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Why peak gasoline deserves your attention

The short-term outlook for crude prices is bullish according to Merrill Lynch commodity strategist Francisco Blanch. The longer-term view is, well, really complicated.

Mr. Blanch recently increased his 2018 price forecast for West Texas intermediate crude, albeit not by much, from $47 (U.S.) to $48.50 a barrel. The strategist credits a current global supply deficit of 230,000 barrels a day (b/d), resulting primarily from stronger global economic growth, for the more optimistic projections for the commodity price.

Mr. Blanch estimates that global oil demand has expanded by a healthy 1.5 million b/d in 2017, and he expects this pace to continue through 2018.

Importantly, demand growth is almost entirely a developing-world phenomenon. OECD demand is increasing by 360,000 b/d annually while emerging-market demand is accelerating by 1.2 million b/d.

Oil prices in 2017 have been also boosted by a previous slowdown in non-OPEC production growth.

Mr. Blanch notes that ex-cartel oil production fell by 760,000 b/d in 2016, but he expects production to climb by 470,000 b/d this year, and almost 700,000 b/d in 2018. On the whole, Merrill Lynch forecasts that 2018 oil markets will be "finely tuned … with quarterly surpluses and deficits likely below 0.5 million b/d for the next five quarters."

Energy-consulting firm Wood Mackenzie attempted to forecast energy fundamentals over a much longer time frame in a fascinating report called The Rise and Fall of Black Gold: When Will Peak Oil Demand Spike? (available on their website at woodmac.com).

The most important of the projections in the report is that, while peak oil demand is highly unlikely before 2035, demand for gasoline is set to begin a secular decline earlier; on a global basis, gasoline demand peaks at some point between 2025 and 2030 (above). "It's a double whammy for gasoline: In the next decade it's a fuel efficiency story. Post 2025, it's an [electric vehicle] story." The report also notes that of the 97 million barrels of oil consumed globally every day, 60 million are consumed by transportation.

The dichotomy between developed and developing world oil-demand forecasts is startling. Wood Mackenzie believes that OECD oil demand will start a permanent decline in 2020 (below). For emerging markets, however, "demand for consumer goods, including plastics, and the need to move freight in an increasingly consumer-driven world" will see crude demand climb by 16 million b/d by 2035.

The Merrill Lynch forecast implies a constructive short-term outlook for energy investors, but Wood Mackenzie's longer term outlook could prove tricky to navigate.

For one, if oil demand is set to become entirely an emerging-markets phenomenon, the domestic energy industry must ensure that their output can get to the developing world at a competitive price. The likelihood of peak gasoline demand has obvious and significant implications for the refining sector.

Naptha, used in agriculture, is expected to see strong demand but while it can be made from oil, refiners can produce it more cheaply from natural gas.

Investors should view the Wood Mackenzie report as a credible, important series of facts among others, in my opinion. The accuracy of the forecasts depends on numerous variables that include global economic growth, the economic viability and adoption of electric vehicles, fuel-savings standards for internal combustion engines, and many others.

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