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Will $30/bbl oil in December cause OPEC to rethink production cuts?

Will $30/bbl oil in December finally get OPEC's attention?

Oil prices in the past week have flirted with $26-27/bbl largely on the strength of OPEC's remarkably consistent solidarity and reports that the fourth quarter drawdown in oil stocks is well under way. Not only is the group's compliance with pledged cutbacks remaining at a high level-albeit slipping a bit in October from the previous month, as the Middle East Economic Survey table (Table 1) below shows-but a number of OPEC oil ministers have been in agreement of late that they favor extending the production cuts beyond next March. OPEC's current round of production cuts is scheduled to expire in March, but ministers continue to point to the sketchy data on stocks and the devastatingly low prices that held sway for so much of this year as justification for keeping a hawkish stance on prices and production.

Oil prices this week also got a boost from gasoline futures, which surged to their highest point in over 3 years when Amerada Hess decided to shut down its Virgin Islands refinery as precaution against an advancing hurricane; another factor was a surprising (for this time of year) surge in gasoline demand.

But analysts such as Centre for Global Energy Studies continue to warn that stocks soon will dwindle to a crisis point, and the resulting price spike will derail the current rebounding trend in demand-with negative long-term implications for OPEC and the oil industry.

CGES notes that OECD stocks were drawn down at the rate of 1.8 million b/d in September and a further 800,000 b/d in October in the US and Europe. This, the London think tank says, sends a clear message that markets will be tight as stock cover levels fall to dangerously law levels.

"Even to hint that OPEC's cuts might contine (beyond March) seems both premature and ill-advised," CGES said in its latest monthly market report.

CGES contends that, based on the latest data, global oil stocks should have declined by 235 million bbl between Jan. 1 and the end of September. However, only a fifth of this implied decline has actually been accounted for by OECD stock numbers in that time.

While the data at hand seem to suggest that OECD stock cover is adequate for now, it is falling rapidly. What's more, says CGES, is that there is little in the way of spare stocks outside the OECD, on the water, or in the temporary storage.

With the advance of cold weather looming, middle distillate inventories are falling as well, and refiners soon could find themselves in the unenviable position of hitting their minimum operating requirements, or 50 days' worth of stock cover, perhaps in the first quarter of next year.

To prevent the industry from reaching this crisis point, warns CGES, more oil is needed from OPEC. While non-OPEC oil supply is expected to rise by 1 million b/d in 2000, or about equal to the expected increase in global oil demand next year, that won't assure a balance. Unless supply growth exceeds the growth in demand next year, the stock draw will continue pretty much at its current steep rate, bringing markets back to square one: not enough stock cover to keep oil prices out of a damagingly high range.

CGES reckons that a rollover of the current production cut accord by OPEC will pull stock cover down to 45 days' worth, and that will result in oil prices hitting heights note seen since the Persian Gulf crisis of 1990-about $35/bbl. That, in turn, will mean serious damage to a recovering global economy.

But a major question here is whether the stock draw is related to a genuine increase in demand downstream, or whether many refiners are accelerating what would be a normal stock draw level out of concern for a Y2K or millennium-related disruption at the turn of the year. If that is the case, then the first of the year could see a huge offloading of crude inventories plus increased crude runs. That, in turn, could contribute to a glut in both crude and products by the second quarter.

Is OPEC playing a dangerous high-wire act? Are the group's concerns about the effects of increasing production again to head off a possible catastrophic price spike?

One thing that the market seems to have been overlooking is the imminent resumption of Iraqi oil supplies. Its awareness was nudged only this week, when reports surfaced that Iraq was having technical problems resuming exports under under the oil-for-aid humanitarian program that the UN is overseeing. This is an uncertain variable, especially given the situation with higher oil prices today. Iraq has a dollar limit placed on how much oil it can sell and never approached that when oil prices were in the cellar. Just as Baghdad managed to wangle an increase in permitted export volumes to meet the dollar limit when oil prices were low, don't be surprised to see Iraq also win an exception to the dollar limit when oil prices are high. This could put more oil on the market that is widely expected, thus taking some of the heat out of oil prices.

Another key is Saudi Arabia, which was conspicuous by its absence from the production cuts extension bandwagon this week. The Saudis say they are keeping their options open (would we expect anything more demonstrative from them?). That suggests to this corner that they are waiting to see how the Northern Hemisphere winter makes its bow and just where the latest stock levels are before taking action.

If oil is bouncing around $30/bbl this winter, it would not surprise to see an SPR drawdown (no way Clinton is going to let anything untoward happen to the US economy in an election year) to soften prices. And Saudi Oil Minister Ali al-Naimi might just be agreeable to another rendezvous with Mexican Energy Minister Luis Tellez and Venezuelan Energy and Mines Minister Ali Rodriguez to push the market the opposite direction of where they pushed earlier this year and all of last year.

That sounds like a reasonable scenario ahead of the upcoming OPEC ministerial meeting and (tentatively scheduled) OPEC heads of state meeting in Caracas in March. Just don't count on that $30/bbl oil sticking around for long.

Table 1

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Table 3

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OGJ Hotline Market Pulse
Latest Prices as of November 18, 1999

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