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Structural uncertainty

The drivers of global oil consumption are changing. Demand will rise in 2017, but risks lurk beneath the surface

The price slump has flipped the drivers of oil-demand growth on their head. Two trends remain in place. First, efficiency gains are leading to less oil use per capita. Second, China and India remain the engines of demand growth. But the one-two punch of low oil prices and global macroeconomic instability means the story for 2017 is no longer just a continuation of the robust oil-demand trend from 2010-14 nor of the volatility of 2015-16. Instead, a slightly higher $50-60-a-barrel price band means that oil demand will struggle if prices rise too far too fast, if seasonal demand doesn't perform as normal, or if broader macroeconomic growth doesn't match expectations. We expect global oil consumption to rise by 1.29m barrels a day in 2017.

But bear in mind that the core driver of oil demand is shifting from industry to consumers. Thanks to the price decline, oil-demand growth almost doubled from around 1m barrels a day in 2014 to almost 2m b/d in 2015. Gasoline and transport-related demand gave oil consumption a tailwind. But non-transport demand has shifted from supporting half the demand growth to being a drag on it. In short, economies aren't doing the heavy lifting in terms of oil consumption - consumers and drivers are. They, not industry, responded to cheaper oil.

Global economic expansion - supported by loose monetary and fiscal policy - is averaging about 3% a year. That's below historical norms, but also comfortably above what would be considered recessionary on a worldwide scale. Still, investment activity remains weak; strip out the recent resurgence in China's public investment, and global investment shrank in Q2.

In non-OECD countries, which supported middle-distillate demand growth in the past, economic activity is not occurring at the pace it was. As the Institute of International Finance and the IMF have highlighted, emerging markets posted an estimated $0.531 trillion in net capital outflows in 2015, compared with $48bn in net inflows in 2014. As capital leaves emerging markets, energy-intensive manufacturing activity should contract. That's significant, because growth in gasoil and diesel demand accounted for almost half of oil-demand growth in the past five years. So, as capital leaves emerging markets, gasoil and diesel demand have reversed their earlier role too, no longer boosting oil demand but pulling at its coattails.

Lacklustre industrial demand is one of the biggest headwinds to clearing the crude and product overhang in 2017. Comparing data for the summer of 2016 with those of a year earlier shows that roughly two-thirds of the growth in petroleum stocks came from crude. Rising product demand last year took some momentum out of the tide of new crude supplies, even with refinery margins in positive territory in all regions (which incentivised refiners to create more products). But, this year, it is getting harder for the refining sector to convert the extra crude supply into products, because refining margins are weakening.

In 2017, demand will remain tepid, but some shining spots will remain visible - in transportation, during peak demand seasons, and in emerging economies like China, India and those in the Middle East.

In America, gasoline will remain crucial. It was the main source of rising petroleum demand in 2015 and 2016. Since December 2014, drivers have consumed 230,000 b/d more, on an annual basis, each year. By contrast, total petroleum demand has only risen by 260,000 b/d. For 2016 as a whole, we see gasoline demand growth of about 200,000 b/d. In 2017, we expect gasoline consumption to rise again, by 70,000 b/d, as the increase in vehicle miles travelled exceeds the pace of improvements in fuel economy.

In China, the overarching story will remain its transition to a consumer- and services-led economy. A surge in credit expansion since early in 2016 has perked up the all-important housing market, boosting consumption through wealth and sentiment. A sharp increase in public investment spending, mainly in infrastructure and rural electric-grid expansion, is supporting demand for commodities as well. Recent State Council announcements confirm that fiscal efforts to support growth will continue. Programmes such as One Belt One Road, a vast infrastructure development, will also bring more demand.

The number of cars on the road in China is still expanding at a record pace as sales outstrip the scrap rate. This will form the backbone of gasoline demand growth in the coming years. New-vehicle sales are up by almost a quarter and the small and com-pact passenger-vehicle segment has been growing by 13% - an extra 14m cars or so. And even though state statistics show moderate gasoline-demand growth, we believe that it is understated since state data fail to include all types of fuels that are used and produced in the country.

Outside gasoline the weakness in diesel demand is being partially offset by new-found strength from the demand for liquefied petroleum gas. This is likely to keep rising as petrochemicals capacity expands in the next couple years at an even faster pace than before.

India's demand for oil will grow at twice China's pace in 2017, spurred along by rising car sales and government policy. Gasoline consumption in the country hit a record in August 2016 and was 15% higher in the summer months than a year before. Passenger-vehicle sales in August were almost 17% higher than in the same month in 2015. Indians have also found a love of SUVs. But it's not just drivers lifting oil consumption. Bitumen demand is strong too, thanks to the government's breakneck road-building pace, which is adding 30km a day, and rural LPG distribution programmes. Policies designed to give more people access to energy will also increase India's per capita usage of oil. The average Indian consumes just 1.33 barrels a year, less than half the consumption in China.

Yet despite these underlying trends two risks face oil demand in 2017: the consumer response to higher oil prices and the macroeconomic outlook. This takes some unpacking. Gasoline demand from OECD countries, like the US, responded more swiftly to the recent decline in oil prices because most of it was transferred to the pump. But this wasn't the case in most of the developing world.

US gasoline consumption rose in the two years to April 2016 by about 3% in response to a 41% drop in average retail prices. That implies a price sensitivity of about -0.07. But this was a remarkable price change. The broad trend in industrialised countries is of less sensitivity to retail price changes. The opposite is the case in developing countries. So, given that we expect most of the world's oil-demand growth in 2017 (and beyond) to stem from non-OECD countries - where customers are more sensitive to prices changes - their thirst for oil will depend on price. In short, if oil prices rise in 2017, global demand will rise more slowly.

Macroeconomic threats lurk too. First, China's temporary state-led support may ebb in the second half of next year. That would crimp demand for all commodities. Second, Brexit and the associated uncertainty of the UK's vote to leave the EU carries risks for the eurozone and the UK, with possible contagion to their largest trading partners. These risks remain tangible and could re-emerge in 2017.

The pace of interest-rate rises from America's Federal Reserve will inevitably affect the value of the dollar and other currencies. Sharp, unexpected currency moves could lead to more - or less - oil demand.

On balance, oil demand in 2017 will still grow. But the structure is changing and new uncertainties can't be ignored.

This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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