Does OPEC have a death wish, pushing oil prices so high? Or is it all part of a canny game designed to extract maximum value from temporarily high prices while the group can-before wrecking demand and bolstering non-OPEC supply?
London's Centre for Global Energy Studies (CGES) worries that the former may be true. I'm guessing that it's the latter.
Perhaps a new crack in OPEC's resolve will manifest itself soon, given the announcement this week by US Energy Sec. Richardson that he plans to slow the injection of crude supplies into the US Strategic Petroleum Reserve, thus taking a little bit of heat out of the market and tempering prices as a Siberian express blankets much of the US in snow and freezing temperatures.
Oil prices have dropped about a dollar in the past 2 days and are down about $2.50 on the week, despite the big pull on heating oil demand from the cold snap. Is the market somehow starting to talk itself out of some of its own hyperventilation? That may true to some degree, but we still have Nymex crude topping $27/bbl now, which worries most analysts about the long-term effects on the market of such lofty price levels.
CGES worries that, having nearly touched $30/bbl this month, $40/bbl oil may be around the corner: "It may somewhat early for this," the London think tank said, "but with the 12-month forward curve in a $7/bbl backwardation, we seem to be in the midst of a white-hot oil shortage that can only get worse if OPEC does not boost output soon."
When Saudi Oil Minister last week suggested that the current pledged production cuts by OPEC might be rolled over, it was enough to rocket oil prices to near the $30/bbl psychological watershed. CGES puzzled over this, harking back to the recent OPEC ministerial monitoring committee's finding that inventories still remain too high to suggest that production increases are necessary.
"How can OPEC talk about 'remaining high stock levels,' when product stocks in the key US market at the start of 2000 provided only 34 days of cover, 6 days less than a year ago?" CGES asked, noting declines in stocks of crude in November (800,000 b/d) and of products in December (1.2 million b/d).
"Sometime in the next few months, forward industry stock cover in the OECD (Organization for Economic Cooperation and Development), will dip below 50 days' worth, taking us into uncharted territory; moreover, there are no surplus non-OECD stocks (nor) oil at sea to help stave off the looming crisis.
"At present, we cannot know how companies will react to cover below minops (minimum operating levels)-they have never faced such a predicament.
"Those with weaker nerves and pockets will pay to entice scarce supplies from others, causing prices to rocket."
In light of this view, it was interesting to note that some oil companies, in response to Sec. Richardson's move, this week have suggested that they are not yet ready to hit the panic button and, in fact, seemed fairly comfortable with the idea of operating at a much-lower-than-normal inventory level-especially heading into the seasonally slack second quarter.
(Those of us with longer memories of oil markets than some can recall the trepidation with which producers greeted the approach of oil price futures in the early 1980s, fearing the idea of prices being set by crazed Wall Street traders rather than by refiners' postings and term or spot liftings. Despite the griping when futures prices plummet, most producers today [especially today] would have to admit that the futures market has been more of a boon than a bane to their business.)
Maybe those uncharted waters won't prove to be such choppy sailing, either. Maybe 40 days' cover will evolve as the new minops standard. Maybe less.
Still, CGES expressed concern about the run on stocks continuing through the summer, given its projection of global oil demand growing by 1.1 million b/d this year (vs. the IEA's projection of growth of 1.8 million b/d). It already sees signs of oil demand growth slowing. At the same time, non-OPEC supplies continue to grow-non-OPEC output rose by 1.3 million b/d from the second quarter to the fourth quarter of last year and is expected to increase by another 1.1 million b/d (Table 1). But CGES contends that neither of these trends will develop quickly enough to stave off a looming shortage stemming from the steep drop in inventories.
"The huge 1.6 million b/d global stockbuild during '97 and '98 has been eradicated," CGES said. "Now we are overshooting in the opposite direction. More oil is needed-and as quickly as possible."
That leaves the market hurtling toward oil prices in excess of $30/bbl for a sustained period (Table 2). While the world can live with $25/bbl in the near term, oil above $30/bbl represents a level that would seriously squeeze demand and encourage development of alternate supplies. Oil prices could even reach the inflation-adjusted level of $43/bbl in 1985, when the call on OPEC oil was plunging, CGES said.
"It seems key OPEC decision-makers have forgotten the havoc wreaked on oil demand in the '70s and early '80s by gratuitously high oil prices. As for supply, the companies are obviously happy with $30/bbl oil, but OPEC should not be so pleased, for nemesis awaits in the form of higher non-OPEC output it in the future.
"Although oil is not solely to blame, much higher oil prices are inflationary and will affect economic growth via higher interest rates. Does OPEC have a death wish after all?"
Actually, CGES answers its own question in an earlier comment: "
Here's a likely scenario that CGES might be too worried over OPEC's fate to consider: The initiative to keep oil prices buoyed above $25/bbl as long as possible, led by the Saudis and Kuwaitis, will last as long as there is not a critical mass of manifestations that demand is collapsing and that non-OPEC supplies are responding strongly to higher prices. While the official mantra has been that OPEC wants firm evidence that excess stocks have evaporated before considering a production increase, it's apparent that the group's members-particularly the Saudis-are going to ride this bucking bronc as long as they can. With markets as jittery as they are, OPEC can get a bonus in its revenue stream simply by talking bullish. Why else would some oil ministers make comments, such as those made this week, that the March meeting may result in a 9-month rollover of the production cuts at a time when markets are clamoring for more oil now and warning of imminent shortages?
It is likely to take a combination of things to convince OPEC to relent: leaving more strategic supplies on the market (via a slowdown in injection or even a release of stocks), a near-term surge in non-OPEC supply growth after capital budgets are revised in response to higher prices, clear signs that demand is plummeting, and some jawboning by consuming nations to ease up on the spigot as economies shudder under the weight of $30/bbl oil.
The day may not be far off when Iraq is allowed to ratchet up its oil production, which will prove another market-shaking event, depending upon how far off in the future that is. Every petrodollar earned today is one banked for that future day. So why rush things?
Or, as the Saudis might put it: It's all in the timing.
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