Supply And Demand Fundamentals of Crude Oil

Regardless of which side you are on in the peak oil and climate change debates, it is important that you are equipped with a good understanding of the fundamental factors driving the supply and demand of crude oil which is arguably the most important energy source we currently have until an alternative can be found.

A recent overview by Morgan Stanley which is summarized by Zero Hedge (full article here) provides a pretty good primer on crude oil. Below are the key highlights of everything you wanted to know about crude oil fundamentals, but were afraid to ask.

Crude oil fundamental – the pricing of oil

Pricing of oil is complex and multi-factorial, including fundamental factors (such as simple supply and demand and seasonality), macro factors (such as the relative strength of the US dollar) and risk premiums (such as when war breaks out in an oil producing country disrupting production).

Pricing of a barrel of oil varies from location to location, driven by crude quality, geographical and transportation factors. For example, oil produced in Canada is regularly sold at a structural discount to prevalent oil prices due to its lack of ability to ship it to the east (Canada’s industrial heartland) or west (presumably to be shipped to the Far East) and limited capacity to ship to the US to the south.

Crude oil produced from different areas also has different qualities (light versus heavy oil, sulfur content, etc.). Most refineries are designed to refine certain types of oil and cannot easily switch to processing different types.

(Click to see larger image)

oil prices around the world


Overall global crude oil demand

  • The biggest consumers are the US (19.3 mmb/d) and China (10.5 mmb/d)
  • Non-OECD countries constitutes 50% of oil demand growth in 2013.
  • Demand growths are relatively flat (N. America) to slightly negative (OECD Europe).
  • Emerging markets will continue to drive demand growth as the per capita consumption in emerging countries, especially China and India, are still relatively low compared to those of N. America and Europe.

oil consuming countries


Refined oil products and yields

The primary consumers of crude oil are oil refineries which process crude oil into different end products feeding different end consumers and industries. Key refined products include gasoline (vehicles), jet fuels (air transportation), heating oil (home heating), diesel (transportation fuel) and residual field oil (marine transportation).

refinery yield

Typical refinery product yield:

  • Liquefied Petroleum Gas LPG (Propane, 8%) – heating, cooking gas
  • Light distillates (47%)
    • Naphtha (LPG Butane, 2%) – gasoline additive
    • Finished motor gasoline (45%) – petroleum feedstock for polymers and plastics, reformed to make gasoline, transportation fuel
  • Middle distillate (39%)
    • Jet fuel and kerosene (10%) – air travel, heating demand in Asia, all military fuels
    • Distillate fuel oil (29%) – heating oil primarily in U.S. Northeast, diesel fuel
  • Residual field oil (3%) – marine transportation fuel, power generators
  • Other (3%) – lubricants, waxes, asphalt, petroleum coke, bitumen

Middle distillate has been the largest source of demand growth, accounting for 43% of the growth since 2000, driven by emerging market GDP growth, global trade and industrial demand growth.

Transportation – source of global demand growth

transportation demand on oil

  • Transportation now represents 59% of total global demand for oil and accounted for 80% of the demand growth from 1971 to 2008.
  • Oil consumption per capita is highly correlated to the infrastructure of one’s country, perhaps more so than income. The more extensive the road infrastructure, the higher the oil consumption per capita will be. As the majority of demand growth will be coming from emerging countries, any infrastructure expansion and small changes in per capita consumption will have an outsized impact on global demand.

There is currently no practical substitute for oil as transportation fuels.

Oil supply fundamentals and challenges

supply fundamentals

  • Concentration – while oil is present in many parts of the world, supply is dominated by a few key players, namely Saudi Arabia, Russia and the U.S.
  • Supply Stability – a large amount of oil is produced in geopolitically unstable regions such as Libya, Iran, Nigeria, etc.
  • Declines in conventional oil production – production from conventional oil fields are declining 4 to 5% per year globally.
  • Growth in supply in US does not solve long term problem – supply growth in U.S. shale oil has seen surprises on the upside. But the growth prospects are limited and probably overstated, and are barely offsetting decline in oil production in other parts of the world.
  • New supply is increasingly coming from unconventional sources (fracking, oil sand) and extremely difficult to reach sources (deep sea oil fields). New supply is expensive both to find and extract, and, subsequently, need oil prices to stay high in order to be produced.


Peak oil

This article is part of the Peak oil in-depth topic. Get a crash course and read the latest developments on this topic.


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