Genuine oil supply crisis at hand-or just a 'good sweating?'

OPEC continues to shrug off alarms being raised here and there over high oil prices. But the Saudis might just be waiting for a Y2K "surprise" as face-saving cover for a market-moderating move. More about this later.

After falling by about 3% in October from the prior month, oil prices are once again on the rise, climbing by 12% in November. That situation is being propelled by the continuing pull on stocks, with drawdowns averaging 1.1 million b/d in November. It got a further boost when Iraq threw its traditional snit at the close of another 6-month period of oil-for-aid sales, taking its 2.2 million b/d of exports off the markets for 2-3 weeks. Jittery traders became even more nervous when a number of OPEC oil ministers proclaimed that not only would OPEC members refuse to boost production now, but they also would likely extend the production cuts-due to expire at the end of March 2000-into the seasonally slack second quarter. (Conspicuous by its absence from this OPEC market jawboning was Saudi Arabia, which in itself speaks volumes.)

Instead of the quota cheating that so many predicted (not here, however), OPEC solidarity has held fast and even strengthened during November. Adherence to pledged production cuts reached compliance rates estimated at 87-90% in November, up from about 82% in October.

The presumption has been that OPEC simply wanted to see some physical confirmation of the long-speculated drawdown in stocks to a more-manageable level before taking steps to boost production again and thereby moderate oil prices. But the evidence has been at hand for some time now that stocks in fact may soon reach dangerously low levels.

London's Centre for Global Energy Studies notes that the 800,000 b/d US stockdraw in October accelerated to 1.1 million b/d in November-of which 82% was products (see tables below). Much of this has to do with the lousy state of the refining business: Poor margins have shaved refinery runs, reducing supply and thus increasing the call on stocks. The same has held true in Europe, where month-to-month stockdraws were 650,000 b/d and 1.8 million b/d, respectively.

"Continuing heavy December stockdraws in the US and Europe should bring OECD forward stockcover to 50 days' worth on Jan. 1-6 days less than at the start of 1999 and very near minops (minimum operating levels)," CGES said. "Earlier in the year, with OECD stockcover at a comfortable 57 days' worth, the steep price climb was due to a speculative frenzy. Recent price rises have a simpler explanation-a good old scramble for scarce supplies."

CGES notes that the negative effects of higher oil prices are already showing up in oil demand growth. It estimates that the 12-month moving average growth in oil demand in the nine biggest OECD economies has already slowed to 1.1%-and is even negative in Germany, Italy, and the UK.

The London think tank contends that OPEC remains "paralyzed with fear" that he group will repeat the November 1998 mistake of raising oil production quotas just when the demand for OPEC oil was beginning to collapse with the full flowering of the Asian economic crisis.

A 'good sweating'

Paralyzed with fear? Perhaps. Or perhaps OPEC, led by Saudi Arabia, is simply channeling the spirit of John D. Rockefeller-but in reverse. Just as the wily old oil market monopolizer flooded markets to undercut his upstart competitors' attempts at producing more oil ("Gentlemen, the time has come to give them a good sweating."), conversely, the Saudis and their OPEC (and some non-OPEC) cohorts could simply be giving consuming nations a "good sweating" after the debacle of late 1998 and early 1999.

Merrill Lynch estimates that Saudi Arabia needs an oil price equivalent to $20.50/bbl for spot WTI in order to maintain a balanced budget. At last report, the full-year average oil price was still well below that, the $25-27/bbl rally of recent months notwithstanding. Perhaps a yearend surge to almost $30/bbl for a couple of weeks might do that.

While US Energy Sec. Bill Richardson hinted that some unspecified action might be taken by the US government to moderate oil prices he deemed "too high" at $27/bbl, that conflicts with his earlier statements that the US government would not drawn down oil stocks from the Strategic Petroleum Reserve to ease the price spike-but would do so only in the case of an emergency. Earlier this month, Saudi Arabia, Venezuela, and Mexico-those principal architects of the series of OPEC and non-OPEC production cuts that have turned an oil-price collapse into an oil-price boom-jointly announced they would step in to boost their output to offset the shortfall in the event of a Y2K-related supply disruption, which was widely greeted as "statesmanlike."

Is it such a strange scenario to suggest that the expectation of still-higher oil prices and the anticipation of a Y2K-related supply disruption (not likely to be significant, but still carrying an impact in this tight market) might spur an even greater scramble for supplies? Could this then spawn a self-fulfilling prophecy that reduces stockcover to a dangerously low level? And consider that a number of countries (Russia, Nigeria, etc.) have been cited as potential weak links in the supply chain because they have not resolved their Y2K problems. Even a minor, temporary disruption could be magnified into what would be perceived as major supply crisis. And here comes Saudi Arabia (and maybe Venezuela and Mexico, too) to the rescue, perhaps even before the IEA or SPR stocks could be factored in. It is not unreasonable to envision such a scenario (I would consider it smart contingency planning at this stage). And this might allow the Saudis and others in OPEC to tacitly, perhaps surreptitouslym relax their year-long solidarity that has, in fact, delivered to consuming nations a "good sweating."

The upshot? Prices moderate to the low $20s just ahead of the OPEC heads of state meeting in Caracas in March. And then OPEC takes a fresh look at stocks and demand for the second quarter before deciding on another rollover of the cuts.

CGES Outlook

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CGES Price Scenarios

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OGJ Hotline Market Pulse
Latest Prices as of December 17, 1999

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Nymex Unleaded

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Nymex heating oil

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IPE gas oil

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Nymex natural gas

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