 1 Projected ‘trend rate´ of oil demand growth, and actual world demand growth

Million barrels/day (Mbd) increase on year previous

Year	‘Trend´ forecast demand growth July base Mbd	Percent growth on year before (trend versus real world year average daily demand)	Real demand growth (year average) Mbd (ìall liquids”)	BP forecast growth versus real demand growth Difference in percent
1994	1.5	2.2%	1.38	+ 8.5%
1995	1.35	1.9%	1.13	+ 19.5%
1996	1.3	1.9%	1.49	- 12.5%
1997	1.19	1.7%	1.8	- 34%
1998	1.1	1.5%	0.82	+ 34%
1999	0.9	1.2%	1.88	- 108%
2000	0.85	1.1%	0.8	+ 6.5%
2001	0.7	0.9%	0.08	(Not significant)
2002	0.62	0.8%	0.83	- 25.5%
2003	0.5	0.6%	1.75 (minimum forecast)	- 71% to – 85%

Sources/  above Figure 1, and BP Statistical Review World Energy (to 2001-02)

Data for 2002 and 2003 from OECD IEA and US EIA. 2002-03 growth forecast by McKillop

on base of 2002 average demand 76.1 Mbd and 2003 average demand 77.9 Mbd

The lamentable inaccuracy and imprecision of this so-called ‘trend rate´ in forecasting anything like the actual, real world outturn, can be completed by considering the following. Actual demand growth recorded in 2001 was almost nil for the simple reason there was one of the longest and deepest ever contractions of equity numbers taking place on the world´s major bourses, and the September 2001 terror attacks in New York and Washington had instant, and strong impacts on airline and travel movements around the world. Secondly, after 1996-1998, the fast growing errors in the predictive capacity of this so-called ‘trend rate´ (supposed constant decline of oil demand growth) are clear to see. We can note the very large increase in oil demand growth in 1999 – in the first full year following the approximate 230% increase in nominal oil prices through 1998-99!  We can also note that world oil demand growth in 2002-2003 is very unlikely to be less than about 1.7 Mbd, and may even exceed 1.8 Mbd if there is no sharp and severe recession resulting from, for example, a collapse of major equity markets through October-November 2003.

 

Why upward potential in demand growth is ‘unlimited´

 

Whatever the economic, technological, policy or legislative (eg. Kyoto compliance) rationales and desires underpinning the ‘Magic Curve´, real world demographic and energy economic facts and trends make for almost unlimited upside potential. World oil demand, at the current US per capita rate of about 25.6 barrels/person/year (bpy), would for example run at about 445 Mbd if by some somber miracle the world´s population consumed at US rates. As shown in the Table, below, the simple fact of continuing world population growth likely ‘generates´ or leads to about 1 Mbd/year as a near incompressible minimum in the absence of severe, worldwide economic recession.

 

 

Table 2   Demographic rate of oil demand,  2002

 

Country/Region    bpy	World demand at this rate
USA                     25.6	445  Mbd
Italy                    12.4	215  Mbd
China                   1.45	25   Mbd
Rural areas, LDCs   0.2	3.45  Mbd
—————————————-	—————————————-
Real world            4.51	78   Mbd
—————————————-	—————————————-
World annual population growth	Annual ‘latent demand´ increase
85 Million	1.06 Mbd

Sources/ Population data from UN Population Information Network, Oil demand BP Amoco Statistical Review of World Energy, 2003

 

We have only to consider the very fast growth of oil demand recorded by the Asian Tiger economies during their period of fastest industrial growth (about 1975-90), and then apply those rates of growth, and cumulative per capita consumption levels attained, to China, India, Brasil and Pakistan, and other fast industrialising, large population countries. Such growth rates, and cumulative increase of oil demand – often exceeded by natural gas demand growth -  can and will easily compensate stagnating demand patterns and growth trends in the aging, service oriented, Kyoto compliant economies and societies of the OECD group. Overall, very large growth numbers for world oil demand are more likely than smaller. Through the period 2001-2003, and concerning oil import demand we can note that China, because of the combined effect of fast rising demand and declining national production increased its demand on the world oil market by about 55% in two years, and India, for exactly the same reasons, by more than 30%. In both countries, natural gas demand growth runs at an annual average above 10%.

 

Any projection of low – or even zero – growth of world oil demand must assume very significant and committed energy transition away from fossil fuels in the OECD countries and  either slowed economic growth or a completey hypothetical ‘alternate model´ for economic growth in, particularly, the large population fast industrialising countries. At the current time there is little or no sign that either of these ‘adventurous´ hypotheses is coming about in the real world. Annual growth of oil demand by the large population industrialisn countries, by 2010, may attain a combined 1.75 – 2 Mbd which, with continued slow growth by very low income countries will place a firm floor to any continuance of falling annual growth trends.

 

Probable impacts of coming oil price rises

 

In the absence of severe fiscal reaction to rising oil prices – that is use of the interest rate weapon to suppress economic growth resulting in a fall of oil demand, leading to oil price falls (it being assumed that oil exporters will produce at any price) – oil price rises to even USD 60/bbl will have little effect on real world economic growth trends. In the 1975-78 period, for example, with oil prices in 2003 dollars at around USD 38 – 55/barrel, the major OECD economies averaged about 3.5% annual growth of their economies on a real GDP base. The major reaction, in fact, is psychological. Sharp and rapid, large oil price rises (that is ‘oil shock´) always impact financial and corporate sentiment making for at least several months of so-called ‘crisis´, and inevitable sharp compression of stock market capitalization numbers.

 

Belief in the popular myth that ‘High oil prices hurt growth´ is very much more important – for a certain period – than the reality of global macroeconomic adjustment to higher oil and energy prices. Depending, as said, on the fiscal environment any oil price rises at this time and due to the Middle East situation tilting to Arab-Israel war, as in the 1973 ‘Yom Kippur war´, could be absorbed in less than 6 months, resulting in faster economic growth rather than the opposite. This will be through the revenue effect of higher oil and energy prices on low income country exporters of minerals, metals and agrocommodities being much greater than the price effect on end user demand of higher priced oil, natural gas and electricity (all of which rise in price whenever oil prices rise). Increased solvent demand at the world level will be further increased by rising liquidity due to higher oil, energy and real resources prices. The only danger to this spontaneous macroeconomic adjustment process will come from fiscal and monetary policy reaction in the OECD countries to higher oil prices. Initially and most importantly this would come from any sudden and violent increase in interest rates, decided so as to ‘reinforce currency values´ or to ‘reduce or limit inflation´. Given the parlous state of most major stock exchanges in recent months, it would in fact be almost suicidal to raise interest rates at this time, but politically motivated decision makers may react, rather than respond to emerging and above all inevitable oil price rises.

 

There is little need to enumerate the multiple reasons for the world´s increasingly fragile and slow growing world oil supply structure and system being faced by an emerging world demand context that is radically different from the wishful thinking underlying the BP Amoco Magic Curve. We can simply note the recent statements by Lee Raymond and Jon Thompson of ExxonMobil, indicating that in their opinion some 3.25 – 3.75 Mbd of replacement oil production will be needed, each year on average, to compensate economic and geological depletion losses in the next 15-25 years. Current and recent exploration, drilling, proving and development effort is very far behind that rate – suggesting that structural undersupply rather than the opposite is not a ‘long term menace´ but imminent. By about 2008 the shortfalls that could occur anytime there is major regional conflict in the Middle East, or through simultaneous loss of Venezuelan and Nigerian supply, or for any other reasons leading to there being about 4 Mbd shortfall, could become the world oil market´s permanent backdrop and scene setter. Under such circumstances it is obvious oil prices will be much higher than today´s prices. To what extent, and whether this will lead to oil being treated – as it should – outside the market pricing system, are questions which at this time cannot have any reasoned answers.

 

Higher and much less volatile oil and energy prices underlying serious and committed energy conservation, transition to renewable energy and restructuring for a low energy economy, habitat and society are the real long-term solutions to emerging supply difficulties which will surely raise prices, but energy transition is discarded or rejected as utopian and unworkable by political decision makers. While claims are made that today´s economy is ‘less oil dependent than in the 1970s´ world oil consumption has risen by about 48% or 20 Mbd since 1983, and by about 18% since 1990. Oil import dependence as a percentage of total consumption continues to rise in a large number of OECD economies, and unless demand is rapidly substituted oil imports will soon show very fast growth. Unfortunately, the subject of oil prices is given benign neglect when they fall, and energetic propaganda treatment when they rise. Most economic policy makers believe in a simple slogan: the lowest price is always the best. This real world context – paralyzing response and reducing options to zero – is without doubt the real crisis we face. 

Copyright © 2003 by Andrew McKillop

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Andrew McKillop is an economist, evironmentalist, jounalist, and technical translator. He has traveled and lived throughout the world, but currently resides in West England. He is currently working on a new book about the fossil fuel depletion crisis. You can read an excerpt from that book here. I first met Andrew as a contributor to the Energy Resources Yahoo Group.