Why Demand Does Not Explain $4 Gas

Better late than never. President Barack Obama has called to enforce strict civil and criminal penalties against traders who manipulate the market and cause oil prices to shoot up by creating artificial supply shortages.

The Obama administration has finally woken up to the fact that gasoline prices at the pump are high, straining disposable income. The president, along with Attorney General Eric Holder and Treasury Secretary Tim Geithner, has called for a crackdown on speculation in the oil market. Many think this could be another election ruse. I really doubt that. The latest move by the president makes a lot of sense.

There are many reasons to suspect that oil prices aren't simply dictated by demand-supply issues. Here are a few of them:

1. Drilling (and production) of crude oil increased considerably in the past five years; however, in the same period total gasoline retail sales fell substantially.
In 2011, daily U.S. field production of crude oil stood at a little more than 5.6 million barrels per day -- an 11% increase from 2006 productions levels. In the same period, total U.S. gasoline retail sales fell by a massive 35% to 39 million gallons per day. People are driving less. Period. The graph below should give a clearer picture:


Source: Energy Information Administration.  

In the same period, national average gasoline prices rose 37% to $3.58 per gallon in 2011, from $2.62 per gallon in 2006. Last week, average prices at the pump stood at $3.98 per gallon.

The above data shouldn't come as a surprise to the average American. The discovery of shale oil has changed the landscape of the U.S. energy industry. In the past two years, both and large and small oil companies have been increasing production. Kodiak Oil & Gas (NYS: KOG) along with Continental Resources (NYS: CLR) -- operating in North Dakota's Bakken shale oil reserves -- have ramped up oil production substantially. Traditional natural gas producers Chesapeake Energy (NYS: CHK) and SandRidge Energy (NYS: SD) have also increased their proportion of liquids production. While lousy natural gas markets are to be blamed for this, the fact is, liquids production has gone up. Now I haven't actually mentioned the traditional powerhouses such as ExxonMobil, Occidental Petroleum (NYS: OXY) , and Apache, all of which have increased liquids production substantially in the past five years.

2. World petroleum consumption growth has been less than corresponding growth in crude oil production
As of 2010, global oil consumption stood at 87.1 million Bpd, a 2.35% increase from 2006 levels. In the same period, however, global oil supply grew 2.52%. And if 2011 figures are considered, then global crude oil production grew 2.9%. Unfortunately, the corresponding 2011 consumption data have yet to be released. But logically speaking, even an extrapolation of available consumption data will not see growth in demand exceeding growth in supply.

3. Emerging economies are expected to slow down
Both the World Bank and the International Monetary Fund have cut growth forecasts for China and India for this year. China's GDP is expected to grow at 8.2% in 2012, a fall from 9.2% last year and 10.4% in 2010. Similarly, India's economic growth is expected to slow down to 6.9% in 2012 -- a fall from 7.2% and 10.6% in 2011 and 2010, respectively. This will obviously have an effect on oil demand from these nations.

You can see a shortage of supply is not to blame for high crude oil prices in these countries. In fact, the IMF report goes on to say, "The oil price shock could also trigger a reassessment of the sustainability of credit booms and potential growth in emerging Asia, leading to hard landings in these economies."

Foolish bottom line
The media may project daily events like rising oil prices on the front pages, but the real issue lies elsewhere. In the words of fellow Fool Morgan Housel, this is another bias of titanic proportions. If you are looking to invest in energy stocks, we've got a stock idea for you. Read about it right here in The Motley Fool's special free report on the energy industry and its best prospects. It's free for a limited time, so click here today.

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