Andreoli on Oil & Fuel: Demography and its impact on oil and fuel markets

It’s a safe bet that few of you can name a famous demographer alive today. I certainly can’t, and I studied the subject as a graduate and post-graduate student. Yet demography—the statistical study of the size, structure, and distribution of population over time—provides an essential foundation for those wishing to understand oil economics and the development of oil and fuel markets.

Demographers use fertility rates, mortality rates, and migration rates to forecast population by gender and age cohort far into the future. And if it weren’t for wars, epidemics, and famines, demographers’ already accurate projections would be even more accurate.

From these population projections, economists calculate how the evolution of important economic determinants, like the size of the labor force and the dependency ratio, is likely to impact a nation’s economy over time. Demographic shifts and economic development can further be used to forecast a nation’s demand for resources, like oil, provided that resource intensity can be predicted.

To the extent that demography is taught to non-demographers, it is usually limited to an introduction of population pyramids and the all-important demographic transition model—the former providing a tool for visualizing the latter. Though some more detailed variants exist, demographic transition is conventionally portrayed in three stages driven by economic development.

The first stage is characterized by high birth rates and death rates, and a low and stable population. The second stage is characterized by explosive population growth as death rates decline and birth rates remain high. By the third stage, birth rates have declined, and the population has stabilized at a much higher level than in the first stage.

When evaluating oil markets, one can take a simple approach that considers global oil production (supply) and consumption (demand), or a more complex approach that takes demographic change into account. Each approach has pros and cons, and while simple aggregate approaches can be extremely enlightening, simple models fail to account for the impacts that demographic shifts have on oil markets.

In order to understand these impacts, we must first recognize that oil markets are imperfect. Some countries discourage consumption through taxation. Anyone who has traveled to the Netherlands, where a gallon of gas costs more than $8, understands how effective these taxes are at curbing consumption.

On the other side of the coin, a number of countries do the exact opposite by subsidizing fuel consumption. In Saudi Arabia, a gallon of gasoline will set you back $0.91, and the guaranteed price charged to thermoelectric power plants is far cheaper. Across the board, Saudi prices seem cheap until you consider that in Nigeria that same gallon of gas only costs $0.38, and that filling a 10-gallon tank will set you back a scant $1.20 in Venezuela.

In addition to cheap gas, each of these countries shares a few other important characteristics: They are all net oil exporters; they are all in the second stage of the demographic transition (hence their populations are exploding); and the leaders of each know that the provision of cheap fuel is critical to maintaining their despotic regimes.

As a consequence, dual oil markets exist not just in Saudi Arabia, Nigeria, and Venezuela, but also in the majority of net oil-exporting countries. In these places, domestic oil and fuel demand is satisfied first, and only the surplus oil is sold on the world oil market where competition amongst oil importers sets the price.

Net oil importers, a group including nine of the 10 largest economies, rely on a steady supply of oil from net oil exporting countries. Unfortunately, only two of the world’s net oil exporters—Canada and Norway—have progressed to the third stage of the demographic transition.

All other net oil exporters are in the midst of population explosions. This fact strongly suggests that subsidized domestic consumption will continue to rise rapidly and cut into the oil exports upon which the world’s largest economies depend. This will be the case even if per capita consumption in places like Saudi Arabia remains unchanged. The problem, of course, is that per capita consumption is rising along with these nations’ populations.

There is a simple explanation for the compounded exponential growth of oil consumption across most oil exporting nations. Rapidly rising oil incomes support investment and generate jobs. In turn, increased national income and rising employment lead to increased oil demand, and because domestic oil and fuel prices are inflexible, oil and fuel can in practice become cheaper in real terms.

The perverse incentive of subsidized oil and fuel consumption is essentially mandated, albeit indirectly, by the fact these nations’ populations are exploding. Take Saudi Arabia as a case in point. Despite the fact that Saudi Arabia’s oil income increased apace with oil prices through 2008, the unemployment rate rose from just over 8 percent to 12 percent between 2000 and 2006 before falling back to 9.8 percent in 2008. Due to the Saudi population explosion, both total employment and the unemployment rate have risen concurrently.

Because oil is the master resource that provides both energy and industrial feedstocks, rapidly rising oil prices exert strong inflationary pressures across the global economy. This is especially true of food and other essential commodities and even truer in net oil exporting economies that become flush with rising income.

The combination of food inflation and rising unemployment across the oil-rich Middle East and North Africa (MENA) region has proven to be an intoxicating recipe for domestic discontent, which has evolved from sporadic, unorganized bread riots to the highly effective Arab Spring revolts that toppled the Mubarak and Qadaffi regimes and caused dictators and despots across the MENA region to react.

In Saudi Arabia and elsewhere discontent has been quelled, though certainly not eradicated, by approaches which mix carrot and stick incentives. The carrots come in the form of federal spending programs, and the sticks come in the form of violent, often deadly, suppression.

The increase in social spending programs in places like Saudi Arabia has caused the fiscal break-even oil price to rise. Saudi Arabia and Nigeria both need roughly $84/bbl to balance their federal budgets. That figure sounds high because it is high, but not as high as it is in Iran (~$90/bbl), Algeria and Bahrain (~$100/bbl), Russia (~$115/bbl), and Iraq (~$120/bbl). And so long as the populations of net oil exporting countries continues to boom, high break-even oil prices will persist.

Most oil market analysts have a short view that largely ignores demographic shifts and focuses solely on production and consumption. While the short view helps oil traders guess what each other are thinking, shippers and carriers must take a long view educated by the work of demographers whose names we’ll never remember.

The fact that nearly all oil-exporting economies are in the second stage of the demographic transition all but guarantees tight world oil markets and high fuel prices. The consequences of ignoring the impacts of demographic shifts on oil and fuel prices, and therefore your bottom line, could be dire. 

Derik Andreoli, Ph.D.c. is the Senior Analyst at Mercator International, LLC. He welcomes any comments or questions, and can be contacted at [email protected].