The rebound in oil prices over the last few months has vindicated the view that oil prices had fallen too far, even if they have bounced back a little more sharply than the anticipated. Stronger demand is expected to help soak up some of the surplus supply of oil over the next few years.
However, the removal of subsidies in developing countries, high taxes on oil products in advanced economies and government regulation to improve energy efficiency will prevent demand from surging and prices returning to anywhere near $100 per barrel.
Oil demand was set to grow steadily over the next few years even before the plunge in oil prices as incomes continue to rise rapidly in developing countries and economic growth picks up in the world more generally.
"Lower prices should mean that oil demand grows more rapidly as consumers can afford more oil products for a given level of income. What's more, lower prices should dull the incentive to invest in energy-efficient vehicles, further boosting demand", says Capital Economics.
However, there are a number of reasons why oil demand is not expected to surge. First, the removal, or at least reduction, in fuel subsidies in developing countries should mean that the prices paid by consumers don't change by much, and could potentially even rise.
Second, high taxes on petroleum products in most developed countries mean that the full effects of the decline in oil prices aren't passed on to consumers, limiting the positive effect of lower oil prices on demand.
Third, increasing energy efficiency, especially in transportation, should help to keep any rises in demand in check. Admittedly, lower oil prices means that consumers are less concerned about minimising energy usage. But many of the efficiency increases are driven by government policy and regulation, which will be in place regardless of the level of oil prices.
The upshot is that whilst demand will inevitably still grow over the next few years, and most likely at a faster pace than would have been expected this time last year, ample supply means that prices are now more likely to fall than to rise further over the rest of the year.
Over the medium term $70 per barrel seems a reasonable equilibrium level and remains the forecast for 2020, according to Capital Economics.
