Oil, gas prices end the year with positive outlooks for 2000

Oil and gas prices are ending the year on generally positive notes, and a strong spell of cold temperatures in the weeks to come could make both markets approach the 3-related threshold that would warm the hearts of producers everywhere: $30/bbl oil and $3/Mcf gas.

Oil prices have slipped a bit from their recent high of about $27/bbl for Nymex crude-which itself represented a 9-year high. And gas prices have settled a bit after colder weather in the US bolstered them in the past week.

Oil outlook

On the oil side, the signs all augur for even higher oil prices than current levels. A number of analysts have called on OPEC to boost production soon by 1.2-1.6 million b/d in order to avoid serious inventory deficits in 2000.

Instead, OPEC insists that it will maintain the pledged production cuts that have doubled oil prices this year and may even extend them beyond their scheduled expiration in March to the seasonally slack second quarter.

Merrill Lynch, for one, thinks that rapidly depleting inventories will force OPEC to increase output early in 2000 prior to the group's next ministerial meeting, currently slated for Mar. 27 in Caracas. Nevertheless, the analyst thinks that oil prices are likely to surpass the $19.22/bbl (spot WTI) that it pegs for the industry consensus in 2000.

Merrill Lynch sees two factors allowing OPEC to engineer the soft landing in oil prices that (the analyst says) most oil producers would like to see:

  • Unlike 1997 and 1998, global oil demand growth this year has accelerated and non-OPEC supply has fallen. That means oil markets will need an incremental 1.6 million b/d from OPEC in order to maintain inventories at normal levels in 2000.

  • Leadership changes in several key OPEC countries have dramatically increased the probability for continued OPEC cooperation. OPEC's March 2000 heads of state meeting (the first in 25 years and one roughly coinciding with the ministerial meeting in Caracas) will likely increase the market's appreciation for the higher level of cooperation within OPEC, says Merrill Lynch: "We believe that oil producers are highly motivated to avoid the oil price calamity that devastated country fiscal budgets during 1998. Our analysis of the Saudi budget suggests that the kingdom requires an oil price of $20.50/bbl (spot WTI) in order to maintain a balanced budget."

    No argument here on the latter point, but the jury is definitely still out on the former point. OPEC collectively took a $51 billion bath in 1998 because of the collapse in oil prices, and it has a lot of ground to recover. At last report, OPEC members still were complaining that, even with oil prices above $25/bbl in recent weeks, the annualized average oil price for 1999 was still below a level needed to recoup the 1998 losses.

    An interesting note came recently from a financial consultant based in Saudi Arabia, which has been notably silent on the question of production increases next year. The Akhit financial consulting house, based in Riyadh, concluded that an "equitable" price for crude oil should be $29-31/bbl, if one were to take inflation into consideration. Considering that the cost of living in the US has risen by 33% since 1990, the consultant said, current oil prices have risen by only 22% (we're not real sure what price point the Saudi consultant is using, for oil prices were much higher at one point in 1990-courtesy of Iraq's invasion of Kuwai-than they are today). That would put WTI at $29/bbl. Or, in comparison with other commodities listed on the Goldman Sachs commodity index, oil prices have risen only 21% during the past 10 years, vs. an increase of 43% during the same period. To make them equivalent, WTI would have to be priced at $31/bbl.

    What our Saudi consultant neglects to point out is that: 1.) oil prices operate under a completely different set of rules than do those for other commodities because of oil's omnipresent and critical role in the running of the global economy; and 2.) the low oil prices he complains about during the 1990s were a key factor in keeping US inflation down during the period.

    Still, the likelihood grows that $30/bbl oil will be touched in the weeks to come; the betting here is that it will happen when Iraq plays another stalling game over the UN Security Council proposal to suspend sanctions in exchange for allowing arms inspections to resume. This latter point is pretty certain, as evinced by the orgy of nose-thumbing from Baghdad that greeted the proposal. While this delay won't have much significant immediate physical effect on markets, the psychological effects could be significant. A possible scenario is the US seriously considering plans to draw down SPR stocks in response to the Iraqi "outage." That might be the step that brings the Saudis OPEC off high center-especially if there are also Y2K bug-related supply problems-using the "crisis" to justify the market intervention, say, along with Venezuela and Mexico. So don't blink, or you'll miss the $30/bbl watershed. It won't be around long.

    Gas price outlook

    While gas prices have been disappointing in relation to expectations for this winter, spot prices enjoyed a brief rally last week when temperatures were 6% lower than a year ago.

    But bear in mind that even this temperature level represents a point that is 20% warmer than normal. For the heating season to date, temperatures have been 3% lower than last year but 22% higher than normal.

    Things may finally be turning around, as temperatures in the key US consuming regions were closer to normal this week and expected to be normal next week.

    It's important to note that gas prices in the US have remained above $2/Mcf for the entire heating season so far, despite temperatures that have remained stubbornly above normal. That points to an underlying supply-demand balance that continues to tighten as wellhead deliverability continues to decline and weather gradually returns to more-normal seasonal conditions.

    Natural gas inventories continue to dwindle, with withdrawals last week up about 50% from the prior week drawdown rate. And so the year-to-year storage deficit rose to 227 bcf vs. 196 bcf and 172 bcf in the previous 2 weeks.

    The upshot is that $2.40/MMbtu gas looks like a good bet through April, but a sustained arctic blast could easily push spot prices past the watershed $3 mark in the interim.

    Happy holidays.

    OGJ Hotline Market Pulse
    Latest Prices as of December 24, 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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