Oil demand

Within the OECD, European oil demand has taken a substantial hit. In aggregate, European oil consumption contracted at a rate of 272 thousand bpd or 1.9 percent last year. Similarly, crisis-struck Greece has seen its oil consumption rate contract by 8.9 percent in 2011 as GDP continued to drop. Other deficit nations in Europe such as France, Italy and Spain have also experienced substantial declines in recent months as the sovereign debt crisis continued to unfold. For instance, Italy's oil demand contracted at a yearly rate of 4.9 percent in November just as Spain's fell by 7.4 percent in the same month.
 
US gasoline demand

While demand has been dismal in Europe as the sovereign debt crisis worsened, demand for oil in the US has also surprised to the downside. According to the US Energy Information Agency, demand for oil in America has now fallen to about 18 million bpd, a shockingly low figure that stands 820 thousand bpd below last year's levels, on a 4-week moving average basis. The decline in US consumption has come mostly on the back of a sharp drop in gasoline. What's driving these steep demand declines? Despite the apparently better economic data, US oil consumption has been particularly hit by mild winter weather on top of substitution of natural gas for home heating given pricing advantages. The global oil demand decline has been very apparent in OECD nations, but now emerging economies are also starting to see a marked deceleration in their consumption patterns. China's oil demand picture is striking, with consumption in December of 2011 pretty much remaining at the same level of the previous year

despite a GDP growth rate of 8.9 percent in Q4, 2011. In fact, when looking at non-OECD demand in aggregate, only the former Soviet Union, the Middle East and other parts of Asia are posting positive demand growth in Q4, 2011. The fact that oil demand is only holding up in countries that produce it speaks to the lack of available supplies, the large-scale domestic subsidies offered by oil exporters, and the extremely high prices. Put differently, oil is now so expensive that only those that produce can actually afford it!
 
Non-OPEC supply

As described before, 2011 was a year mired with non-OPEC supply shocks. With the exception of the US and Russia, oil production in almost every other major producing country has been much weaker than expected. In the North Sea, unplanned outages at Buzzard and other fields including Ekofisk and Grane reduced output by 323 thousand bpd, or 8.5 percent, in 2011.

Although BofA Merrill Lynch was expecting some recovery in Q4, 2011 volumes, non-OPEC supply came in flat versus Q4, 2010 as unplanned outages failed to recover fully and civil unrest in the Middle East and Africa further hurt non-OPEC production. For the full year, non-OPEC supply growth in 2011 showed only 40 thousand bpd growth from 2010.

On the other hand, OPEC supplies are finally starting to show some recovery. In December, OPEC-11 crude oil production levels reach three-year highs of 28.2 million bpd, which is 0.9 million bpd higher than the same month in 2010. The faster than expected recovery of Libyan output has been a major contributor to growth, with production averaging 800 thousand bpd in December and still on the rise. Saudi Arabia, of course, has been making up for any lost barrels in Libya and elsewhere including Nigeria. As a result, production averaged 9.9 million bpd in December, the highest monthly level on record.
 
High liquidity

Another important factor to keep in mind is that the prices of real assets tend to appreciate in times of ample liquidity. Oil prices are no exception and have been supported by the environment of negative real interest rates prevalent in DM. This negative correlation between real rates and oil prices is the result of several mechanisms; some very direct and some more subtle. First, not all sectors of the economy respond in the same way to monetary policy. As a sector with severe supply constrains, oil prices should behave differently to other prices in the economy when demand is expanding due to easy monetary policy measures. In addition, if easy monetary are to force consumers to consume and companies to invest, the impact of low real rates is likely to gear consumption toward durable goods and investment toward infrastructure, both of which are energy intensive components of GDP. Finally, oil producing nations have very little incentive to produce beyond their budgetary requirement if returns on their assets, held in international reserves or in a SWF for instance, are yielding below inflation expectations.
 
Brent

Using historical data on money supply growth from the OECD and BRICS economies, BofA Merrill Lynch estimates that the first $1.7 trillion tranche of quantitative easing alone impacted oil prices by 11 percent, with a twelve-month lag. The second tranche of $600 billion finalized in Q2, 2011 contributed to a pick up in oil prices of another 11 percent. It also estimates that a third tranche of quantitative easing $600 billion could bring Brent oil price to levels above $120 a barrel.