Divergent Times for U.S. Oil and Natural Gas Demand, Supply

Dean Foreman
Posted September 22, 2021

Economics and energy market data for the third quarter of 2021 were marked by divergences. That’s the main thrust of API’s quarterly Industry Outlook for Q3 2021 and Monthly Statistical Report (MSR) with primary data for August. 

Demand for oil and natural gas has risen strongly along with the economic recovery, as we discussed here. At the same time, global oil and natural gas investments have fallen to record lows so far in 2021, (see here). Consequently, supplies have failed to keep pace with demand and generally resulted in lower inventories, higher U.S. imports and the strongest prices for crude oil, gasoline and natural gas since 2014.

Specifically, U.S. petroleum demand rose to 21.3 million barrels per day in August 2021 and exceeded its August 2019 level, which was among the strongest months in the past decade. Summer travel and freight transportation contributed positively to the monthly increase, but other oils – that is, intermediate products in refining and petrochemicals – led the rise (up 6.9% from July) and represented 27.9% of U.S. total petroleum demand. 

As demand has risen, supply has not kept pace. U.S. crude oil and natural gas liquids production fell in August despite the highest oil prices for the month since 2014. With demand that outpaced supply, crude oil inventories decreased to their lowest for the month since 2018 and to within 4.7% of the bottom of the five-year range. Additionally, the U.S. was a petroleum net importer in August and for five out of the past six months.

These indications reinforce the concerning combination we noted here last quarter about demand that had risen while capital investment fell by record amounts. By the numbers, the extremes were amplified through Q3 2021 despite ongoing concerns about the COVID-19 pandemic.

At the same time, the roughly 200 companies across the energy value chain that we monitor collectively invested $37.4 billion in Q2 2021, which was a record low for any quarter including the 2008-2009 Great Financial Crisis.

A prime concern is that, with major conventional global oil and natural gas developments, it can take years to bring new production, and many of these long-lead projects may not be able to come on stream next year if they are needed. Without them – provided the economy remains on track as the consensus expects – there could be global oil market tightening in 2022 and consequently further upward pressure on prices. 

Increased energy prices have contributed to price inflation, which, as we discussed here, could bring unfavorable surprises for macroeconomic policies and households along with broader implications.

In general, a combination of demand generally outpacing supply, lower inventories and higher imports has historically been a recipe for higher prices.

For producers of oil, natural gas, refined products and petrochemicals, the anticipated prices and policies can also influence trade and investments. 

Notably, oil trades in a relatively mature global market with recent conditions are expected to result in OPEC and Russia capturing the majority of 2022 production gains, based on projections by the U.S. Energy Information Administration (EIA). 

By contrast, natural gas is relatively nascent as a globally traded commodity. Recent record-high summer prices in Asia Pacific and Europe – as high as $25 per mmBtu as of mid-September – highlight the essentiality of natural gas – and a likely further pull for U.S. exports, given that U.S. prices have been as low as one-fifth of international ones.  However, if high natural gas prices are sustained, this could threaten the role that gas might play in the energy transition due to its lower economic competitiveness within utilities’ existing portfolios as well as hesitancy to invest in more natural gas power generation given the volatile prices.

The responsiveness of drilling activity to prices is therefore an uncertainty both for crude oil and natural gas, and a visible gap has emerged between low drilling and high prices as we discussed here.

For U.S. natural gas producers, this points toward a potential divergence within the industry.  Producers that can export their natural gas have done so full speed ahead, while those that cannot have scaled back their drilling activity to serve the domestic market, which consumed 4.2 billion cubic feet per day (9.6% year over year) less natural gas in power generation in July 2021, per EIA. This reflected natural gas’ economic competitiveness vis-à-vis coal and renewables at natural gas prices over $4 per million Btu.

For policymakers, be careful what you ask for. With the financial, workforce and supply chain issues that persist from the 2020 COVID-19 recession, supportive energy policies would have been helpful to get domestic production back on track. That has not been the Biden Administration objective, as it has focused more on solar and other energy sources. The economic benefits of the U.S. energy revolution, consumer benefits of historically low prices for energy and things made using it, as well as enhanced U.S. economic and energy security all hang in the balance.

The comparative historical trends of U.S. petroleum demand, crude oil production and net imports underscore the divergences.

With higher demand but flat domestic supply, the U.S. returned to being a net importer of petroleum for five of the past six months. Higher imports have meant increased reliance on foreign suppliers and a weakening of U.S. energy security.

Again, this combination historically has put upward pressure on prices. A potential counterpoint is that the economy could fail to meet the consensus expectations for growth and thereby alleviate some of this pressure. However, with the aforementioned exception of the drop in consumer sentiment for August, leading economic indicators of U.S. industrial activity – including the Institute for Supply Management’s manufacturing Purchasing Managers Index (PMI) and API’s Distillate Economic Indicator – suggest that manufacturing and industrial production have continued to grow strongly.

Specifically, API’s Distillate Economic Indicator^™, which is based primarily on diesel/distillate supply, demand, and inventories, had a reading of +2.0 in August and a three-month average of +2.1, which has suggested that U.S. industrial production and broader economic activity have continued to accelerate. 

Other MSR highlights:

• Summer driving sustained the highest gasoline demand in two years.
• Trucking drove the highest distillate demand since February 2020.
• Air travel demand propelled highest jet fuel demand since February 2020.
• Solid marine shipping and residual fuel oil demand.
• Lowest crude oil inventories for August since 2018.

In summary, API’s latest data and analysis suggest the economic recovery and demand for oil and natural gas market have continued to be strong, but supply has remained challenged. Cogent energy policies with an aim toward supporting domestic production and sustaining downward pressure on consumer prices are what's needed just now.